By Thomas M. Fafinski
Most of us are familiar with the right of first refusal (“ROFR”) but not with the right of first offer (“ROFO”). Generally, a ROFR is advantageous to the purchaser and the ROFO is advantageous to the seller.
With a ROFR, prior to selling your interest to another, you must first allow an existing partner (or other person holding the right of first refusal) the opportunity to match the offer. Ordinarily, there is a notice component and an obligation to allow the holder of the right to match the offer for a period of time. The problem with the ROFR is that it tends to depress the value of the interest being sold.
As an example, lets imagine that Steve owns a 50% interest in a Managed Services provider worth $1M. Steve enters into a buy-sell agreement with a ROFR in favor of his partner, Mary, who owns a 50% interest as well. If Steve decides he wants to sell, he will likely first approach Mary to see if she is interested in purchasing his interest without having to market the interest for sale. Steve offers to sell it to Mary for the fair value, $500,000. Mary declines because she believes that his interest will likely sell for less than the fair value due to the lack of control or for other reasons. After all, even if he does find a buyer for fair value, she can always match the offer later. Steve then finds a broker to generate demand for his ownership interests. The broker is able to find someone who wants to buy the entire company but Mary is unwilling to sell. Some time passes and the broker finally finds someone who is willing to pay $450,000 but not the full value. Since Mary has a ROFR, Steve must allow Mary to match the offer, which she does at the conclusion of her 60 days notice opportunity. Steve is forced to sell to Mary at $450,000 and also has to pay the broker for finding the buyer.
A ROFO means that, prior to selling your interest to another, you must first offer your interest to the person holding the ROFO rights on at least as favorable of terms as the offer being made by the third party. If the party holding the right declines to make the offer, the interest is freely salable and without having to allow for the offers to be matched so long as the offer being made is at least as favorable as the final sale.
If Mary held a ROFO instead of a ROFR, Steve would go to Mary and seek a firm offer. If Mary wanted to exercise her rights, she would have to make an offer within a period of time. Her failure to make an offer would extinguish her rights under the ROFO. If she made an offer, say an offer of $440,000, Steve could either accept or reject. If Steve rejects, he could not sell the interest for less than $440,000 without first allowing Mary to match. When Steve markets his interest, so long as it exceeds the offer made by Mary, he can sell the interest without any delay, notice or having to offer it to Mary again.
A ROFR is very common. It seems to be used as a shield against the aggressive and unwanted conduct of the person holding the interest. The ROFO is far less common, to the point where it hardly exists in practice. However, the ROFO is far more likely to lead to a fair result if fair is measured in terms of the fair market value of the interest.
Thomas M. Fafinski is co-founder of Virtus Law PLLC. Virtus Law PLLC has a practice focus in technology, primarily supporting managed services providers. Our main office is located in Minneapolis, with other offices located in Maplewood, Cambridge, Edina, Mendota Heights, and Red Wing.