ROFR, ROFO for Shareholders

In the world of shareholders' agreements, two commonly used terms that often spark confusion and debates are the Right of First Refusal (ROFR) and Right of First Offer (ROFO). Understanding these clauses is crucial for shareholders as they can significantly impact the dynamics within a company and the rights of its stakeholders.

Right of First Refusal (ROFR)

Let's start by with the Right of First Refusal (ROFR). In essence, when a shareholder has a ROFR, they possess the power to purchase a designated number of shares before these shares can be offered to anyone else (whether a third party or another shareholder). Essentially, it provides one or more existing shareholders with the chance to maintain or increase their ownership stake before anyone else. Operationally, a ROFR holder receives an offer from the selling shareholder containing the number of shares proposed to be sold along with the sale price and associated terms, which the ROFR holder has the chance to accept and complete the transaction.

A ROFR serves as a protective shield for existing shareholders, ensuring that they have a say in any changes regarding ownership within the company and preventing dilution of their ownership rights without their consent.

Right of First Offer (ROFO)

On the other hand, a Right of First Offer (ROFO) dictates that before a shareholder can sell their shares to a third party, they must first allow the existing shareholder/ shareholders the opportunity to make an offer for the shares. However, the selling shareholder reserves the right to accept/ reject such offer and then proceed with another purchaser. Operationally, when the seller approaches the ROFR holder, only the number of sale shares are known and the ROFR holder has the onus to make an offer to purchase the shares (i.e., purchase price and other terms). The completion of such sale is subject to the seller accepting this offer.

The ROFO ensures that existing shareholders have the first opportunity to invest in additional shares and further solidify their ownership within the company.

Considerations

A ROFR effectively means that the Seller needs to get a third party (bona fide) offer to set the price at which the ROFR holder can purchase the shares. This is often very hard to come by, given the hesitation among buyers to undertake an assessment of the opportunity where the ROFR holder has the inside track.

A ROFR is more palatable to third party buyers since they are comfortable that the offer made by the ROFO holder will at worst set the floor price for the sale but will not preclude them from completing the sale at a higher price.

Needless to add, each of these provisions can have additional conditions/ limitations built in.

In exchange-controlled countries like India, a ROFR holder's ability to exercise its rights may be limited by purchase price caps (i.e., a resident cannot pay more than fair value per a third-party valuer's assessment). Separately, sector specific regulations may impose ownership concentration limitations (such as with ownership of banks), which may restrict a shareholder's ability to exercise these rights. Shareholders, often include the right to assign these rights to a nominee (in whole or in part) to be able to circumvent some of these restrictions.

Understanding the nuances of ROFR, ROFO, or choosing neither is pivotal in steering the course of a company's growth and ensuring a harmonious relationship among shareholders. Shareholders are advised to delve deep into the implications and intricacies of these clauses before making informed decisions.