Transfer restrictions are a core feature of closely held companies. Founders, investors, and minority owners rarely want unrestricted transfers that introduce unknown or misaligned owners. One of the most common tools used to manage this risk is the Right of First Offer (ROFO).
Although ROFOs are often grouped with other transfer rights, their mechanics—and their consequences—are distinct. Understanding how a ROFO operates is essential when drafting shareholder agreements, operating agreements, and private equity documents.
1. What a Right of First Offer Is
A Right of First Offer requires a selling owner to offer their equity to specified parties—usually the company or other owners—before negotiating with a third party.
Unlike a Right of First Refusal, the seller initiates the process by presenting the proposed terms. Only after the ROFO process is exhausted may the seller pursue an external sale.
ROFOs are commonly used in:
• founder-owned companies,
• family businesses,
• private equity portfolio companies,
• joint ventures and closely held LLCs.
2. The Basic ROFO Process
While ROFO provisions vary, most follow a similar sequence:
1. Notice of Intent to Sell
The selling owner delivers a written notice stating:
• the number of interests to be sold,
• the proposed purchase price,
• key economic terms.
2. Offer Period
The ROFO holders are given a defined period—often 15 to 30 days—to elect whether to purchase the interests on the stated terms.
3. Allocation Mechanics
If more than one holder elects to participate, the agreement typically allocates the interests:
• pro rata based on existing ownership, or
• in a specified priority order.
4. Failure to Exercise
If the ROFO is not exercised, the seller may proceed to sell to a third party—subject to restrictions on pricing and terms.
3. ROFO vs. ROFR: Why the Distinction Matters
ROFOs are often confused with Rights of First Refusal (ROFRs), but the difference is meaningful:
• A ROFO forces the seller to negotiate internally first.
• A ROFR allows a third party to set the price, which the ROFR holder can then match.
Because ROFO pricing is set without a market check, sellers often prefer ROFOs. Buyers and existing owners may prefer ROFRs, which anchor pricing to an actual third-party offer.
The choice between the two reflects how much control the company wants over future ownership and pricing.
4. Pricing and Market Constraints
A well-drafted ROFO includes guardrails to prevent abuse:
• Price floors or formulas to discourage artificially high internal pricing.
• Market-check protections that prevent the seller from offering insiders unfavorable terms simply to reach a third-party sale.
• Consistency requirements requiring third-party deals to be no more favorable than the ROFO offer.
Without these protections, ROFOs can become procedural hurdles rather than meaningful transfer rights.
5. Timing and Lapse Provisions
ROFO provisions typically include:
• strict notice requirements,
• defined response periods,
• a limited window during which a third-party sale may occur.
If the seller fails to close within that window, the ROFO process often resets. This prevents stale offers from being used months later to justify an external transfer.
6. ROFOs in Private Equity and Minority Investments
In private equity and minority investment contexts, ROFOs often appear alongside:
• drag-along rights,
• tag-along rights,
• co-sale rights.
ROFOs help existing owners manage partial exits without triggering full liquidity events or forcing a company sale. For minority holders, however, overly restrictive ROFOs can limit liquidity and affect valuation.
Balancing flexibility and control is critical.
7. Common Drafting Pitfalls
ROFO provisions frequently cause disputes because of:
• vague pricing terms,
• unclear allocation mechanics,
• inconsistent treatment across documents,
• failure to align with drag-along or tag-along provisions.
These issues typically surface during financing, succession planning, or an attempted sale—when leverage is already constrained.
Conclusion
A Right of First Offer is a powerful tool for managing ownership transitions, but only when its mechanics are clearly defined and aligned with the company’s broader governance framework.
Poorly drafted ROFOs create uncertainty and disputes at the exact moment owners need clarity. Clean drafting preserves flexibility, protects existing owners, and reduces friction when a transfer is contemplated.
