Transfer of Share Rights: ROFO and ROFR

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Startups are privately owned companies. By definition the shareholding is private and restricted and the shareholders typically tend to keep it that way during the early stages of the enterprise. This means investors who are strategic shareholders in a private company are sensitive to change in ownership structure of the company and have restrictive provisions to participate in any transfer of share transactions. These are encapsulated in rights such as ROFO and ROFR. Let’s decode them further.

Understanding ROFO and ROFR

Right of First Refusal (ROFR): At its core, ROFR is a clause that gives existing shareholders (usually investors) the first chance to purchase shares that another shareholder (like a founder or employee) wishes to sell before they can be offered to an external party. Imagine you're considering selling some of your shares to an outsider; with a ROFR in place, you first have to offer those shares to your current investors at the same terms as the outside offer. If they decline, only then can you proceed with the third-party sale. ROFR is designed to protect investors from having their stakes diluted by unknown or unwanted shareholders.

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Right of First Offer (ROFO): ROFO, on the other hand, gives existing shareholders the opportunity to make an offer on shares before they're offered to anyone else. Here, if you're looking to sell your shares, you must first approach the ROFO holder with an offer to buy those shares. They then have the right, but not the obligation, to make a counter-offer. If they pass or if their offer is not accepted, you're free to seek offers from third parties. ROFO is often seen as more founder-friendly since it allows for price discovery and gives founders more control over the sale process.

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The Crucial Differences

Control Over Sale Process: With ROFO, founders retain more control as they can initiate the sale process and set the price. ROFR, however, can limit this control since founders must first secure an offer from a third party before offering it to existing shareholders.
Price Discovery: ROFO enables price negotiation with existing shareholders before going to market, potentially leading to a better deal for the seller. ROFR ties the price to an external offer, which might not always reflect the highest possible value.
Liquidity and Flexibility: ROFO gives sellers more flexibility to explore external offers if internal ones are not satisfactory. ROFR can restrict this, potentially reducing liquidity options for founders.

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Navigating ROFO and ROFR: A Founders’ Guide

Negotiate Terms:some text
- Push for ROFO over ROFR if possible. ROFO provides more control over share sales and can be less restrictive.
- If ROFR is unavoidable, negotiate the response time investors have to match offers, keeping it as short as possible to not delay potential sales.
Consider the Impact on Future Funding:some text
- Think about how these clauses might affect future rounds. A ROFR might deter new investors if they know existing ones can preemptively claim any shares.

Summing Up

Navigating ROFO and ROFR clauses is about balancing control, flexibility, and investor relations. While ROFR can provide security for investors, ROFO offers founders more agency in their equity's future. As an early-stage founder, your goal should be to create terms that protect your vision while still attracting and retaining the right investors. Remember, every negotiation is a step in building your company's foundation. With knowledge, preparation, and strategic foresight, you can turn these clauses from potential pitfalls into stepping stones towards your startup's success.

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