What Is Right of First Refusal (ROFR), and How Does It Work?

What Is a Right of First Refusal (ROFR)?

Right of first refusal (ROFR), also known as first right of refusal, is a contractual right to match or refuse to match an offer on an asset after other offers have been made.

If the party with this right declines to enter a transaction, the seller is free to entertain other offers. This is a popular clause among lessees of real estate because it gives them preference for the properties in which they occupy. It is also popular among venture capitalists looking for assurances that their investments will not be sold out from under them.

How a Right of First Refusal (ROFR) Works

Rights of first refusal clauses are similar to options contracts in that holders are granted rights but not obligations. In this case, the rights holder has the right, but not the obligation, to match or refuse to match an offer already made on an asset by another party.

So, if a shareholder wants to sell their share and is subject to an ROFR, they must find someone willing to make an offer on the share. Once they have an offer, they must notify the rights holder, who then exercises their option to match that offer and purchase the share or refuse to match it and let another party purchase it.

Rights of first refusal are usually requested by individuals or companies who want to see how an opportunity will turn out. The rights holder may prefer to get involved later rather than make the outlay and commitment right away, and a right of first refusal allows them to do so. However, the rights holder generally only has a specified time before the seller can accept another offer. The right is also only valid with the seller they contracted with.

Right of first refusal clauses can be customized to create variations of the standard agreement. As such, the parties can incorporate changes, such as specifying how long the right is valid or allowing a third party nominated by the buyer to make the purchase.

Advantages and Disadvantages of Rights of First Refusal

Buyers are generally favored in ROFR contracts, but these agreements also have cons.

Advantages for Buyers

• It's akin to an insurance policy for a buyer
• Might give a buyer a competitive edge
• Allows buyers to be prioritized

Disadvantages for Buyers

• Prices might drop after the purchase
• Sellers may forget they have an ROFR

Advantages for the Seller

• The seller may be comforted knowing there is a buyer ready
• The seller finds other buyers in case the contract holder doesn't want to purchase the asset
• The seller can prioritize certain individuals

Disadvantages for the Seller

• It limits the ability to negotiate with multiple buyers
• The seller may have a difficult time attracting buyers
• The rights holder isn't obligated to purchase
• Another buyer might be willing to pay more than the rights holder

Special Considerations

In the business world, rights of first refusal are commonly seen in joint venture situations. The partners in a joint venture generally possess the right of first refusal on buying out the stakes held by other partners who leave the venture.

Rights of first refusal are a common feature in many other areas, from real estate to sports and entertainment. For example, a publishing house may ask for the right of first refusal on future books by a new author.

The Bottom Line

A right of first refusal is a contractual agreement between two parties that gives one the ability to be the first buyer. This party can match an offer made by a third party and purchase an asset, or they can refuse to match it, in which case the seller can proceed with selling it to another party.

These contracts are generally used by interested parties who don't want a contractual obligation to purchase an asset but want the option to do so if other parties become interested in it.