The Right of First Refusal (ROFR) is a staple clause in most corporations’ shareholder agreements and by-laws. Simply put, it requires any shareholder who is offering (or receives an offer) to sell their shares to first offer the shares to existing shareholders of the corporation (or the corporation directly) before offering it to any non-shareholder. The right of first refusal must be on substantially the same terms as the third-party offer (e.g. if the non-shareholder will buy at $3/share, you must offer to sell your shares to the the other shareholders or the corporation at that same price).

This gives the Board of Directors a heads-up that shares are being transferred to a third party, which may change how the company is managed (e.g. if a CEO sells to someone who will be a passive shareholder). It also offers companies the chance to buy back shares before the transfer happens.

An added benefit of this provision is that you can potentially avoid a problem with the sale of securities under US securities laws. U.S. Security Laws cover any sale of securities in the US. All sales of securities must be registered with the Securities Exchange Commission (SEC) unless some exemption applies. Shares issued by a private company without registration are called “restricted securities” (they are called “control securities” if issued to the company’s employees and founders) and can’t be re-sold without complying with SEC rules that place significant restrictions on sale. If those restrictions are not met, then it’s possible that the original issuance of securities might be tarnished, to the detriment of the issuer. For instance, if shares were issued to an early-stage investor under a private offering (under the so-called “private placement” exemption), and that investor were to sell those same shares to the public, the SEC could theoretically try to treat the investor as an underwriter of company securities. This would, in turn, mean that the initial issuance was not a private offering, and the company could be held liable for failing to register the securities. If a right of first refusal is placed on those shares that could stop the investor’s transfer, then that issue could be completely avoided.

Looking to learn more about incorporating in the United States? Check out Clausehound’s Delaware Public Benefit Corporation By-Laws learning library template, and be sure to click through our tags to learn more about each clause!

Author: Phil Weiss and Sahil Kanaya

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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