To ROFR or Not to ROFR

What is a ROFR?  In a capital raising context it refers to a Right of First Refusal and is a common – and often controversial – term in equity investment negotiations.

We recently were asked by a prospective client to offer our advice on an equity investment they were negotiating with a potential strategic partner.  By the time we were asked to be involved many of the investment terms had been broadly agreed and the company co-founder and CEO was “comfortable” with providing a ROFR to the investor.  Most of the deal terms actually looked fine to us in the context of the opportunity, but we challenged the CEO to think further about the ROFR.

Since a ROFR typically provides the new minority investor (ROFR’s are mostly relevant in practice for minority investors) a right only to match any offer made by another to buy the company it seemed harmless enough to the CEO.  We challenged him to think about whether or not it would be truly harmless in practice.

Let’s assume for example that another party wanted to buy his company at some point in the future – which the CEO views as a likely scenario once he has built his company to sufficient scale.  Would that party be willing to make an aggressive bid for the company knowing that an existing minority shareholder would have a right to match the offer?  In practice, the answer to this question is probably not and the effect of having a ROFR would be to chill the bidding and hinder the CEO from realizing maximum value for himself and his other shareholders in a sale transaction.

Once viewed through this lens, our CEO rethought his position and was able to negotiate some important conditions to ROFR (he unfortunately was not able to remove it entirely, but in the context of the deal felt he obtained the flexibility he needed).

Of course all situations are different and ROFR’s are quite common terms in investment transactions.  As such, we cannot say whether they make sense in a particular situation or not absent all the facts unique to that deal.  What we can say, however, is that ROFR’s are important terms with important considerations that should be throughly vetted before any agreement is reached.

Since Fundamental Financial does not provide advisory services as a line of business, the advice we offered in this situation was simply done as a value added service to a prospective client with whom we hope to have to have a long fruitful receivables based lending relationship.  One which we feel confident will be an important component of the company’s financial management strategy even after the minority equity investment is completed.