Beware the Right of First Refusal

In a previous post, we likened the process of selling a company to courtship. When things go well, the parties in question unite in marriage – the company sells, the deal closes.

But those of us who have made an appearance on the dating scene – or have yet to escape it — know that things don’t always go well. One minute, you’re on the fast-track to wedded bliss; the next, you’re tearing up photographs and listening to “One is the Loneliest Number” on repeat. (Maybe that’s just us.)

What comes between a union that, on the surface, appears to be perfect? The possibilities are endless, but let’s focus on a common scenario: an existing “significant other.” In the business world, this is known as the dreaded “right of first refusal,” or ROFR.

Generally speaking, the holder of this contractual right is given the option to purchase something (for our purposes, a company) before it is sold to another party. A ROFR typically provides its holder with security when a contract ends.

But a ROFR becomes a potential roadblock when a company is being sold. Why? By the time a buyer is ready to bid for a company, a good deal of energy has been spent in the “dating phase” – the buyer has been busy researching, analyzing and valuing the target…all the while spending lots of man hours and hard dollars. If the seller is bound by a ROFR, there’s a good possibility that the buyer’s efforts will be fruitless: Before a bid can be accepted, the seller must offer the right-holder the opportunity to purchase the company in question.

Even if the right-holder doesn’t plan to purchase the company, he can drag out the process and negatively affect the deal. Often, the seller approaches the right-holder, asking for a release so that his advisors can conduct a thorough sales process. Sensing that money is about to change hands, the right-holder says, “Sure, I’ll release it…just send me a check for $XXX!”

Moral of the story? Think twice about a ROFR if you plan to sell your company – or if there’s a chance you might do so in the future. Like wearing a wedding band to a bar, entering into a ROFR contract screams “unavailable” to potential buyers.