Terms and Conditions of Venture Capital Transactions: ROFR. Pre-emption rights
- Who can have pre-emptive rights?
- Sequence of implementation of ROFR and right of first refusal
- Procedure for exercising pre-emptive rights
New this week is a new post about the key tools in venture capital and M&A deals that funders definitely need to know about.
The next tools we want to talk about are the right of first refusal and pre-emption right. What are they and what are they for? Let's get to the bottom of it.
| Right of first refusal (ROFR) is the pre-emptive right of the shareholders of a startup to purchase the current shares in the startup in case of their sale by one of the participants. The pre-emptive right works both when selling to one of the current participants and to a third party. |
The tool aims to protect the interests of the participants, namely preventing unwanted third parties from entering the business.
Pre-emption right is the pre-emptive right of current shareholders to make an additional investment in the startup's capital, i.e. to subscribe for additional shares. It is necessary for shareholders to be able to maintain or increase their share in new rounds of investment.
Who can have pre-emptive rights?
As a rule, at the very beginning of negotiations, the investor extends ROFR and pre-emption rights to himself. When financing a business, the investor is interested, among other things, in retaining the stable team that was at the origin of the project's development. It is logical that the investor would not want to see a new, completely unknown member of the team.
At the same time, if you, as funders, are also interested in maintaining a stable shareholder base, you can suggest that the investor grant pre-emptive rights to you as well. As a rule, investors will agree to them.
It is important to remember that pre-emptive rights may be established by the laws of the jurisdiction in which you are structuring the transaction. If your and your investor's arrangements differ from the law, it is imperative that they are spelt out in detail in the shareholders' agreement and articles of association to ensure that they work in practice.
Sequence of implementation of ROFR and right of first refusal
The sequence in which pre-emptive rights are exercised will also depend on the agreements of the parties and where the transaction is structured.
The most frequently encountered in our practice variant of the order of priority is as follows. A shareholder intending to sell its shares (part of them) in a startup offers them:
- First and foremost, the investor
- Secondly, to the rest of the faunders
- Thirdly, the startup itself
- And only fourthly to a third party
Note again that pre-emptive rights may also be provided for forounders in the event of a sale of their shares by the investor.
As for the peculiarities of realisation of the right depending on the jurisdiction, let us give the following example. In the state of Delaware (USA), the right of first refusal is basically granted to the company itself: i.e. a shareholder intending to sell shares first offers them to a start-up. If you want to establish a different procedure, then in the transaction documents it is necessary to record that the company waives its right of first refusal. Therefore, it is very important to be careful when drafting binding documents, recording all the specifics in them.
Procedure for exercising pre-emptive rights
A shareholder intending to sell its shares (or the company in the case of an additional issue) must send a notice of sale to the first priority shareholders. The notice must contain information on the number of shares to be sold, their price, potential buyer and other information.
The shareholders of the first turn have, as a rule, 15-20 days to consider the received offer (the parties may set a different term in the transaction documents). If the shareholders send a refusal to exercise the pre-emptive right or do not respond within the established period of time, the shares are offered to the next in line. The content of the notice and the term for its consideration are similar.
In the event that no one has expressed a desire to purchase/subscribe to the additional issue shares, the shares may be alienated to a third party.
Thus, both the right of first refusal and the pre-emption right give the parties to the transaction pre-emptive rights to acquire shares in the startup. These instruments can work for both the investor and the funders, the main thing is to reach an agreement.
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