What is a Right of First Refusal (ROFR)?

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Hey, it's Scott Orn at Kruze Consulting, and today I'm answering the question, what is the Right of First Refusal when it comes to startup equity?

And, you know, oftentimes this term will actually be called a ROFR, it's the initials of all Right Of First Refusal. It's kind of like the classic venture capital or legal thing where people like to throw big words around or abbreviations that the normal people like us don't actually know. But luckily you have an accounting firm, Kruze Consulting, who's willing to explain this stuff to you. So, yipee! So Right of First Refusal is something that's actually negotiated by the venture capitalists in your stock purchase agreement.

And basically what that says is, "Hey, we the venture capitalists, if someone," you know on the inside of the executive team, common stock holders wants to or even preferred, this actually can apply to other preferred, but much less often preferred. It's mostly about common stock holders. If they wanna sell some stock, they have to come to us, the venture capitalists, because we have a Right of First Refusal, we get to make the first offer. And the reason for that is the VCs, most VCs typically in good companies always want more ownership. They're professional investors. That's all they do is have money and they buy stock. They buy stock in good companies, hopefully and so they always wanna increase their ownership.

There's a secondary issue here in that like if the founding, the executive team or employees start selling stock to outsiders, there could be information rights transferred where all of a sudden the actual financial results of those companies get out. Now there's some other language usually in a stock purchase agreement that blocks, you know that you only have information rights if you own a certain amount of a company, but still what kind of happens is there's, this becomes like a wild secondary market in stock for private companies and I think generally speaking most companies try to do an IPO, Initial Public Offering and sell stock in a very organized way and try not to have like a lot of stock trading outside the company's control.

This really came to a head when Facebook and Twitter, probably like 10 years ago, 11 years ago, 12 years ago when they were in their huge ramp and running towards an IPO. A lot of Twitter and Facebook folks were able to sell stock or get around ROFRs or those companies didn't have them. I'm not sure if they had them or not, but they were able to sell stock to just everyday people or funds and so there became like just a lot of outside ownership in those companies, which was great for the people who were able to buy the stock and also great for the employees who are able to sell some take some liquidity and then get to the IPO.

So typically the venture capitalists though they wanna maximize their ownership, so it was a little problematic for them and it had a bunch of secondary consequences so companies have gotten a little tighter on ROFRs that said venture capital firms are a lot more willing to do a secondary buy, which means buying though they'll put their initial investment in which is primary shares, the company issues shares to the VC.

That's a primary transaction, but a lot of VC firms are more willing to do secondary sales nowadays where they'll buy like a million or $2 million or $3 million of stock from the founders as part of our primary transaction. So in a way that Facebook, Twitter and all the other success, the Valley and New York and Santa Monica have had recently has kind of loosened investors up to they're more willing to buy secondary pieces but they still like to enforce the Right of First Refusal or ROFR so that they can, you know buy as much stock as possible before any employees sell it to the outsiders.

So I hope that helps, if you are working at a venture backed startup it's very high likelihood that your company has a ROFR so you're just gonna have to work through the proper channels, The CFO, the accounting firm, the general counsel, sometimes the founder handles this stuff too but just make sure you get permission and make sure you do it in the right way. You don't want anything invalidated or anything weird happen. So hope that helps. Hope the definition of Right of First Refusal makes sense to you. Thanks. Bye.