Available Now

Order now and be among the first to learn from Alternative Investing expert Bob Rice. Begin building your alternatives portfolio today! Order from Amazon.com, Barnes & Noble or 800-CEO-Reads

This episode aired on BloombergTV on Dec 20, 2012

Right of First Refusal

Right of First Refusal is a common feature of private company stock options. These provisions generally state that before the employee or investor can sell the option to an outsider, they must first offer it to the company, and can include restrictions on transfer of stock to non-insiders.’

Q. You mentioned this yesterday in the context of a “D Round”: what a ROFR?

A. It stands for Right of First Refusal. Typically, when companies that aren’t public issue options, they come with restrictions, both on the options themselves and the stock those options can convert to. One of those restrictions is almost always a “ROFR” that kicks in if the employee or investors wants to transfer the security.

Q. So, this provision gives the company the right to veto the transfer if they don’t like the transferee?

A. Depends, but that sort of clause is very common. In the classical formulation, the does what it sounds like: before the employee or investor can offer the options or stock to someone else, they must first offer it to the company. Sometimes the company has to buy the stock or options to prevent the transfer; but, often, it can just say “no”. Sometimes, also there’s a strict provision against any transfer without company consent. One way or the other, the company can almost always control to whom the options or stock is transferred.

Q. Do companies actually exercise these rights often?

A. Yes. Its frequently a big friction point with employees who want cash and companies who don’t want strangers as investors (because even in private companies, investors have annoying rights that can be exercised). This is where our story from yesterday kicks in: what has become a lot more common for very late stage companies is that they’ll actually seek out investors who can buy some employee stock, or at very least not object to the right kinds of institutional and HNW buyers.

Q. So, as you said yesterday, a huge benefit for the company compared to selling shares into the public, where you never know who the buyers are… and where those buyers have broader rights.

A. Yes indeed. And here’s a nice thing, too: with ROFRs and related provisions, you keep your shares out of the hands of the short sellers, the bane of public companies.

Q. So, there’s a new noun for us, ROFR.

A. Ha, yes, but it’s a verb, too. You can ask about a potential deal, “hey, think the company will ROFR it?”.