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Right Of First Offer

Updated on May 30, 2024
Article byNanditha Saravanakumar
Edited byAaron Crowe
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A Right Of First Offer?

A Right of First Offer (ROFO) is a contractual provision that grants the right-holder the first opportunity to make the first offer to purchase an asset. If the right-holder chooses not to proceed, the owner may approach third parties with offers at terms more favorable than those presented to the right-holder.

Right Of First Offer

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ROFO agreements are prevalent in real estate and business contexts. In these arrangements, the seller, often the lessor, property owner, or business owner, can either accept or decline the offer extended by the right-holder before exploring alternative sales options.

Key Takeaways

  • A Right of First Offer (ROFO) is an addendum to a contract that allows a specific party, the right-holder, to make the initial purchase offer when the owner decides to sell the asset.
  • ROFOs can apply to various assets, including real estate, business shares, or the entire business.
  • If the right-holder is interested in purchasing the asset, they make an offer. If the seller accepts the offer, the transaction proceeds. If not, the seller may seek alternative buyers while adhering to specific conditions and limitations set by the ROFO agreement.

Right Of First Offer Explained

A Right of First Offer (ROFO) agreement plays a crucial role in various business transactions, particularly in scenarios involving property or business partnerships. Here is how it typically operates:

Consider two individuals, X and Y, engaged in a business relationship with a ROFO agreement. If X intends to sell a property or business, this pact allows Y the first chance to propose a purchase offer. X can choose to accept Y’s offer, leading to the sale to Y, or reject it, allowing the asset to be sold to others. These ROFO agreements are underpinned by specific rules and considerations essential to understand.

Three critical considerations guide ROFO agreements: Firstly, there’s a specified timeframe to ensure the asset’s value isn’t compromised, particularly for depreciating assets. Secondly, pricing is essential. If the asset is not bought by the right-holder and is sold in the open market, it must typically be sold at a higher price than the premium offered to the right-holder. It safeguards their interests.

For example, if X offers an asset to Y at a set price of $100,000 with a 10% premium, the open market price should be $110,000. Lastly, acting in good faith is fundamental. Sellers must provide accurate, transparent information about the property or business to avoid legal repercussions.

ROFO agreements offer various advantages as follows.

  • Tenants enjoy reduced eviction risks and business continuity assurance, while ROFO holders secure the first-offer advantage.
  • Sellers find it more convenient to sell without marketing costs. However, ROFO agreements may also present challenges, mainly when predetermined pricing is not favorable.
  • Sellers’ ability to propose a sale at any time can create difficulties, even if the right-holder’s financial situation isn’t ideal.
  • Furthermore, if both parties are interested, the seller is usually obliged to sell to the right-holder without seeking higher bids.

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Examples

Refer to the following examples to understand the concept better.

Example #1

Suppose Robert rents out a building space to Stacy, who runs a grocery store. Due to financial issues, Robert decides to sell the space. However, owing to the right of first offer clause in their agreement, Robert informs Stacy of his decision. Concerned about any chances of eviction from the new owner, Stacy makes a purchase offer to Robert. Robert evaluates the offer and decides to accept it, resulting in the sale of the space to Stacy. This arrangement ensures Stacy’s continued tenancy and business operations.

Example #2

Suppose a tech startup, Company A, has been operating in a shared office space within a larger office building owned by Company B. Company A and Company B have a Right of First Offer lease in place as part of their leasing contract. Company A has recently experienced rapid growth and needs a larger office space to accommodate its expanding team.

Company B decided to sell the entire office building, including the space occupied by Company A, as part of a strategic decision to focus on other real estate ventures. Prior to listing the building on the open market, Company B is obligated by the ROFO agreement to offer Company A the opportunity to purchase the space they currently occupy.

Recognizing the value of their existing location and wanting to secure more space for future growth, Company A decides to accept Company B’s offer and purchases the office space. It allows Company A to continue its operations seamlessly in the space they are familiar with and expand further, ensuring business continuity.

In this hypothetical scenario, the ROFO agreement benefits both Company A by enabling its expansion within the same building and Company B by facilitating a direct sale to a willing buyer, all while ensuring a smooth transition for Company A’s growing team.

Right Of First Offer vs Right Of First Refusal

Right of first refusal (ROFR) and right of first offer (ROFO) are contractual obligations commonly found in various agreements. Let us explore the distinctions between them:

  • ROFR empowers the right-holder with the option to purchase an asset or business from the seller. In contrast, ROFO enables the right-holder to initiate a sales offer to the seller when the decision to sell is made.
  • ROFR primarily benefits the right-holder by granting them the opportunity to acquire the asset, irrespective of the seller’s intentions to sell it to others. Conversely, ROFO aligns in favor of the seller, providing them with the flexibility to either sell the asset to the right-holder or explore other potential buyers as they see fit.

Let us understand the advantages and disadvantages to sellers and right-holders through this table:

Contractual ObligationAdvantages to sellerDisadvantages to sellerAdvantages to right-holderDisadvantages to right-holder
ROFOCan accept or reject the offer. The selling process is made more accessible. Reduction in marketing costs.Sale price restrictions if the right-holder is uninterested or the seller rejects the offer. Decreased scope of negotiations.No fear of eviction. Get a head start before other prospective buyers.The seller has the right to accept or reject the offer. The seller can plan to sell at any time.
ROFRReduced marketing costs. Increased chances of making higher profits.The owner should sell the asset to the ROFR holder if they plan on selling it.If the right-holder is interested, they can procure the asset free of competition (guaranteed purchase).The seller will make the offer at any time.

Frequently Asked Questions (FAQs)

1. Can a seller choose to reject the right-holder’s offer in a ROFO agreement?

Yes, In a ROFO agreement, the seller can accept or decline the right-holder’s offer, offering flexibility to assess the offer and act in their best interests. If they reject the offer, they can pursue other buyers or alternative sales, following ROFO agreement conditions and limitations.

2. Is a ROFO legally binding?

Yes, a Right of First Offer (ROFO) is legally binding when included in a contract. It is a contractual provision, and once agreed upon and signed by all involved parties, it holds legal enforceability. The ROFO outlines the specific terms and conditions governing the right-holder opportunity to make an initial purchase offer when the owner intends to sell the asset, ensuring legal rights and obligations for both parties.

3. Can a ROFO be included as an addendum to an existing contract?

Yes, a ROFO can be added as an addendum to an existing contract, offering flexibility to amend the agreement. This addendum specifies the terms and conditions under which the right-holder has the initial opportunity to make an offer when the owner decides to sell the asset, providing clarity and legal enforceability within the existing contract.

This article has been a guide to what is a Right Of First Offer. Here, we explain it with its examples and comparison with right of first refusal. You may also find some useful articles here –

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