Drafting a Shareholders Agreement: What is “First Right of Refusal”?

In Short

• Right of First Refusal (ROFR) lets existing shareholders buy shares before a third party can.

• It helps maintain control and stability by preventing unwanted outsiders from acquiring shares.

• A well-drafted ROFR clause should specify notice periods, timeframes, and procedures for share transfers.

Tips for Businesses

Including a Right of First Refusal in your shareholders agreement ensures that existing shareholders have the opportunity to purchase shares before they are offered to external parties. This clause helps protect the company’s structure and prevents unwanted third-party involvement. Consult with legal professionals to tailor the ROFR clause to your business’s specific needs.

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Table of Contents

• How Does the “Right of First Refusal” Clause Work?
• Why is a “Right of First Refusal” Clause Important?
• What Should a “Right of First Refusal” Clause Include?
• Key Takeaways
• Frequently Asked Questions

In the dynamic world of small businesses, it is important to maintain control and stability in ownership structures for long-term success. Shareholders agreements are essential for achieving this goal. They provide a framework for collaboration, decision-making, and protecting shareholders’ interests. Your shareholders agreement will outline how to manage the business and the procedure if one of the shareholders wants to sell their shares. The “right of first refusal” clause is common in a shareholders agreement. This clause allows other company shareholders to purchase shares before a third party buys them if a shareholder wants to sell some or all of their shares.

This article will explain the right of first refusal clause, its essential elements, and what to do if a shareholder decides to sell their shares.

How Does the “Right of First Refusal” Clause Work?

A well-drafted shareholders agreement will outline the process for selling and transferring shares. This will usually include a first right of refusal clause. The clause gives other shareholders the right to have “first dibs” when purchasing another shareholder’s shares or the first chance to “refuse” to buy shares. 

A standard first right of refusal clause will require the selling shareholder to provide notice of an offer from a third party who wishes to buy their shares. This notice must be in writing to all other shareholders in the company. Consequently, other shareholders have the first opportunity to purchase the shares on the same terms as that offer.

Furthermore, shareholders can purchase the shares from the selling shareholder, or the company can buy back the shares on the same terms the third-party buyer offers. If the other shareholders or the company choose not to buy the exiting shareholder’s shares, the exiting shareholder will proceed with the third party’s sale.

Why is a “Right of First Refusal” Clause Important?

The first right of refusal clause is often essential in a shareholders agreement as it helps control the company’s structure. This clause can protect your business by preventing unsuitable third parties from becoming shareholders and disrupting operations. It allows existing shareholders to block outsiders from gaining a significant stake without their consent, maintaining control and stability. The clause is crucial for shares with substantial voting rights and enables shareholders to retain control over the company’s vision.

What Should a “Right of First Refusal” Clause Include?

Your first right of refusal clause should contain a few essential terms.  

Time Frame

The clause should specify the time frame within which other shareholders have to exercise the first right of refusal. Without a time frame, the clause will be open-ended. Ambiguity around time periods can cause problems when dealing with third-party interested buyers. The time period for other shareholders to respond to a notice of intention to sell should not be overly short. It is usually a 30-day period.

Notice Period

The clause should also specify how the selling shareholder must provide the notice of intention to sell shares to other shareholders. 

Commercial Terms of Sale

Moreover, the first right of refusal clause needs to address the different circumstances of the sale.

Procedure for Sale and Transfer of Shares

Further, the first right of refusal clause must include the procedure for transferring shares. Once the remaining shareholders have agreed to purchase the shares, you must transfer them. Issues can arise if the selling shareholder, for whatever reason, refuses to sell or does not transfer the shares when required. The shareholders agreement can set out that, in such circumstances, the company can act as the attorney of the selling shareholder and undertake the transfer on the agreed terms.

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Key Takeaways

Including a First Right of Refusal provision in a shareholders’ agreement is common, particularly in family-owned businesses or startups. This provision is a useful tool for maintaining the stability and continuity of the business. It gives existing shareholders a say in who can become a shareholder and under what conditions. However, it is important to carefully structure and define the terms and procedures for exercising this right in the shareholders’ agreement to prevent disputes or misunderstandings. Consulting with legal counsel is highly advisable when drafting a shareholders’ agreement or related provisions.

Your shareholders agreement must include a right to first refusal clause. This clause helps protect the interests of remaining shareholders by allowing them to control the company’s structure and composition. A shareholders agreement is an essential legal document.

If you have questions about a shareholders agreement or the first right of refusal clause, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions