Shareholders’ agreement: pre-emptive right to purchase shares and other shareholder protection mechanisms
- Pre-emption right
- Right of First Refusal, ROFR
- Right of First Offer, ROFO
- Distinction of the three mechanisms
Pre-emption right
A Pre-emption right gives existing shareholders of a company a pre-emptive right to purchase new shares in the company that are issued in proportion to their shareholdings in the company. This means that if the company issues additional shares, it must first offer them to existing shareholders in proportion to their shares before offering them to third parties.
Sometimes the transaction documents establish the order and scope of the investor's pre-emptive right. For example, the issued shares are first offered to the investor, then to the other shareholders.
Right of First Refusal, ROFR
A Right of First Refusal (ROFR) is a right granted to shareholders or investors that allows them to be the first to buy shares in a company on the same terms as those offered to a third party. If a shareholder intends to sell his shares, he must first offer them to the holders of the ROFR. If they refuse, the shares can be sold to a third party on the same terms.
Right of First Offer, ROFO
A Right of First Offer (ROFO) is a right under which a shareholder wishing to sell his shares must first offer them to existing shareholders or investors at a price he is willing to receive. If they do not agree to the proposed terms, the shareholder may sell the shares to third parties, but not at a lower price or on more favorable terms than those offered to ROFO holders.
For both ROFR and ROFO, special investor conditions compared to other shareholders are also possible.
Distinction of the three mechanisms
- Preemptive right of purchase: the company must offer shares first to existing shareholders in proportion to their shares.
- Right of first refusal: a shareholder must offer its shares to existing shareholders on the same terms as those offered to a third party. If the shareholders refuse, the shares can be sold to a third party.
Unlike pre-emptive rights in the case of ROFR, the shareholder rather than the company has the obligation to offer the alienated shares to other shareholders before selling to third parties.
- Right of first offer: a shareholder first offers shares to existing shareholders at its price. If the shareholders refuse, the shares can be sold to a third party, but not on more favorable terms than those offered to ROFO holders.
Unlike ROFR in the case of ROFO, the shareholder selling his shares first of all (before any discussions with third parties) offers the current shareholders to buy the shares. A subtle nuance - it is very difficult to understand the market price of shares in practice without discussing the company with potential buyers, so ROFO makes the sale of shares as if closed, internal.
The inclusion of the pre-emptive right to purchase shares, right of first refusal and right of first offer in the company's charter and shareholders’ agreement is an important step to protect the interests of investors first and foremost and to ensure the long-term stability of the business.
Author: Kuheika Irina
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