When it comes to transactions involving financial services firms, finding the right partner is often the hardest part. In some cases, you may identify that perfect advisor or firm to partner with, but the timing just isn’t right. There’s mutual interest, but maybe you’re not quite ready to sell. Or perhaps the partner isn’t ready to enter into a transaction.
In these instances, a right of first refusal (ROFR) can be an extremely helpful tool. An ROFR is essentially an agreement allowing one party to make a matching offer should the other party receive a buyout offer from a third party.
For example, assume you’re planning on retiring in three years and wish to sell your business. There’s another advisor interested, but neither of you are quite ready to make it official. You could establish a right of first refusal, allowing the other adviser to match any bid for your business. That way, you could still field other offers, but also keep the other advisor in the fold.
Rights of first refusal are also helpful in mergers. Assume that you merge with a new firm and plan on retiring in five years. Your new partners may wish to have the first option to buy your equity in the firm. By establishing an ROFR, you ensure that they’ll have every opportunity to purchase your equity.
Rights of first refusal can be complex and there are a number of things you’ll want to consider. Here are a few of the most important items to think about in your ROFR:
Duration of the ROFR. A right of refusal should have an end date. Without an end date, the ROFR could go on indefinitely, which may be problematic if you and the other party lose touch or go your separate ways in the future.
Instead, you should state that the ROFR is in force for a defined period, like three years or five years. Should no transaction happen during that time, you can simply agree to a new ROFR if you wish.
Definition of triggering event. For a first refusal to happen, there has to be an offer to refuse. Something has to happen to trigger the ROFR. That “something” is usually an offer.
However, you should define exactly what kinds of offers count. Does a letter of intent count or does it need to be a signed, enforceable letter? What about offers with contingencies, such as obtaining financing? Spell out exactly when the ROFR kicks in so your partner knows exactly what they need to match.
Time to match. Also, you don’t want your ROFR to sit on an offer indefinitely while they make up their mind. After the trigger event happens, the ROFR partner should have a defined period to either match or refuse the offer. That period may be a matter of days, weeks, or even a month. However, you don’t want it to be so long that you scare off your other potential buyers.
Definition of a match. Does your buyer need to match the other offer exactly in terms of price and structure? That may be difficult to do since these transactions have so many moving parts. You may want to give your ROFR partner some flexibility to match the total compensation buy change the underlying structure a bit.
An ROFR can be a powerful tool to facilitate a transaction, but you should consider all the factors carefully before putting an agreement in writing.