Key Takeaways:

  • Definition and Importance: Right of first offer (ROFO) allows a specified party to make the first bid when an asset is being sold or leased, reducing market listing times and brokerage fees for sellers while giving holders a prime opportunity to acquire.
  • Real Estate and Business Use: ROFO is common in commercial real estate and business sales, particularly beneficial in tenant-landlord and business partnership scenarios.
  • Legal Considerations: Clearly defined terms in a ROFO contract, including timeframes, pricing, and sale conditions, are crucial to avoid misunderstandings. Legal assistance is recommended to ensure the contract is equitable and enforceable.
  • Advantages vs. Disadvantages: ROFO offers stability for tenants and fast sales for landlords but lacks the strength of the right of first refusal (ROFR), which deters third-party bids.
  • Practical Contractual Elements: Effective ROFO contracts detail who can buy, resale restrictions, and conditions preventing "flipping" in partnerships.

What Is Right of First Offer?

Right of first offer is an agreement that when an owner is ready to sell or lease an asset, the holder of the right of first offer gets the first chance to buy or lease the property within a given time frame. Once the holder has made the offer, the seller is able to accept or refuse the offer. If the seller refuses it, he or she can move on to a third party offer.

The right of first offer (ROFO) arrangement allows a rights holder, often a tenant or business partner, to be informed when a property owner or business partner decides to sell or lease. They can then make the initial offer to acquire the property or additional share of the business before it becomes publicly available. This structure benefits both parties by potentially expediting the transaction process while reducing the costs and complications associated with public listing. However, because the ROFO gives limited control to the rights holder in determining the final price or terms, it is often less advantageous than a right of first refusal.

Right of First Offer: In Depth

Most commonly, right of first offer is used in contracts within the real estate market and in the selling and buying of businesses. Typically, the stipulation is included in a tenant-landlord contract and in businesses with business partners and investors.

The most practical reason to have right of first offer is for a commercial tenant. If the owner decides to sell, it would give the tenant a chance to make an offer. If accepted, this prevents the need for the tenant to move his or her business to a new location.

It also helps the owner of the property by preventing the property from being on the market for an extended period of time, and it minimizes brokerage and legal fees. There's no need to attract buyers and convince them of the property's value or how it would be a good site for their business. As long as the tenant makes a reasonable offer, it's a win-win.

Note that the right of first offer can also apply to a landlord that is looking to lease a property. For example, let's say there's a business that is leasing a space on one floor of a commercial building. The owners anticipate needing to expand their office in the next year or two. They may have a right of first offer if space on another floor in the same building opens up. If the company is ready to expand when it opens, they'll have first shot at leasing this additional space.

In scenarios beyond tenant-landlord relationships, the right of first offer proves invaluable for investors who aim to consolidate ownership or control over an asset. ROFO agreements can also prevent destabilization in long-term partnerships by offering partners an opportunity to maintain or expand their stakes before outside buyers are invited. Furthermore, a well-crafted ROFO clause offers essential protections by specifying how and when the offer will be presented, along with an accepted pricing method to avoid inflated valuations that can sometimes hinder transaction success​.

How ROFO Differs from Right of First Refusal (ROFR)

While ROFO enables the holder to make the initial offer on an asset, right of first refusal (ROFR) gives them the right to match or better any offer the owner receives from a third party. This difference is crucial because ROFR discourages third-party interest; buyers are often reluctant to bid on properties where existing rights holders can easily match or outbid their offers, potentially lowering the property’s value. ROFO, in contrast, does not deter third parties since they may step in freely if the rights holder's initial offer is declined​.

Why Is Right of First Offer Important?

Right of first offer is important because it's a compromise between right of first refusal and no preemptive rights whatsoever. Many landowners would prefer not to offer a right of first refusal because of the complications it adds to the selling process.

Right of first offer, however, is fairly quick and only involves one round of offering (either by the seller offering to the holder or the holder making an offer to the seller). If that offer is not accepted, the seller can then move on with taking the sale public.

When adding this right to a contract or creating a right of first offer agreement, you'll want to make sure that the deal makes sense for both parties. This may include providing enough time, wording how the offer will take place, and outlining what happens if the offer is not accepted. For that reason, it's best to have a lawyer involved who can help with the negotiation process. You'll want someone who can explain what provisions are offered and what you should ask for.

If no agreement can be reached and the sale goes public, the seller can always return to the holder of the right of first offer again. However, the holder is also free to reduce his or her offer if this happens.

Getting Right of First Offer: Advantages and Disadvantages

When it comes to including a right of first offer, whether for a property you're renting, one you're interested in, or a business, here are some pluses and minuses to having it in the contract.

Advantages

  • For tenants, it helps prevent a new landlord from coming in and evicting them from their location. An eviction would lead to major expenses and potentially a loss of business.
  • For business partners, right of first offer would give them the option of owning a larger percent of the business.
  • For landlords, it gives them the option of quickly selling to a tenant rather than seeking out new buyers who might not realize the property's advantages.
  • For landlords and business owners, it reduces transaction costs as long as the tenant or business partner gives a reasonable offer.
  • Selling a business takes time and help from legal counsel, accountants, and advisors. Selling the business to the holder of this right lessens those fees and hassle. At the same time, it saves the holder money because the price should be at market value or slightly below.
  • Because the risk is minimal, it's fairly easy to get a right of first offer for commercial properties. This is helpful when you are interested in a property that the owner doesn't plan to sell. This will ensure you'll be notified if it ever does go up for sale.
  • Reduced Competition: ROFO provides a significant competitive advantage, giving the holder an exclusive window to negotiate without competing bids.
  • Predictable Process: Knowing that they have the first opportunity to buy, the holder can plan strategically for potential acquisitions, making it easier to secure financing or prepare other resources ahead of time.

Disadvantages

  • For sellers, if you have someone in mind that you want to sell to, all you have to do is refuse the offer from the rights holder. Then you can move on to selling to a third party.
  • For buyers, the right of first offer is not as strong as right of first refusal.
  • If the contract states that the seller can ask for a price with the right of first offer, rather than the holder offering a price, many sellers will ask too much. Owners often have an inflated idea of how much their property is worth.
  • Market Price Risk: If the seller sets an inflated asking price, the holder may miss out on a fair deal or be forced to negotiate down.
  • Limited Leverage: Since the ROFO holder doesn’t control the transaction terms, they risk facing stricter conditions or a higher initial asking price than anticipated.

Essential Elements in Drafting a ROFO Agreement

When drafting a ROFO agreement, it’s critical to include the following elements for clarity and protection:

  1. Clear Offer Terms: Specify the method for determining an acceptable price, ideally linking it to market value or a third-party valuation to prevent overpriced offers.
  2. Defined Response Timeline: Establish a clear timeframe for the rights holder to respond to the offer, typically 30-60 days, ensuring ample time for consideration.
  3. Exclusivity and Transfer Restrictions: Limit the right of first offer to the original rights holder, prohibiting third-party transfers without the owner’s consent.
  4. Non-Flip Clauses: In partnership settings, prevent "flipping" by barring the rights holder from immediately reselling their share without offering it back to the original owner​.

These conditions not only protect the parties but also enhance the ROFO’s enforceability. Legal consultation is highly recommended when including such complex provisions to ensure both the rights holder and asset owner understand and benefit from the agreement​.

Common Mistakes

  • Not Specifying Market Value Benchmarks: ROFO contracts should tie the initial offer to an objective market value benchmark, whether through an appraisal or specific valuation method, to prevent disputes.
  • Ignoring Financing Contingencies: Allowing sufficient time for financing within the offer period can prevent the rights holder from losing out on an opportunity due to funding delays.
  • Inadequate Clarity on Successive Sales: Agreements should specify whether ROFO rights reset after each public sale attempt, ensuring both parties have a clear understanding of the extent and duration of the right of first offer.

Not Getting Right of First Offer: Advantages and Disadvantages

There are also some advantages and disadvantages to not having it as well.

Advantages

  • The only advantage for a buyer would be to have right of first refusal rather than right of first offer.

Disadvantages

  • For sellers, you don't have to wait the time frame outlined in the agreement before you take your sale public.
  • For a tenant, this means that the property your business resides in could be sold without your knowledge. By not having the right of first offer or refusal, the owner could potentially broker a deal to sell the property without you knowing it was up for sale or that you could have purchased it.

Common Mistakes

If you need to have a right of first offer agreement drawn up, here are some common pitfalls that you should avoid where possible.

Not Having the Right Stipulations in the Contract

When drafting the clause or agreement for right of first offer, there should be specific information included that helps both the tenant and the property owner.

For the tenant, timing protections should be included. Often, the period of time to respond with an offer (or acceptance of an offer) is 30 days. That may not be long enough for the holder to figure out whether to commit and how much to offer. This is especially true if the holder needs time to get financing together to ensure that committing is the best choice.

In addition to timing, pricing should also be noted. It should be stated in the clause that the seller is not able to offer the property to the tenant for less favorable terms than he or she offers the property to the public. They should be the same terms. To protect the tenant's interest, a memorandum detailing these rights should be recorded to prevent any sale of the property without the tenant's knowledge.

For the landlord, the contract should state that he or she only has to offer the property to the tenant once. If the landlord is not able to sell when it's available to the public, the landlord should not be required to offer it to the tenant again.

Another stipulation should be that only the tenant can purchase the property and can't have someone else come in and buy the property when right of first offer is engaged.

Clauses in the Deal That Prevent "Flipping"

If a right of first offer comes up in a business partnership, most partners will accept the deal. If for no other reason, this ensures that they have control over who they end up getting into a partnership with.

If the business partner (aka business partner number two) doesn't exercise the right to make an offer, the selling business partner (aka business partner number one) could sell to anyone without the business partner number two's say or opinion being considered. By having partner two purchase it, he or she can then find someone that the business partner two feels would be a great partner to work with and then sell to that person. This could potentially be at a profit, thus "flipping" the deal.

However, this isn't possible because of the wording of the right of first offer. Often, in order to bring someone else in, partner two would have to give a right of first offer notice to partner one and then wait 30 days. This would defeat the purpose of trying to bring anyone else in.

To avoid this, you want to have clauses in the agreement that prevent this scenario.

Not Including Enough Details in the Clause

When the agreement is written, there needs to be answers to some of the most common questions in order to make sure the right of first offer can be exercised. Here are some questions that you should ensure are answered in the contract:

  • Does the holder need to put down a deposit?
  • Will there be a contract of purchase and sale?
  • Are brokerage commissions subtracted from the sale price or applied on top?
  • Are there any additional subtractions above and beyond what is subtracted in a typical contract?
  • What are the consequences if the holder's offer is accepted and then the deal falls through (such as the holder's financing falling through)?
  • Does the seller make any representations or warranties?

Not Getting a Lawyer to Help With Negotiations

There are many variations that can be included in a right of first offer agreement, such as transferability and limits. For that reason, having legal counsel to help you in negotiating those terms is crucial. This is especially true if getting the property is essential to your future business plans.

There have been many cases in the past where right of first offer agreements were written poorly. This leads to them being almost pointless. For example, one such agreement included a clause that invalidated the right of first offer if the sale included multiple assets. The seller, who didn't want to sell to the holder, decided to throw in another property into the sale, just to enact this clause. The right of first rights, therefore, didn't apply.

Having someone on your side to negotiate the agreement is your best bet to avoiding any major and obvious pitfalls.

Frequently Asked Questions

  • 1. What is the primary purpose of a Right of First Offer (ROFO)?
    A Right of First Offer (ROFO) provides the rights holder, such as a tenant or business partner, the opportunity to make the first bid when the owner decides to sell or lease an asset. This ensures the rights holder gets priority in negotiations before the asset is made available to the public.
  • 2. How is a ROFO different from a Right of First Refusal (ROFR)?
    A ROFO allows the rights holder to make the first offer when an asset becomes available, but the owner can decline and open the sale to others. In contrast, a ROFR requires the owner to inform the rights holder of any third-party offers, giving the rights holder the option to match or outbid them before a sale is finalized.
  • 3. What are the key benefits of including a ROFO in a contract?
    Including a ROFO can streamline sales by reducing marketing costs and time on the market for owners. It also offers rights holders a competitive advantage by granting them an exclusive chance to purchase or lease the asset without competing bids.
  • 4. Can a Right of First Offer apply to business partnerships?
    Yes, in business partnerships, a ROFO can ensure that existing partners have the first opportunity to buy out a partner’s stake before the shares are offered to external buyers. This helps maintain internal stability and control within the partnership.
  • 5. What legal considerations are important when drafting a ROFO agreement?
    Key considerations include specifying a fair market value benchmark for pricing, establishing clear response deadlines, and detailing whether the right is transferable or limited to the original holder. Consulting an attorney is crucial to ensure the agreement is enforceable and protects the interests of all parties involved.

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