Right of First Offer: Everything You Need to Know
Right of first offer is an agreement that when an owner is ready to sell or lease an asset, the holder gets the first chance to buy or lease the property.9 min read
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.
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.
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.
- 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.
- 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.
Not Getting Right of First Offer: Advantages and Disadvantages
There are also some advantages and disadvantages to not having it as well.
- The only advantage for a buyer would be to have right of first refusal rather than right of first offer.
- 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.
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
- What is the difference between right of first offer and right of first refusal?
The right of first refusal means that if a third party makes an offer, the seller has to notify the holder of this sale. The holder then has the right to meet that offer and purchase the asset. Note, however, that the holder may have to offer a better price depending on how the right of first refusal agreement was worded.
With right of first offer, the seller tells the holder the asset is up for sale. With right of first refusal, the seller has to tell the holder that there's an offer and give them a chance to make an offer.
This makes rights to first refusal a weaker position for the seller than rights to first offer. With rights to first offer, the holder gets one shot to make an offer and the seller has complete power to accept or refuse and then the seller can move on to other offers.
But with the rights to first refusal, some third parties may not want to even make an offer. They know the holder of this right will likely meet, or beat if necessary, any offer the third party makes. This can lead to a diminished value of the property.
Sometimes, if there are no parties that currently have right of first refusal, the first party to bid on an asset may ask for that right, or a seller could possibly offer it to entice potential buyers.
- What's the difference between right of first offer and an option?
An option is a contractual obligation for the option to sell or lease an asset at a specified time and for a specified price. Where the owner chooses when the right of first offer is enacted, by choosing to sell the asset, the period of time for an option is predetermined. The holder of the option can exercise it anytime within that option period.
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