Right of first offer (ROFO) is a contractual right that gives a potential buyer the opportunity to make the first offer on a property or asset before the owner entertains bids from other parties. Typically used in real estate or business transactions, ROFO can benefit both parties. It can help the seller gauge interest. The buyer, meanwhile, has a chance to secure a deal without having to bid against other prospective purchasers. ROFOs can be employed with nearly any kind of asset and can involve leasing as well as buying.

A financial advisor can clarify how a ROFO functions, aiding in evaluating opportunities and risks for involved parties.

What Is the Right of First Offer (ROFO)?

ROFO is a pre-emptive opportunity granted to a specific buyer to negotiate a purchase before the seller lists the asset on the open market. In essence, ROFO gives the potential buyer a first shot at making an offer, often before other interested parties are even aware of the sale.

This type of agreement is commonly found in real estate, business acquisitions and partnership buyouts but can be applied to other asset types as well. A ROFO clause may be included in a term sheet spelling out conditions for negotiating a proposed transaction.

ROFO works by giving the designated buyer a set window of time to submit an offer once the seller signals their intention to sell. If the buyer decides to make an offer, the seller can accept, negotiate or reject it. If the offer is rejected, the seller is then free to seek other buyers but typically cannot accept an offer for a lower amount or on better terms than the ROFO holder proposed.

This arrangement benefits buyers by providing a prioritized opportunity to secure desired assets. For sellers, it offers a smoother process for potential sales without committing to exclusive negotiations. It can help both parties in terms of setting expectations and facilitating a quicker transaction.

Pros and Cons of Right of First Offer

ROFO agreements present advantages and challenges for both buyers and sellers, depending on the specific circumstances of the transaction. These agreements can influence negotiation dynamics, price discovery and the overall efficiency of the sale process.

Here’s a breakdown of the key pros and cons:

Pros

Prioritized opportunity for buyers: Provides buyers with a prioritized chance to secure an asset without competition from other bidders before it hits the open market.
Faster transaction process: Can lead to a quicker transaction process for sellers, reducing time and effort.
Early expectation setting: Allows both parties to establish expectations early, which may simplify negotiations.
Seller flexibility: Offers sellers a way to test and encourage buyer interest without committing to complete exclusivity.

Cons

Additional pressure on buyers: Buyers may feel pressured to make an offer before the asset is exposed to full market competition.
Potential lower price for sellers: Sellers may not get the highest possible price if they accept the ROFO buyer’s offer.
Complicated process if rejected: If the buyer’s offer is rejected, it can complicate the process, especially if other buyers make lower offers.
Limited seller flexibility: The seller’s flexibility may be limited, particularly if they are obligated not to accept a lower offer than the ROFO holder proposed.

Right of First Offer vs. Right of First Refusal

A woman evaluating a real estate investment.

ROFO and right of first refusal (ROFR) are both contractual rights that give potential buyers an advantage, but they differ in how and when the buyer is allowed to make an offer. In a ROFO, the buyer has the opportunity to make an initial offer before the asset is offered to others, which often leads to less market competition but requires the buyer to act quickly.

On the other hand, a right of first refusal allows the holder to match any offer received by the seller from a third party. This means the buyer with ROFR can wait until the seller has received an offer from another party, giving them more insight into the market value but requiring a swift response to match the terms. While ROFO provides an early opportunity, ROFR provides the buyer with more information at the cost of having to compete with offers already on the table.

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How to Use a Right of First Offer

From the seller perspective, using a ROFO can be broken down into six clear steps:

Evaluate if ROFO is suitable: Determine if a ROFO agreement is appropriate for the asset by considering factors like market conditions, potential buyer interest and the type of asset being sold.
Include ROFO in the agreement: Draft and include the ROFO clause in the contract with the designated buyer, clearly specifying the conditions, timeline and terms of the agreement.
Notify the buyer: When ready to sell, formally notify the ROFO holder of intent to sell. Provide details like the price, terms and other relevant conditions for the transaction.
Set the offer window: Allow the ROFO holder a specific timeframe to make an offer. During this period, the seller cannot negotiate with other parties.
Review the offer: If the buyer submits an offer, evaluate it. The seller can accept, negotiate, or reject this offer, depending on the terms of the ROFO.
Proceed accordingly: If the offer is accepted, finalize the sale. If rejected, the seller is free to engage with other buyers within agreed limits, such as not accepting a lower offer than what the ROFO holder proposed.

Bottom Line

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ROFO agreements can be practical for both buyers and sellers who are looking to streamline transactions and set clear expectations. For buyers, it provides a way to secure an asset before others are involved. For sellers, it offers a controlled and potentially faster sales process.

Real Estate Investing Tips

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