What does a right of first refusal mean in practice?
A right of first refusal means that certain parties have a priority right to buy shares when a seller wants to transfer them. Rules on rights of first refusal can be found in the articles of association or in a shareholders' agreement, and the terms govern how the process works.
In practice, this means that the seller must inform those who hold the right of first refusal and give them the opportunity to step in on the same terms as an external buyer.
Common terms of a right of first refusal
A right of first refusal can be drafted in different ways depending on what has been agreed and what the articles of association say.
- A right for existing owners ahead of an external buyer
- Specific deadlines for exercising the right
- A requirement for written notice from the seller
- The opportunity to accept the same price as an external buyer
- Rules on how several holders of the right are prioritised
When these terms are clearly worded, it becomes easier to determine how a sale should be handled and who is entitled to step in as the buyer.
When a right of first refusal comes into play
Worth bearing in mind
Rights of first refusal are used mainly in unlisted companies, where shares are not traded continuously on a stock exchange. The right is triggered when a shareholder wants to sell their shares and then gives those who hold it the opportunity to step in and buy the shares on the same terms before any external buyer may do so.
Knowing whether a right of first refusal exists in the company is important when investing, as it can affect how easy it is to complete a sale to the party you want.
Frequently asked questions
Why do rights of first refusal exist?
They exist to give existing owners the opportunity to keep control over the company's ownership structure and avoid unwanted external owners.
How does the process work with a right of first refusal?
The seller offers the shares to the existing owners first. They get a set time to respond before the shares may be sold externally.
Does the price have to be the same as in an external sale?
Yes. A right of first refusal normally means that existing owners must be able to buy at the same price and on the same terms as an external buyer is offered.
Can a right of first refusal hold up a quick deal?
The process can take longer, since the set deadlines must be observed before the shares may be sold externally.
Do all companies have a right of first refusal?
No. It must be included in the articles of association or in a shareholders' agreement to apply. It is, however, common in many unlisted companies.