Right of First Refusal on Secondary Sales: A Practical Guide for Founders

Understanding the Right of First Refusal in Startup Funding

For founders and early employees at pre-seed to Series B startups, selling a small portion of your equity can feel like a distant dream. But when the need for personal liquidity arises, you will quickly encounter a critical clause in your financing documents: the Right of First Refusal, or ROFR. Misunderstanding this common component of the secondary sale process can unintentionally block access to cash you were counting on. Understanding the mechanics of the right of first refusal in startup funding is not just a legal formality; it's a practical necessity for managing founder equity restrictions and investor expectations. For related VC term sheet clauses, see the term sheet hub.

A Right of First Refusal is a contractual right giving the company and its existing investors the opportunity to purchase shares from a selling shareholder before those shares can be sold to an external third party. The primary purpose is to give the company and its key backers control over the capitalization table. This allows them to prevent competitors, unknown entities, or potentially disruptive individuals from gaining an ownership stake and influencing company direction.

The entire process is triggered by a "bona fide" third-party offer, which is a legitimate, legally enforceable offer to buy your shares. Critically, ROFR is a matching right, not a veto right. The company or its investors cannot simply block your sale; they must step in and purchase your shares on the exact same terms offered by the outside party. This means matching the price, payment schedule, and all other conditions. For a clear primer on how ROFRs function in secondary transactions, this overview explains the role of a bona fide third-party offer.

The ROFR Process: A Step-by-Step Guide

Navigating the ROFR process can seem daunting, especially without an internal finance or legal team to guide you. However, the steps are logical and predictable. Breaking the process down clarifies the timeline and potential outcomes, helping you avoid last-minute disruptions to your cash planning and manage the secondary sale process effectively.

1. Secure a Bona Fide Third-Party Offer. Before anything can happen, you must have a legitimate, written offer from an external buyer. This offer must detail all essential terms: price per share, number of shares, payment terms, and any other relevant conditions. This cannot be a casual expression of interest; it must be a formal offer you are prepared to accept. The practical consequence tends to be that the company or investors must match these exact terms later, not just the price, so ensure the offer is clean and straightforward.
2. Submit a Formal ROFR Notice to the Company. Once you have the offer, you must formally notify the company's Board of Directors. This is typically done via a written notice that includes a complete copy of the third-party offer. Your notice officially triggers the start of the ROFR procedure as outlined in your company’s governing documents, such as the Stockholders' Agreement. This is the official starting gun for the entire process.
3. The Matching Period Begins. After receiving your notice, the clock starts ticking on the “matching period” or “waiting period.” This is the window of time, typically 30 to 45 days, during which the company and its investors can decide whether to exercise their right. During this time, you and your potential buyer are in a holding pattern, unable to proceed with the transaction.
4. The Priority Cascade Determines Who Can Buy. A scenario we repeatedly see is confusion over who gets the first chance to purchase the shares. Most shareholder agreements define a clear priority order, often called a cascade, to manage investor rights in startup exits:
   • The Company: The corporation itself usually gets the first option to purchase all or a portion of the offered shares.
   • Major Investors: If the company declines, the right often passes to major investors, typically large VCs. They can usually purchase a pro-rata portion of the shares based on their current ownership percentage.
   • Other Shareholders: In some agreements, if major investors do not fully subscribe to the available shares, the opportunity may extend to other shareholders.
   Any party exercising this right must agree to the exact terms of the external offer.
5. The Two Possible Outcomes. At the end of the matching period, one of two things will happen:
   • Outcome A: The ROFR is Exercised. The company or one or more investors elect to buy your shares. They must match the third-party offer's terms precisely. You complete the sale with the internal party, receive your cash, and the deal with the external buyer is terminated.
   • Outcome B: The ROFR is Waived or Expires. The company and investors either formally waive their rights in writing or simply let the matching period expire without taking action. You are now free to proceed with selling your startup shares to the original third-party buyer under the exact terms you provided in your notice.

US vs. UK ROFR Rules: Key Differences in Managing Shareholder Agreements

While the concept of ROFR is common in both US and UK startup ecosystems, its legal implementation and context differ. Overlooking these UK- and US-specific legal and tax requirements can trigger costly compliance issues and shareholder disputes, making it a critical area of focus for international teams and investors.

ROFR in the United States

In the US, particularly for venture-backed Delaware C-Corporations, ROFR is primarily a matter of contract law. The rules are defined in governing documents like the Stockholders' Agreement or a Voting Agreement. The process is standardized, and the priority cascade is typically spelled out in detail, creating a predictable framework for all parties. For more on standard practice, see this guidance on secondary sales of private company stock.

ROFR in the United Kingdom

In the UK, the framework for startup share transfer rules is slightly different. ROFR rights are often defined in both the Shareholders' Agreement and the Articles of Association. Embedding the right in the Articles, the company's constitutional documents, gives it additional legal weight. Furthermore, it is important to distinguish ROFR on secondary sales from statutory 'pre-emption rights' under the Companies Act 2006. These statutory rights apply to new share issuances, giving existing shareholders the first chance to buy new shares to avoid dilution, a distinct concept from ROFR on secondary sales.

Finally, cross-border transactions involve different tax implications, such as UK Capital Gains Tax versus US long-term capital gains, which adds another layer of complexity for shareholders to consider when planning for liquidity.

Practical Strategy for Founders and Shareholders

For resource-constrained founders and employees, navigating the secondary sale process requires proactivity, not a deep legal budget. The reality for most Pre-Seed to Series B startups is more pragmatic: understanding the process is your best defense against delays and disputes. A clear grasp of your rights and obligations ensures you can manage expectations effectively.

For Company Leadership

• Document Your Process: Don't wait for a sale notice to figure this out. Have a clear, simple internal checklist for handling a ROFR notice. This ensures fairness, predictability, and compliance with your governing documents.
• Communicate Clearly: When an employee or founder submits a notice, acknowledge it promptly and explain the timeline. This transparency builds trust and helps the selling shareholder plan accordingly.
• Know Your Documents: Be fluent in the specific ROFR provisions in your Stockholders' Agreement or Articles of Association. Understand the company's rights, the matching period, and the priority cascade before a notice ever arrives.

For Selling Shareholders (Founders & Employees)

• Read Before You Shop: Before seeking a buyer, review your stock purchase agreement and the company's governing documents. Understand the waiting period, notice requirements, and any transfer restrictions.
• Set Buyer Expectations: Be transparent with your potential third-party buyer about the ROFR process and the mandatory waiting period. This avoids surprises that could otherwise cause a promising deal to fall apart.
• Be mentally and financially prepared: Prepare for either outcome. Be ready for the company or an investor to exercise their right. The good news is you still achieve liquidity on the same economic terms you negotiated with your external buyer.

For a deeper view of related concepts, visit the Term Sheet Understanding hub.

Frequently Asked Questions

Q: What happens if the company or investors only want to buy some of my shares?
A: Most agreements allow the company or investors to purchase all or a portion of the shares you intend to sell. If they only buy a part, you are typically free to sell the remaining shares to your third-party buyer, provided the sale is completed under the same terms and within a specified timeframe.

Q: Can I change my mind after submitting a ROFR notice?
A: Generally, no. Submitting a ROFR notice signals a firm intent to sell based on a bona fide offer. Backing out after the company or an investor decides to exercise their right could lead to legal disputes. It is critical to be certain about your decision to sell before formally starting the process.

Q: Is the price the only term that must be matched in a Right of First Refusal?
A: No, all material terms of the bona fide offer must be matched exactly. This includes not only the price per share but also the form of payment (cash, stock), the payment schedule, and any other significant conditions of the sale. The exercising party cannot selectively choose favorable terms.