Know your Shareholders’ Agreement (SHA) — 2 of 5
Transfer restrictions, as I discussed earlier, carry paramount importance in an SHA both for the investor and the founders. Why should founders care? Well, their liquidity needs depend on these restrictions.
ROFR vs ROFO
In this post, I will discuss some other restrictions after lock-in, popularly known as ROFR and ROFO.
A right of first refusal, or ROFR, is a right that gives the investor the opportunity to match a third-party offer to buy the founder’s shares before it is accepted. The right of first offer, or ROFO, on the other hand, gives the investor the first opportunity to accept an offer before it is made to a third party.
The main difference between a ROFO and a ROFR is price discovery. In ROFR, price discovery happens (by exploring third-party buyers in the market first) before making an offer to the investor, whereas in ROFO, the investor has to determine the price and make an offer.
Which one is better for the founders? Certainly ROFO. An investor will discover the price and make an offer, after which founders can explore the market and find a buyer who will match that price or make a better offer.
What happens when an investor rejects his ROFO or ROFR but opts to Tag Along?
Tag Along
We discussed the difference between ROFO and ROFR, as most of them ignore the concept with the expression “potato, potahto.” But do investors stop here?
Well, the answer is no. Even if they request ROFO/ROFR rights in the SHA, it might be the case that they do not opt to exercise their rights. Do they let founders sell their shares to any third parties? Here is the catch: they can still stop founders by exercising their right to ‘Tag Along’.
What is Tag along? In simple terms, this right requires the founders to include the shares of the investors in any sale of their shares and to offer those shares to the third-party buyer on the same terms and conditions.
What must founders look for while giving away this right? Here is the list:
✅ Make sure the investors have the right to tag along only those shares that are pro-rata to the shares being sold by the founders. Founders may never be able to find any buyers if this provision is not taken care of.
✅ Investors will push for the right to sell all their shares in case the sale of shares by the founders results in a change in control of the entity. Depending on the facts of each case, this may be negotiated.
✅ Carve out for transfer by founders to their affiliates from Tag Along provisions.
Also, make sure the provisions in the SHA are not broad but very specific, including the detailed timeline for submission of Tag-Along notice by the founders and response notice by the investors, investors’ failure to provide response notice, R&W and corresponding indemnities to be provided by investors in case of sale, etc.
Want to know more? Hit me up at khushbookhatreja23@gmail.com
Here is the link to the next post in this series: https://medium.com/@khushbookhatreja/know-your-shareholders-agreement-sha-3-of-5-2e22e93b4eb7