Right of first refusal gives an individual, business, or other entity the right -- but not the obligation -- to buy an asset if its owner decides to sell it. There are many different applications of right of first refusal clauses and some important implications for investors, especially in the real estate sector. In this article, we’ll cover what the right of first refusal is, how it works, and how it applies to investing.
What is right of first refusal?
Right of first refusal, or ROFR, is a right given to one party by another to enter into a transaction before anyone else is allowed. For example, if you give someone the right of first refusal to buy your home at $300,000, and you decide to sell, they get to decide whether or not they want to buy it before you can consider any other offers.
While the right of first refusal can technically apply to any type of business transaction, it is most common in real estate, both among individuals and corporations. As one example, the right of first refusal to buy a property is often included in real estate leases, giving the tenant the right to purchase the property they live in or use instead of having to relocate when the property is sold.
ROFR deals are also often seen in cases where a property or other asset is jointly owned. For example, if you and a partner each own a 50% stake in an apartment building, you might have a right of first refusal clause that gives the remaining owner the right to acquire the other half if one owner wants to sell their stake.
How it works
Think of a right of first refusal in the same context as buying a stock option. A stock option gives you the right to purchase a stock at a certain price, but not the obligation. The biggest difference is that a ROFR clause doesn’t take effect unless the asset owner decides to sell. In a ROFR agreement, neither party has an obligation to buy or sell anything. The seller simply has to give the other party the option to be the buyer.
Right of first refusal agreements can come in a variety of forms. Some have a time limit, while others are indefinite. A ROFR agreement can cover one asset or several. And some ROFR clauses can have more complex rules, as we’ll see in a later example.
Right of first refusal in investing
Having the right of first refusal to purchase certain assets can give a company a competitive advantage over rivals. We’ll take a look at an example in the next section, but the general idea is that right of first refusal can allow a business to prevent competitors from acquiring properties and other assets that could be beneficial to their growth strategy, but without the obligation to spend any money if the deal doesn’t look attractive.
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