Comments on: What is a right of first offer or right to maintain proportionate ownership in future financings?

By: Yokum

Yokum — Tue, 09 Sep 2008 22:00:33 +0000

You are correct. I meant 25/125, not 24/120.

By: Terrence Smith

Terrence Smith — Tue, 09 Sep 2008 21:54:09 +0000

Yokum,

I must admit my math skills aren’t ideal, so my apologies if I’m missing something very simple, but if 24 shares of Series B stock is being issued, wouldn’t the percentage be 24/124 (common, Series A, and Series B), not 24/120?

Thanks.

By: YW452

YW452 — Tue, 09 Sep 2008 16:31:17 +0000

Thanks so much for the corrections.

By: Yokum

Yokum — Tue, 09 Sep 2008 07:34:38 +0000

@YW452 - See the post "What is a right of first refusal and co-sale agreement?" As a practical matter, almost all founders are subject to a RFR/Co-sale (right of first refusal and co-sale), so I'm not sure it is meaningful to consider whether the RFR/Co-sale inhibits third parties from making offers to purchase the founders' stock. In most cases, a third party would want newly issued preferred stock, not the common stock typically held by founders. The RFO (right of first offer) typically allows an investor to maintain its percentage ownership on a fully-diluted basis. You math is not correct because additional shares issued to the Series A investor will dilute the Series B investor's goal of owning 20%, so there is a circular formula that needs to be solved for. Let's assume there are 100 fully-diluted shares, 80 common and 20 Series A. The Company proposes to sell 25 shares of Series B, so that the Series B holder would have 25/125, or 20%. The right of first offer would allow the Series A investor to purchase 20% of 25 shares, or 5 shares. However, this would mean that the Series B holder has less than 20% (20/125). Thus, in order to result in the Series B holder owning 20% and Series A holder owning 20%, you would need to solve for the following equation: [X - .2X] / [100 + X] = .2 where X is the number of shares offered in the financing. The answer is X = 33.3, so that the new Series B investor purchases 26.66 shares and the old investor purchases 6.66 shares.

By: YW452

YW452 — Tue, 09 Sep 2008 00:05:36 +0000

I thought ROFR means when an investor/founder is trying to sell its share to any other third party, the company have the right to purchase from the selling investor/founder the shares it intents to sell at a matching price. I think it does have an effect to repel third party to buy shares from the investor/founder. Am I correct?
I understand that the right of first offer does not really affect the third party investor because the right of first offer “attaches to”, rather than “replaces”, the shares the third party investor wants to buy.
Let’s say a company initially have a Series A shareholder with 20% interest in the company, and the remaining 80% is held by founders. If a Series B investor wants to invest in the company 2 million for a 20% interest, then, the Series A investor, if he wants to maintain a 20% interest in the company, has to use the right of first offer to invest an additional 400k (if he doesn’t invest, it would be diluted to 16%, so he has to pay for the 4%, which is 400k in our case) to maintain the 20% interest . After exercising his right of first offer, the company would be 20% owned by each of the Series A and Series B investor, and the founders will own 60%. Am I right?

By: Yokum

Yokum — Fri, 05 Sep 2008 03:55:37 +0000

@Terrence – As a practical matter, no. A right of first offer is in almost every financing. As a practical matter, I don’t think potential investors even consider the issue. If a company is meeting with a VC, there is an expectation that the company wants the VC’s money and that appropriate steps will be taken to facilitate it. This is, of course, different from a right of first refusal on a sale of company.

By: Terrence Smith

Terrence Smith — Fri, 05 Sep 2008 03:21:42 +0000

Yokum,

Although the ROFR is a very common provision in financings, do you believe that potential investors may limit engaging seriously with a potential investment target if they feel that an existing investor may “match” them, by exercising an existing ROFR?

I envision that this would depend upon the percentage to which this ROFR applies. I am curious to know whether in practice you have experienced such a scenario.