Anatomy of a Term Sheet - Share Transfers and Rights of First Refusal

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or more information on this post contact Scott Preece.

It is fairly typical in UK transactions, for Investors to insist that founders cannot sell or transfer their shares without the consent of the Investor. This helps protect the Investor from the founders selling out early (although the reality is, that the shares are pretty illiquid and it is very difficult to sell the shares until an exit (or upon an investment if there is investor demand).

Regardless of whether the documents contain a veto on founder transfers, it is standard for investors to require Right of First Refusal (or "ROFR") provisions.

ROFR provisions require a founder and/or other shareholders, to first give the Company or the Company and thereafter certain shareholders the right to purchase shares, before selling any shares. Any such offer would be on the same terms and conditions for the proposed third-party sale. This right helps protects Investors from having to deal with unknown outsiders becoming shareholders.

In practice ROFR provisions are rarely used, however the items typically negotiated include:

  • Who should be subject to the ROFR?  From the Company’s and VCs' perspective, they want to ensure that they have some control over the transfers of large shareholdings. In the US investors/VCs are not typically subject to any transfer restrictions or subject to the ROFR (on the basis that as a fund the VCs want to have the ability to freely sell their shares if required). In Europe it is not uncommon for Investors/VCs to be subject to the ROFR. 
  • Who should benefit from the ROFR? In the US, the ROFR usually operates in that any offer is made first to the Company and then to the VCs (if the Company does not take its rights). In the UK, there are restrictions on a Company’s ability to acquire its own shares so such rights are usually structured in favour of just the VCs or the other shareholders. One consideration is that in the unlikely event that the ROFR is ever exercised, in having the right in favour of all shareholders could be cumbersome and time-consuming, so it is probably advisable to keep the ROFR rights in favour of a small group.
  • Permitted Transfers. Shareholders subject to a ROFR will want various share transfers to be exempt from the ROFR provisions in order to allow for tax planning or inter-group transfers. We are also seeing, provisions that allow Founders to sell a certain number of shares (although the commercial reality is that there is a limited market for such shares).

The Anatomy of a Term Sheet series can be found in full here.

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