Rights of First Refusal and Co-Sale Agreement

One of the dangers inherent to most startups, and to any relatively small corporation for that matter, is the ability of a single individual to fundamentally affect the overall welfare of the corporation. For example, a founder or major stakeholder can sell his or her shares to a competitor whose only interest is to dissolve the corporation and prevent it from competing. As a result, it is important for a corporation to place checks and controls on the ability of large stakeholders to sell their shares, and the execution of a Right of First Refusal and Co-Sale Agreement is one way to do that.

That said, founders and large stakeholders in the corporation will generally want to limit the amount of investors subject to a Right of First Refusal, namely because of all the legal and administrative hassles that arise in connection with subsequent financing rounds. In such cases, Rights of First Refusal may have to be amended. Smaller investors, on the other hand, will more likely than not favor having these agreements in place, given that the value of their investment in the company is subject to the whims of larger shareholders. The balance between these competing interests will be struck in the form of an agreeable Right of First Refusal and Co-Sale Agreement.

The Right of First Refusal is typically granted first to the company itself and accords the company the right to receive notice of any intention of a person covered by the agreement to sell his or her shares, and grants the company sufficient time to make a decision as to whether it will make an offer to purchase those shares. If the company chooses not to exercise its right to purchase the shares, then the preferred shareholders will typically be given a right to purchase the shares as well. As among the preferred shareholders the Right of First Refusal is distributed on a pro rata basis.