Right of First Refusal and Your Business

November 16, 2000
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For some it’s a great lifeline; for others, it’s like a spider’s web. It’s a contractual clause called the right of first refusal (ROFR).

Simply stated, the right of first refusal is an agreement made between a seller and a potential buyer allowing the buyer the option to purchase a home or business in the future by matching any other bids. Should an outside offer to the seller arise, the buyer with the right of first refusal has the option of matching the bid or walking away from the deal.

Say, for example, that you sign a right of first refusal agreement with Manufacturer “A”; along come Mr. and Mrs. “B,” who want to take over your business, and they offer you $1 million. Manufacturer “A” hears about the offer — because you are legally obligated to inform the company — and also offers $1 million. You have to sell to “A.”

“The problem with these types of clauses is that they keep future competition from knocking on the door,” said Wendell Bedell of the Excellence Alliance Institute (EAI). “Competitors will not put their best offer on the table due to the fact that information is immediately given to the existing provider, who can then choose to match the offer.”

However, it isn’t mandatory for contractors to sign onto ROFR agreements. Contractors have a choice.



The Effect On Hvacr Contractors

A typical scenario might involve a contractor who sells predominantly one manufacturer’s line of products; the manufacturer may have a strong interest in acquiring the contractor at some time in the future, and offers the ROFR agreement. The contractor signs a ROFR clause with the manufacturer, knowing that the manufacturer has a definite interest in acquiring the business should the owner decide to retire or move on to something else.

One contractor wanted to keep the business in the family, so he simply said no. “We were approached by Lennox to be one of their associate dealers, giving them first right of refusal if we ever wanted to sell out,” said Brad Tanner of Triple “T” Heating & Cooling in Spanish Fork, UT.

“With our current focus on keeping this a very strong family-owned, independent business, we did not see any gain for us to do this.” However, “Our choice was to maintain our Lennox and Bryant brands as our preferred brands of equipment.”

Another contractor, who asked to remain anonymous, said the manufacturer whose equipment he sells has a plan for contractors who sign a ROFR agreement with them. “In exchange for right of first refusal, the manufacturer would set up a retirement program for me as long as I continued to purchase 75% of my equipment from them,” he said. “If my percentages dropped below that, I would lose their contribution to the retirement plan.

“It was obvious I’d never have full vesting in the retirement plan. They also would have the option to buy me out if I wasn’t performing to their expectations.

“The right of first refusal discourages anyone else from coming in because they realize that the manufacturer can match their offer and walk away with the deal.”



Manufacturers’ Views

Doug Young, vice president and general manager, North American Residential Sales & Distribution for Lennox Industries, Inc., offered his input on the subject of ROFRs and the advantages of having a ROFR in place between manufacturers and contractors.

“A ROFR is not limiting the contractor in any way unless the purchaser is scared off because of it,” Young said. “ROFRs are customary in business today.

“A contractor who has a ROFR may be better off if he or she chooses to sell their business. By having the ROFR, they are allowing another prospective buyer an opportunity to agree that the business has value and perhaps more value than the original offer. ROFRs don’t tend to depress the sales price.

“Manufacturers tend to prefer ROFRs,” he continued. “They identify owners who may be thinking about selling their business or who may want to in the future, and owners who clearly have no interest to sell their business at this time. They make the acquisition time period more efficient and tend to align the buyer and seller quicker.”

David Trust, Carrier manager of business development for commercial systems and services, said his company does purchase commercial hvacr service contractors, but Carrier has never used the ROFR clause in its purchasing strategy. “Our acquisitions are strategic in nature and structured,” he said. We have never felt the need to [use ROFR].”



Not An Exit Strategy

The right of first refusal can be viewed as an exit strategy, although one expert said the whole scenario is a little hard to swallow.

“At first blush, the right of first refusal seems to be implausible for any contractor or business owner in this day of consolidators and other buyers of hvacr businesses,” said EAI’s Mike Hajduk. “Just a few short years ago, there was a wealth of sellers and virtually no buyers.

“Most hvacr companies transferred ownership to children or employees under an aggressive earn-out plan, or merely shrunk to a shadow of their past. While the frenzy has died down of late, the 55- to 65-plus-year-old owners still maintain the desire for an exit strategy.”

Bedell added that there is a time and place for ROFR clauses. However, “If buyers wish to avail themselves in the future of the best deal in order to remain competitive, they should limit the duration of such clauses to a reasonable period,” he said. “The reasonable period should be hedged based on environmental trends that drive pricing.”

The bottom line, according to hvacr insiders, is to maintain a strong business and a strong working relationship with manufacturers — and read the fine print in the clauses.

Publication date: 11/20/2000

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