April In addition, we encounter valuation practices that present concerns in certain contexts, including:

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1 April 2011 We wanted t take the pprtunity prvided by the AICPA s recent release f the expsure draft Practice Aid t share with ur clients and friends sme bservatins and best practice suggestins n this tpic. We refer t the accmpanying article by Cgent Valuatin titled Cheap Stck Valuatin Allcatin Methds fr mre infrmatin n the AICPA Practice Aid and the significance f its release. Federal tax rules gverning deferred cmpensatin (Internal Revenue Cde Sectin 409A) have changed the landscape f private cmpany valuatin practices since The Sectin 409A regulatins impse a reasnableness requirement n the determinatin f the fair market value f the stck underlying emplyee stck ptins, with dire cnsequences fr ptins with strike prices belw the grant date fair market value. Because these regulatins ffer a presumptin f reasnableness if the stck value is based upn an independent appraisal that meets certain requirements (we refer t this presumptin as the independent valuatin safe harbr ), many private technlgy and bitechnlgy cmpanies nw rutinely btain third-party valuatins t supprt their ptin pricing decisins. Althugh many f the private cmpanies we wrk with nw rutinely btain independent valuatins f their stck, questins cntinue t arise. The AICPA Practice Aid will certainly draw renewed attentin t these issues, and perhaps bring greater clarity. Frm ur vantage pint, thugh, the Practice Aid release is just ne f several develpments related t private cmpany stck valuatin matters that merit attentin. These include: Increased IRS fcus n private cmpany valuatin matters, including in the cntext f nging 409A audits f larger public cmpanies that acquire private cmpanies, Public cmpanies increased reluctance t take n risk arising frm the valuatin practices f the private cmpanies they acquire, and Secndary sales f private cmpany stck at prices that vary frm a cmpany s 409A valuatin. We attach t this Alert sme Further Observatins n private cmpany valuatin matters in which we discuss these develpments in mre depth. In additin, we encunter valuatin practices that present cncerns in certain cntexts, including: Meaningful delays between the as f date f a third-party valuatin reprt and the issuance date f the same reprt t the cmpany, such that events ccurring after the as f date make the reprt s cnclusin bslete befre the cmpany can even use it, Obtaining a valuatin after the fact t supprt the pricing used fr already-granted ptins, where the valuatin btained reflects a grant date fair market value that is higher than the exercise price, Obtaining bard apprval f ptin grants prir t btaining the valuatin reprt n which the ptin pricing will be based, Cntinuing t rely n an independent valuatin fr 12 mnths (the maximum perid permitted under the safe harbr), withut cnsidering whether any material events made the valuatin bslete, and An absence f any prcess r back-up fr stck valuatins by early-stage cmpanies.

2 As we cntinue t watch these develpments, we wanted t ffer these best practice suggestins: Even early stage private cmpanies that d nt btain an independent valuatin shuld establish thughtful valuatin practices that include cnsideratin f the factrs identified in the Sectin 409A regulatins and shuld dcument the steps taken t determine the values used fr ptin pricing purpses. Such practices wuld ptimally include a mem t file that discusses the relevant factrs and circumstances that existed each time ptins are granted, as well as a bard recrd that reflects the bard f directr s cnsideratin f these same factrs and circumstances. The Sectin 409A regulatins ffer a secnd safe harbr fr early-stage private cmpanies that have access t a valuatin expert, such as a venture capitalist r smene else with at least five years apprpriate experience valuing cmpanies, prvided that the prcess is dcumented in a written reprt. Cmpanies nt btaining an independent valuatin shuld try t avail themselves f this safe harbr, when practicable. Private cmpanies that btain independent valuatins shuld recgnize that: Yu get what yu pay fr Saving a few thusand dllars nw might be imprtant, but it needs t be weighed against the truble that culd fllw if, a few years hence when the cmpany s stck value has risen cnsiderably, the auditrs, an acquirer r the IRS reject the valuatin, e.g., n the basis that the valuatin firm did nt use apprpriate methdlgy. Garbage in/garbage ut The valuatin firm needs t have all relevant infrmatin affecting the cmpany s stck value when they prepare their valuatin reprt. If in prximity t the valuatin reprt the cmpany has, fr example, received an acquisitin ffer r experienced significant secndary sales, we expect that n audit r in diligence it wuld be very helpful t see the valuatin reprt specifically reference these events, even if nly t dismiss them as nt influencing entity r stck value. Private cmpanies wrking with an appraisal firm shuld determine an apprpriate valuatin update cycle. While the independent appraisal safe harbr prvides that the appraisal may be relied upn fr as lng as 12 mnths, ur view is that the permitted reliance perid ends when an event ccurs that materially affects the valuatin. A bard f directrs shuld cnsider whether the business envirnment in which the cmpany perates requires either a mre frequent valuatin cycle r a less frequent ptin grant cycle. Valuatin firms will wrk with clients t help them determine whether an updated appraisal is apprpriate and many ffer a fixed annual rate that includes quarterly r semi-annual valuatin updates. Cmpanies whse circumstances are changing rapidly, in particular thse entering the registratin prcess r likely t receive acquisitin bids, shuld wrk with the valuatin firm t cmpress the time between delivery f the valuatin reprt and its as f date. Private cmpany valuatin matters are likely t see cntinued fcus and develpments ver the next few years. Fr cmpanies that have nt reviewed their valuatin practices recently, the issuance f the AICPA Practice Aid might serve as a useful wake-up call that nw wuld be a gd time t undertake such a review. Gundersn Dettmer s lawyers are available t assist in addressing questins yu may have regarding the issues discussed in this Alert. Please cntact the Gundersn Dettmer attrney with whm yu regularly wrk. Cntact infrmatin fr ur attrneys can be fund at LEGAL DISCLAIMER Gundersn Dettmer Stugh Villeneuve Franklin & Hachigian, LLP prvides these materials n its web pages fr infrmatin purpses nly and nt as legal advice. The Firm des nt intend t create an attrney-client relatinship with yu, and yu shuld nt assume such a relatinship r act n any material frm these pages withut seeking prfessinal cunsel.

3 DISCLAIMER UNDER IRS CIRCULAR 230 T ensure cmpliance with requirements impsed by the IRS, we infrm yu that any U.S. federal tax advice cntained in this cmmunicatin (including any attachments) is nt intended r written t be used, and cannt be used, fr the purpse f (i) aviding penalties under the Internal Revenue Cde r (ii) prmting, marketing r recmmending t anther party any transactin r matter addressed herein. Attrney Advertising: The enclsed materials have been prepared fr general infrmatinal purpses nly and are nt intended as legal advice. Our website may cntain attrney advertising as defined by laws f varius states.

4 April 2011 We wanted t share in greater detail sme bservatins we have related t the valuatin issues we discuss in ur Client Alert, Private Cmpany Stck Valuatin and Optin Pricing Matters. Our cmments n the tpics belw are merely that bservatins drawn frm ur practice and ur nging wrk with ver ne thusand private cmpanies: Increased IRS fcus n private cmpany valuatin matters. In the curse f its practice f nearly cntinual audits f large U.S. public crpratins, the IRS has issued multi-page infrmatin dcument requests that include Sectin 409A requests. These IDRs include requests fr detailed infrmatin relating t private cmpanies acquired by the public cmpany under audit, and we understand that in the curse f these audits the Service is lking clsely at the private target cmpany s valuatin practices. Cheap stck charges taken fr financial statement purpses at the time f an initial public ffering n the basis f after-the-fact (as ppsed t cntempraneus) valuatins is itself nthing new. Hwever, many clients express cncern abut the pssibility that the IRS might use a later-btained valuatin develped fr this nn-tax purpse t undermine the reasnableness f the valuatin used when the cmpany granted ptins s as t cnclude that the affected ptins are subject t and vilate Sectin 409A. In additin, the IRS has increased its audits f smaller cmpanies. We expect that recently-public cmpanies with relatively high valuatins wuld be a primary target f such audits. Secndary sales f private cmpany stck at prices that vary frm the cmpany s 409A valuatin. With high-valuatin private cmpanies seeing a dramatic increase in sales f their stck by existing stckhlders, including thrugh SecndMarket, SharesPst and in a variety f ther types f transactins, we currently have mre questins than answers abut the effect f such sales n 409A valuatins. This issue, which the AICPA Practice Aid may ultimately help clarify, bears clse attentin. T date, ur experience has generally been that limited secndary sales f a cmpany s stck, especially if the sales are t cmpany affiliates r t parties wh have access t little financial infrmatin abut the cmpany, have nt had much influence n the cmpany s 409A valuatin n the basis that sales under such circumstances are nt thught t be a gd indicatin f actual value. The valuatin analysis in this cntext, hwever, depends n the specific facts and circumstances, and cmpanies experiencing secndary sales will face increasing pressure t cnsider the need t update their 409A valuatin if they want t cntinue perating within the independent appraisal safe harbr. Clients shuld als nte that in sme circumstances insiders wh sell stck t the cmpany r t cmpany affiliates at a premium t the sale date fair market value f the stck can be deemed t have cmpensatin incme n sme r all f the sales prceeds abve fair market value. In certain fact-specific cntexts, the cmpany can als have withhlding bligatins n this incme, ntwithstanding that the cmpany may nt have been a direct party t the sale transactin. Cmpanies shuld seek advice n these matters early in the curse f the transactin. We nte this issue t highlight that successfully distinguishing the secndary sales values frm the cmpany s 409A valuatin can in sme circumstances result in transactins that feel capital in nature being re-characterized as cmpensatry transactins. Public cmpany acquirers exhibiting increasing reluctance t take n risk arising frm the valuatin practices f the private cmpanies they acquire. We nw see fewer acquisitins in which public cmpany acquirers assume private cmpany stck ptins and suspect that this change in deal structure relates in part t the acquirers reluctance t assume alng with the ptins themselves the tax and emplyee relatins risk that might accmpany the ptins if the histric stck values seem unreasnable.

5 In additin, ptins granted in the weeks preceding an acquisitin with strike prices at a discunt t the deal price receive a high level f scrutiny. The results f this scrutiny are unpredictable and are likely influenced by the parties risk prfiles. In sme deals, the parties have cncluded that ptins granted in the weeks prir t the transactin must be uppriced under existing IRS crrectins prcedures (if these prcedures are available in the specific circumstances). In ther cntexts, parties have btained a retractive independent valuatin cncluding that the actual fair market value was nt nly substantially less than the deal price but less even than the value the target cmpany used fr purpses f setting the exercise price! Further, and while we wuld nt suggest this is a trend, we have encuntered acquirers that, when faced with what they view as inadequate prcess supprting the exercise prices that apply t the target cmpany s ptins, are inclined t simply cncede that pre-acquisitin ptins vilate Sectin 409A (and require that they be reprted as such, a matter which the acquirer cntrls nce the deal clses) withut waiting fr that pint t be raised in an audit. Shuld this extremely cnservative apprach develp int a trend, it seems that Sectin 409A wuld have the effect f impsing a ptentially substantial premium n the cst f acquiring private cmpanies. Fr all f these reasns, it is in ur view well wrth it fr even an early-stage cmpany t develp and keep current n thughtful valuatin practices and t cntinue t pay attentin t further develpments n these issues. Gundersn Dettmer s lawyers are available t assist in addressing questins yu may have regarding the issues discussed in this Alert. Please cntact the Gundersn Dettmer attrney with whm yu regularly wrk. Cntact infrmatin fr ur attrneys can be fund at T ensure cmpliance with IRS requirements, any U.S. federal tax advice cntained in this cmmunicatin is nt intended r written t, and cannt, be used (i) by any taxpayer fr the purpse f aviding tax penalties under the Internal Revenue Cde, and (ii) fr prmting, marketing r recmmending t anther party any transactin r matter addressed herein. Attrney Advertising: The enclsed materials have been prepared fr general infrmatinal purpses nly and are nt intended as legal advice.