THE CHANGING VENTURE CAPITAL LANDSCAPE:

1. THE CHANGING VENTURE CAPITAL LANDSCAPE: Summary of Recent U.S. and European Legislative ProposalsEvolving PRC Investment StructuresBest Tax Compliance Practices for Funds with U.S. Investors or Managers CVCFO November 2009 Meeting Steven R. Franklin sfranklin@gunder.com

2. U.S. Advisers Act Legislation GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

3. U.S. Advisers Act Legislation • Private Fund Investment Advisers Registration Act of 2009 (House of Representatives) • Removes exemption from registration historically relied upon by venture capital and private equity funds • Authorizes SEC to collect additional information in the public interest/investor protection • Exempts • “Venture Capital” funds, a term to be defined later • Unclear how this will ultimately be defined. It is intended to exclude buy-out funds, which may pose problems for late-stage venture capital funds • Advisers managing SBICs • Advisers with individual funds <$150m • Includes Non-U.S. funds that have raised money from U.S. investors • Passed House Financial Services Comm. 67-1 GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

4. U.S. Advisers Act Legislation (Cont.) • Private Fund Investment Advisers Registration Act of 2009 (Senate) • Remove Adviser Act exemption from funds with less than 15 clients • Limited foreign private adviser exemption • No U.S. place of business • Fewer than 15 U.S. clients • Less then $25 million assets under management attributable to U.S. Clients • Exempts • “Venture Capital Funds,” term to be defined by SEC; exempt from registration • “Private Equity Funds,” term to be defined by SEC; exempt from registration, but subject to recordkeeping and access requirements • “Family Offices,” term to be defined by SEC; excepted from the definition altogether • Advisers with individual funds <$150m • Introduced by Sen. Chris Dodd • Chairman of the Senate Committee on Banking, Housing and Urban Affairs. • Likely supersedes previous legislation (including Sen. Reed’s similar proposal) • Part of >1000 page legislation on financial systems reform • Increases the minimum threshold from $25M to $100M for SEC registration; smaller funds must register with the states. • Directs the SEC to adjust the “accredited investor” threshold under the 1933 Act every 5 years. GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

5. U.S. Advisers Act Legislation (Cont.) What does Adviser Act compliance entail? • Electronic registration on Form ADV • Part I – Basic information, including jurisdiction of incorporation, place of business, structure of investment adviser, states in U.S. where they operate, criminal/civil legal proceeding history • Part II – Nature of services, fees charged, investment objectives, risks, strategies, methods of analysis of prospective investments, sources of information, affiliations in financial sector including related conflicts, education and other business background • Performance Fees • May only be charged if investor is a “Qualified Client” – defined as (i) a Qualified Purchaser under the Investment Company Act, (ii) if $750,000 is invested in fund, (iii) net worth in excess of $1.5 million or (iv) non-U.S. person • Result = Traditional 3(c)(1) funds (i.e, funds that want to raise money from smaller institutions and from individuals with less than $5MM of investment assets) will be more difficult to form without an exemption • SEC Examinations, compliance program, code of ethics, periodic filings to clients and the SEC, appointment of Chief Compliance Officer, custodial rules, prohibitations on certain forms of advertising, no assignment of services without consent, and recordkeeping GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

6. Additional U.S. Legislation GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

7. Additional U.S. Legislation • Other bills have been introduced to study the effects investment funds have had on the market and recommend further regulations. • Financial Oversight Commission Act of 2009 • Financial Crisis Investigation Act of 2009 • Hedge Fund Adviser Registration Act of 2009 • Pension Security Act of 2009 • Hedge Fund Transparency Act GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

8. Additional U.S. Legislation (Cont.) NY State Power of Attorney Statute • Effective Sep. 1, 2009 all powers of attorney (“POA”) signed in NY by natural persons must comply with a new set of rules • Require disclosures, certain fonts, notarization • Any new POA revokes all previously executed POAs • Major implications for funds • Changes fiduciary relationship (GP owes duty to LP) • Careful drafting of new POAs so as not to affect old POAs • “Passing through New York” problems • Be careful about amending vs. amending and restating agreements so as not to extinguish existing POA GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

9. EU Legislation GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

10. EU Legislation • The Directive on Alternative Investment Fund Managers was proposed on April 29, 2009 by the European Commission. • Attempts to regulate investment funds that are not already covered by current EU regulations, UCITS (Undertakings for Collective Investment in Transferrable Securities). • Subjects fund manager with € 500 million in assets under management with no right of redemption for 5 years (or €100 million in assets if leveraged) to various regulatory restrictions. • Aimed at both EU and Non-EU domiciled funds. • Requires disclosure requirements similar to Adviser Act of 2009. GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

11. EU Legislation (Cont.) • EU based fund managers would be subject to local regimes (i.e. U.K. Financial Services Authority) • LPA must be provided to regulator • Conduct of business principles, strict conflicts of interest rules, risk management, GP capital account requirement (€125,000 + 0.02% of assets > €250,000), independent valuator for portfolio valuation, custodial requirements, annual report to investors and regulator, among other items GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

12. EU Legislation (Cont.) • Marketing to EU based investors • EU based manager • Must be authorized (see above) • Can only market to “professional investors” (institutions, and only limited high net worth individuals), except as provided by local law • Before marketing must provide regulator with all fund related documents • Non-EU domiciled funds → Same rules as above and must be based in OECD compliant tax jurisdiction • Non-EU fund mangers → Must elect to be subject to the financial regulatory rules of at least one EU country GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

13. EU Legislation (Cont.) Recent developments regarding these proposed EU regulations: • Charles River study of compliance costs (as a % of assets under management) • VC – one-time .338%, ongoing annual.248% • PE – one-time .421%, annual .138% • European Central Bank warned in October that private equity would flee Europe if adopted • UK has mounted stiff opposition, though France, Spain and Germany are supportive • Requires approval of EU Parliament and EU governments GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

14. U.S. Carried Interest Tax Legislation GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

15. U.S. Carried Interest Tax Legislation History of Proposals • In 2007 Representative Sander Levin introduced bill to address carried interests, treating carried interests as services income • Later in 2007, House of Representatives passed the “Temporary Tax Relief Act of 2007,” which included provision on carried interests • Similar provision passed House in “Alternative Minimum Tax Relief Act of 2008” • On April 3, 2009, Representative Levin introduced bill revising technical aspects of House legislation • On May 11, 2009, Administration budget described provision to tax carried interests GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

16. U.S. Carried Interest Tax Legislation (Cont.) Recent Developments • House Ways and Means Committee has announced it intends to move forward in the coming months to pass carried interest tax legislation • Sen. Schumer, a past critic, is now in favor of such proposals • Any proposal will require 60 votes in the Senate • Top marginal tax rate is scheduled to increase to 39.6% in 2011; self employment tax would add another 3% GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

17. U.S. Carried Interest Tax Legislation (Cont.) Who is Covered? • Levin Bill covers only holders of “investment services partnership interest” • Obama Administration budget proposal would expand scope so that all industries are covered by carried interest legislation • Obama Administration proposal would apply ordinary income treatment to a “services partnership interest” • Accordingly, covers a common/preferred capital structure of an operating company (including a non-U.S. company that is treated as flow-through entity) • Earlier versions of the bill would have taxed even non-U.S. investment managers (not resident in the U.S.) if the Fund had any personnel inside the U.S. Current version appears to only affect managers who are U.S. citizens or residents or otherwise generally subject to U.S. tax (including Green Card holders) or who are performing services in the U.S. GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

18. U.S. Carried Interest Tax Legislation (Cont.) Potential Impact • What is the potential impact of the Levin bill for a party who holds a carried interest? • Net income and net loss with respect to an investment services partnership interest is treated as ordinary. • However, net losses are allowed only to the extent that aggregate net income for prior years exceeds aggregate net losses for such years. • Net income is also treated as self-employment income, subject to self-employment tax GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

19. U.S. Carried Interest Tax Legislation (Cont.) In-Kind Distributions Will Become Difficult Impossible for Funds with U.S. Managers • Property distributions no longer qualify for favorable deferral available under existing law • If the partnership distributes appreciated property with respect to an investment services partnership interest • Gain will be triggered to the partnership as if it sold the property for its fair market value and that gain will be allocated to the distributee as ordinary income • The property is treated as cash with respect to the distributee partner, so that gain will be triggered to the extent that the value of the distributed property exceeds the partner’s basis in the partnership interest (determined after adjustment for gain allocated) • Distributee partner takes fair market value basis in distributed property GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

20. U.S. Carried Interest Tax Legislation (Cont.) Treatment of Capital Interests • The Levin bill exempts from its coverage the portion of a service provider’s partnership interest that is acquired for invested capital. • This requires that the partnership interest be acquired on account of invested capital and that allocations of distributive share to the service partner satisfy certain requirements, primarily that the allocations are no more favorable than those made to other third-party investors. • A partner providing services will not be treated as having a qualified capital interest to the extent that contributed capital is attributable to a loan or other advance made or guaranteed, directly or indirectly, by any partner or the partnership (or a related person). • Similarly, the Common “cashless contribution” technique would convert all returns on cashless contributions into ordinary income rather than capital gain. GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

21. U.S. Carried Interest Tax Legislation (Cont.) Anti-Avoidance Rules • Section 6662 would be amended to provide a 40% penalty where a person had an underpayment as a result of being treated as violating anti-abuse regs. • The penalty imposes “strict liability,” as it could not be avoided by showing reasonable cause. GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

22. U.S. Carried Interest Tax Legislation (Cont.) Effective Date • Effective date under Levin bill would apply to income with respect to carried interests in taxable years after the date of enactment • No grandfather for existing carried interests GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

23. U.S. Carried Interest Tax Legislation (Cont.) Obama Budget • Other than applying to a broader class of service providers, the Obama Administration proposal appears to follow the general structure of the Levin Bill • Ordinary income and self-employment tax • Exception for “invested capital” • No mention of 40% penalty • Administration proposal would be effective for taxable years beginning after December 31, 2010 GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

24. U.S. Carried Interest Tax Legislation (Cont.) Cashless Contributions Assumes 1) a 25% federal and state capital gains rate and 50% ordinary income rate (including state and self-employment tax); 2) a 4-year deferral period; and 3) a cost of capital of 6%, compounded annually. GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

25. U.S. Carried Interest Tax Legislation (Cont.) Planning Options • Front-load income to the General Partner prior to the effective date of Carried Interest bill. • Change in Law provisions of the Fund limited partnership agreement theoretically can provide future flexibility, although difficult to negotiate in today’s fund-raising environment. • There is no effective date specified for Carried Interest bill and it is still early in the legislative process. • Taking steps to plan for Carried Interest bill now may be premature. GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

26. Other U.S.Tax Legislation GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

27. Other U.S. Tax Legislation Elimination of Disregarded Entities • The Obama budget plan proposed that after December 31, 2010, certain Non-U.S. disregarded entities be classified as corporations for U.S. tax purposes. • Exceptions – • An eligible entity with a single owner organized in the same jurisdiction can elect to be classified as a disregarded entity; and • An eligible entity owned by a single U.S. person can elect to be classified as a disregarded entity if it is not used for U.S. tax avoidance. • U.S. tax avoidance is so far an undefined concept. • Current disregarded entities not meeting an exception will likely be converted when and if the law takes effect. • This could impact most of the common investment structures used by international funds to make PRC investments GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

28. Other U.S. Tax Legislation (Cont.) Eliminate Look-Thru on Withholding for Non-Qualified Intermediary • The Obama budget plan proposed that the rules regarding withholding on Non-U.S. partnerships and other pass-thru entities be tightened up. • Under the proposed rules, a Non-U.S. pass-thru entity (such as a Cayman limited partnership) would no longer be entitled to provide the withholding agent with the relevant tax information of its beneficial owners. • Instead, unless the Non-U.S. pass-thru entity registered with the IRS as a “qualified” intermediary, the pass-thru entity could be treated as an “unknown foreign person,” thereby requiring the withholding agent to withhold tax at the maximum 30% rate. GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

29. Other Tax Legislation (Cont.) Foreign Tax Compliance Act • Introduced to both House and Senate in late October • Will require U.S. LPs in Non-U.S. Venture Funds to disclose such investments • This will, in turn, increase LP information requests • Similarly, direct and indirect holders of PFICs will be required to report details of such holdings • May possibly require sponsors of Non-U.S. Funds to files certain reports detailing U.S. investor participation in the Fund GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

30. PRC Permanent Establishment (“PE”) Developments GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

31. Offshore PRC PRC PE Developments Traditional Offshore Structure Cayman SPV WFOE GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

32. Cayman SPV Treaty SPV (typically Hong Kong) Offshore PRC WFOE PRC PE Developments (Cont.) More Recent Offshore Structure GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

33. PRC PE Developments (Cont.) • Circular 124 and Recent PRC cases (Xingjiang and Chongging) have cast doubt on the effectiveness of structures utilizing special purpose vehicles (“SPV”) in tax treaty jurisdictions where the tax treaty entity has no substance (i.e., no office, place of business, employees or activities) in its country of organization GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

34. PRC PE Developments (Cont.) Evolving Offshore Structure Typical Locations: Hong Kong Mauritius Barbados Switzerland Luxembourg Singapore Ireland Treaty Platform (Including Employees and Offices) Treaty SPV 1 Treaty SPV 2 Treaty SPV 3 Cayman 1 Cayman 2 Cayman 3 Treaty SPV A Treaty SPV B Treaty SPV C Offshore PRC WFOE WFOE WFOE GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

35. PRC PE Developments (Cont.) • Query how recent U.S. international tax proposals, including the Obama administrations elimination of “check the box” rules will impact the choice of optimal structure • Circular 601, released last week, also calls into question the use of intermediate SPVs GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

36. Best Tax Compliance Practices for Funds with U.S. Investors GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

37. Best Tax Compliance Practices for Funds with U.S. Investors UBTI • Most funds that have raised money from U.S. tax exempt investors will have an obligation to avoid, or at least minimize, the generation of “unrelated business taxable income (commonly referred to as UBTI). GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

38. Best Tax Compliance Practices for Funds with U.S. Investors (Cont.) Type of Investors Subject to UBTI • U.S. private pension funds • U.S. Charitable organizations • U.S. Charitable Remainder Trusts • U.S. Universities (including state universities) • U.S. State and local pension plans if qualified under 401, but possible exception under 115 (most state and local plans take the position they are exempt under 115 and thus not subject to UBTI tax) GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

39. Best Tax Compliance Practices for Funds with U.S. Investors (Cont.) Tax Treatment if There Is UBTI • File 990T U.S. Tax Return • Pay tax at graduated corporate or trust rates as if a taxable entity GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

40. Best Tax Compliance Practices for Funds with U.S. Investors (Cont.) Non-UBTI Income Categories (“Good Income”) • Assuming No Debt Financing (See UDFI discussion below): • Capital gains • Interest • Dividends • Subpart F inclusions (except insurance) • PFIC distributions • Royalties • Some rental income from real estate • Other income from routine investments (See Rev. Rul. 78-88) GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

41. Best Tax Compliance Practices for Funds with U.S. Investors (Cont.) UBTI Income Categories (“Bad Income”) • Income from business activity (e.g., sales of goods/services) conducted anywhere • Includes business conducted through lower-tier tax partnerships (e.g., portfolio companies not treated as corporations for U.S. tax purposes) • Gains from dealer property (relevant to real estate funds) GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

42. Best Tax Compliance Practices for Funds with U.S. Investors (Cont.) Fees as Potential UBTI • Portfolio companies may pay fees to the Fund or its management company, e.g. • directors fees • advisory fees • transaction-related fees • Issue: • Is this UBIT for the Fund? • What if the benefit to the Fund is indirect? GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

43. Best Tax Compliance Practices for Funds with U.S. Investors (Cont.) Tax Treatment of Various Fees • Directors Fees – services/UBTI • Advisory Fees – services/UBTI • Break-Up Fees – arguably lost profits/Non-UBTI • Completed Transaction Fees – probably reduce basis/Non-UBTI • Loan Commitment Fees, Equity Commitment Fees • loan commitment fee is not UBTI per IRC 512(b)(1) GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

44. Best Tax Compliance Practices for Funds with U.S. Investors (Cont.) Debt-Financed UBTI (UDFI) • Income from debt-financed property is UBTI, in ratio that “average acquisition indebtedness” bears to average adjusted basis • “Debt-financed property” = financed with “acquisition indebtedness” (a broadly defined term) • “Acquisition” indebtedness may in some cases include debt incurred before the asset was acquired • “Indebtedness” may include non-traditional sources of financing such as deferral of accrued management fees • May also include deferred payments for stock (i.e., 100 shares of stock acquired for a $50 immediate payment and a $50 payment due six months later). • Property is debt-financed property if there is acquisition indebtedness at any time during the taxable year in which the income is earned or, with respect to sales, the preceding 12 months • Applies to borrowing by the exempt entity or by an investment partnership such as a venture capital fund GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

45. Best Tax Compliance Practices for Funds with U.S. Investors (Cont.) UDFI Solutions Borrowing is usually restricted, e.g., • To short-term borrowing pending receipt of capital calls, or where borrowing is essential (e.g., to fund commitments where there are defaulting partners) • If viewed as “acquisition indebtedness,” (perhaps) the debt will be “history” by the time there is significant income or gains (i..e, paid off more than 12 months prior) • Borrowing incidental to the management of an investment portfolio and not increasing its size does not create UDFI (Rev. Rul. 78-88) • Application not clear to Venture Funds • Occasional borrowing incident to investment, but also serving exempt function, and not increasing the overall portfolio size, does not create UDFI (PLRs 8721104; 8721107) • Application not clear to Venture Funds GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

46. Best Tax Compliance Practices for Funds with U.S. Investors (Cont.) Management Fee Offsets and UBTI Risk • Offset is a reduction in the periodic management fee otherwise payable by the Fund to its manager on account of fees payable by portfolio companies or other parties to the manager • Offset typically range from 50% to 100%, and unused offsets carry forward to reduce the management fee in future periods • Sometimes fee amounts not offset against management fee prior to the end of the Fund’s term will be payable to the investors upon the liquidation of the Fund GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

47. Best Tax Compliance Practices for Funds with U.S. Investors (Cont.) Guarantees Of Portfolio Company Debt and UDFI • UDFI could be created as a result of fund’s guarantee of portfolio company debt if the fund, rather than the portfolio company, is the true borrower (Plantation Patterns). Should turn on portfolio company’s ability to service the debt based on its own assets/anticipated revenues. • GP may be contractually obligated not to allow fund to provide a guarantee unless GP first determines that there is not a material risk of UBTI GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

48. Best Tax Compliance Practices for Funds with U.S. Investors (Cont.) Fees (such as cash or warrants) For Guaranteeing Portfolio Company Debt as Potential UBTI • Guarantee Fee should not be UBTI if the guarantee activity was isolated and not regularly carried on. • This could be helpful, but as fund size increases, perhaps multiple guarantees will be given and multiple fees will be charged. • Unclear whether recurring guarantee fees will be treated as services income and thus UBTI GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

49. Best Tax Compliance Practices for Funds with U.S. Investors (Cont.) Critical Portfolio Company Information Rights and Covenants GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP

50. Best Tax Compliance Practices for Funds with U.S. Investors (Cont.) Summary of Portfolio Company Information Rights and Covenants: • In general, in connection with each investment in a Non-U.S. portfolio company, a Fund with U.S. taxable and tax-exempt investors should: • Corporate Status: confirm that the Non-U.S. portfolio company will be classified as a corporation for U.S. income tax purposes, and not as a partnership or other pass-through entity. For those entities that are eligible to elect to be treated as a pass-through entity, obtain a representation that the entity will not elect to be treated as a partnership for U.S. income tax purposes; GUNDERSON DETTMER STOUGH VILLENEUVE FRANKLIN & HACHIGIAN, LLP