4th Quarter 2007

Sponsored by

A Publication of The National Venture Capital Association

How to navigate this document

To move through the pages of the document:

Click on the links in the Highlights area below.

Click the Bookmarks tab on the left side of the work area. Click a bookmark to jump to a topic.

Click page thumbnails on the Pages tab on the left side of the work area. Click a page thumbnail to jump to that page.

Use the Previous Page or Next Page buttons in the toolbar, or the page up and page down keys.

To magnify or reduce the view use the Zoom In or Zoom Out buttons in the Toolbar .

•

•

•

•

Carried Interest Lands Back In the Senate

What goes around comes around. Although the U.S. House of Representatives launched

itself to the forefront of the debate around the taxation of carried interest when Rep.

Sander Levin introduced legislation on the topic in June of this year, the Senate had actu-

ally quietly begun its own investigation months earlier. The House on Friday November

9, 2007 passed its carried interest provisions as part of a larger measure that temporarily

forestalls additional taxpayers from having to pay the Alternative Minimum Tax. With

that action, all eyes are once again on the Congress’ “more deliberative” chamber, as

the Senate is often called.

Unfortunately, the path forward remains murky at best, in part because the legislative

power of the minority party in the Senate — currently the Republicans — is sufficient to

generally force compromise or stalemate on the majority party’s priorities. In this instance,

the topic under debate is as much whether to pay for a temporary AMT “hold harmless”

provision as it is whether to include carried interest as a means to pay for any such change.

Senator Grassley (R-IA), the ranking minority member of the Senate Finance Com-

mittee, has long argued that revising or eliminating the AMT does not need to be offset

by increasing other federal revenues (or decreasing federal spending) because the money

collected under the AMT regime was never meant to be due to the government. Strict

adherents to new “pay-as-you-go” rules enacted by both Senate and House Democrats,

however, counter that budget projections include the revenue, so eliminating the AMT

income without replacing it would leave the government borrowing to meet the shortfall.

Continued on p. 2

Highlights:Policy Roundup ...............................................2

Protect Your Investments ................................5

Idemnification Protection ................................8

Emerging Markets ....................................... 10

Mark Your Calendar: 2008 Annual Meeting .11

Maximizing Donations ................................12

East Coast Vs. West Coast............................13

Research From VentureXpert .......................14

NVCA Data Snapshot ...................................16

NVCA CFO Task Force Update ....................18

NVCA Visits NASDAQ ..................................20

Looking Ahead to Annual Meeting .............23

Welcome New NVCA Members .................23

NVCA Webcast Series ..................................24

About NVCA’s Partners ...............................25

Upcoming NVCA Events .............................27

Protect Your InvestmentsRecent Developments In California Law Regarding Non-Competition Agreements And Other Restrictive CovenantsBy Eric A. Tate of Morrison & Foerster LLP

The 2nd Quarter 2007 edition of NVCA Today reported the results of a study showing that more jobs were contributed by venture‑backed companies in California than in any other state (with California more than doubling the total of the second place state) and that revenues for venture‑backed companies in California were higher than in any other state (with California revenues exceeding the next highest state by well over $200 billion). Likewise, a recent MoneyTree Report (cited in the same edition of NVCA Today) showed that approximately 50% of all venture capital dollars invested in the U.S. in the 2nd Quarter of 2007 were invested in California. Non‑competition and non‑solicitation agreements (collectively, “restrictive covenants”) are a key tool used by venture‑backed companies and the firms funding them to protect the sizable investments described above. By using restrictive covenants, companies hope to prevent employees from working for competitors after employment, which aids in securing trade secret information and generally maintaining a competitive advantage in the marketplace.

Restrictive covenants generally are enforceable across the U.S. so long as neither the duration, geographic scope, or activities prohibited are greater than necessary to protect the employer’s legitimate interests in restraining the employee’s mobility. In California, however, Business and Professions Code (“B&P Code”) Section 16600 renders non‑competition agreements void and unenforceable ‑‑ “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade or business is to that extent void.”

The only exception to this rule barring non‑competition agreements is in the context of a sale of business, where a shareholder possesses such a significant stake in the company that transferring that stake constitutes a transfer of the good will of the company.1 The sale of business excep‑tion also applies to partners in a partnership and members of an LLC.

The law in this area is constantly changing. This article highlights a number of new developments of which those investing in and working with California companies should be aware.

No‑Hire Agreements UnenforceableA few months ago, a ruling was issued that directly impacts many merger and acquisition and venture financing deals. No‑hire agreements are frequently used by companies to ensure that key employees who do not meet the sale of business exception can nonetheless be barred from competing with the newly‑acquired or financed business. The enforceability of such provisions under California law, however, had been in question. This question was resolved in July 2007 in the case of VL Systems v. Unisen, Inc., 152 Cal.App.4th 708 (2007). In VL Systems, a con‑sulting firm sued a client to enforce a provision in its contract that provided that the client would not hire any employee of the consulting firm for 12 months after the contract’s termination without paying a penalty equivalent to 60% of the employee’s new annual salary. Even though the employee was not a party to the contract, and thus, not directly involved, the court ruled that enforcing the contract would unfairly limit the employee’s mobility and struck it down. In short, VL Systems confirmed that “no‑hire” agreements are unenforceable under California law.

California Courts Will Not Automatically Revise Overbroad Non‑Solicitation AgreementsNon‑solicitation agreements have long been thought of as a much less restrictive covenant than non‑competition agreements, since non‑solici‑tation agreements essentially permit employees to work with their former employers’ customers – compete – as long as the employee does not solicit, or initiate the business contact with the customer. While that very well may be true, a recent California court decision reminds us that

courts will still scrutinize non‑solicitation agreements to ensure that they are reasonably tailored to minimize interference with employee mobil‑ity. In Strategix, Ltd. v. Infocrossing West, Inc., 142 Cal.App.4th 1068 (2006), the court invalidated as overbroad a non‑solicitation agreement that barred the seller of a business from soliciting all employees and customers of the buyer, even those who were not seller’s former employ‑ees or customers. Significantly, the court refused to exercise its discretion to “blue pencil” the agreement ‑‑ revise it to effect a permissible limitation on the seller’s solicitation of the customers and employees rights.

Thus, parties investing in California should be careful when drafting restrictive covenants as they cannot count on a court to “blue pencil” an otherwise overbroad agreement to make it enforceable.

California Courts Will Apply California Law To Restrictive Covenants Involving California Employees A California court recently decided another case holding that California courts will not automatically abide by the terms of contracts when it comes to restrictive covenant and trade secrets issues. The court in Olinick v. BMG Entertainment2, confirmed that as a general matter, out‑of‑state forum selection and choice‑of‑law provisions in employment contracts with California employees may be enforceable if the laws of the chosen forum provide an adequate remedy in comparison to California law. With the Olinick decision, it is helpful to recall that when it comes to restrictive covenants, California courts will apply California law to bar the enforcement of non‑compete agreements against Califor‑nia employees even where the contract specifically states that the law of another state will govern the agreement. See, e.g., Scott v. Snelling &

Fourth Quarter 2007 | 2

In debating their bill earlier this month, House Republicans carried Senator Grassley’s arguments about not offsetting the cost of

AMT forward but were out outvoted on party lines in the final House debate. However, Senate rules – which were designed by

the nation’s founding fathers to ensure the rights of the minority party – mean that the Senate effectively needs 60 votes to approve

controversial issues rather than a simple majority. And, whether and how to pay for AMT reforms much less whether to change the

taxation of carried interest certainly meet the definition of controversial. Members of both parties have expressed concern about an

expansive change in partnership tax law, but many are also feeling pressure to use measures aimed at the wealthy to pay for limit-

ing the reach of the AM The power of the minority in the Senate was demonstrated in full force on November 15th when Majority

Leader Harry Reid attempted to bring AMT legislation to the floor for debate. As proposed by the Democrats, the Senate would

have first voted on (and presumably rejected) the House-passed version of the tax bill, then would have considered a Republi-

can offered alternative, and finally would have voted on the measure offered by Senate Finance Chairman Max Baucus (D-MT).

Although Sen. Baucus’ language was never formally introduced, it was widely reported to have “patched” the AMT for one year,

without providing revenue offsets, and extended other business tax breaks for two years. No carried interest provisions were in-

cluded. However, Senate Minority Leader Mitch McConnell (R-KS) was able to block the Majority Leader’s proposal, leading to a

stalemate on any action until the Senate returns the first week of December.

The timeline for decisions to be made are quickly compressing: both the House and Senate will be out of session November 16th

through the 30th. With action blocked this week, Congress will have missed the IRS deadline for printing tax forms with correct

AMT information. Even if the Senate makes another attempt to tackle the issue immediately upon its return, any Senate passed

proposal would still have to be reconciled with the radically different House passed legislation. That, in turn, could ultimately

delay taxpayer refunds.

As this process moves forward, the NVCA will continue to outline the issues associated with more than doubling the tax burden

on an industry that has helped to create more than 10 million jobs. While AMT reform is clearly necessary, and doing so in a

fiscally responsible manner is challenging, the solution proposed should not be one that ultimately will harm the US leadership in

innovation. We will continue to work with all Members of Congress, advocating an understanding of the VC community and its

measurable, long-term economic impact that could be put at risk.

Continued from p. 1

Energy Legislation Still Front and Center in CongressDespite veto threats from the White House, House and Senate lawmakers intent on pass-

ing energy legislation are moving forward with an effort to find consensus between the

two chambers on the long-awaited energy bill. Although no conferees have been ap-

pointed, informal negotiations have begun at the staff level while meetings have also taken

place between House and Senate leaders. The Administration objects to several provisions

including the House passed roll-back of tax incentives for oil and gas companies in favor of

tax incentives for renewable energy technologies such as solar and wind. The Renewable

Electricity Standard, which NVCA has strongly supported, has also garnered opposition

from the White House as have provisions in the Senate bill that would make gasoline price

gouging a federal crime and which would allow the US to sue OPEC for manipulating oil prices. As if those obstacles weren’t enough,

negotiators must also navigate the other hurdle represented by the Senate-passed CAFE provision which would increase the fuel efficiency

Policy Roundup

Continued on p. 3

When every decision matters.

MORRISON & FOERSTER LLP www.mofo.com

Experience matters most. Whether we’re doing

a key technology transaction, taking a company public or

advising on a merger or acquisition, we have unmatched

experience in law and business. We know how to get the right

result with maximum efficiency. Plus, we have the versatility

and strategic acumen to help win the game. One thousand

lawyers in the world’s finance and technology centers.

One compelling mission: to deliver success for our clients.

Snelling, 732 F.Supp. 1034, 1042 (N.D. Cal. 1990) (despite choice of law provision, California law must be applied to issue of enforceability of restrictive covenants given strong California public policy against enforcement of restrictive covenants).

Open Issue: Is There A Small Or Limited Part Exception To Business And Professions Code Section 16600 Under California Law? The most recent development, which has yet to occur, involves the “small or limited part” exception and could reflect the greatest change in California’s treatment of restrictive covenants in decades.

On November 26, 2006, the California Supreme Court agreed to review the refusal of the court in Raymond Edwards II v. Arthur Andersen LLP to apply the “small or limited part” exception to California’s general ban on non‑competition agreements. 142 Cal.App.4th 603, 620 (2006), review granted, 2006 Cal. LEXIS 14181 (Cal. Nov. 29, 2006) (employment agreement that prohibited employee from servicing, regardless of solicitation, any clients he worked with before terminating employment violated B&P Code Section 16600, and was not enforceable under the “small or limited part” exception). Likewise, on October 17, 2007, the California Supreme Court agreed to review Alliance Payment Systems, Inc. v. Walczer, which also turns on the application of the “small or limited part” exception. 152 Cal.App.4th 620 (2007), review granted, 2007 Cal. LEXIS 11659 (Cal. Oct. 17, 2007) (contract provision requiring one party to forfeit to the other any revenues received from other party’s customers, regardless of solicitation, violated B&P Code Section 16600, and was not enforceable under the “small or limited part” exception).

Before Arthur Andersen and Alliance Payment Systems, some federal courts had interpreted B&P Code Section 16600 to bar only contracts that restrain a person from engaging in an entire business, trade or profession, but determined that contracts “where one is barred from pursuing only a small or limited part of a business, trade or profession” are valid. See, e.g., IBM Corp. v. Bajorek, 191 F.3d 1033 (9th Cir. 1999) (claw‑back provision allowing IBM to take back employee’s stock options and requiring that employee forfeit any profits from his stock options if he worked for a competitor within six months after exercising options was valid because ban on working for competitors only “would exclude him from one small corner of the market but would not preclude him from engaging in his profession, trade or business” in general).

In both Arthur Andersen and Alliance Payment Systems, the California Supreme Court is set to resolve whether California will follow federal law and adopt the “small or limited part” exception.

ConclusionAs reflected above, the general trend in California appears to be consistent with California’s traditional abhorrence of restraints on employee mobility. However, the California Supreme Court’s pending review of the “small or limited part” exception in Arthur Andersen and Alliance Payment Systems raises the possibility for a sea change in California’s treatment of restrictive covenants. Regardless, the new developments reported here make clear that anyone seeking to do business in California must pay close attention to its ever‑evolving legal landscape.

Eric A. Tate (etate@mofo.com) is a partner in the San Francisco office of Morrison Foerster LLP, specializing in counseling companies and executives in all areas of labor and employment law, with a particular emphasis on the litigation of disputes regarding trade secrets and restrictive covenants.

1. In a number of states, e.g., Illinois, New York, North Carolina, Pennsylvania, and Texas, employers can preclude an employee from going to work for a competitor even in the absence of a non‑competition agreement under the “inevitable disclosure” doctrine if employment in the same or similar position with a competitor would cause “inevitable disclosure” of trade secrets known by the former employee. It is well settled, however, that the “inevitable disclosure doctrine” is not the law in California. Whyte v. Schlage Lock Co., 1010 Cal.App.4th 1443, 1460 (2002).

2. See Olinick v. BMG Entertainment, 138 Cal.App.4th 1286 (2006) (enforcing choice‑of‑New York law and New York forum selection clauses in employment contract between New York company and California employee where contract was negotiated and entered into in New York and New York law provided an adequate remedy for employee’s dis‑crimination claims).

Fourth Quarter 2007 | 3

standards for cars and light trucks by 10 miles per gallon by 2020. White House National Economic Council Director, Allan Hubbard, sent

Speaker Pelosi a letter outlining all of the provisions that they believe will trigger a veto response by the President.

NVCA has also been lobbying in support of a Renewable Fuel Standard and earlier this month met in Washington with mem-

bers of the House and Senate Agriculture Committee and members of Senate Finance Committee to discuss concerns around

pricing in the ethanol industry and to press Congress to include the Renewable Fuels Standard in the energy bill conference

product, when and if that bill emerges this year.

Success at drafting a bill that both chambers can agree to is by no means a sure thing, and the process has been complicated by procedural

missteps by the Democrats that allowed Republicans to launch a distracting, parliamentary debate. At this point, House Speaker Pelosi

remains determined to pass an energy bill before Congress heads towards its December conclusion, but the fate of the energy bill is far from

clear. It is reported that there are six or more “holds” on the bill in the Senate by senators who object to various provisions or who want the

entire bill stalled. Absent a mega-compromise between House and Senate leadership, it is unlikely any agreement will be reached.

Other various pieces of energy legislation, outside the conference committee purview, continue to be introduced and move

through the Congress. In fact, two energy bills, H.R. 3775 and H.R. 3776 were passed by voice vote in the House after be-

ing passed by the House Science Committee last week. The bills authorize new funding to improve energy efficiency and to

develop new energy storage techniques.

Now Authorized, Competitiveness Bills Need FundingAs the legislative calendar winds down, the FY 08 spending bills will dominate most of the agenda, with members in both cham-

bers struggling to reconcile appropriations bills. At the present time, none of the 12 appropriations bills have been signed by the

President which has left the federal government operating on a temporary funding footing (known as a continuing resolution). One

issue under discussion is the funding for initiatives aimed at US competitiveness. In early August, the President signed the America

COMPETES Act into law and now efforts are underway to make certain that the programs authorized in the legislation get the cor-

responding appropriation. The COMPETES Act implements the goals of the National Academies report, “Rising Above the Gathering

Storm” which was a major influence in the launch of NVCA’s MAGNET initiative. Given these delays, the appropriations bills will

likely be bundled into one large package - an omnibus bill - to get them all passed and signed into law. Despite severe fiscal con-

straints, the House and Senate leadership remain steadfast in their intent to fully fund the programs in these bipartisan competitive-

ness bills, but the longer it takes to pass the appropriations bills, the louder the rhetoric and the threat of a Presidential veto becomes.

Patent Reform Stuck in the SenateSince the September 7th House passage of H.R. 1908, the Patent Reform Act of 2007, Senate sponsors of that bill’s counterpart,

S. 1145, have been working with stakeholders to reach a consensus on several key provisions in order to allow a Senate vote on

the bill. However, the prospects for Senate passage are complicated by an already full legislative calendar leaving limited floor

time for votes and by the ongoing concerns on several major provisions. If the most controversial issues can be resolved, Majority

Leader Reid (D-NV) has said he will allow floor time for the legislation.

Patent reform legislation is important to NVCA members, both in the traditional technology sector, as well as, the life sciences sec-

tor. NVCA has tapped many of our members to help represent the industry’s views at stakeholder meetings, and participated in a press

conference to voice concerns on the Senate bill in particular. NVCA continues to have significant concerns regarding the damages

apportionment provisions in both the House and Senate bills. These provisions would change the way patent damages are calculated

Continued from p. 2

Continued on p. 4 © 2007, The National Venture Capital Association. All rights reserved. This article is reprinted with permission from The National Venture Capital Association and originally appeared in the NVCA TODAY 4th Quarter 2007 Newsletter pages 5‑8.