Broad-Based Stock Options: The Fight is NOT Over

1. Broad-Based Stock Options: The Fight is NOT Over Jeffrey Harris, Warburg Pincus John Doerr, KPCB Marc Jones, Visionael NVCA, May 13, 2004

2. A Call To Action • Proposed FASB rule changes will: • Seriously hamper the entrepreneurial community • Create misleading financial statements • Add to the administrative and auditing costs of all companies • Powerful forces are advocating these changes • Time is running out to stem the growing tide • WE CAN WIN THIS BATTLE

3. NVCA Position On Expensing Stock Options • Reduces the information value of financial statements by adding a highly abstract and contingent deduction • Penalizes emerging growth companies who use stock options to attract, incentivize, and align employees interests • Expensing will reduce the use of stock options, and stifle new company formation • Current option pricing models are not effective for measuring the value of employee stock options especially for non-public companies

4. Public Policy Messages • FASB’s actions jeopardize the use of employee stock options that drive the entrepreneurial economy and job creation • Implementation of new FASB rules creates less transparent, less consistent, less intelligible financial statements • Implementation expense is a deadweight on the economy, but a boon to the accounting and appraisal firms

5. Current Rules/Implementation • Companies can expense and/or disclose the amount of expense in their footnotes • Intrinsic value at date of grant • Non-public companies’ common stock value determined by Board/auditors

6. FASB Exposure Draft • “Grant date fair value” in the P&L (footnote disclosure is no longer adequate) • Expense determined using complex option pricing models • Private company rules • Fair value at date of grant, or • Intrinsic value at each reporting date (mark-to-market) • Implementation period

7. NVCA Activity To Date • Active participation in International Employee Stock Option Coalition with Cisco, Genentech, Qualcomm, etc. • Multiple meetings with SEC Commissioners, Chief Accountant, etc. • Meetings with The White House • Numerous Congressional meetings • Testimony at numerous Congressional hearings • Presentation to FASB (August 2003) • Numerous Op/Ed pieces, considerable media outreach

8. Effectiveness Of Our Effort • Pending legislation in Congress • Parts of the FASB Exposure Draft suggest some of our message has been heard: • Flexibility on implementation methods due to the incremental cost to non-public companies • An added year for implementation

9. Today’s Goal • Provide awareness, resources to learn more • If you share our concern, Take Action: • Sign up 2 partners from your venture firm to drive this initiative • Substantive letters to FASB • Personal e-letters to Congress

10. Why Stock Options? Broad-based employee stock ownership…delivers higher returns to the shareowners of the companies who use them, produces higher productivity, higher returns on equity, higher returns on assets, counting the effects of dilution… It fuels innovation, and fires the entrepreneurialspirit. Source: Craig Barrett, Wall Street Journal, March 31, 2004

11. Where’s The Expense? The consumption of a corporate asset or the creation of a corporate liability • An option is NOT an expense • Options DO dilute existing shareowner • Options do NOT affect revenue or cash expenditures, or impact company operations

12. If Not An Expense, What Is It? • Options make employees equity partners • Expensing options confuses a capital account transaction with a P&L event • Financial statements aren’t the right place to create corporate governance policies or penalize management excesses

13. Says Who? From the viewpoint of the grantor corporation, no measurable cost can be said to have been incurred. (Accounting Procedures Committee– FASB Predecessor, 1950 ) The FASB proposal would reflect, in effect, a double dip or double cost of capital. (Eugene M. Freedman, Chairman, Coopers & Lybrand, February 5, 1993)

14. Says Who? A year ago, the Mercury News' editorial board called for the expensing of options, based, in part, on the assumption that an accurate valuation method could be found. That turns out to be a work in progress. Further, it's clearer now that the abuses uncovered in recent years won't be solved by expensing. Finally, the industry's economic policy argument must be fully studied. For all of those reasons, Congress should impose a cooling-off period so that the country can make an informed choice about how best to serve the needs of investors and to assess the impact on our technological future as well. (San Jose Mercury News, April 1, 2004)

15. And That’s Exactly the Bill in Congress • S.1890/H.R. 3574 • Mandates expensing of top 5 officers using fair value at grant with 0 volatility models • Exempts small businesses with revenues <$25M • Prohibits broad-based options expensing until completion of joint study on the economic impact • More than >108 bi-partisan co-sponsors

16. And Now, the Quiz…. C = SN(d1) – Xe-rtN(d2) d1 = ((Ln(s/x) + (r-y+V2/2))/(V*t1/2) d2 = d1 – V*t1/2

17. FASB Proposal Significantly Overstates Option “Expense” • Black-Scholes and binomial methods were designed for freely tradable, fully vested options • Even if options were “expenses,” their fair value is significantly less than the value derived from Black-Scholes/binomial method • Our conclusion is that the methodology in the [Exposure Draft] for calculating the fair value of employee stock options significantly overstates their fair value, but by how much is pure conjecture.(Price Waterhouse, December 17, 1993)

18. Expensing Hurts Investors • Will investors look through the expense? • 50% on NASDAQ not covered by research • Companies will have lumpier quarterly earnings and higher stock volatility • Worsens comparability: each company determines variables for future volatility, option term and dividend yield • How can CEOs & CFOs certify under SOX? • Can’t accurately forecast Black-Scholes input variables • Even if they could, the “expense” produced by Black-Scholes is wrong

19. Inconsistent with Long-Standing Accounting Principles • Financial statements should record historical, not unknowable future events • Financial statements should record both the burdens and benefits of a transaction • Options cause dilution ONLY if the stock price rises above the option price – where shareholders obtain a benefit greater than the dilution • Paid-in capital should only increase when cash actually comes into the company • Paid-in capital increases with option expense even though no cash has been received

20. Impact of Expensing Options • Broad-based stock options in jeopardy • Need for ‘profitability’ • Slows economy and job creation • Penalizes emerging growth companies • Venture backed jobs are 11% of GDP • 14M Americans hold options • US less competitive in the global market • China, India not expensing options • China's 5 year plan for innovation calls for broad-based employee stock options

21. Marc Jones is Active • CEO of Visionael, an enterprise security company • Privately held, 75 employees • Testified to Senate Small Business Committee

22. What Can You do? Take Action! • If you’re concerned, sign on to this campaign • Substantive letters to FASB • 2+ partners from each VC firm • CEO & CFO of 20 ventures with each VC firm • e-Letters supporting congressional bills • You and your partners • Employees in all of your portfolio companies

23. Take Action 1: Sign on to this Campaign • If concerned, pull out the ORANGE form now….. • Fill it in and hand in now • Two names, emails addresses from each venture firm • We will help you track progress • Through a database • Weekly conference call • Details to follow via email

24. Take Action 2: Letters to FASB • Who: 2+ VC Partners & 20+ Venture CEOs & CFOs • Deadline: June 15 to express OPPOSITION to Exposure Draft • Each letter unique, and SUBSTANTIVE • Send to: director@fasb.org& jcdowling@nvca.org • Reference: File Reference No. 1102-100

25. Take Action 3: e-Letters to Congress • Who: Everyone • SUPPORT "Stock Option Accounting Reform Act" (S.1890/H.R. 3574) • www.savestockoptions.org, click on Take Action! • Personalize as much as possible • Send an email to all your portfolio companies requesting employee action • AL, AK, AR, DE, MD, LA, MS, NH, NY, OH, PA, SD, VT

26. SaveStockOptions.org

27. Have Questions? Contact: Jennifer Dowling: jcdowling@nvca.org Mark Heesen: mheesen@nvca.org Alix Burns: aburns@technet.org