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Westlake Assists Companies with Section 409A Compliance Issue

January 11, 2006

Westlake Securities' investment bankers have observed that the recent IRS issuance of regulations intended to clarify Internal Revenue Code (IRC) Section 409A have resulted in an increased demand for private company valuations. As there are a limited number of firms in Austin qualified to conduct independent appraisals, Westlake Securities has decided to work proactively with private companies to offer independent valuations which satisfy the requirements of IRC Section 409A.

IRC Section 409A provides that companies which grant employees stock options with an exercise price lower than the fair market value of the associated equity shall withhold income taxes, as well as incur penalty taxes, on these grants. If a Company determines its stock option price using an informal, internally generated valuation, then the burden will be on the Company to prove to the IRS that the fair market value of the equity is reasonable. However, if the Company relies on one of the new "Presumptive Methods" recommended by the IRS, then the burden of proof will shift to the IRS and may only be rebutted by the IRS if the Company's application of the method is found to be "grossly unreasonable."

Many private companies and their legal advisors believe that the most clearly defensible Presumptive Method suggested by the IRS is to have a valuation completed by an independent appraiser (or investment banker). A valuation performed by a qualified independent appraiser using traditional appraisal methodologies will be presumed reasonable if it values the stock as of a date that is no more than 12 months before the applicable stock option grant date. If a Company reasonably anticipates that it will undergo a change in control event or an IPO within the next 12 months, the Company may no longer rely on an internally generated valuation to determine option pricing.

As an investment banking firm with significant transactional experience in dealing with venture and private-equity funded companies, Westlake Securities is familiar with many of the key issues that affect the value of private company stock options and related common stock. These include not only standard valuation methods and adjustments for marketability and/or control, but also include analyses applicable to small private companies (e.g financial trend analysis, adjustments for key customer concentrations, and liquidation analysis when multiple classes of stock exist).

Due to the significant potential liability associated with Internal Revenue Code Section 409A, many of the private company Management teams that we know are choosing to mitigate this risk by selecting an independent appraiser. If you believe that your company would be interested in our valuation services, please contact Michael McAllister at (512)306-5258 or mike@westlakesecurities.com.

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