MEGABIOS CORP
S-1/A, 1997-08-15
COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH
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<PAGE>
 
    
 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 15, 1997     
                                                   
                                                REGISTRATION NO. 333-32593     
 
================================================================================
 
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                               ----------------
                               
                            AMENDMENT NO. 1 TO     
 
                                   FORM S-1
 
                            REGISTRATION STATEMENT
                                     UNDER
                          THE SECURITIES ACT OF 1933
 
                               ----------------
 
                                MEGABIOS CORP.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
        DELAWARE                     8731                    94-3156660
     (STATE OR OTHER     (PRIMARY STANDARD INDUSTRIAL     (I.R.S. EMPLOYER
     JURISDICTION OF      CLASSIFICATION CODE NUMBER)  IDENTIFICATION NUMBER)
    INCORPORATION OR
      ORGANIZATION)
 
                               ----------------
 
                               863A MITTEN ROAD
                             BURLINGAME, CA 94010
                                 
                              (650) 697-1900     
  (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
                   REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
 
                               ----------------
 
                              PATRICK G. ENRIGHT
                  CHIEF FINANCIAL OFFICER AND VICE PRESIDENT
                                MEGABIOS CORP.
                               863A MITTEN ROAD
                             BURLINGAME, CA 94010
                                 
                              (650) 697-1900     
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
                             OF AGENT FOR SERVICE)
 
                               ----------------
 
                                  COPIES TO:
 
        ALAN C. MENDELSON, ESQ.            ROBERT V. GUNDERSON, JR., ESQ.
        PATRICK A. POHLEN, ESQ.                 DAVID T. YOUNG, ESQ.
          COOLEY GODWARD LLP             GUNDERSON DETTMER STOUGH VILLENEUVE
         FIVE PALO ALTO SQUARE                FRANKLIN & HACHIGIAN, LLP
          3000 EL CAMINO REAL                  155 CONSTITUTION DRIVE
       PALO ALTO, CA 94306-2155                 MENLO PARK, CA 94025
             
             (650) 843-5000                      (650) 321-2400     
 
                               ----------------
 
  APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
 
  If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
 
  If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
 
  If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
 
  If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
 
                               ----------------
 
  THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION
8(a), MAY DETERMINE.
 
================================================================================
<PAGE>
 
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A         +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE   +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY  +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT        +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR   +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE      +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE    +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF  +
+ANY SUCH STATE.                                                               +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
                  
               SUBJECT TO COMPLETION, DATED AUGUST 15, 1997     
 
                                2,500,000 SHARES
                                      
                              [LOGO OF MEGABIOS]     
 
                                  COMMON STOCK
 
  All of the 2,500,000 shares of Common Stock offered hereby are being sold by
Megabios Corp. ("Megabios" or the "Company"). Prior to this offering, there has
been no public market for the Common Stock of the Company. It is currently
estimated that the initial public offering price for the Common Stock will be
between $11.00 and $13.00 per share. See "Underwriting" for a discussion of the
factors to be considered in determining the initial public offering price.
Application has been made to have the Common Stock approved for quotation on
the Nasdaq National Market under the symbol "MEGA."
 
  THE SHARES OF COMMON STOCK OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. SEE
"RISK FACTORS" BEGINNING ON PAGE 6 FOR A DISCUSSION OF CERTAIN FACTORS THAT
SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS IN PURCHASING THE SHARES OF
COMMON STOCK OFFERED HEREBY.
 
                                  -----------
 
 THESE SECURITIES HAVE NOT BEEN APPROVED  OR DISAPPROVED BY THE SECURITIES AND
  EXCHANGE  COMMISSION  OR  ANY  STATE  SECURITIES  COMMISSION  NOR  HAS  THE
   SECURITIES AND  EXCHANGE COMMISSION  OR  ANY STATE  SECURITIES COMMISSION
    PASSED  UPON  THE   ACCURACY  OR  ADEQUACY  OF   THIS  PROSPECTUS.  ANY
             REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
 
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                               Price to Underwriting Proceeds to
                                                Public  Discount (1) Company (2)
- --------------------------------------------------------------------------------
<S>                                            <C>      <C>          <C>
Per Share....................................    $          $           $
Total (3)....................................   $          $           $
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
 
(1) See "Underwriting" for information concerning indemnification of the
    Underwriters and other matters.
 
(2) Before deducting expenses payable by the Company estimated at $600,000.
 
(3) The Company has granted to the Underwriters a 30-day option to purchase up
    to an additional 375,000 shares of Common Stock solely to cover over-
    allotments, if any. If the Underwriters exercise this option in full, the
    Price to Public will total $       , the Underwriting Discount will total
    $        and the Proceeds to the Company will total $       . See
    "Underwriting."
 
  The shares of Common Stock are offered by the several Underwriters named
herein, subject to receipt and acceptance by them and subject to their right to
reject any order in whole or in part. It is expected that delivery of the
certificates representing such shares will be made against payment therefor at
the office of Montgomery Securities on or about    , 1997.
 
                                  -----------
 
MONTGOMERY SECURITIES                                          HAMBRECHT & QUIST
 
                                       , 1997
<PAGE>
 
DESCRIPTION OF GRAPHIC
 
This page will feature an hourglass-like image. The "hourglass" will contain
three blocks of language extracted from the prospectus which relate to (i) the
opportunity created by the field of genomics for gene-based therapeutics, (ii)
the limitations of gene delivery technology and (iii) the Company's
commercialization strategy and corporate partnerships to date.
 
TITLE: (Centered)
                        "Megabios Business Opportunity"
 
A. GENES AS POTENTIAL THERAPEUTIC PRODUCTS
    . 100,000 genes in the human genome.
    . At least 5,000 genes of known function.
    . Many genes have been identified as potential therapeutic genes.
    . Certain therapeutic genes may be attractive product candidates.
 
B. MEGABIOS' PROPRIETARY GENE DELIVERY SYSTEMS
    . Lack of safe, effective gene delivery technology has limited the
    development of gene-based therapeutics.
    . Megabios develops proprietary gene delivery technology and provides
    preclinical development expertise.
    . Megabios' in vivo, non-viral gene delivery technology is designed to
    avoid the limitations of other gene delivery systems.
 
C. PORTFOLIO OF PRODUCT CANDIDATES SPONSORED BY CORPORATE PARTNERS
    . Megabios' goal is to create a portfolio of funded product development
    programs.
    . Clinical programs are expected to be sponsored through corporate
    partnerships.
    . Such collaborations are structured to provide research and development
    funding, milestone payments and royalties.
    . Megabios' three corporate partners are: Glaxo Wellcome plc for the
    treatment of cystic fibrosis, Pfizer Inc for the treatment of cancer via
    angiogenesis inhibition, and Eli Lilly and Company for the treatment of
    cancer using BRCA-1.
 
 
 
 
 
 
                               ----------------
   
  CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN ACTIVITIES THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE SECURITIES OFFERED
HEREBY INCLUDING OVER-ALLOTMENT, STABILIZING TRANSACTIONS, SYNDICATE SHORT
COVERING TRANSACTIONS AND PENALTY BIDS. THESE TRANSACTIONS MAY BE EFFECTED ON
NASDAQ OR OTHERWISE AND, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."     
   
  The Company was incorporated in California in April 1992 and will be
reincorporated in Delaware prior to effectiveness of this offering. The
Company's executive offices are located at 863A Mitten Road, Burlingame,
California 94010, and its telephone number is (650) 697-1900.     
<PAGE>
 
                 [GRAPHIC DEPICTION OF MEGABIOS' TECHNOLOGY]

The artwork will feature a rendering of the information contained in the table 
on page 30 of the prospectus and a rendering of the drawing on page 25 of the 
prospectus. In addition, the left hand panel will contain text describing 
Megabios' core technology, as drafted in the prospectus.

LEGEND

The Company's gene delivery systems are under development and have not been 
approved for sale in any country. Such approval may take several years and there
can be no assurance that such approval will ever be obtained. See "Risk 
Factors."

TEXT

A. MEGABIOS' PLATFORM TECHNOLOGY

   Megabios is developing seven series of gene delivery systems and expects to 
   design additional series of gene delivery systems.

   Megabios believes that its gene delivery systems may have the following 
   benefits:
   . therapeutically-relevant gene expression,
   . tissue-specific gene delivery and expression,
   . ease of handling and administration,
   . stability and scalable manufacturing methods and
   . improved safety profile.

B. DELIVERY AND EXPRESSION OF A THERAPEUTIC GENE

   Megabios' proprietary gene delivery systems consist primarily of two
   components: (i) DNA plasmids containing a therapeutic gene that controls its
   proper expression; and (ii) lipids and other agents that facilitate the
   delivery of the DNA plasmids into the target cell.



<PAGE>
 
                               PROSPECTUS SUMMARY
   
  The following summary is qualified in its entirety by the more detailed
information and the Financial Statements and Notes thereto appearing elsewhere
in this Prospectus. Unless otherwise indicated, all information in this
Prospectus assumes: (i) a 1-for-3 reverse split of the Company's outstanding
Common Stock and Preferred Stock to be effected prior to effectiveness of this
offering; (ii) the reincorporation of the Company in the State of Delaware to
be effected prior to effectiveness of this offering; (iii) the conversion of
all outstanding shares of Preferred Stock into shares of Common Stock to be
effected upon the closing of this offering; and (iv) no exercise of the
Underwriters' over-allotment option. Except for the historical information
contained herein, the discussion in this Prospectus contains forward-looking
statements that involve risks and uncertainties. The Company's actual results
could differ materially from those discussed herein. Factors that could cause
or contribute to such differences include, but are not limited to, those
discussed in "Risk Factors," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business," as well as those discussed
elsewhere in this Prospectus.     
 
                                  THE COMPANY
   
  Megabios develops proprietary gene delivery systems and provides preclinical
development expertise to create gene-based therapeutics designed for the
treatment or prevention of genetic and acquired diseases. The Company has
developed several in vivo, non-viral gene delivery systems to address a number
of potential therapeutic applications using a variety of therapeutic genes. The
Company's clinical development and commercialization strategy is to enter into
collaborative research and development agreements or "corporate partnerships"
with pharmaceutical and biotechnology companies. To date, the Company has
established corporate partnerships with Glaxo Wellcome plc ("Glaxo Wellcome")
to develop a treatment for cystic fibrosis using the CFTR gene, Pfizer Inc
("Pfizer") to develop a treatment for solid tumors through angiogenesis
inhibition and Eli Lilly and Company ("Lilly") to develop treatments for breast
and ovarian cancer using the BRCA1 gene.     
 
  Gene-based therapy is an approach to the treatment or prevention of certain
diseases in which therapeutic genes are introduced into target cells to cause
the production of specific proteins needed to bring about a therapeutic effect.
To date, a limiting factor in gene-based therapy has been the lack of safe,
effective gene delivery systems. The Company's in vivo, non-viral gene delivery
systems are designed to avoid the significant limitations of ex vivo (whether
viral or non-viral) and in vivo, viral gene delivery. Furthermore, the Company
believes it has made progress in overcoming the limitations often associated
with in vivo, non-viral gene delivery approaches. The Company believes that its
proprietary, non-viral gene delivery systems may have the following benefits:
(i) therapeutically relevant gene expression; (ii) tissue-specific gene
delivery and expression; (iii) ease of handling and administration, stability
and scalable manufacturing methods and (iv) an improved safety profile. The
Company's portfolio of gene delivery systems is classified by series based on
the mode of administration and the cell type to which the gene-based
therapeutic is delivered, with each formulation within a series having distinct
specifications and potential applications. The Company intends to enter into
corporate partnerships using each of its gene delivery systems for multiple
potential applications.
   
  Megabios' emphasis on entering into corporate partnerships is intended to
enable the Company to extend and leverage its technology platform, focus on
preclinical development of gene-based therapeutics and create a portfolio of
product development programs sponsored by its corporate partners. This strategy
limits the Company's exposure to capital-intensive activities such as large-
scale clinical trials, commercial manufacturing and sales and marketing, while
providing the opportunity to receive a substantial economic interest in the
products which it develops in conjunction with corporate partners, primarily
through the receipt of royalties on product sales. In addition, the Company
believes that creating a portfolio of product development programs will reduce
the Company's dependence on any particular product development program.     
 
                                       3
<PAGE>
 
 
  In April 1994, the Company entered into a corporate partnership with Glaxo
Wellcome to develop a gene-based therapeutic for the treatment of cystic
fibrosis. Cystic fibrosis is caused by a defect in the CFTR gene and is
believed to afflict approximately 60,000 patients in the United States and
Europe. The Company has conducted preclinical testing of a gene delivery system
in the MB100 Series as a carrier for the CFTR gene. These studies include
primate inhalation studies which have demonstrated expression of the human form
of the CFTR gene in the correct cell type and at levels believed to be
potentially therapeutic, with no evidence of inflammation, a common problem
associated with non-viral gene-based therapeutics. In June 1997, Glaxo Wellcome
commenced a Phase I/II clinical trial in cystic fibrosis patients using a gene
delivery system in the MB100 Series as a carrier for the CFTR gene.
 
  In May 1996, the Company entered into a corporate partnership with Pfizer to
develop a gene-based therapeutic for the treatment of solid tumors using gene
delivery systems in the MB200 Series which are designed to deliver genes that
inhibit angiogenesis. Angiogenesis is the formation of new blood vessels needed
for solid tumors to survive and multiply. The initial disease targeted by this
corporate partnership is non-small cell lung cancer, which affects over 300,000
patients annually in the United States and Europe. Gene delivery systems in the
MB200 Series have been shown in animal models to achieve gene expression
selectively in the vascular endothelial cells of the lung and other tissues
following intravenous administration.
   
  In May 1997, the Company entered into a corporate partnership with Lilly to
develop a gene-based therapeutic to treat breast and ovarian cancer using
BRCA1, a gene which has been identified as a putative tumor suppressor. There
are over 180,000 new cases of breast cancer and over 26,000 new cases of
ovarian cancer reported each year in the United States. When a tumor suppressor
gene, such as BRCA1, is missing or defective, a cell may begin to replicate
uncontrollably resulting in the formation of a tumor. Increased expression of
the BRCA1 gene in diseased tissue may inhibit or prevent the uncontrolled cell
growth associated with cancer, without causing any adverse effect in normal
cells. BRCA1 will be developed as a gene-based therapeutic initially using gene
delivery systems in the MB300 Series, which are administered via direct
injection, and gene delivery systems in the MB700 Series, which are
administered into the intraperitoneal cavity.     
 
                                  RISK FACTORS
 
  The Common Stock offered hereby involves a high degree of risk. See "Risk
Factors."
 
                                  THE OFFERING
 
<TABLE>   
<S>                                    <C>
Common Stock offered by the Company...  2,500,000 shares
Common Stock to be outstanding after
 the offering......................... 12,225,939 shares(1)
Use of proceeds....................... For research and development activities,
                                       leasehold improvements, the purchase of
                                       capital equipment, working capital and
                                       general corporate purposes.
Proposed Nasdaq National Market
 symbol............................... MEGA
</TABLE>    
- --------
   
(1) Based on 9,725,939 shares outstanding as of July 15, 1997. Excludes
    (i) 476,189 shares of Common Stock issuable upon exercise of outstanding
    stock options as of July 15, 1997 at a weighted average exercise price of
    $1.22 per share, (ii) 84,008 shares of Common Stock issuable upon exercise
    of warrants outstanding at July 15, 1997 at an exercise price of $3.88 per
    share, (iii) an additional 781,699 shares of Common Stock reserved for
    future grants pursuant to the Company's 1997 Equity Incentive Plan and (iv)
    200,000 shares of Common Stock reserved for purchase pursuant to the
    Company's 1997 Employee Stock Purchase Plan.     
 
                                       4
<PAGE>
 
                             SUMMARY FINANCIAL DATA
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>   
<CAPTION>
                             APRIL 23, 1992
                             (INCEPTION) TO       YEAR ENDED JUNE 30,
                                JUNE 30,    ----------------------------------
                                1993(1)      1994     1995     1996     1997
                             -------------- -------  -------  -------  -------
<S>                          <C>            <C>      <C>      <C>      <C>
STATEMENTS OF OPERATIONS
 DATA:
 Collaborative research and
  development revenue.......     $  --      $   500  $ 1,157  $ 1,890  $ 5,793
 Operating expenses:
  Research and development..       593        1,922    4,691    6,487    8,598
  General and
   administrative...........       165          796    1,811    2,169    2,417
                                 -----      -------  -------  -------  -------
    Total operating
     expenses...............       758        2,718    6,502    8,656   11,015
                                 -----      -------  -------  -------  -------
 Loss from operations.......      (758)      (2,218)  (5,345)  (6,766)  (5,222)
 Interest income (expense),
  net.......................       (20)          65      (84)    (135)     275
                                 -----      -------  -------  -------  -------
 Net loss...................     $(778)     $(2,153) $(5,429) $(6,901) $(4,947)
                                 =====      =======  =======  =======  =======
 Pro forma net loss per
  share(2)..................                                           $ (0.50)
                                                                       =======
 Shares used in computing
  pro forma net loss per
  share(2)..................                                             9,926
                                                                       =======
</TABLE>    
 
<TABLE>   
<CAPTION>
                                                             JUNE 30, 1997
                                                        ------------------------
                                                         ACTUAL   AS ADJUSTED(3)
                                                        --------  --------------
<S>                                                     <C>       <C>
BALANCE SHEET DATA:
 Cash, cash equivalents and short-term investments..... $ 24,269     $ 51,569
 Working capital.......................................   21,629       48,929
 Total assets..........................................   29,978       57,278
 Long-term debt........................................    1,487        1,487
 Accumulated deficit...................................  (20,208)     (20,208)
 Total stockholders' equity............................   25,223       52,523
</TABLE>    
- --------
(1) The Company's financial data for fiscal 1992 and 1993 is not presented
    separately as the Company's operations from April 23, 1992 to June 30, 1992
    were immaterial.
(2) See Note 1 of Notes to Financial Statements for an explanation of the
    computation of pro forma net loss per share.
(3) Adjusted to give effect to the receipt of the estimated net proceeds from
    the sale of 2,500,000 shares of Common Stock offered by the Company hereby
    at an assumed initial public offering price of $12.00 per share. See "Use
    of Proceeds."
 
                                       5
<PAGE>
 
                                 RISK FACTORS
   
  An investment in the shares of Common Stock offered hereby involves a high
degree of risk. Accordingly, prospective investors should consider carefully
the following factors, together with the other information contained in this
Prospectus, in evaluating the Company and its business before purchasing the
shares of Common Stock offered hereby. This Prospectus contains forward-
looking statements that involve risk and uncertainty. Actual results and the
timing of certain events could differ materially from those projected in the
forward-looking statements as a result of the risk factors set forth below and
other factors discussed elsewhere in this Prospectus. See "Special Note
Regarding Forward-Looking Statements."     
 
UNCERTAINTIES RELATED TO EARLY STAGE OF DEVELOPMENT
 
  The Company is at an early stage of development and must be evaluated in
light of the uncertainties and complications present in an early stage
biotechnology company. Since the Company's inception in 1992, substantially
all of the Company's resources have been dedicated to the research and
development of gene delivery systems, and no revenues have been generated from
product sales. Because substantially all of the products under development by
the Company are in research or preclinical development, revenues from the sale
of any such products will not be realized for at least the next several years,
if at all. There can be no assurance that any of the Company's product
development efforts will be successfully completed, that any of the Company's
products will be proven to be safe and effective, that regulatory approvals
will be obtained at all or be as broad as sought, that the Company's products
will be capable of being produced in commercial quantities at reasonable cost
or that any products, if introduced, will achieve market acceptance.
 
DEPENDENCE ON CORPORATE PARTNERS; NEED FOR ADDITIONAL CORPORATE PARTNERSHIPS
   
  The Company is highly dependent upon its separate corporate partnerships
with Glaxo Wellcome, Pfizer and Lilly. In connection with these corporate
partnerships, the Company has entered into agreements with Glaxo Wellcome (the
"Glaxo Wellcome Agreement"), Pfizer (the "Pfizer Agreement") and Lilly (the
"Lilly Agreement"). Under these agreements, each of Glaxo Wellcome, Pfizer and
Lilly were or are required to undertake certain collaborative activities with
the Company, fund research and development activities with the Company, make
certain payments to the Company upon achievement of related milestone events
and pay royalties to the Company if and when a product is commercialized by
its corporate partners. There can be no assurance that Glaxo Wellcome, Pfizer
or Lilly will devote sufficient resources to the Company's research programs
or product development efforts on a timely basis, and such resources could
vary and have varied due to factors unrelated to the Company's product
development efforts. If such corporate partners fail to conduct these
collaborative activities in a timely manner or at all, the preclinical or
clinical development or commercialization of the Company's gene delivery
systems will be delayed or terminated.     
   
  The Pfizer Agreement permits Pfizer to cancel the Company's research and
development program with Pfizer, for any reason, including reasons unrelated
to such program, after June 1998 upon six months prior notice. In order to
extend the program beyond June 1998, Pfizer is required prior to January 1998
to commit to purchase $10.0 million of the Company's Common Stock at a premium
to the then current market value, subject to certain adjustments. The Company
is uncertain whether Pfizer will exercise its option to extend the Pfizer
Agreement and make the corresponding equity investment in the Company. Even if
Pfizer exercises its option, there can be no assurance that research funds or
milestone payments under the Pfizer Agreement will be received. The Lilly
Agreement permits Lilly to cancel the Company's research and development
program, for any reason, including reasons unrelated to such program, after
May 1999 upon three months prior notice. There can be no assurance that the
Lilly Agreement will be extended or that research funds or milestone payments
under the Lilly Agreement will be received. Megabios' research obligations and
Glaxo Wellcome's funding obligations under the Company's research program with
Glaxo Wellcome have been completed, and the Company will only receive future
payments, if any, under the Glaxo Wellcome Agreement through the achievement
of a certain milestone and the payment of royalties. There can be no assurance
that any of these corporate partnerships will result in successfully
commercialized products and the receipt by the Company of related royalty
revenues.     
 
                                       6
<PAGE>
 
Should the Company fail to receive research funds or should milestones set
forth in any or all of the Glaxo Wellcome Agreement, the Pfizer Agreement or
the Lilly Agreement not be achieved, or should Glaxo Wellcome, Pfizer or Lilly
breach or terminate their respective agreements, either prior to scheduled
termination or on a termination date, the Company's business, financial
condition and results of operations will be materially adversely affected. See
"Business--Corporate Partners."
   
  The Company will need to enter into additional agreements with corporate
partners or otherwise raise substantial additional funds to conduct the
research and development, preclinical studies, clinical trials, manufacturing,
marketing and sales necessary to commercialize its gene delivery systems. The
Company expects that future revenues from corporate partnerships, if any, will
be dervied primarily from royalties on product sales. There can be no
assurance that the Company will be able to establish such additional corporate
partnerships on favorable terms, or at all, or that its current or future
corporate partnerships will be successful. In addition, there can be no
assurance that existing or future corporate partners will not pursue
alternative technologies or develop alternative products either on their own
or in collaboration with others, including the Company's competitors. There
also can be no assurance that disputes will not arise in the future with
respect to the ownership of rights to any technology developed with corporate
partners. Disagreements between corporate partners and the Company could lead
to delays or termination in the research, development or commercialization of
certain product candidates or result in litigation or arbitration, which would
be time consuming and expensive. Should any corporate partner fail to develop
or commercialize successfully any product to which it has obtained rights from
the Company, the Company's business, financial condition and results of
operations may be materially adversely affected. See "Business--Corporate
Partners."     
 
UNCERTAINTY OF PRODUCT DEVELOPMENT AND GENE-BASED THERAPEUTICS
 
  Before the Company or its corporate partners can obtain regulatory approval
for the commercial sale of any of its products, the Company or its corporate
partner must demonstrate, through preclinical studies and clinical trials,
that a potential product is safe and efficacious for use in each target
indication. There can be no assurance that the Company or its corporate
partners will be permitted to undertake clinical testing of the Company's
products, or, if permitted, that such products will receive other necessary
regulatory approvals. The Company or its corporate partners may also
experience delays in commencing clinical trials due to a variety of factors
including unfavorable or delayed preclinical study results, inability to
manufacture sufficient quantities of materials used for clinical trials,
delays or difficulties in patient enrollment, delays in regulatory approvals
and other factors. While the Company has demonstrated some evidence of the
utility of its gene delivery systems in preclinical animal studies, these
results do not predict safety or efficacy in humans, when, and if, clinical
trials are conducted. The Company's products may prove to have undesirable and
unintended side effects or other characteristics in preclinical development or
clinical trials that may prevent or limit their use. In addition, there can be
no assurance that any of the Company's products will ultimately obtain United
States Food and Drug Administration ("FDA") or other regulatory or foreign
marketing approval for any indication. See "Business--Corporate Partners" and
"--Government Regulation."
 
  In addition to risks particular to the development of the Company's
products, the Company's products are also subject to risks particular to the
development of gene-based therapeutics. Gene-based therapy is a new and
rapidly evolving technology and is expected to undergo significant
technological changes in the future. While many companies are seeking to
identify therapeutic genes and understand their function in the development
and progression of various diseases, there is limited clinical data available
regarding the safety and efficacy of gene-based therapeutics. The Company is
not aware of any gene-based therapeutics that have received marketing approval
from the FDA or the regulatory bodies of other countries. As a result of the
limited data available or other factors, clinical trials relating to gene-
based therapeutics may take longer to complete than clinical trials involving
more traditional pharmaceuticals. There can be no assurance that any gene-
based therapeutics will be demonstrated to be safe or effective or that the
Company or its corporate partners will be able to manufacture such gene-based
therapeutics on a commercial scale or in an economical manner.
 
                                       7
<PAGE>
 
UNCERTAINTY OF PATENT POSITION AND PROPRIETARY RIGHTS
 
  The patent positions of biotechnology and pharmaceutical companies are often
uncertain and involve complex legal and factual questions, and the breadth of
claims allowed in biotechnology and pharmaceutical patents cannot be
predicted. In addition, there is a substantial backlog of biotechnology patent
applications at the U.S. Patent and Trademark Office (the "PTO") that may
delay the review and the potential issuance of patents. The Company's success
will depend to a significant degree on its ability to obtain patents and
licenses to patent rights, to maintain trade secrets and to operate without
infringing on the proprietary rights of others, both in the United States and
in other countries.
 
  To date, the Company has filed a number of patent applications in the United
States and other countries and has participated as a licensee in the filing of
a number of patent applications in the United States and other countries. The
Company intends to continue to file applications as appropriate for patents
covering both its products and processes. There can be no assurance that
patents will issue from any of these applications, that any patent will issue
on technology arising from additional research or that patents that may issue
from such applications will be sufficient to protect the Company's technology.
Patent applications in the United States are maintained in secrecy until a
patent issues, and the Company cannot be certain that others have not filed
patent applications for technology covered by the Company's pending
applications or that the Company was the first to invent the technology that
is the subject of such patent applications. Competitors may have filed
applications for, or may have received patents and may obtain additional
patents and proprietary rights relating to, compounds, products or processes
that block or compete with those of the Company. The Company is aware of
patent applications filed and patents issued to third parties relating to gene
delivery technologies. The Company's development efforts are at an early
stage, however, and the Company currently is unable to verify that any such
patent applications or patents will have any effect on its products in
development. Should any of its competitors have filed patent applications in
the United States that claim technology also invented by the Company, the
Company may have to participate in interference proceedings declared by the
PTO in order to determine priority of invention and, thus, the right to a
patent for the technology in the United States, all of which could result in
substantial cost to the Company. In addition, litigation, which could result
in substantial cost to the Company, may be necessary to enforce any patents
issued to the Company or to determine the scope and validity of the
proprietary rights of third parties. There can be no assurance that any
patents issued to the Company or to licensors from whom the Company has
licensed rights will not be challenged, invalidated or circumvented, or that
the rights granted thereunder will provide proprietary protection or
commercial advantage to the Company.
 
  The commercial success of the Company depends significantly on its ability
to operate without infringing upon the patents and other proprietary rights of
third parties. There can be no assurance that the Company's technologies do
not and will not infringe upon the patents or other proprietary rights of
third parties. In the event of such infringement, the Company and its
corporate partners may be enjoined from pursuing research, development or
commercialization of their products or may be required to obtain licenses to
these patents or other proprietary rights or to develop or obtain alternative
technologies. There can be no assurance that the Company or its corporate
partners will be able to obtain alternative technologies or any required
license on commercially reasonable terms, if at all. If such licenses or
alternative technologies are not obtained, the Company may be delayed or
prevented from pursuing the development of certain of its potential products
which could have a material adverse effect on the Company's business,
financial condition and results of operations.
 
  The Company also relies on proprietary information and trade secrets,
including its proprietary database of preclinical in vivo experiments, to
develop and maintain its competitive position. There can be no assurance that
third parties will not independently develop equivalent proprietary
information or techniques, will not gain access to the Company's trade secrets
or disclose such technology to the public, or that the Company can maintain
and protect unpatented proprietary technology. The Company typically requires
its employees, consultants, collaborators, advisors and corporate partners to
execute confidentiality agreements upon commencement of employment or other
relationships with the Company. There can be no assurance, however, that these
agreements will provide meaningful protection or adequate remedies for the
Company's technology in the event of unauthorized use or disclosure of such
information, that the parties to such agreements will not breach such
 
                                       8
<PAGE>
 
agreements or that the Company's trade secrets will not otherwise become known
or be discovered independently by its competitors. See "Business--Patents and
Proprietary Technology."
 
NEED TO OBTAIN RIGHTS TO PROPRIETARY GENES AND TECHNOLOGY
 
  A number of the gene sequences that the Company and its corporate partners
are investigating or may use in its products are or may become patented by
others. As a result, the Company or its corporate partners may be required to
obtain licenses to such gene sequences or other technology in order to use or
market such products. In addition, some of the products based on the Company's
gene delivery systems may require the use of multiple proprietary
technologies. Consequently, the Company or its corporate partners may be
required to make cumulative royalty payments to several third parties. Such
cumulative royalties could reduce amounts paid to the Company or be
commercially prohibitive. In connection with the Company's efforts to obtain
rights to such gene sequences or other proprietary technology, the Company may
find it necessary to convey rights to its technology to others. There can be
no assurance that the Company or its corporate partners will be able to obtain
any required licenses on commercially reasonable terms or at all. Failure by
the Company or a corporate partner to obtain a license to any technology
required to commercialize its products could have a material adverse effect on
the Company's business, financial condition and results of operations. See
"Business--Patents and Proprietary Technology."
 
SIGNIFICANT GOVERNMENT REGULATION; NO ASSURANCE OF REGULATORY APPROVAL
 
  The production and marketing of the Company's products and its ongoing
research and development activities are subject to extensive regulation by
governmental authorities in the United States and other countries. The Company
believes that the commercial uses of its products will be regulated as
biologics by the FDA and comparable regulatory bodies of other countries.
Gene-based therapy is, however, a relatively new technology, and the
regulatory requirements governing gene-based therapeutics are uncertain. This
uncertainty may result in excessive costs or extensive delays in the
regulatory approval process, adding to the already lengthy review process for
human therapeutic products in general. The Company is not aware of any gene-
based therapeutics that have received marketing approval from the FDA or any
comparable regulatory body of other countries. The regulation of the Company's
products and its ongoing research is subject to change, and future legislative
or administrative acts in the United States or other countries could have a
material adverse effect on the Company's business, financial condition and
results of operations. Regulatory requirements ultimately imposed could
adversely affect the ability of the Company's corporate partners to clinically
test, manufacture or market products, and could significantly delay or reduce
the milestone or royalty payments payable to the Company.
   
  Currently, the Company is conducting preclinical studies and a corporate
partner is conducting a clinical trial of one of the Company's gene delivery
systems. Prior to marketing in the United States, any drug, including any
biological product, developed by the Company or its corporate partners must
undergo rigorous preclinical studies, clinical trials and an extensive
regulatory approval process implemented by the FDA under the federal Food,
Drug and Cosmetic Act and, for biologics, the Public Health Service Act.
Satisfaction of such regulatory requirements, which includes satisfying the
FDA that the product is both safe and efficacious, typically takes several
years or more depending on the type, complexity and novelty of the product,
and requires a substantial commitment of resources. In addition, academic
institutions and companies conducting research in the gene-based therapy field
are using a variety of approaches and technologies. Any adverse results
generated by such academic institutions or companies in preclinical studies or
clinical trials could adversely affect the regulatory environment for gene-
based therapeutics generally, possibly leading to delays in the approval
process for the Company's products or preventing approval altogether.
Preclinical studies must be conducted in conformance with the FDA's Good
Laboratory Practice regulations. Before clinical trials may be commenced, an
Investigational New Drug Application ("IND") for each planned trial must be
filed with and cleared by the FDA. There can be no assurance that submission
of an IND will result in regulatory authorization to commence clinical trials.
The sponsors of any clinical trials of the Company's products will be
responsible for initiating and overseeing the clinical trials to demonstrate
the safety and efficacy that are necessary to obtain FDA marketing approval of
such products.     
 
                                       9
<PAGE>
 
  Clinical trials must meet FDA regulatory requirements for Institutional
Review Board ("IRB") oversight, informed consent and Good Clinical Practices.
The Company has limited experience in conducting preclinical studies and
clinical trials. The Company will rely primarily on its corporate partners to
conduct the clinical trials necessary to obtain regulatory approval, but it
may conduct initial clinical trials to attract corporate partners. There can
be no assurance that those clinical trials can be conducted at preferred
sites, sufficient test subjects can be recruited or clinical trials will be
started or completed successfully in a timely manner, or at all. Furthermore,
the FDA may suspend clinical trials at any time if it believes the subjects
participating in such trials are being exposed to unacceptable health risks or
if it finds deficiencies in the IND or the conduct of the trial. There can be
no assurance that the Company or its corporate partners will not encounter
problems in clinical trials that cause the Company or its corporate partners
or the FDA to delay, suspend or terminate such trials.
   
  Manufacturing facilities in the United States are subject to periodic
inspection by the FDA and state authorities, and must comply with the FDA's
Good Manufacturing Practice ("GMP") regulations. Manufacturers of biologics
also must comply with the FDA's general biological product standards and also
may be subject to state regulation. Failure to comply with GMP or other
applicable regulatory requirements may result in withdrawal of marketing
approval, criminal prosecution, civil penalties, recall or seizure of
products, warning letters, total or partial suspension of production, FDA
refusal to review pending marketing approval applications or supplements to
approved applications, or injunctions, as well as other legal or regulatory
action against the Company or its corporate partners.     
 
  There can be no assurance that any product developed by the Company and its
corporate partners will prove safe and effective in clinical trials or will
meet all the applicable regulatory requirements necessary to receive marketing
approval from the FDA or any appropriate regulatory body in other countries.
Data obtained from preclinical studies and clinical trials are susceptible to
varying interpretations that could delay, limit or prevent regulatory
approvals. If regulatory approval is granted for a product, such approval will
be limited to only those disease states and conditions for which the product
is safe and effective, as demonstrated through clinical trials. Furthermore,
approval may require ongoing post-marketing studies. After a product is
approved for marketing, the product, its manufacturer and its manufacturing
facilities are subject to continued regulatory review oversight and periodic
FDA inspections. Discovery of previously unknown problems with a product,
manufacturer or facility may result in penalties such as restrictions on such
product, manufacturer or facility, including withdrawal of the product from
the market.
 
  In order to market its products outside of the United States, the Company
and its corporate partners must also comply with numerous and varying
regulatory requirements of other countries implemented by authorities of such
other countries governing the design and conduct of clinical trials and
marketing approval. The approval procedures vary among countries and can
involve additional testing. The time required to obtain approval in other
countries may differ from that required to obtain FDA approval. The regulatory
approval process in other countries includes all of the risks associated with
obtaining FDA approval set forth above, and approval by the FDA does not
ensure approval by the regulatory authorities of any other country. See
"Business--Government Regulation."
 
INTENSE COMPETITION
 
  The pharmaceutical and biotechnology industries are highly competitive. The
Company is aware of several pharmaceutical and biotechnology companies which
are exploring the field of gene-based therapy, are actively engaged in
research and development in areas related to gene-based therapy, or have
commenced clinical trials of gene-based therapeutics. Many of these companies
are addressing diseases which have been targeted by the Company or its
corporate partners. Megabios also may experience competition from companies
that have acquired or may acquire gene-based technology from universities and
other research institutions. As competitors develop their technologies, they
may develop proprietary positions in certain aspects of gene delivery and
gene-based therapeutics that may have a material adverse effect on the
Company's business, financial condition or results of operation. The Company
faces and will continue to face intense competition from other companies for
corporate partnerships with pharmaceutical and biotechnology companies, for
establishing relationships with
 
                                      10
<PAGE>
 
academic and research institutions, and for licenses to proprietary
technology, including intellectual property related to gene delivery systems.
Corporate partners may also elect to internally develop gene-based
therapeutics which compete with the Company's products. In addition, many
other companies are developing non-gene-based therapies to treat these same
diseases.
 
  Most of the Company's competitors and potential competitors have
substantially greater product development capabilities and financial,
scientific, manufacturing, managerial and human resources than the Company.
There can be no assurance that research and development by others will not
render the Company's delivery systems or the products developed by corporate
partners using the Company's delivery systems obsolete or non-competitive or
that any product developed by the Company or its corporate partners will be
preferred to any existing or newly developed technologies. In addition, there
can be no assurance that the Company's competitors will not develop safer,
more effective or less costly gene delivery systems, gene-based therapeutics
or non-gene-based therapies, achieve superior patent protection or obtain
regulatory approval or product commercialization earlier than the Company, any
of which could have a material adverse effect on the Company's business,
financial condition or results of operations. See "Business--Competition."
 
ACCUMULATED DEFICIT; UNCERTAINTY OF FUTURE PROFITABILITY
   
  Since its inception, the Company has been engaged in research and
development activities, has generated minimal revenues from operations and has
experienced significant operating losses. As of June 30, 1997, the Company had
an accumulated deficit of approximately $20.2 million. The process of
developing the Company's gene delivery systems will require significant
additional research and development, preclinical testing, clinical trials and
regulatory approvals. These activities, together with the Company's general
and administrative expenses, are expected to result in operating losses for
the foreseeable future. There can be no assurance that the Company will
generate revenues or achieve and sustain profitability in the future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."     
 
NEED FOR ADDITIONAL FUTURE CAPITAL; UNCERTAINTY OF ADDITIONAL FUNDING
 
  The Company will require additional funding after this offering in order to
continue its research and development activities. The Company has financed its
operations primarily through the sale of equity securities and through
corporate partnerships. The Company has generated no royalty revenues from
product sales, and no such revenues are expected for the foreseeable future,
if ever. The Company anticipates that its existing resources, including the
net proceeds of this offering, committed funding from existing corporate
partnerships and projected interest income, will enable the Company to
maintain its current and planned operations through fiscal 1999. However,
there can be no assurance that the Company will not require additional funding
prior to such time. The Company's future capital requirements will depend on
many factors, including scientific progress in its research and development
programs, the size and complexity of such programs, the scope and results of
preclinical studies and clinical trials, the ability of the Company to
establish and maintain corporate partnerships, the time and costs involved in
obtaining regulatory approvals, the time and costs involved in filing,
prosecuting and enforcing patent claims, competing technological and market
developments, the cost of manufacturing preclinical and clinical material and
other factors not within the Company's control. There can be no assurance that
such additional financing to meet the Company's funding requirements will be
available on acceptable terms or at all. If additional funds are raised by
issuing equity securities, substantial dilution to existing stockholders may
result. Insufficient funds may require the Company to delay, scale back or
eliminate some or all of its research or development programs or to relinquish
greater or all rights to products at an earlier stage of development or on
less favorable terms than the Company would otherwise seek to obtain. See "Use
of Proceeds" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
 
DEPENDENCE ON KEY PERSONNEL; NEED TO ATTRACT AND RETAIN KEY EMPLOYEES AND
CONSULTANTS
 
  The Company is highly dependent on its executive officers and scientific
staff. In addition, the Company relies on consultants and advisors to assist
the Company in formulating its research and development strategy. The loss of
any of these persons could have a material adverse effect on the Company's
corporate partnerships,
 
                                      11
<PAGE>
 
business, financial condition and results of operations. In order to pursue
its research and product development plans, the Company is and will be
required to attract and retain additional qualified scientific and other
personnel. There can be no assurance that the Company will be successful in
attracting and retaining these skilled persons who generally are in high
demand by pharmaceutical and biotechnology companies and by universities and
other research institutions. The failure to successfully attract and retain
qualified personnel, consultants and advisors may impede the achievement of
the Company's objectives and have a material adverse effect on the Company's
business, financial condition and results of operations. See "Business--
Scientific Advisory Board" and "Management."
 
LIMITED MANUFACTURING EXPERIENCE
 
  The Company has limited experience in manufacturing and currently lacks the
resources or capability to manufacture any of its products on a commercial
scale. While the Company has a pilot manufacturing facility, successful large-
scale manufacturing of the Company's gene delivery systems or its products has
not been demonstrated by the Company or any third parties. The Company will be
dependent initially on corporate partners, licensees or other third parties
for commercial-scale manufacturing of its products. Successful large-scale
manufacturing of gene-based therapeutics has not been demonstrated by any
third parties. There can be no assurance that the Company will be able to
reach satisfactory agreements with its corporate partners, licensees or other
third parties or that these parties will be able to develop adequate
manufacturing capabilities for commercial-scale quantities of gene-based
therapeutic products. See "Business--Manufacturing and Commercialization."
 
UNCERTAINTY OF COMMERCIAL ACCEPTANCE
   
  The Company's success is dependent on commercial acceptance of its products.
The Company believes that recommendations by physicians and health care payors
will be essential for commercial acceptance of its products. Concerns have
arisen regarding the potential safety and efficacy of gene-based therapeutics
using viral delivery systems. While the Company's gene delivery systems are
lipid-based and do not contain viruses, there can be no assurance that
physicians' and health care payors' evaluations of the Company's products will
not be unfavorably effected by concerns over viral gene-based therapies or
that they will conclude that the Company's products or technology are safe and
effective. There can be no assurance that products developed by the Company
and its corporate partners will achieve commercial acceptance among patients,
physicians or third-party payors. Failure to achieve commercial acceptance
would have a material adverse effect on the Company's business, financial
condition and results of operations.     
 
UNCERTAINTY OF PRODUCT PRICING AND REIMBURSEMENT
 
  The ability of Megabios' corporate partners to manufacture and sell its
products successfully will depend in part on the extent to which reimbursement
for the cost of such products and related treatments will be available from
government health administration authorities, private health insurers and
other organizations. Third-party payors are increasingly challenging the price
of medical products and services. Significant uncertainty exists as to the
reimbursement status of newly-approved health care products, and if the
Company and its corporate partners succeed in bringing any products to market,
there can be no assurance that these products will be considered cost
effective, that reimbursement will be available, or if available, that the
payors' reimbursement policies will not adversely affect the corporate
partner's ability to sell such products on a profitable basis, and thus the
Company's ability to derive revenue through royalties on sales of such
products.
 
PRODUCT LIABILITY EXPOSURE; AVAILABILITY OF INSURANCE
   
  The manufacture and sale of therapeutic products involve an inherent risk of
product liability claims and associated adverse publicity. The Company
currently has only limited product liability insurance. There can be no
assurance that the Company will be able to maintain existing or obtain
additional product liability insurance on acceptable terms, if at all, or that
it will provide adequate coverage against potential liabilities. An inability
to     
 
                                      12
<PAGE>
 
obtain sufficient insurance coverage on reasonable terms or to otherwise
protect against potential product liability claims could prevent or inhibit
the commercialization of the Company's products. A successful product
liability claim brought against the Company in excess of its insurance
coverage, if any, could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Business--
Product Liability Insurance."
 
HAZARDOUS AND RADIOACTIVE MATERIALS; ENVIRONMENTAL MATTERS
 
  The Company's research and development processes involve the controlled use
of hazardous materials, chemicals and radioactive materials and produce waste
products. The Company is subject to federal, state and local laws and
regulations governing the use, manufacture, storage, handling and disposal of
such materials and waste products. There can be no assurance that
contamination or injury from these materials will not occur. In such event,
the Company could be held liable for any damages that result and any such
liability could exceed the resources of the Company. There can be no assurance
that the Company will not be required to incur significant costs to comply
with environmental laws and regulations, or that the Company's business,
financial condition or results of operations will not be materially adversely
affected by current or future environmental laws or regulations. See
"Business--Government Regulation."
 
ABSENCE OF PRIOR PUBLIC MARKET; VOLATILITY OF STOCK PRICE
   
  Prior to this offering there has been no public market for the Common Stock,
and there can be no assurance that an active market will develop or be
maintained. The initial public offering price will be negotiated between the
Company and the representatives of the Underwriters and may not be indicative
of future market prices. See "Underwriting" for information related to the
method of determining the initial public offering price. The market price of
the shares of Common Stock, like that of the common stock of many other
biotechnology companies, is likely to be highly volatile. Factors such as the
Company's operating results, developments in the Company's relationships with
corporate partners, developments affecting the Company's corporate partners,
announcements of results of preclinical studies and clinical trials by the
Company, its corporate partners, its competitors or their products, regulatory
action or regulatory approval with respect to the Company, its corporate
partners, its competitors or their products, announcements of new products by
the Company or its competitors, developments related to patent or other
proprietary rights by the Company or its competitors, changes in the
recommendation of securities analysts with respect to the Common Stock, and
market conditions for biotechnology stocks in general may cause the market
price of the Common Stock to fluctuate, perhaps substantially. The Company
expects that operating results will fluctuate from quarter to quarter and that
such fluctuations may be substantial. In addition, in recent years the stock
market in general, and the shares of biotechnology and healthcare companies in
particular, have experienced extreme price fluctuations. These broad market
and industry fluctuations may have a material adverse effect on the market
price of the Common Stock. In the future, the Company's operating results may
be below the expectations of public market analysts and investors, and, as a
result, the price of the Common Stock would likely be materially adversely
affected.     
 
CONTROL BY EXISTING STOCKHOLDERS; ANTI-TAKEOVER EFFECTS OF CERTAIN CHARTER
PROVISIONS AND DELAWARE LAW
 
  After this offering, the Company's named executive officers, directors and
principal stockholders will beneficially own approximately 4,959,568 or 40.6%
of the outstanding shares of Common Stock (39.4% if the underwriters'
overallotment option is exercised in full). As a result, such persons may have
the ability to effectively control the Company and direct its affairs and
business. Such concentration of ownership may also have the effect of
delaying, deferring or preventing a change in control of the Company. In
addition, the Company's Board of Directors will have the authority to issue up
to 10,000,000 shares of Preferred Stock and to determine the price, rights,
preferences and privileges of those shares without any further vote or action
by the stockholders. The rights of the holders of Common Stock will be subject
to, and may be materially adversely affected by, the rights of the holders of
any Preferred Stock that may be issued in the future. The issuance of
Preferred Stock could have the effect of making it more difficult for a third
party to acquire a majority of the outstanding voting stock of the Company.
Furthermore, certain provisions of the Company's Restated Certificate
 
                                      13
<PAGE>
 
of Incorporation, including the provision for a staggered Board of Directors,
may have the effect of delaying or preventing changes in control or management
of the Company, which could adversely affect the market price of the Company's
Common Stock. In addition, the Company will be subject to the provisions of
Section 203 of the Delaware General Corporation Law (the "Delaware Law"), an
anti-takeover law. See "Principal Stockholders" and "Description of Capital
Stock."
 
SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS
   
  Sales of a substantial number of shares of Common Stock in the public market
following this offering could adversely affect the market price for the
Company's Common Stock. The number of shares of Common Stock available for
sale in the public market is limited by restrictions under the Securities Act
of 1933, as amended (the "Securities Act"), and lock-up agreements pursuant to
which all directors and executive officers and certain other stockholders of
the Company have agreed not to sell or otherwise dispose of any of their
shares without the prior written consent of the Company or Montgomery
Securities. However, Montgomery Securities or the Company, as applicable, may
at any time without notice, release all or any portion of the securities
subject to lock-up agreements. The Company has agreed with Montgomery
Securities not to release any stockholder from such lock-up agreement between
the stockholder and the Company without the consent of Montgomery Securities.
As a result of such restrictions and based upon the number of shares
outstanding on July 15, 1997, on the date of this Prospectus approximately
22,645 shares, other than the 2,500,000 shares offered hereby, will be
eligible for sale pursuant to subsection (k) of Rule 144 promulgated under the
Securities Act. An additional 8,045,052 shares and 96,709 shares issuable upon
exercise of outstanding vested options will be eligible for sale 180 days
after the date of this Prospectus upon expiration of the lock-up agreements
and in compliance with certain limitations set forth in the Securities Act. An
additional 1,385,706 shares held by existing stockholders will become eligible
for sale at various times over a period of less than one year. The remaining
272,536 shares currently held by existing stockholders will be subject to
rights of repurchase in favor of the Company that expire at various dates
through May 2001 pursuant to monthly vesting. After this offering, the holders
of approximately 8,154,779 shares of Common Stock will be entitled to certain
demand and piggyback registration rights with respect to registration of such
shares under the Securities Act. If such holders, by exercising their demand
or piggyback registration rights, cause a large number of securities to be
registered and sold in the public market, such sales could have an adverse
effect on the market price for the Company's Common Stock. If the Company were
to include in a Company-initiated registration shares held by such holders
pursuant to the exercise of their piggyback registration rights, such sales
may have an adverse effect on the Company's ability to raise needed capital.
See "Shares Eligible For Future Sale" and "Description of Capital Stock--
Registration Rights."     
 
DILUTION; ABSENCE OF DIVIDENDS
   
  The initial public offering price will be substantially higher than the book
value per share of Common Stock. Assuming an initial public offering price of
$12.00 per share, investors purchasing shares of Common Stock in this offering
will incur immediate, substantial dilution of $7.70 per share in the net
tangible book value of Common Stock. Additional dilution will occur upon the
exercise of outstanding options and warrants. See "Dilution." The Company has
never declared or paid any cash dividends and does not anticipate paying cash
dividends in the foreseeable future. See "Dividend Policy."     
 
                                      14
<PAGE>
 
               
            SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS     
   
  Certain statements contained in this Prospectus, including without
limitation, statements containing the words "believes," "anticipates,"
"expects" and words of similar import, constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995
(the "Reform Act"). Such forward-looking statements involve known and unknown
risks, uncertainties and other factors which may cause the actual results,
performance or achievements of Megabios, or industry results, to be materially
different from any future results, performance or achievements expressed or
implied by such forward-looking statements. Such factors include, among
others: the early stage of development of the Company and its products;
dependence on corporate partnerships and need for additional corporate
partnerships; uncertainty of product development and gene-based therapeutics;
dependence on proprietary technology and uncertainty of patent protection;
existing government regulation and changes in, or the failure to comply with,
government regulation; intense competition; history of operating losses; the
Company's need for additional financing; dependence on key personnel; limited
manufacturing experience; uncertainty of commercial acceptance of its products
and other factors referenced in this Prospectus. Certain of these factors are
discussed in more detail elsewhere in this Prospectus, including, without
limitation, under the captions "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business." Given these uncertainties, prospective investors
are cautioned not to place undue reliance on such forward-looking statements.
Megabios disclaims any obligation to update any such factors or to publicly
announce the result of any revisions to any of the forward-looking statements
contained herein to reflect future events or developments.     
 
 
                                      15
<PAGE>
 
                                USE OF PROCEEDS
 
  The net proceeds to the Company from the sale of the shares of Common Stock
offered hereby are estimated to be $27,300,000 ($31,485,000 if the over-
allotment option is exercised in full) at an assumed initial public offering
price of $12.00 per share after deducting underwriting discounts and estimated
offering expenses payable by the Company.
 
  The Company intends to use approximately $15.0 million of the net proceeds
of the offering to fund research and development activities, including the
development of existing and future gene delivery systems and $8.0 million for
leasehold improvements to the Company's facilities and for the purchase of
certain capital equipment. The balance of the net proceeds of the offering are
expected to be used for working capital and general corporate purposes. These
corporate purposes may include the purchase of technology assets and licenses.
The Company has no present understandings, commitments or arrangements with
respect to the purchase of any technology assets or licenses, and the amount
and timing of these expenditures will depend on numerous factors, including
the progress of the Company's research programs and its ability to attract
additional corporate partners. Pending application of the net proceeds of the
offering as described above, the Company intends to invest such proceeds in
short-term, investment-grade, interest-bearing financial instruments.
 
  The Company anticipates that its existing resources, including the net
proceeds of this offering, committed funding from existing corporate
partnerships and projected interest income, will enable the Company to
maintain its current and planned operations through fiscal 1999. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
 
                                DIVIDEND POLICY
 
  The Company has never declared or paid any cash dividends on its capital
stock. The Company currently intends to retain any future earnings to finance
the growth and development of its business and therefore does not anticipate
paying any cash dividends in the foreseeable future. The Company's term loan
with a commercial bank, which expires in August 1998, prohibits the payment of
dividends.
 
                                      16
<PAGE>
 
                                CAPITALIZATION
   
  The following table sets forth as of June 30, 1997, (i) the pro forma
capitalization of the Company giving effect to the conversion of all
outstanding shares of Preferred Stock into Common Stock and the
reincorporation of the Company into Delaware and (ii) the pro forma
capitalization as adjusted to give effect to the receipt by the Company of the
estimated net proceeds from the sale of the shares of Common Stock offered
hereby at an assumed initial public offering price of $12.00 per share, after
deducting the underwriting discounts and estimated offering expenses payable
by the Company. This table should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Financial Statements and Notes thereto included elsewhere in this
Prospectus.     
 
<TABLE>   
<CAPTION>
                                                              JUNE 30, 1997
                                                          ----------------------
                                                          PRO FORMA  AS ADJUSTED
                                                          ---------  -----------
                                                             (IN THOUSANDS)
<S>                                                       <C>        <C>
Long-term debt........................................... $  1,487    $  1,487
Stockholders' equity(1):
 Preferred stock, $.001 par value; 10,000,000 shares
  authorized; no shares issued and outstanding, pro forma
  and as adjusted........................................      --          --
 Common stock, $.001 par value; 30,000,000 shares
  authorized; 9,722,506 shares issued and outstanding,
  pro forma; 12,222,506 shares issued and outstanding, as
  adjusted, at amounts paid-in...........................   46,110      73,410
Deferred compensation....................................     (679)       (679)
Accumulated deficit......................................  (20,208)    (20,208)
                                                          --------    --------
   Total stockholders' equity............................   25,223      52,523
                                                          --------    --------
    Total capitalization................................. $ 26,710    $ 54,010
                                                          ========    ========
</TABLE>    
- --------
   
(1) Based on 9,722,506 shares outstanding as of June 30, 1997. Excludes (i)
    479,622 shares of Common Stock issuable upon exercise of outstanding stock
    options as of June 30, 1997 at a weighted average exercise price of $1.22
    per share, (ii) 84,008 shares of Common Stock issuable upon exercise of
    warrants outstanding at June 30, 1997 at an exercise price of $3.88 per
    share, (iii) an additional 781,699 shares of Common Stock reserved for
    future grants pursuant to the Company's 1997 Equity Incentive Plan and
    (iv) 200,000 shares of Common Stock reserved for purchase pursuant to the
    Company's 1997 Employee Stock Purchase Plan.     
 
                                      17
<PAGE>
 
                                   DILUTION
   
  The pro forma net tangible book value of the Company as of June 30, 1997 was
approximately $25.2 million, or $2.59 per share of Common Stock. Pro forma net
tangible book value per share is determined by dividing the net tangible book
value (tangible assets less total liabilities) of the Company by the number of
shares of Common Stock outstanding at that date, including shares of Common
Stock from the conversion of the Preferred Stock immediately prior to the
consummation of the Offering. Without taking into account any other changes in
the net tangible book value after June 30, 1997, other than to give effect to
the receipt by the Company of the estimated net proceeds from the sale of
2,500,000 shares of Common Stock offered by the Company hereby at an assumed
initial public offering price of $12.00 per share, the pro forma net tangible
book value of the Company as of June 30, 1997, would have been $52.5 million,
or $4.30 per share. This represents an immediate increase in the pro forma net
tangible book value of $1.71 per share to existing stockholders and an
immediate dilution of $7.70 per share to new public investors. The following
table illustrates this per share dilution:     
 
<TABLE>   
   <S>                                                              <C>   <C>
   Assumed initial public offering price...........................       $12.00
    Pro forma net tangible book value before offering.............. $2.59
    Increase attributable to new public investors(1)...............  1.71
                                                                    -----
   Pro forma net tangible book value after offering................         4.30
                                                                          ------
   Dilution to new public investors................................       $ 7.70
                                                                          ======
</TABLE>    
   
  The following table summarizes, on a pro forma basis, as of June 30, 1997,
the difference between existing stockholders and purchasers of shares in the
offering (at an assumed initial public offering price of $12.00 per share and
before deducting underwriting discounts and estimated offering expenses
payable by the Company) with respect to the number of shares of Common Stock
purchased from the Company, the total consideration paid and the average price
per share paid:     
 
<TABLE>   
<CAPTION>
                           SHARES PURCHASED(1)    TOTAL CONSIDERATION  AVERAGE
                           --------------------  --------------------   PRICE
                             NUMBER     PERCENT     AMOUNT    PERCENT PER SHARE
                           ------------ -------  ------------ ------- ---------
   <S>                     <C>          <C>       <C>         <C>     <C>
   Existing stockholders..    9,722,506     79.5% $45,534,000   60.3%   $4.68
   New public investors...    2,500,000     20.5   30,000,000   39.7    12.00
                           ------------  -------  -----------  -----
     Total................   12,222,506    100.0% $75,534,000  100.0%
                           ============  =======  ===========  =====
</TABLE>    
- --------
   
(1) The foregoing computations exclude (i) 479,622 shares of Common Stock
    issuable upon exercise of stock options outstanding as of June 30, 1997,
    at a weighted average exercise price of $1.22 per share, (ii) 84,008
    shares of Common Stock issuable upon exercise of warrants outstanding at
    June 30, 1997, at an exercise price of $3.88 per share, (iii) an
    additional 781,699 shares of Common Stock reserved for future grants
    pursuant to the Company's 1997 Equity Incentive Plan and (iv) 200,000
    shares of Common Stock reserved for purchase pursuant to the Company's
    1997 Employee Stock Purchase Plan. To the extent that options or warrants
    are exercised and shares of Common Stock are issued, there will be further
    dilution to new investors. See "Management's Discussion and Analysis of
    Financial Condition and Results of Operations--Liquidity and Capital
    Resources," "Management--Stock Plans" and "Description of Capital Stock."
        
                                      18
<PAGE>
 
                            SELECTED FINANCIAL DATA
   
  The selected financial data presented below for the years ended June 30,
1995, 1996 and 1997 and the balance sheet data as of June 30, 1996 and 1997
are derived from the financial statements of the Company included elsewhere in
this Prospectus which have been audited by Ernst & Young LLP, independent
auditors. The Statements of Operations Data for the period from April 23, 1992
(Inception) to June 30, 1993 and for the year ended June 30, 1994 and the
balance sheet data as of June 30, 1993, 1994 and 1995 are derived from
financial statements audited by Ernst & Young LLP not included in this
Prospectus. The data should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Financial Statements and the Notes thereto included elsewhere in this
Prospectus. The Company has not paid any cash dividends.     
 
<TABLE>   
<CAPTION>
                               APRIL 23,
                                  1992
                             (INCEPTION) TO       YEAR ENDED JUNE 30,
                                JUNE 30,    ----------------------------------
                                1993(1)      1994     1995     1996     1997
                             -------------- -------  -------  -------  -------
                                 (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                          <C>            <C>      <C>      <C>      <C>
STATEMENTS OF OPERATIONS
 DATA:
 Collaborative research and
  development revenue.......     $  --      $   500  $ 1,157  $ 1,890  $ 5,793
 Operating expenses:
  Research and development..       593        1,922    4,691    6,487    8,598
  General and
   administrative...........       165          796    1,811    2,169    2,417
                                 -----      -------  -------  -------  -------
    Total operating
     expenses...............       758        2,718    6,502    8,656   11,015
                                 -----      -------  -------  -------  -------
 Loss from operations.......      (758)      (2,218)  (5,345)  (6,766)  (5,222)
 Interest income (expense),
  net.......................       (20)          65      (84)    (135)     275
                                 -----      -------  -------  -------  -------
 Net loss...................     $(778)     $(2,153) $(5,429) $(6,901) $(4,947)
                                 =====      =======  =======  =======  =======
 Pro forma net loss per
  share(2)..................                                           $ (0.50)
                                                                       =======
 Shares used in computing
  pro forma net loss per
  share(2)..................                                             9,926
                                                                       =======
</TABLE>    
 
<TABLE>   
<CAPTION>
                                                  JUNE 30,
                                   -------------------------------------------
                                   1993    1994     1995      1996      1997
                                   -----  -------  -------  --------  --------
                                               (IN THOUSANDS)
<S>                                <C>    <C>      <C>      <C>       <C>
BALANCE SHEET DATA:
 Cash, cash equivalents and short-
  term investments................ $ 374  $ 1,886  $   282  $  5,253  $ 24,269
 Working capital..................  (702)     758     (873)    3,568    21,629
 Total assets.....................   430    4,344    4,969     9,956    29,978
 Long-term debt...................   --       412    1,305     1,894     1,487
 Accumulated deficit..............  (778)  (2,931)  (8,360)  (15,261)  (20,208)
 Total stockholders' equity.......  (701)   2,436    2,219     6,086    25,223
</TABLE>    
- --------
(1) The Company's financial data for fiscal 1992 and 1993 is not presented
    separately as the Company's operations from April 23, 1992 to June 30,
    1992 were immaterial.
   
(2) See Note 1 of Notes to Financial Statements for an explanation of the
    computation of pro forma net loss per share.     
 
                                      19
<PAGE>
 
  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
                                  OPERATIONS
   
  The discussion below contains certain forward-looking statements that are
based on the beliefs of the Company's management, as well as assumptions made
by, and information currently available to, the Company's management. The
Company's future results, performance or achievements could differ materially
from those expressed in, or implied by, any such forward-looking statements.
See "Risk Factors" for a discussion of factors that could cause or contribute
to such material differences. The following presentation of Management's
Discussion and Analysis of Financial Condition and Results of Operations
should be read in conjunction with the Company's Financial Statements and
Notes thereto and other financial information included therein.     
 
OVERVIEW
   
  Megabios, incorporated in 1992, develops proprietary gene delivery systems
and provides preclinical development expertise to create gene-based
therapeutics designed for the treatment or prevention of genetic and acquired
diseases. The Company has developed several in vivo, non-viral gene delivery
systems to address a number of potential therapeutic applications using a
variety of therapeutic genes. The Company's clinical development and
commercialization strategy is to enter into corporate partnerships with
pharmaceutical and biotechnology companies. The Company has established
corporate partnerships with Glaxo Wellcome, Pfizer and Lilly. To date,
substantially all revenue has been generated by collaborative research and
development revenue from corporate partners, and no revenue has been generated
from product sales. The Company expects that future revenue will be derived in
the short-term from research and development revenue and milestone payments
and in the long-term from royalties on product sales.     
   
  A substantial portion of the Company's revenues to date have been from
payments under the Glaxo Wellcome Agreement and Pfizer Agreement, totaling
approximately $4.8 million and $3.6 million, respectively, through June 30,
1997. The research and development funding portion of the Glaxo Wellcome
Agreement terminated in April 1997. The Company has completed all of its
obligations under the Glaxo Wellcome Agreement and will receive future
payments, if any, under the Glaxo Wellcome Agreement only through the
achievement of a certain milestone and the payment of royalties.     
   
  The Company has incurred significant losses since inception and expects to
incur substantial losses for the foreseeable future, primarily due to the
expansion of its research and development programs and because the Company
does not expect to generate revenues from the sale of products in the
foreseeable future, if at all. The Company expects that operating results will
fluctuate from quarter to quarter and that such fluctuations may be
substantial. As of June 30, 1997, the Company's accumulated deficit was
approximately $20.2 million.     
   
  The Company's business is subject to significant risks, including the risks
inherent in its research and development efforts, reliance on corporate
partners, uncertainties associated with obtaining and enforcing patents, the
lengthy, expensive and uncertain regulatory approval process, competition from
other companies' products, and the need for additional capital. See "Risk
Factors."     
 
RESULTS OF OPERATIONS
       
          
 FISCAL YEARS ENDED JUNE 30, 1997, 1996 AND 1995     
   
  Revenue. Revenue from corporate partnerships totaled $5.8 million, $1.9
million, and $1.2 million for the years ended June 30, 1997, 1996 and 1995,
respectively. The 1997 revenue was attributable to amounts earned for research
performed under the Company's corporate partnerships with Glaxo Wellcome,
Pfizer and Lilly. The 1996 revenue was attributable to amounts earned for
research performed under the Company's corporate partnerships with Glaxo
Wellcome and Pfizer and the 1995 revenue resulted entirely from research
payments under the Glaxo Wellcome corporate partnership.     
 
 
                                      20
<PAGE>
 
   
  Research and Development Expenses. Research and development expenses
increased to $8.6 million in 1997 from $6.5 million in 1996 and $4.7 million
in 1995. The increases in each period were primarily attributable to increased
payroll and personnel expenses as the Company hired additional research and
development personnel to support its independent research and collaborative
programs, increased purchases of laboratory supplies, increased equipment and
leasehold improvement depreciation, increased facilities expenses in
connection with the build-out of the present facility and an increased use of
consultants and analytical lab services. The Company expects to expand its
independent research and collaborative programs in future periods, which will
result in increased research and development expenses in absolute dollars.
       
  General and Administrative Expenses. General and administrative expenses
increased to $2.4 million in 1997 from $2.2 million in 1996 and $1.8 million
in 1995. The increases in each period were primarily attributable to increased
payroll and personnel expenses as the Company hired additional management, and
to increased consulting, legal, professional, travel and other fees and
expenses associated with an increase in business development activities.
General and administrative expenses are expected to increase in absolute
dollars in the future to support the Company's expanding business activities
and the increased costs expected to be incurred as a publicly-traded company.
       
  Interest Income (Expense), Net. Interest income (expense), net increased to
$275,000 in 1997 compared with interest income (expense), net from ($135,000)
in 1996 and ($84,000) in 1995. Interest income increased to $656,000 in 1997
from $230,000 in 1996 and $56,000 in 1995. Increases in interest income
resulted from the change in average cash and investment balances as a result
of sales of equity securities of the Company. Interest expense increased to
$381,000 in 1997 from $365,000 in 1996 and $140,000 in 1995. The increase in
interest expense in 1997 was due to the higher average outstanding balance on
an equipment financing line of credit. The increase in interest expense in
1996 was attributable to amounts due under a term loan executed in early 1996
and to the increased utilization of an equipment financing line of credit.
    
LIQUIDITY AND CAPITAL RESOURCES
   
  The Company has financed its operations since inception primarily through
the sale of equity securities, funds provided under corporate partnerships and
equipment and leasehold improvement financing. As of June 30, 1997, the
Company had received approximately $45.4 million in net proceeds from the sale
of equity securities and approximately $10.2 million for license fees and
research support payments under corporate partnerships.     
   
  Cash, cash equivalents and short-term investments at June 30, 1997 were
$24.3 million compared to $5.3 million at June 30, 1996. The increase was due
primarily to the proceeds received from the sale of equity securities and
research payments received under corporate partnerships, offset by net cash
used in operations.     
   
  Net cash used in the Company's operations decreased to $2.8 million for 1997
from $5.5 million for 1996. The decrease was primarily due to the increased
research and development funding from corporate partnerships. The Company's
capital expenditures for 1997 and 1996 were $1.9 million and $1.1 million,
respectively.     
   
  In May 1996, the Company entered into an equipment financing agreement for
up to $2.7 million. As of June 30, 1997, the Company had borrowed
approximately $1.6 million under this agreement for equipment purchases
structured as loans. These loans are being repaid over 48 months at interest
ranging from 15.2% to 16.2% per annum. In connection with this agreement, the
Company issued to the lender a warrant to purchase 38,238 shares of the
Company's Series C Preferred Stock at an exercise price of $3.88 per share.
The warrant expires at the earlier of April 30, 2006 or five years after the
closing of this offering.     
   
  In June 1995, the Company obtained a $1.5 million line of credit from a
commercial bank. In August 1995, the Company converted this line of credit
into a $1.5 million term loan bearing interest at the prime rate plus 2%. The
loan is payable in 36 equal monthly installments beginning August 31, 1995. In
connection with the     
 
                                      21
<PAGE>
 
   
term loan, the Company issued to the lender a warrant to purchase 24,140
shares of Series C Preferred Stock at an exercise price of $3.88 per share.
The warrant expires on the earlier of June 1, 2000, or a merger or sale of
substantially all of the Company's assets.     
   
  In December 1993, the Company entered into a financing agreement for up to
$2.3 million with another financing company. As of June 30, 1997, the Company
had borrowed $1.9 million under the agreement for equipment purchases and
tenant improvements structured as loans. These loans are being repaid over 42
months at interest rates ranging from 13.8% to 16.2% per annum. In connection
with this agreement, the Company issued a warrant to purchase 21,630 shares of
the Company's Series B Preferred Stock at an exercise price of $3.88 per
share. The warrant expires on the earliest of May 13, 2000, or the day prior
to the effectiveness of a registration statement covering an underwritten
offering of the Company's securities with aggregate gross proceeds of at least
$7.5 million, or a merger or sale of substantially all of the Company's
assets.     
 
  The Company anticipates that its existing resources, including the net
proceeds of this offering, committed funding from existing corporate
partnerships and projected interest income, will enable the Company to
maintain its current and planned operations through fiscal 1999. However,
there can be no assurance that the Company will not require additional funding
prior to such time. The Company's future capital requirements will depend on
many factors, including scientific progress in its research and development
programs, the size and complexity of such programs, the scope and results of
preclinical studies and clinical trials, the ability of the Company to
establish and maintain corporate partnerships, the time and costs involved in
obtaining regulatory approvals, the time and costs involved in filing,
prosecuting and enforcing patent claims, competing technological and market
developments, the cost of manufacturing preclinical and clinical materials and
other factors not within the Company's control. There can be no assurance that
additional financing to meet the Company's funding requirements will be
available on acceptable terms or at all. If additional funds are raised by
issuing equity securities, substantial dilution to existing stockholders may
result. Insufficient funds may require the Company to delay, scale back, or
eliminate some or all of its research or development programs or to relinquish
greater or all rights to products at an earlier stage of development or on
less favorable terms than the Company would otherwise seek to obtain.
   
  The Company recorded deferred compensation representing the difference
between the exercise price of options granted and the deemed fair market value
of its Common Stock at the time of grant. Deferred compensation of
approximately $750,000 was recorded through June 30, 1997, and an additional
$390,000 is expected to be recorded for options granted subsequent to June 30,
1997. Deferred compensation will be recognized as an expense over the related
vesting term of the options, generally four years.     
   
  The Company has not generated significant taxable income to date. At June
30, 1997, the net operating losses available to offset future taxable income
for federal income tax purposes were approximately $15.6 million. Because the
Company has experienced ownership changes, future utilization of the
carryforwards may be limited in any one fiscal year pursuant to Internal
Revenue Code regulations. The carryforwards expire at various dates beginning
in 2008 through 2012 if not utilized. As a result of the annual limitation, a
portion of these carryforwards may expire before becoming available to reduce
the Company's federal income tax liabilities.     
 
                                      22
<PAGE>
 
                                   BUSINESS
 
  Megabios develops proprietary gene delivery systems and provides preclinical
development expertise to create gene-based therapeutics designed for the
treatment or prevention of genetic and acquired diseases. The Company has
developed several in vivo, non-viral gene delivery systems to address a number
of potential therapeutic applications using a variety of therapeutic genes.
The Company's clinical development and commercialization strategy is to enter
into collaborative research and development agreements or "corporate
partnerships" with pharmaceutical and biotechnology companies. To date, the
Company has established corporate partnerships with Glaxo Wellcome to develop
a treatment for cystic fibrosis using the CFTR gene, Pfizer to develop a
treatment for solid tumors through angiogenesis inhibition and Lilly to
develop treatments for breast and ovarian cancer using the BRCA1 gene.
 
BACKGROUND
 
 Genes and Gene-based Therapeutics
 
  Genes provide the "code" for proteins, which determine the nature and
function of cells and tissues in all living organisms. The study of genes and
their function ("genomics") provides the fundamental basis for understanding
human health and disease and has led to the identification of many genes with
potential therapeutic utility ("therapeutic genes").
   
  The entire genetic content of an organism is known as its genome. In humans,
the genome is believed to contain approximately 100,000 genes, each of which
is composed of a unique sequence of DNA molecules that encode genetic
instructions. These genetic instructions enable cells to carry out their
normal biological functions. The process by which an organism utilizes genetic
instructions and produces proteins is known as gene expression. The expression
of a defective gene, or the over- or under-expression of a normal gene, is
responsible for certain disease conditions. For example, the expression of a
single defective gene is known to cause cystic fibrosis and sickle cell
anemia, and the defective expression of multiple genes is believed to be
involved in the progression of diseases such as cancer and diabetes, as well
as cardiovascular, neurological and other diseases.     
 
  The worldwide effort to decipher the human genome and to understand the
function of its constituent genes is yielding important insights into the
roles that genes play in disease conditions, as well as how genes may be
useful in the treatment of such diseases. It is estimated that there are at
least 5,000 genes of known function, many of which have been identified as
potential therapeutic genes. Various companies and academic institutions are
investing substantial financial and human resources to identify additional
therapeutic genes, and the Company believes that this process will create
opportunities for gene-based therapeutics.
 
  Gene-based therapy is an approach to the treatment or prevention of certain
diseases in which therapeutic genes are introduced into target cells to cause
the production of specific proteins needed to bring about a therapeutic
effect. For gene-based therapy to be effective, the therapeutic gene must be
delivered to the target cell, transported across the outer membrane and into
the cell, where it can be expressed. The expressed protein may remain within
the cell for an intracellular effect, be transported to the cell membrane to
exert a cell surface effect or be secreted into the bloodstream to have a
systemic effect. Most gene-based therapies utilize a delivery system, or
vector, into which the therapeutic gene is incorporated to facilitate its
delivery to, and uptake by, the target cell.
 
                                      23
<PAGE>
 
               
[GRAPHIC DEPICTION OF EXPRESSION OF A THERAPEUTIC GENE IN A TARGET CELL]     
                                     
 
 Gene Delivery Approaches
 
  To date, a limiting factor in gene-based therapy has been the lack of safe,
effective gene delivery systems. A number of gene delivery approaches are
being developed, each of which has exhibited certain limitations. These
approaches may be categorized by their mode of administration, ex vivo
(outside the body) or in vivo (inside the body), and by the nature of the gene
delivery system (viral or non-viral).
 
  Many clinical trials of potential gene-based therapeutics have used ex vivo,
viral gene delivery. Ex vivo gene-based therapies involve procedures in which
selected cells are removed from the patient, transduced with the therapeutic
gene, expanded in number, cleansed of contaminants and then reintroduced into
the same patient. This lengthy and labor-intensive process significantly
differs from traditional pharmaceutical administration and may result in a
complex, high-cost procedure.
 
  In an effort to overcome these limitations, certain companies are developing
in vivo gene delivery systems that employ viruses to deliver the therapeutic
gene into target cells. Although in vivo, viral gene delivery approaches may
be suitable for certain applications, the Company believes that several issues
resulting from the use of viruses may limit their broad application. Certain
types of viral gene delivery systems permanently alter the DNA of the target
cell due to integration of the virus carrying the therapeutic gene into the
DNA of the cell. This permanent and potentially random integration may result
in the inability to regulate the gene-based therapeutic, the inactivation of a
beneficial gene or the unintended activation of a harmful gene. In addition,
certain viral gene delivery systems have been shown to cause immune reactions,
limiting their use for chronic diseases that may require repeat dosing. Viral
gene delivery systems may also have limitations as to the size of the
therapeutic gene that can be delivered. Furthermore, the Company believes that
it may be difficult and expensive to manufacture and purify the desired viral
strain due to the risks associated with handling viruses.
 
  To overcome the concerns associated with the use of viruses, in vivo, non-
viral gene delivery methods are being developed. Such methods typically
include the insertion of a therapeutic gene into a circular segment of DNA
known as a DNA plasmid, which is designed to control expression of the
therapeutic gene in the cell. The plasmid is packaged with a carrier, often a
lipid-based formulation, and delivered into the target cell by various modes
of administration, including inhalation, intravenous administration, direct
injection and intraperitoneal administration. These traditional modes of
administration are familiar to physicians and may be more convenient and cost
effective than ex vivo approaches. In addition, DNA plasmids degrade over time
and do not integrate into the host genome. Therefore, plasmid-based systems
avoid the potentially random integration associated with some viral approaches
and allow for more flexible treatment since the gene is not permanently
expressed. In
 
                                      24
<PAGE>
 
spite of the advantages of in vivo, non-viral delivery approaches, their
development has been limited by a number of considerations, including low
levels and short duration of gene expression, non-specific cell targeting,
inflammation or other adverse effects and manufacturing difficulties.
 
MEGABIOS' IN VIVO, NON-VIRAL GENE DELIVERY APPROACH
 
  The Company's in vivo, non-viral gene delivery systems are designed to avoid
the significant limitations of ex vivo (whether viral or non-viral) and in
vivo, viral gene delivery. Furthermore, the Company believes it has made
progress in overcoming the limitations often associated with in vivo, non-
viral gene delivery approaches. The Company's proprietary gene delivery
systems consist primarily of two components: (i) DNA plasmids containing a
therapeutic gene that controls its proper expression; and (ii) lipids and
other agents that facilitate the delivery of the DNA plasmids into the target
cell. In most of its gene delivery systems, the Company combines negatively
charged DNA with novel, positively charged lipids and neutral lipids to form
DNA:lipid complexes. These complexes are the active ingredient in the
Company's gene delivery systems. Certain of the Company's other gene delivery
systems utilize polymers and peptides instead of lipids to facilitate the
delivery of DNA plasmids.
             
      [GRAPHIC DEPICTION OF FORMULATION AND ADMINISTRATION OF THERAPUTIC]    
                                     
 
  The Company's portfolio of gene delivery systems is classified by series
based on the mode of administration and the cell type to which the gene-based
therapeutic is delivered, with each formulation within a series having
distinct specifications and potential applications. For example, different
gene delivery systems within the MB200 Series result in different patterns of
expression following intravenous administration. To date, the Company has
developed seven series of gene delivery systems and expects to design
additional series of gene delivery systems, expanding the scope of its
commercial opportunities. The Company believes its proprietary, non-viral gene
delivery systems may have the following benefits:
 
  Therapeutically Relevant Gene Expression. Megabios has developed DNA
  plasmids that, following their formulation with lipids and their
  administration to animals, produce therapeutically relevant protein levels
  that persist for up to two months. Following intravenous administration to
  mice of the gene for a commercially available cytokine, the cytokine was
  detected in the blood at levels consistent with those required for
  therapeutic effect. Similarly, following aerosol administration to primates
  of the therapeutic gene to treat cystic fibrosis, the resulting human
  protein was produced in the correct cell type (lung epithelial cells) and
  at levels believed to be potentially therapeutic.
 
  Tissue-specific Gene Delivery and Expression. The Company believes that its
  gene delivery systems result in specific targeting to certain tissues and a
  number of cell types. In preclinical studies, the Company has demonstrated
  that various formulations are taken up selectively by (i) ciliated
  epithelial cells lining the airways of the lungs following aerosol
  administration, (ii) vascular endothelial cells lining the blood vessels of
  several tissues, including lung, heart, spleen and lymphatic tissues,
  following intravenous administration, (iii) solid tumors following direct
  administration either into the tumor or other local tissues, (iv) antigen
 
                                      25
<PAGE>
 
  presenting cells following intramuscular, intradermal, subcutaneous or
  intravenous injection, (v) circulating macrophages following intravenous
  administration and (vi) cells in the central nervous system following
  direct injection. For example, in a preclinical study to test the pattern
  of uptake of two intravenous formulations, one formulation resulted in over
  90% of observable gene expression in the vascular endothelial cells of the
  lungs, while the other formulation resulted in over 90% of observable gene
  expression in the spleen. In addition, following direct injection in
  animals, the Company's formulations have been demonstrated to result in
  transfection of solid tumors and muscle and brain tissue.
 
  Ease of Handling and Administration, Stability and Scalable Manufacturing
  Methods. The Company's gene delivery systems are designed to be handled and
  administered like traditional pharmaceuticals. These gene delivery systems
  are also designed to be stable when refrigerated and are intended to be
  distributed like other pharmaceuticals. Megabios has demonstrated that it
  can produce clinical-grade DNA plasmids, DNA:lipid complexes and
  formulations under controlled conditions without the expense and handling
  requirements associated with viral gene delivery systems. In addition,
  Megabios has developed manufacturing and production methods designed to be
  scaled to meet commercial requirements and has produced DNA plasmids at a
  contract manufacturer at the 1,000 liter scale.
 
  Improved Safety Profile. Megabios has tested its gene delivery systems in
  hundreds of in vivo, preclinical experiments. In animal models, the
  Company's aerosol gene delivery systems do not appear to cause serious
  adverse effects, such as inflammation, which has been seen following the
  aerosol administration of lipid-based gene delivery systems under
  development by other companies. Megabios believes that its gene delivery
  systems may allow for repeat administration of gene-based therapeutics for
  the treatment of chronic diseases, such as asthma and other inflammatory
  conditions.
 
  The Company has also developed techniques that allow it to screen genes for
potential therapeutic utility. Because the Company believes that in vitro gene
expression experiments do not correlate well with in vivo results, Megabios
has focused on testing its gene delivery systems in animals. The Company has
developed a methodology to test therapeutic genes in vivo in rapid succession.
For example, in a matter of weeks, the Company can prepare plasmids containing
different therapeutic genes, formulate them in an appropriate lipid-based
delivery system and administer the formulations to animals. After testing
several different genes, the Company can demonstrate the potential clinical
utility of a panel of therapeutic genes, facilitating selection of the gene-
based therapeutic to be developed. In addition, Megabios has expertise in the
selection of appropriate animal models, as well as in the development of
various assays and analytical techniques, to assess the performance of
formulations containing various genes. While the results of preclinical animal
studies do not predict safety or efficacy in humans, when, and if, further
clinical trials are conducted, the Company believes that its gene screening
capability and its experience in preclinical development will enable it to
accelerate the development of gene-based therapeutics and thereby attract
corporate partners.
 
COMMERCIALIZATION STRATEGY
 
  The Company provides technology and preclinical development expertise that
it believes will be critical to the successful commercialization of many
therapeutic genes. The Company's commercialization strategy is to enter into
corporate partnerships with pharmaceutical and biotechnology companies to
develop gene-based therapeutics. Megabios corporate partnerships' are
structured to provide the Company with funding for research and development,
milestone payments and, upon commercialization, product royalties. This
strategy is intended to enable Megabios to extend and leverage its technology
platform, focus on preclinical development of gene-based therapeutics and
create a portfolio of product development programs sponsored by its corporate
partners. The key components of the Company's commercialization strategy are
to:
 
  Exploit Broad Technology Platform. The Company believes that its gene
  delivery systems can be used for multiple therapeutic applications. The
  Company's goal is to establish several corporate partnerships for each
  series of gene delivery systems that it has developed, since the plasmid
  component of its formulations may contain any of several genes. For
  example, the Company has entered into a corporate partnership with Glaxo
  Wellcome to develop a gene-based therapeutic to treat cystic fibrosis using
  the Company's aerosol gene
 
                                      26
<PAGE>
 
  delivery technology, referred to as the MB100 Series. Gene delivery systems
  in the MB100 Series may also be useful with different therapeutic genes to
  treat other pulmonary diseases, such as asthma. Therefore, once a
  particular gene delivery technology has been developed, it may be
  commercialized with several partners for several different diseases. The
  Company intends to expand its technology platform to include additional
  non-viral gene delivery systems which target additional tissues and cell
  types, creating an even broader portfolio of potential commercial
  applications.
 
  Focus Resources on Conversion of Genes into Drug Candidates. The Company
  intends to focus on (i) DNA plasmid development to optimize expression of
  the therapeutic gene, (ii) formulation development to achieve appropriate
  targeting of the therapeutic gene to various cell types, (iii) gene
  screening to validate the potential utility of a therapeutic gene, (iv)
  preclinical studies, including animal models of disease, toxicology and
  pharmacological testing, (v) assay development in support of preclinical
  studies and clinical trials and (vi) supply of material for preclinical
  studies and early clinical trials. Under certain circumstances, the Company
  may sponsor early clinical testing of a potential gene-based therapeutic to
  attract prospective corporate partners. In most cases, however, the
  Company's corporate partners will be responsible for clinical trials,
  sales, marketing, and large-scale clinical and commercial manufacturing. By
  limiting its role primarily to research and preclinical development of gene
  delivery systems, the Company believes it will be able to build and
  maintain its expertise in the area of in vivo, non-viral gene delivery.
     
  Diversify Through Multiple Projects and Corporate Partners. The Company's
  strategy is to structure its corporate partnerships so that its research
  and development activities on behalf of corporate partners will be fully
  subsidized. Other potential payments that may be received by the Company
  from corporate partners, including licensing fees, equity investments and
  milestone payments, will be used to fund the further development of the
  Company's core technology. The Company believes this will limit financial
  risk by eliminating its exposure to capital-intensive activities such as
  large-scale clinical trials, commercial manufacturing and sales and
  marketing, while enabling the Company to continue to advance its core
  technology. In addition, the Company believes that creating a portfolio of
  product development programs will reduce the Company's dependence on any
  particular product development program.     
 
CORPORATE PARTNERS
 
  The Company has entered into three collaborative research and development
agreements or "corporate partnerships" and is actively seeking additional
partnerships with pharmaceutical and biotechnology companies. Many of these
companies have identified therapeutic genes, but Megabios believes many such
companies do not possess the technology or the know-how to develop gene-based
therapeutics. Megabios seeks license fees, equity investments, funding for
research and development, milestone payments and royalties on product sales in
exchange for commercial licenses to the Company's gene delivery technologies
and access to its preclinical development expertise.
 
 Glaxo Wellcome
 
  In April 1994, the Company entered into a corporate partnership with Glaxo
Wellcome to develop a gene-based therapeutic for the treatment of cystic
fibrosis. Cystic fibrosis is the most common lethal genetic disease in
Caucasians, occurring in about 1 in 3,000 live births. The disease is believed
to afflict approximately 60,000 patients in the United States and Europe.
Cystic fibrosis is caused by a defect in the CFTR gene. This defect results in
production of defective CFTR protein, leading to the build-up of mucus in the
lungs that often results in multiple infections, loss of lung function and
premature death. The median life expectancy of a patient with cystic fibrosis
is approximately 30 years. Patients with cystic fibrosis typically incur
annual medical costs ranging from $15,000 to $55,000. The Company believes
that a gene-based therapeutic which results in increased levels of normal CFTR
protein on the surface of ciliated epithelial cells may slow or halt the
progression of this disease while reducing the total cost of patient care.
 
  The Company has conducted preclinical testing of a gene delivery system in
the MB100 Series as a carrier for the CFTR gene. Data from these studies,
including the administration of the gene to primates via inhalation, have
demonstrated expression of the human form of the CFTR gene in the correct
location in the appropriate
 
                                      27
<PAGE>
 
cell type with no evidence of inflammation, a common problem associated with
non-viral gene-based therapeutics. In addition, approximately 20% of the
target cells were shown to produce CFTR protein six weeks after a single
administration, which exceeds the level believed to be the threshold for
achieving a therapeutic effect. The Company believes that these results
suggest that this product may be useful in the treatment of cystic fibrosis.
In June 1997, Glaxo Wellcome commenced a Phase I/II clinical trial in cystic
fibrosis patients with cystic fibrosis using a gene delivery system in the
MB100 Series as a carrier for the CFTR gene.
   
  Under the Glaxo Wellcome Agreement, the Company conducted research and
preclinical development activities for a three-year period ending April 1997.
The terms of the Glaxo Wellcome Agreement provide Glaxo Wellcome with the
exclusive rights to manufacture, market and sell gene-based therapeutics
incorporating the Company's gene delivery systems for the treatment of cystic
fibrosis. Glaxo Wellcome will be responsible for clinical trials, large-scale
clinical and commercial manufacturing, and sales and marketing of any
potential gene-based therapeutics resulting from the corporate partnership. In
addition to receiving $5.0 million in research funding, the Company is
entitled to receive a milestone payment from Glaxo Wellcome upon the
commencement of a Phase III clinical trial, a portion of which will be
credited against future royalties, as well as royalties on the sales of
products resulting from the corporate partnership. The Company has completed
all of its obligations under the Glaxo Wellcome Agreement and will receive
future payments, if any, only through the achievement of a certain milestone
and the payment of royalties.     
 
 Pfizer
 
  In May 1996, the Company entered into a corporate partnership with Pfizer to
develop a gene-based therapeutic for the treatment of solid tumors using gene
delivery systems in the MB200 Series which are designed to deliver genes that
inhibit angiogenesis. In order to survive and multiply, clusters of cancer
cells, referred to as solid tumors, require oxygen and other nutrients that
are delivered via the bloodstream. To access this blood supply, cancer cells
initiate a biochemical process that stimulates angiogenesis (the process by
which new blood vessels are formed), creating a new network of blood vessels
that nourish the tumor and remove waste products. As cancer cells grow and
metastasize (spread from primary sites to secondary sites), they stimulate
angiogenesis to form and nourish new tumors. Angiogenesis inhibitors have been
shown to slow or stop the formation of new blood vessels and therefore the
growth and spread of solid tumors.
 
  The Company's gene-based therapeutic under development with Pfizer is
intended to inhibit angiogenesis associated with the formation and growth of
solid tumors. Gene delivery systems in the MB200 Series have been shown in
animal models to achieve gene expression selectively in vascular endothelial
cells of the lungs and other tissues. The initial disease targeted in the
Pfizer collaboration is non-small cell lung cancer ("NSCLC"). It is estimated
that there are approximately 300,000 new cases of NSCLC each year in the
United States and Europe. The Company believes there is no adequate treatment
for NSCLC. The median survival for patients with advanced forms of the disease
is approximately six months after diagnosis. The Company believes that a
therapy which is useful for the treatment of NSCLC also may be useful for
other solid tumors, such as cancer of the breast, prostate and ovaries.
 
  Under the Pfizer Agreement, the Company is responsible for performing
research and preclinical development activities for a period of up to four
years. The Company's responsibilities include DNA plasmid development,
formulation development, assay development, preclinical studies including
toxicology and pharmacological testing and supply of material for preclinical
studies. In addition, the Company is conducting gene screening using gene
delivery systems in the MB200 Series using intravenous administration to
determine the relative utility of various therapeutic genes believed to
inhibit angiogenesis.
 
  The Pfizer Agreement provides that Pfizer receive the exclusive rights to
develop, make, use and sell gene-based therapeutics resulting from the
corporate partnership. Under the Pfizer Agreement, the Company is conducting
research and preclinical development activities and will receive funding for
such activities through at least June 1998. Pfizer will be responsible for
clinical trials, large-scale clinical and commercial manufacturing, and sales
and marketing of any potential gene-based therapeutics resulting from the
corporate partnership. The Company will be entitled to receive up to $16.4
million in research and development funding if the agreement
 
                                      28
<PAGE>
 
   
continues for four years, as well as up to $20.0 million in payments upon the
achievement of certain clinical milestones, which milestone payments will be
credited against future royalties, if any. In addition, if a product receives
marketing approval from the FDA or an equivalent agency in another country,
the Company is entitled to receive royalties on sales of products resulting
from the corporate partnership. In connection with the execution of the Pfizer
Agreement, Pfizer purchased 484,697 shares of Series D Preferred Stock for
$3.5 million. The Pfizer Agreement permits Pfizer to terminate the program for
any reason, including reasons unrelated to such program, after June 1998 upon
six months prior notice. If Pfizer elects to extend the research term beyond
two years, it will be required, prior to January 1998, to commit to purchase
within 60 days $10.0 million of the Company's Common Stock at a premium to the
then current market value, subject to certain adjustments. The Company is
uncertain whether Pfizer will exercise its option to extend the Pfizer
Agreement and make the corresponding equity investment in the Company. Under
the terms of the Pfizer Agreement, Pfizer's aggregate ownership in the Company
may not exceed 19.99% of the Company's outstanding capital stock.     
 
 Lilly
   
  In May 1997, the Company entered into a corporate partnership with Lilly to
develop gene-based therapeutics using BRCA1, a gene which has been identified
as a putative tumor suppressor. In normal cells, tumor suppressor genes act to
inhibit cell division. When a tumor suppressor gene, such as BRCA1, is missing
or defective, a cell may begin to replicate uncontrollably, resulting in the
formation of a tumor. Various scientific publications have associated defects
in BRCA1 with breast, ovarian and prostate cancers. Increased expression of
the BRCA1 gene in diseased tissue may inhibit or prevent the uncontrolled cell
growth associated with cancer, without causing any adverse effect in normal
cells. BRCA1 will be developed as a gene-based therapeutic initially using
gene delivery systems in the MB300 Series, which are administered via direct
injection, and gene delivery systems in the MB700 Series, which are
administered into the intraperitoneal cavity.     
 
  The Company's gene-based therapeutic under development with Lilly is
initially focused on the delivery and expression of BRCA1 in diseased cells in
breast and ovarian tissue. Preliminary studies of Megabios' gene delivery
systems indicate that gene delivery systems in the MB300 Series may be useful
in the targeting of genes to ovarian and breast tissues. There are over
180,000 new cases of breast cancer and over 26,000 new cases of ovarian cancer
reported each year in the United States. In addition, other gene delivery
systems will be tested and potentially developed for the purpose of delivering
BRCA1 to various tissues using other modes of administration, including
intraperitoneal and intravenous administration.
   
  Under the Lilly Agreement, the Company is responsible for performing
research and preclinical development activities for a period of up to four
years. The Lilly Agreement provides that Lilly receive the exclusive rights to
develop, make, use and sell gene-based therapeutics incorporating BRCA1
resulting from the corporate partnership. Under the Lilly Agreement, the
Company will conduct research and preclinical development activities and will
receive funding for a minimum of two years. Lilly will be responsible for
clinical trials, large-scale clinical and commercial manufacturing, and sales
and marketing of any gene-based therapeutics resulting from the corporate
partnership. The Company will be entitled to receive at least $7.0 million in
research and development funding during the first two years of the agreement,
which may be extended for up to two additional years provided that Lilly and
the Company agree on an appropriate level of research and development funding
for such extension period. In addition, the Company may receive up to $27.5
million in payments upon the achievement of certain preclinical and clinical
milestones and, if a product receives marketing approval from the FDA or an
equivalent foreign agency, the Company is entitled to receive royalties on
sales of products resulting from the corporate partnership. In connection with
the execution of the Lilly Agreement, Lilly purchased 285,714 shares of the
Company's Series F Preferred Stock for $3.0 million. The Lilly Agreement
permits Lilly to terminate the program for any reason, including reasons
unrelated to such program, after May 1999 upon three months prior notice.     
 
  The Company is highly dependent upon its corporate partnerships with Glaxo
Wellcome, Pfizer and Lilly. There can be no assurance that either, or both of,
the Pfizer Agreement or the Lilly Agreement will be extended, that research
funds under the Pfizer Agreement or the Lilly Agreement or milestone payments
contemplated by
 
                                      29
<PAGE>
 
any of the Company's corporate partnerships will be received, that the equity
investment contemplated by the Pfizer Agreement will be consummated, or that
any of these corporate partnerships will result in successfully commercialized
products and the receipt by the Company of related royalty revenues. Should
the Company fail to receive research funds or should milestones set forth in
any or all of the Glaxo Wellcome Agreement, the Pfizer Agreement or the Lilly
Agreement not be achieved, or should Glaxo Wellcome, Pfizer or Lilly breach or
terminate their respective agreements, either prior to scheduled termination
or on the termination date, the Company's business, financial condition and
results of operations will be materially adversely affected. The Company will
also need to enter into additional corporate partnerships, and there can be no
assurance that the Company will be able to do so on favorable terms, or at
all. Should any corporate partner fail to develop or commercialize
successfully any product to which it has obtained rights from the Company, the
Company's business, financial condition and results of operations may be
materially adversely affected.
 
MEGABIOS' GENE DELIVERY SYSTEMS
 
  The Company has developed several gene delivery systems and has identified a
number of potential therapeutic applications for each of these systems using a
variety of therapeutic genes. The Company's portfolio of gene delivery systems
are classified by series based on the mode of administration and the cell type
to which the gene-based therapeutic is delivered, with each formulation within
a series having distinct specifications and potential applications. For
example, one gene delivery system in the MB100 Series has been optimized for
the aerosol delivery of the CFTR gene to ciliated epithelial cells in the
lungs, while a different aerosol gene delivery system in the same series is
under development to deliver genes for the treatment of asthma. The table
below summarizes the Company's gene delivery systems, potential applications
and agreements with corporate partners:
 
 
<TABLE>   
<CAPTION>
    DELIVERY SYSTEM
  (MODE OF ADMINISTRATION)   CELL TYPE(S) TRANSFECTED        POTENTIAL APPLICATIONS              STATUS(1)
  ------------------------   ------------------------ ------------------------------------ ---------------------
  <S>                        <C>                      <C>                                  <C>
  MB100 Series                 Ciliated               Cystic fibrosis                      Phase I/II with Glaxo
   (Inhalation)                 epithelial cells      Asthma                               Wellcome
                                in the lungs and      Inflammation of the lungs            Preclinical
                                respiratory tract     Mucosal immunization                 Research
                                                      Infectious diseases of the lungs     Research
                                                                                           Research
 
  MB200 Series                 Vascular               Angiogenesis inhibition (cancer)     Preclinical with
   (Intravenous injection)      endothelial cells     Angiogenesis inhibition (non-cancer) Pfizer
                                in the lungs,         Protein replacement therapy          Preclinical
                                heart, spleen and     Cardiovascular diseases              Preclinical
                                lymph nodes           Inflammatory diseases                Preclinical
                                                                                           Research
 
  MB300 Series                 Solid tumor cells      Cancer (using BRCA1)                 Preclinical with
   (Direct injection)                                 Cancer (other genes)                 Lilly
                                                                                           Preclinical
 
  MB400 Series                 Various cells          Preventive vaccines                  Research
   (Intramuscular,              involved in           Therapeutic vaccines                 Research
   intradermal,                 antigen               Immunotherapy (cancer, infectious    Research
   subcutaneous and             presentation           diseases, autoimmune diseases)
   intravenous injection)
 
  MB500 Series                 Circulating            Infectious diseases                  Research
   (Intravenous injection)      macrophages           Hyperlipidemia                       Research
 
  MB600 Series                 Cells in the           Neurodegenerative diseases           Research
   (Direct injection)           central nervous       Cancer                               Research
                                system
 
  MB700 Series                 Solid tumor cells      Cancer (using BRCA1)                 Preclinical with
   (Intraperitoneal                                   Cancer (other genes)                 Lilly
   injection)                                                                              Research
</TABLE>    
 
- --------
(1)  "Phase I/II" indicates that the compound is being tested in humans for
     safety and preliminary indications of biological activity in a limited
     patient population.

     "Preclinical" indicates that Megabios is conducting efficacy,
     pharmacology and/or toxicology testing of a gene delivery system in
     animal models or biochemical or cell culture assays. 

     "Research" includes the development of animal models and assay systems,
     discovery of prototype gene delivery systems and evaluation and
     refinement of prototype gene delivery systems in in vitro and in vivo
     testing.
     
                                      30
<PAGE>
 
 MB100 Series
 
  The Company has developed a class of gene delivery systems, the MB100
Series, which, following aerosol administration to animals, results in genes
being taken up and expressed primarily by ciliated epithelial cells in the
lungs and respiratory tract. The Company believes that the MB100 Series may be
useful in the delivery of therapeutic genes for a variety of purposes,
including treatment of cystic fibrosis, asthma, inflammatory conditions and
infectious diseases of the lungs, as well as for mucosal immunization. One of
these gene delivery systems is the subject of the Company's corporate
partnership with Glaxo Wellcome to develop a gene-based therapeutic for the
treatment of cystic fibrosis. See "--Corporate Partners--Glaxo Wellcome."

  The Company intends to enter into a corporate partnership to develop the
MB100 Series for the treatment of asthma. Asthma, characterized by obstruction
of airways in the lung, is estimated to affect 5% of the population in the
United States, or approximately 13 million people. Certain genes believed to
be associated with the onset and progression of asthma have been identified,
and various companies are investing heavily in further understanding the
genetic cause of asthma. The Company believes that the MB100 Series may be
useful for the delivery of therapeutic genes to treat asthma as well as other
therapeutic genes to treat other inflammatory diseases in the lungs.
 
  The Company also intends to conduct studies using the MB100 Series together
with certain therapeutic genes to achieve mucosal immunity. Mucosal immunity
is a form of immunization resulting from the introduction of an antigen to the
mucosal cells lining the airways of the lungs, oral cavity or nasal passages.
The Company believes that the MB100 Series may be useful to deliver
therapeutic genes that result in mucosal immunity in diseases, such as
tuberculosis and pneumonia. The Company believes that the MB100 Series also
may be useful to deliver therapeutic genes for the treatment of other
pulmonary disorders, such as infectious diseases.
 
 MB200 Series
 
  Megabios has developed a class of gene delivery systems, the MB200 Series,
which, following intravenous administration, are taken up preferentially by
vascular endothelial cells in the lungs and other tissues. The Company
believes that gene delivery systems in the MB200 Series, in combination with
various genes, may be useful in the treatment of several diseases that are
associated with angiogenesis, including cancer, macular degeneration, diabetic
retinopathy, rheumatoid arthritis and psoriasis. In addition, Megabios
believes that gene delivery systems in the MB200 Series may be useful for
protein replacement therapy and to treat other medical disorders such as
cardiovascular and inflammatory diseases. Megabios has entered into a
corporate partnership with Pfizer to develop a gene-based therapeutic to treat
solid tumors using gene delivery systems in the MB200 Series which are
designed to deliver genes that inhibit angiogenesis. See "--Corporate
Partners--Pfizer."
 
  In preclinical studies, administration of a gene delivery system in the
MB200 Series has resulted in expression levels of a therapeutic protein
consistent with those required for a therapeutic effect. These preclinical
studies suggest that a gene delivery system in the MB200 Series could be used
for protein replacement therapy, in which the gene coding for a therapeutic
protein is administered rather than the protein itself. The Company believes
that the use of gene-based therapeutics in this manner may be a viable
alternative when therapeutic levels of a protein are difficult to sustain or
when the therapeutic protein is difficult or expensive to manufacture.
 
  In addition, the Company believes that the ability to target certain cell
types with gene delivery systems in the MB200 Series may be useful in
developing gene-based therapeutics for a number of other medical disorders.
For example, Megabios believes that the administration of gene delivery
systems in the MB200 Series combined with certain therapeutic genes that
stimulate angiogenesis may be useful to treat certain cardiovascular diseases,
such as peripheral vascular disease and atherosclerosis, both of which may
result in the blockage of blood vessels, leading to heart attacks and strokes.
In addition, the use of gene delivery systems in the MB200 Series to deliver
therapeutic genes coding for anti-inflammatory agents may be useful to treat
inflammatory diseases following intravenous administration.
 
 
                                      31
<PAGE>
 
 MB300 Series
 
  Megabios has developed a class of gene delivery systems, the MB300 Series,
which, following direct injection in animals, are taken up by cancer cells and
may be useful for the treatment of certain solid tumors. In preclinical
studies involving a canine model of spontaneously occurring oral melanoma, a
gene delivery system in the MB300 Series was used to deliver two therapeutic
genes. The data from this study indicated that a majority of the dogs that
received the treatment regimen exceeded their expected median survival period.
These dogs also had a higher number of activated white blood cells compared to
untreated animals, which suggests that the therapeutic genes augmented the
immune response to the tumor cells resulting in an increased survival rate for
these animals. The Company believes that these results support the potential
utility of the gene delivery systems in the MB300 Series to facilitate
immunotherapy approaches for the treatment of multiple forms of cancer.
 
  Other gene delivery systems in the MB300 Series have been tested by the
Company to facilitate the treatment of multiple forms of cancer using
different approaches, such as through the delivery of suicide genes or tumor
suppressor genes. Megabios has entered into a corporate partnership with Lilly
to develop gene-based therapeutics using the MB300 Series as well as other
gene delivery systems, to deliver the BRCA1 gene to treat breast cancer and
ovarian cancer. See "--Corporate Partners--Lilly." The Company intends to
pursue additional corporate partnerships to develop gene-based therapeutics to
treat cancer using other (non-BRCA1) therapeutic genes.
 
 MB400 Series
 
  The Company is developing a class of gene delivery systems, the MB400
Series, designed to administer genetic vaccines following various modes of
administration, including intramuscular, intradermal, subcutaneous or
intravenous injection. To date, the use of DNA for vaccination purposes has
been limited by inadequate levels of expression of the vaccine antigen in the
appropriate cell type. The Company has designed and screened many delivery
systems, some of which may have improved targeting and expression
characteristics. If successful, these efforts could result in novel
formulations that may allow the treatment or prevention of certain diseases,
including infections and autoimmune diseases, as well as certain forms of
cancer, through a genetic vaccine approach.
 
 Other Gene Delivery Systems
 
  The Company is developing other classes of gene delivery systems for
additional therapeutic applications. For example, the Company believes that
the MB500 Series, which is designed to deliver genes to circulating
macrophages, has potential utility in various infectious diseases and
hyperlipidemia. The MB600 Series is designed to deliver genes to cells in the
central nervous system, which is an important target for the potential
treatment of neurodegenerative diseases, including Parkinson's and Alzheimer's
disease, as well as for the treatment of certain cancers. The MB700 Series is
designed to result in the delivery of genes to solid tumor cells following
intraperitoneal administration.
 
  There can be no assurance that any of the Company's gene delivery systems
will have the performance attributes to justify their further development or
to attract corporate partners. While the Company has demonstrated some
evidence of the utility of its gene delivery systems in preclinical animal
studies, these results do not predict safety or efficacy in humans, when, and
if, further clinical trials are conducted. The Company's products may prove to
have undesirable and unintended side effects or other characteristics that may
prevent or limit their use. There can be no assurance that any of the
Company's products will ultimately obtain FDA or other regulatory or foreign
marketing approval for any indication. The Company's products are also subject
to risks particular to the development of gene-based therapeutics. Gene-based
therapy is a new and rapidly evolving technology and is expected to undergo
significant technological changes in the future. As a result of the limited
clinical data available regarding the safety and efficacy of gene-based
therapeutics and other factors, clinical trials relating to gene-based
therapeutics may take longer to complete than clinical trials involving more
traditional pharmaceuticals. There can be no assurance that any gene-based
therapeutics will be demonstrated to be safe or effective or that the Company
or its corporate partners will be able to manufacture such gene-based
therapeutics on a commercial scale or in an economical manner.
 
                                      32
<PAGE>
 
TECHNOLOGY LICENSES
 
  Megabios actively reviews technologies under development at academic and
other research institutions. The Company believes that such institutions are
an important source of breakthrough technologies and has entered into and
intends to enter into additional licensing arrangements to expand its core
technology.
   
  The Company has an exclusive license to certain patent applications held by
The Regents of the University of California ("The Regents") related to in
vivo, non-viral delivery of genes using positively charged lipids, including
delivery by various modes of administration and for use in the treatment of
cystic fibrosis. One patent has issued in the United States and one Notice of
Allowance has been received in the United States with respect to two patent
applications and two equivalent notices have been received in a foreign
country. Under the terms of the agreement, the Company has paid a license fee
and is obligated to make payments upon the achievement of certain clinical
milestones and royalty payments on sales of products, if any.     
 
PATENTS AND PROPRIETARY TECHNOLOGY
 
  Patents and other proprietary rights are important to the Company's
business. The Company's policy is to file patent applications and to protect
technology, inventions and improvements to inventions that are commercially
important to the development of its business. The Company also relies on trade
secrets, confidentiality agreements and other measures to protect its
technology and proposed products. The Company's failure to obtain patent
protection or otherwise protect its proprietary technology or proposed
products may have a material adverse effect on the Company's competitive
position and business prospects.
   
  The Company has rights under its license with The Regents to one issued
United States patent which expires in 2014. In addition, the Company has
eleven pending patent applications in the United States as well as foreign
counterparts of these applications. The Company has received Notices of
Allowance in the United States with respect to three patent applications. The
patent application process takes several years and entails considerable
expense. In addition to its own patent applications, the Company has acquired
exclusive worldwide licenses to patent applications from The Regents. There is
no assurance that additional patents will issue from these applications or, if
patents do issue, that the claims allowed will be sufficient to protect the
Company's technology.     
 
  A number of the gene sequences that the Company and its corporate partners
are investigating or may use in its products are or may become patented by
others. As a result, the Company or its corporate partners may be required to
obtain licenses to such gene sequences or other technology in order to use or
market such products. In addition, some of the products based on the Company's
gene delivery systems may require the use of multiple proprietary
technologies. Consequently, the Company or its corporate partners may be
required to make cumulative royalty payments to several third parties. Such
cumulative royalties could reduce amounts paid to the Company or be
commercially prohibitive. In connection with the Company's efforts to obtain
rights to such gene sequences or other proprietary technology, the Company may
find it necessary to convey rights to its technology to others. There can be
no assurance that the Company or its corporate partners will be able to obtain
any required licenses on commercially reasonable terms or at all.
 
  The patent positions of pharmaceutical and biotechnology firms are often
uncertain and involve complex legal and factual questions. Further, the
breadth of claims allowed in biotechnology patents is unpredictable. Patent
applications in the United States are maintained in secrecy until a patent
issues, and the Company cannot be certain that others have not filed patent
applications for technology covered by the Company's pending applications or
that the Company was the first to invent the technology that is the subject of
such patent application. Competitors may have filed applications for, or may
have received patents and may obtain additional patents and proprietary rights
relating to, compounds, products or processes that block or compete with those
of the Company. While the Company is aware of patent applications filed and
patents issued to third parties relating to genes, gene delivery technologies
and gene-based therapeutics, there can be no assurance that any such patent
applications or patents will not have a material adverse effect on products
the Company or its corporate partners
 
                                      33
<PAGE>
 
are developing or may seek to develop in the future. There can be no assurance
that third parties will not assert patent or other intellectual property
infringement claims against the Company with respect to its products or
technology or other matters.
 
  Patent litigation is widespread in the biotechnology industry. Litigation
may be necessary to defend against or assert claims of infringement, to
enforce patents issued to the Company, to protect trade secrets or know-how
owned or licensed by the Company, or to determine the scope and validity of
the proprietary rights of third parties. Although no third party has asserted
that the Company is infringing such third party's patent rights or other
intellectual property, there can be no assurance that litigation asserting
such claims will not be initiated, that the Company would prevail in any such
litigation, or that the Company would be able to obtain any necessary licenses
on reasonable terms, if at all. Any such claims against the Company, with or
without merit, as well as claims initiated by the Company against third
parties, can be time-consuming and expensive to defend or prosecute and to
resolve. If other companies prepare and file patent applications in the United
States that claim technology also claimed by the Company, the Company may have
to participate in interference proceedings to determine priority of invention,
which could result in substantial cost to the Company even if the outcome is
favorable to the Company.
 
  The Company also relies on proprietary information and trade secrets,
including its proprietary database of preclinical in vivo experiments, to
develop and maintain its competitive position. There can be no assurance that
third parties will not independently develop equivalent proprietary
information or techniques, will not gain access to the Company's trade secrets
or disclose such technology to the public, or that the Company can maintain
and protect unpatented proprietary technology. The Company typically requires
its employees, consultants, collaborators, advisors and corporate partners to
execute confidentiality agreements upon commencement of employment or other
relationships with the Company. There can be no assurance, however, that these
agreements will provide meaningful protection or adequate remedies for the
Company's technology in the event of unauthorized use or disclosure of such
information, that the parties to such agreements will not breach such
agreements or that the Company's trade secrets will not otherwise become known
or be discovered independently by its competitors.
 
MANUFACTURING AND COMMERCIALIZATION
 
  The Company's focused commercialization strategy is based on entering
corporate partnerships with pharmaceutical and biotechnology companies whereby
the Company will primarily pursue preclinical development of gene-based
therapeutics, and the Company's partners will be responsible for clinical
trials, sales, marketing, and large-scale clinical and commercial
manufacturing. Under the terms of the Glaxo Wellcome Agreement, Pfizer
Agreement and Lilly Agreement, the Company's corporate partners have received
exclusive rights for large-scale, clinical and commercial manufacturing of the
gene-based therapeutics for use in the areas covered by these agreements.
 
  The Company has demonstrated that its DNA plasmids, DNA:lipid complexes and
formulations can be produced at pilot scale and believes that commercial
quantities of material may be prepared using conventional fermentation and
purification processes. The Company currently operates a pilot manufacturing
facility and has produced DNA plasmids at a contract manufacturer at the 1,000
liter scale. The lipid components of Megabios' gene delivery systems can be
synthesized using readily scalable, organic synthesis procedures. To date, the
Company has obtained access to lipid manufacturing through arrangements with
contract manufacturers. Preparation of DNA:lipid complexes is carried out at
the Company's pilot manufacturing facility using proprietary processes.
 
  The Company has supplied clinical-grade material to Glaxo Wellcome for use
in a Phase I/II clinical trial of a gene-based therapeutic to treat cystic
fibrosis. Glaxo Wellcome is in the process of scaling up its production
capabilities using the Company's proprietary processes and methods to meet
clinical requirements. Under the Pfizer Agreement and the Lilly Agreement,
Megabios is obligated to provide material used in preclinical testing and may
supply material for clinical trials.
 
                                      34
<PAGE>
 
  Megabios does not currently operate manufacturing facilities for commercial
production of its gene delivery systems. The Company has no experience in, and
currently lacks the resources and capability to, manufacture or market any of
its products on a commercial scale. Accordingly, the Company will be dependent
initially on corporate partners, licensees or other third parties for
commercial-scale manufacturing of its products. Successful large-scale
manufacturing of gene-based therapeutics has not been demonstrated by any
third parties. There can be no assurance that the Company will be able to
reach satisfactory agreements with its partners or that its corporate partners
will be able to develop adequate manufacturing capabilities for production of
commercial-scale quantities of gene-based therapeutics.
 
  Under the terms of the Glaxo Wellcome Agreement, Pfizer Agreement and Lilly
Agreement, the corporate partners have received exclusive rights to market and
sell the Company's gene-based therapeutics that are developed pursuant to
these corporate partnerships. The Company is highly dependent upon each of its
corporate partnerships with Glaxo Wellcome, Pfizer and Lilly. The Company
cannot control whether Glaxo Wellcome, Pfizer or Lilly will devote sufficient
resources to the commercialization of the Company's potential products on a
timely basis, and such resources could vary due to factors unrelated to the
Company's products. If such corporate partners fail to conduct these
activities in a timely manner or at all, the commercialization of the
Company's products could be delayed or terminated. There can be no assurance
that any of these corporate partnerships will result in successfully
manufactured or commercialized products and the receipt by the Company of
related royalty revenues. Failure of the Company's corporate partners to
manufacture successfully the potential products for large-scale clinical
trials or commercial use, or to commercialize successfully the potential
products, would have a material adverse effect on the Company's business,
financial condition and results of operations.
 
GOVERNMENT REGULATION
 
  The production and marketing of the Company's products and its research and
development activities are subject to extensive regulation for safety,
efficacy and quality by numerous governmental authorities in the United States
and other countries. In the United States, pharmaceutical products are subject
to rigorous regulation by the FDA. The Company believes that the commercial
uses of its products will be regulated as biologics by the FDA and comparable
foreign regulatory bodies. Biologics are regulated under certain provisions of
the Public Health Service Act and the Federal Food, Drug, and Cosmetic Act.
These laws and the regulations promulgated thereunder govern, among other
things, testing, manufacturing, safety, efficacy, labeling, storage, record
keeping, and the promotion, marketing and distribution of biological products.
At the FDA, the Center for Biologics Evaluation and Research is responsible
for the regulation of biological products and has handled FDA's regulation of
most gene-based therapeutics to date. Gene-based therapy, however, is a
relatively new technology and the regulatory requirements governing gene-based
therapeutics are uncertain. The Company is not aware of any gene-based
therapeutics that have received marketing approval from the FDA or any
comparable foreign authorities.
 
  The necessary steps before a new biological product may be marketed in the
United States include: (i) preclinical laboratory tests and in vivo
preclinical studies; (ii) the submission to the FDA of an IND for clinical
testing, which must become effective before clinical trials commence; (iii)
under certain circumstances, approval by a special advisory committee convened
to review IND's involving gene-based therapeutics; (iv) adequate and well-
controlled clinical trials to establish the safety and efficacy of the
product; (v) the submission to the FDA of a product license application and
establishment license application ("PLA/ELA") and (vi) FDA approval of the
PLA/ELA prior to any commercial sale or shipment of the biologic. The FDA has
eliminated the requirement of a separate ELA for certain categories of
biotechnology products, including, for example, therapeutic recombinant DNA-
derived products. At this time, however, it is unclear whether these new
regulations would apply to gene-based therapeutics. Furthermore, the FDA has
announced its intention ultimately to review all new biologic products under a
single biologics license application. However, it is impossible to predict
when this procedure will be adopted.
 
  Manufacturing facilities in the United States are subject to periodic
inspection by the FDA and state authorities, and must comply with GMP.
Manufacturers of biologics also must comply with FDA general
 
                                      35
<PAGE>
 
biological product standards and also may be subject to state regulation.
Failure to comply with GMP or other applicable regulatory requirements may
result in withdrawal of marketing approval, criminal prosecution, civil
penalties, recall or seizure of products, warning letters, total or partial
suspension of production, FDA refusal to review pending marketing approval
applications or supplements to approved applications, or injunctions, as well
as other legal or regulatory action against the Company or its corporate
partners.
   
  Preclinical tests include laboratory evaluation of the product, as well as
animal studies to assess the potential safety and efficacy of the product.
Preclinical safety tests must be conducted by laboratories that comply with
FDA regulations regarding Good Laboratory Practice. The results of the
preclinical tests, together with manufacturing information and analytical
data, are submitted to the FDA as a part of an IND, which must become
effective before clinical trials may commence. The IND will automatically
become effective 30 days after receipt by the FDA unless the FDA indicates
prior to the end of the 30-day period that the proposed protocol raises
concerns that must be resolved before the FDA will allow the trials to proceed
as outlined in the IND. In such case, there can be no assurance that such
resolution will be achieved in a timely fashion, if at all. In addition, the
FDA may impose a clinical hold on an ongoing clinical trial, in which case the
study cannot recommence without FDA authorization under terms sanctioned by
the agency. There be no assurance that the Company's corporate partners will
not encounter problems in clinical trials that cause the Company's corporate
partners or the FDA to delay, suspend or terminate such trials.     
 
  Clinical trials involve the administration of the investigational product to
healthy volunteers or to patients, under the supervision of a qualified
principal investigator. Clinical trials are conducted in accordance with Good
Clinical Practices under protocols that detail the objectives of the trial,
inclusion and exclusion criteria, the parameters to be used to monitor safety,
and the efficacy criteria to be evaluated. Each protocol must be submitted to
the FDA as part of the IND. Further, each clinical trial must be reviewed and
approved by an independent IRB at the academic or medical institution at which
the trial will be conducted. The IRB will consider, among other things,
ethical factors and the safety of human subjects. The IRB may require changes
in a protocol, and there can be no assurance that submission of an IND will
permit a study to be initiated or completed.
 
  Clinical trials are conducted in three sequential phases, but the phases may
overlap. In Phase I, the initial introduction of the product into healthy
human subjects or patients, the drug is tested to assess safety, metabolism,
pharmacokinetics and pharmacological actions associated with increasing doses.
Phase II usually involves studies in a limited patient population to (i)
determine the efficacy of the potential product for specific, targeted
indications, (ii) determine dosage tolerance and optimal dosage and (iii)
further identify possible adverse effects and safety risks. If a compound is
found to be effective and to have an acceptable safety profile in Phase II
evaluations, Phase III trials are undertaken to evaluate further clinical
efficacy and to test further for safety within a broader patient population at
geographically dispersed clinical sites. There can be no assurance that Phase
I, Phase II or Phase III testing will be completed successfully within any
specific time period, if at all, with respect to any of the Company's or its
corporate partners' products subject to such testing. In addition, after
marketing approval is granted, the FDA may require post-marketing clinical
studies which typically entail extensive patient monitoring and may result in
restricted marketing of the product for an extended period of time.
 
  The results of the pharmaceutical development, preclinical studies and
clinical trials are submitted to the FDA in the form of a PLA/ELA for approval
of the manufacture, marketing and commercial shipment of the biological
product. The testing and approval process is likely to require substantial
time, effort and financial and human resources, and there can be no assurance
that any approval will be granted on a timely basis, if at all or that any
product developed by the Company and its corporate partners will prove safe
and effective in clinical trials or will meet all the applicable regulatory
requirements necessary to receive marketing approval from the FDA or the
comparable regulatory body of other countries. Data obtained from preclinical
studies and clinical trials are subject to interpretations that could delay,
limit or prevent regulatory approval. The FDA may deny the PLA/ELA if
applicable regulatory criteria are not satisfied, require additional testing
or information, or require postmarketing testing and surveillance to monitor
the safety or efficacy of a product. Moreover, if regulatory
 
                                      36
<PAGE>
 
   
approval of a biological product is granted, such approval may entail
limitations on the indicated uses for which it may be marketed. Finally,
product approvals may be withdrawn if compliance with regulatory standards is
not maintained or if problems occur following initial marketing. Among the
conditions for PLA/ELA approval is the requirement that the prospective
manufacturer's quality control and manufacturing procedures conform to the
appropriate GMP regulations, which must be followed at all times. In complying
with standards set forth in these regulations, manufacturers must continue to
expend time, financial resources and effort in the area of production and
quality control to ensure full compliance.     
 
  For clinical investigation and marketing outside the United States, the
Company and its corporate partners may be subject to FDA as well as regulatory
requirements of other countries. The FDA regulates the export of biological
products, whether for clinical investigation or commercial sale. In Europe,
the approval process for the commencement of clinical trials varies from
country to country. The regulatory approval process in other countries
includes requirements similar to those associated with FDA approval set forth
above. Approval by the FDA does not ensure approval by the regulatory
authorities of other countries.
 
  The Company's research and development processes involve the controlled use
of hazardous materials, chemicals and radioactive materials, and produce waste
products. The Company is subject to federal, state and local laws and
regulations governing the use, manufacture, storage, handling and disposal of
such materials and waste products. Although the Company believes that its
safety procedures for handling and disposing of such materials comply with the
standards prescribed by such laws and regulations, the risk of accidental
contamination or injury from these materials cannot be eliminated completely.
In the event of such an accident, the Company could be held liable for any
damages that result and any such liability could exceed the resources of the
Company. Although the Company believes that it is in compliance in all
material respects with applicable environmental laws and regulations, there
can be no assurance that it will not be required to incur significant costs to
comply with environmental laws and regulations in the future, or that any the
operations, business or assets of the Company will not be materially adversely
affected by current or future environmental laws or regulations.
 
COMPETITION
 
  Gene delivery and gene-based therapy are relatively new, rapidly evolving
areas of science in which significant and unexpected technological advances
are likely. Rapid technological development could result in the Company's
products or technologies becoming obsolete before the Company recovers a
significant portion of its related research, development and capital
expenditures. The Company is aware of several pharmaceutical and biotechnology
companies which are exploring the field of gene-based therapy, are actively
engaged in research and development in areas related to gene-based therapy, or
have commenced clinical trials of gene-based therapeutics. Many of these
companies are addressing diseases which have been targeted by the Company or
its corporate partners. Megabios also may experience competition from
companies that have acquired or may acquire gene-based technology from
universities and other research institutions. As competitors develop their
technologies, they may develop proprietary positions in certain aspects of
gene delivery and gene-based therapeutics that may materially and adversely
affect Megabios. In addition, the Company faces and will continue to face
competition from other companies for corporate partnerships with
pharmaceutical and biotechnology companies, for establishing relationships
with academic and research institutions, and for licenses to proprietary
technology, including intellectual property related to gene delivery systems.
Corporate partners may also elect to internally develop gene-based
therapeutics which compete with the Company's products. In addition, many
other companies are developing non-gene-based therapies to treat these same
diseases.
 
  Most of the Company's competitors and potential competitors have
substantially greater product development capabilities and financial,
scientific, manufacturing, managerial and human resources than the Company.
There can be no assurance that research and development by others will not
render the Company's delivery systems or the products developed by corporate
partners using the Company's delivery systems obsolete or non-competitive or
that any product developed by the Company or its corporate partners will be
preferred to
 
                                      37
<PAGE>
 
any existing or newly developed technologies. In addition, there can be no
assurance that the Company's competitors will not develop safer, more
effective or less costly gene delivery systems, gene-based therapeutics or
non-gene based therapies, achieve superior patent protection or obtain
regulatory approval or product commercialization earlier than the Company, any
of which could have a material adverse effect on the Company's business,
financial condition or results of operations.
 
PRODUCT LIABILITY INSURANCE
 
  The manufacture and sale of human therapeutic products involve an inherent
risk of product liability claims and associated adverse publicity. The Company
currently has only limited product liability insurance, and there can be no
assurance that it will be able to maintain existing or obtain additional
product liability insurance on acceptable terms or with adequate coverage
against potential liabilities. Such insurance is expensive, difficult to
obtain and may not be available in the future on acceptable terms, or at all.
An inability to obtain sufficient insurance coverage on reasonable terms or to
otherwise protect against potential product liability claims could prevent or
inhibit the commercialization of products by the Company. A product liability
claim brought against the Company in excess of its insurance coverage, if any,
or a product withdrawal, could have a material adverse effect upon the
Company's business, financial condition and results of operations.
 
EMPLOYEES
   
  As of July 15, 1997, Megabios employed 61 individuals full-time, including
17 who hold doctoral degrees. Of the Company's total work force, 51 employees
are engaged in or directly support research and development activities, and 10
are engaged in business development, finance and administrative activities.
The Company's employees are not represented by a collective bargaining
agreement. The Company believes its relationships with its employees are good.
    
FACILITIES
   
  The Company currently leases approximately 45,300 square feet in Burlingame,
California, of which approximately 34,700 square feet is occupied or under
construction (the "Facility"). The Facility has been built to the Company's
specifications to accommodate the Company's laboratory, support and
administrative needs and includes a pilot manufacturing facility designed to
supply material required for preclinical research and development. The term of
the lease for the 34,700 square feet in use expires in 2004, at which time the
Company has the option to renew the lease. Approximately 10,600 square feet of
the Facility is not currently occupied by the Company and is expected to be
built-out for use as a manufacturing facility. The term of the lease for this
portion of the facility expires in 2007, at which time the Company has the
option to renew the lease. Megabios believes that the Facility and its
expansion will be adequate to meet the Company's needs for the foreseeable
future.     
 
SCIENTIFIC ADVISORY BOARD
 
  Megabios' Scientific Advisory Board ("SAB") consists of academic and
industry experts in the fields of gene-based therapeutics, molecular biology,
drug delivery, immunology and infectious diseases. The Company meets with the
members of the SAB on an ad hoc basis to discuss research and development
strategies, and certain members communicate with the Company's scientists
periodically to discuss the details of specific projects. All SAB members own
shares or have been granted options to acquire Common Stock of the Company.
Each SAB member has entered into a consulting agreement specifying the terms
and scope of the advisory relationship with the Company, which provides that
the SAB member will not consult or otherwise provide services to any other
Company engaged in the development of gene-based therapeutics without the
prior consent of Megabios. The Company does not believe that termination of
any individual consulting agreement would materially affect its business. All
of the SAB members are employed by employers other than the Company and may
have other commitments and consulting advisory contracts with other entities
which may compete for such member's time and with their obligations to the
Company.
 
                                      38
<PAGE>
 
  Abul K. Abbas, M.B.B.S., has served as Head of the Immunology Research
Division in the Department of Pathology at Brigham and Women's Hospital, and
Professor of Pathology at Harvard Medical School since July 1991. He is a
member of the American Association of Pathologists and the American
Association of Immunologists. Dr. Abbas received his medical degree from the
All-India Institute of Medical Sciences, New Delhi, India.
   
  Donald E. Ganem, M.D., has served as Investigator, Howard Hughes Medical
Institute since September 1994 and Professor of Microbiology and Medicine,
University of California, San Francisco since July 1990. He is a member of the
American Academy of Microbiology, the American Society for Virology and the
Infectious Diseases Society of America. Dr. Ganem received his M.D. from
Harvard University.     
 
  Raju Kucherlapati, Ph.D., has served as the Lola and Saul Kramer Professor
and Chairman of the Department of Molecular Genetics at Albert Einstein
College of Medicine since 1989. He was a founder and serves on the Board of
Directors of both Cell Genesys, Inc. ("Cell Genesys") and Millennium
Pharmaceuticals, Inc.. Dr. Kucherlapati received his Ph.D. from the University
of Illinois and did post-doctoral training at Yale University. Dr.
Kucherlapati also serves on the Board of Directors of the Company.
 
  Robert S. Langer, Sc.D., has served as the Kenneth J. Germeshausen Professor
of Chemical and Biomedical Engineering at the Massachusetts Institute of
Technology ("MIT") since July 1988. He is a member of the Institute of
Medicine, the National Academy of Engineering and the National Academy of
Sciences. Dr. Langer received his Sc.D. in Chemical Engineering from MIT. He
also serves as a consultant to the Company.
 
  Stuart H. Orkin, M.D., has served as the Leland Fikes Professor of Pediatric
Medicine at Harvard University since June 1987 and Investigator, Howard Hughes
Medical Institute since March 1986. From 1989 to 1990, he was the President of
The American Society of Clinical Investigation. He is a member of the National
Academy of Sciences, the American Academy of Arts and Sciences, and the
American Society of Human Genetics. Dr. Orkin received his M.D. from Harvard
University.
 
                                      39
<PAGE>
 
                                  MANAGEMENT
 
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
   
  The executive officers, directors and key employees of the Company and their
ages as of July 15, 1997 are as follows:     
 
<TABLE>   
<CAPTION>
   NAME                      AGE                    POSITION
   ----                      ---                    --------
   <S>                       <C> <C>
   Executive Officers
   Benjamin F. McGraw, III,   
    Pharm.D................   48 Chairman, Chief Executive Officer and President
   Patrick G. Enright......   35 Chief Financial Officer and Vice President
   Rodney Pearlman, Ph.D...   46 Vice President, Research and Development
   Key Employees
   Simba Gill, Ph.D........   33 Vice President, Business Development
   Beatrice C. Langton-          
    Webster, Ph.D..........   39 Senior Director, Life Sciences
   Lee B. Bussey, Ph.D.....   44 Director, Bioprocessing
   Helen Jenkins...........   34 Director, Project Development
   Ralph W. Niven, Ph.D.,        
    M.R. Pharm.............   37 Director, Pharmaceutics and Delivery
   Robert I. Grove, Ph.D...   49 Principal Scientist, Cardiovascular
   Jackie Papkoff, Ph.D....   41 Principal Scientist, Oncology
   Directors
   Frank J. Caufield(1)....   57 Director
   Edward L. Erickson......   50 Director
   A. Grant Heidrich(2)....   44 Director
   Russell C. Hirsch, M.D.,      
    Ph.D.(1)...............   34 Director
   Raju Kucherlapati,            
    Ph.D.(2)...............   54 Director
</TABLE>    
- --------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
 
  Benjamin F. McGraw, III, Pharm.D., joined the Company as President, Chief
Executive Officer and director in September 1994 and became Chairman of the
Board of Directors in February 1997. From April 1993 to September 1994, Dr.
McGraw was Corporate Vice President for Corporate Development for Allergan,
Inc., a pharmaceutical company. From November 1990 to April 1993, he served as
President of MedTech Trends, Inc., an investment advisory company. From
November 1991 to April 1993, Dr. McGraw was President of Carerra Capital
Management, Inc., an investment company, where he was the fund manager for a
limited partnership that invested in health care companies. From July 1989 to
November 1990, Dr. McGraw was Vice President, Development at Marion Merrell
Dow, Inc., a pharmaceutical company. From November 1987 to July 1989, he was
Vice President, Development at Marion Laboratories, Inc., a pharmaceutical
company. Dr. McGraw received his Doctor of Pharmacy from the University of
Tennessee Center for the Health Sciences.
 
  Patrick G. Enright joined the Company as Chief Financial Officer and Vice
President in March 1995. From September 1993 to June 1994, Mr. Enright was
Senior Vice President of Finance and Business Development for Boehringer
Mannheim Therapeutics ("Boehringer Mannheim"), a pharmaceutical company and a
subsidiary of Corange Ltd. From September 1989 to September 1993, Mr. Enright
was employed at PaineWebber Incorporated, an investment banking firm, where he
became a Vice President in January 1992. From June 1984 to August 1989, he was
employed by Sandoz Corporation, a pharmaceutical company. Mr. Enright received
his M.B.A. from The Wharton School of Business at the University of
Pennsylvania and his B.S. in Biological Sciences from Stanford University.
 
  Rodney Pearlman, Ph.D., has served as Vice President, Research and
Development since January 1995. From January 1988 to December 1994, Dr.
Pearlman was Director of Pharmaceutical Research and Development
 
                                      40
<PAGE>
 
at Genentech, Inc. ("Genentech"), a biotechnology company. At Genentech, he
was a Project Team Leader for Human Growth Hormone from March 1992 to June
1994. From September 1987 to December 1994, Dr. Pearlman was a senior
scientist at Genentech. Dr. Pearlman joined Genentech as a scientist in
September 1984. Prior to joining Genentech, he was an Assistant Professor of
Pharmaceutics at the University of Texas at Austin. From 1978 to 1981, Dr.
Pearlman was a Senior Scientist at Lilly. Dr. Pearlman received his Ph.D. in
Pharmaceutical Chemistry from the University of Kansas.
 
  Simba Gill, Ph.D., joined the Company as Director, Business Development in
November 1995 and has served as Vice President, Business Development since
March 1997. From January 1995 to October 1995, Dr. Gill was Director of
Business Development at Systemix, Inc. ("Systemix"), a biotechnology company.
From September 1994 to December 1994, he was an independent consultant to
Systemix. From April 1991 to September 1994, Dr. Gill held various positions
at Boehringer Mannheim including Global Product Manager for Erythropoietin,
Global Business Development Manager focusing on Genomics and Gene Therapy and
Director of New Diagnostics Business Development. Dr. Gill received his Ph.D.
in Molecular Immunology from King's College, London University and his M.B.A.
from INSEAD, Fontainebleau, France.
 
  Beatrice Langton-Webster, Ph.D., joined the Company as Director, Life
Sciences in November 1996 and has served as Senior Director, Life Sciences
since March 1997. From June 1992 to November 1996, Dr. Langton-Webster was the
Head of the Oncology Strategic Research Unit at Berlex Biosciences, a
subsidiary of Schering AG, a pharmaceutical company. From September 1985 to
October 1990, Dr. Langton-Webster was a Senior Research Scientist at Triton
Biosciences, a biotechnology company. Dr. Langton-Webster received her Ph.D.
in Medical Microbiology and Immunology from the University of California at
Davis.
 
  Lee B. Bussey, Ph.D., has served as Director, Bioprocessing since June 1994.
From August 1990 to June 1994, Dr. Bussey was the Technical Manager of
Bioprocessing for Pel-Freez Biologicals, a biotechnology company. Dr. Bussey
received his Ph.D. in Microbiology from the University of California at Davis.
 
  Helen Jenkins joined the Company as Project Manager in July 1994 and has
served as Director, Project Development since April 1996. From May 1993 to
June 1994, she was Product Manager at Glycomed Incorporated, a biotechnology
company. From August 1990 to May 1993, Ms. Jenkins served as a Project
Coordinator and a Senior Project Coordinator at Genentech. Ms. Jenkins
received her B.S. in Biochemistry from the California Polytechnic State
University at San Luis Obispo and her M.A. in Cellular and Molecular Biology
from San Francisco State University.
 
  Ralph Niven, Ph.D., M.R. Pharm., joined Megabios in January 1996 as a Senior
Scientist and has served as Director, Pharmaceutics and Delivery since October
1996. From July 1991 to December 1995, Dr. Niven was a Research Scientist at
Amgen Inc., a biopharmaceutical company. Dr. Niven received his Ph.D. in
Pharmaceutical Sciences from the University of Kentucky.
   
  Robert I. Grove, Ph.D., joined the Company as Principal Scientist,
Cardiovascular in March 1997. From November 1993 to March 1997, Dr. Grove was
Senior Scientific Investigator/Assistant Director and Group Leader of the
Hypercholesterolemia team in the Gene Therapy Department of Immune Response
Corporation, a biotechnology company. From January 1985 to November 1993, he
served as Senior Research Investigator in the preclinical Cardiovascular
Research Growth Regulators, and Autoimmunity and Transplantation Departments
of Bristol-Myers Squibb, a pharmaceutical company. Dr. Grove received his
Ph.D. in biochemistry from the University of South Florida.     

  Jackie Papkoff, Ph.D., joined the Company as Senior Scientist in February
1995 and has served as Principal Scientist, Oncology since November 1996. From
July 1993 to February 1995, Dr. Papkoff was a Senior Scientist at Sugen, Inc.,
a biotechnology company. From January 1993 to June 1993, she served as Group
Leader of the Tumor Biology Department and from January 1987 to January 1993,
Dr. Papkoff served as a Staff Researcher in the Biochemistry Department of
Syntex Research, a pharmaceutical company. Dr. Papkoff received her Ph.D. in
Biology from the University of California at San Diego.
 
                                      41
<PAGE>
 
  Frank J. Caufield has served as a director of the Company since November
1992. Since 1978 he has held the position of partner of Kleiner Perkins
Caufield & Byers, a venture capital partnership. He serves on the Board of
Directors of Raster Graphics, Inc. and America Online, Inc. He received his
M.B.A. from the Harvard Business School and his B.S. in Engineering from the
United States Military Academy.
 
  Edward L. Erickson has served as a director of the Company since July 1995.
Since June 1993, he has served as the President, Chief Executive Officer and a
director of DepoTech Corporation, a biopharmaceutical company in the field of
drug delivery. From 1991 to 1993, Mr. Erickson was the President, Chief
Executive Officer and a director of Cholestech Corporation, a medical products
company. Prior to joining Cholestech Corporation, he held senior management
positions with two international, publicly-traded biomedical companies, The
Ares-Serono Group and Amersham International plc. Mr. Erickson received his
M.B.A. from the Harvard Business School and his B.S. and M.S. degrees in
Mathematics from the Illinois Institute of Technology.
 
  A. Grant Heidrich, III, has served as a director of the Company since August
1993. Mr. Heidrich joined Mayfield Fund ("Mayfield"), a venture capital firm,
in 1982 and has been a general partner or managing member of several venture
capital funds affiliated with Mayfield since 1983. Mr. Heidrich serves on the
Board of Directors of Millennium Pharmaceuticals, Inc. Mr. Heidrich received
his M.B.A. from Columbia University Graduate School of Business and his B.A.
in Human Biology from Stanford University.
 
  Russell C. Hirsch, M.D., Ph.D., has served as a director of the Company
since August 1993. He joined Mayfield 1992, and has been a managing member of
several venture capital funds affiliated with Mayfield since 1995. From 1984
to 1992, Dr. Hirsch conducted research in the laboratories of Nobel Laureate
Harold Varmus, M.D., and Don Ganem, M.D., at the University of California, San
Francisco. Dr. Hirsch received his M.D. and Ph.D. in Biochemistry from the
University of California, San Francisco.
 
  Raju Kucherlapati, Ph.D., has served as a director of the Company since
March 1995 and also serves on the Company's Scientific Advisory Board. Dr.
Kucherlapati has served as the Lola and Saul Kramer Professor and Chairman of
the Department of Molecular Genetics at Albert Einstein College of Medicine
since 1989. He was a founder of and serves on the Board of Directors of both
Cell Genesys and Millennium Pharmaceuticals, Inc. Dr. Kucherlapati received
his Ph.D. from the University of Illinois.
 
BOARD COMPOSITION
   
  The Company currently has authorized eight directors. In accordance with the
terms of the Company's Restated Certificate of Incorporation, effective upon
the closing of this offering, the terms of office of the Board of Directors
will be divided into three classes: Class I, whose term will expire at the
annual meeting of stockholders to be held in 1998; Class II, whose term will
expire at the annual meeting of stockholders to be held in 1999; and Class
III, whose term will expire at the annual meeting of stockholders to be held
in 2000. The Class I directors are Benjamin F. McGraw, III and Frank J.
Caufield, the Class II directors are A. Grant Heidrich, III and Edward L.
Erickson, and the Class III directors are Raju Kucherlapati and Russell C.
Hirsch. At each annual meeting of stockholders after the initial
classification, the successors to directors whose term will then expire will
be elected to serve from the time of election and qualification until the
third annual meeting following election. In addition, the Company's Restated
Certificate of Incorporation provides that the authorized number of directors
may be changed only by resolution of the Board of Directors. Any additional
directorships resulting from an increase in the number of directors will be
distributed among the three classes so that, as nearly as possible, each class
will consist of one-third of the directors. This classification of the Board
of Directors may have the effect of delaying or preventing changes in control
or management of the Company. Although directors of the Company may be removed
for cause by the affirmative vote of the holders of a majority of the Common
Stock, the Company's Restated Certificate of Incorporation provides that
holders of two-thirds of the Common Stock must vote to approve the removal of
a director without cause.     
 
 
                                      42
<PAGE>
 
BOARD COMMITTEES
 
  The Audit Committee of the Board of Directors reviews the internal
accounting procedures of the Company and consults with and reviews the
services provided by the Company's independent auditors. The Compensation
Committee of the Board of Directors reviews and recommends to the Board of
Directors the compensation and benefits of all officers of the Company and
reviews general policy relating to compensation and benefits of employees of
the Company. The Compensation Committee also administers the issuance of stock
options and other awards under the Company's stock plans.
 
DIRECTOR COMPENSATION
 
  The Company does not currently provide cash compensation to directors for
services in such capacity, but directors may be reimbursed for certain
expenses in connection with attendance at Board and Committee meetings. In
January 1995, the Board granted an option to Dr. Kucherlapati to purchase
13,333 shares of Common Stock at an exercise price of $0.30 per share. In
September 1995, the Board granted an option to Mr. Erickson to purchase 13,333
shares of Common Stock at an exercise price of $0.30 per share. The Company
intends to consider compensating non-employee directors in the future. In
February 1997, for his service as a member of the Company's SAB, the Board
granted an option to Dr. Kucherlapati to purchase an additional 13,333 shares
of Common Stock at an exercise price of $1.50 per share.
 
EXECUTIVE COMPENSATION
 
  The following table sets forth certain compensation awarded or paid by the
Company during the fiscal year ended June 30, 1997 to its President and Chief
Executive Officer and the Company's other executive officers who earned more
than $100,000 during the fiscal year ended June 30, 1997 (collectively, the
"Named Executive Officers"):
 
                          SUMMARY COMPENSATION TABLE
 
<TABLE>   
<CAPTION>
                                                        LONG-TERM
                                                       COMPENSATION
                                                          AWARDS
                                                       ------------
                                          ANNUAL
                                     COMPENSATION(1)    SECURITIES   ALL OTHER
                                    ------------------  UNDERLYING  COMPENSATION
NAME AND PRINCIPAL POSITION         SALARY($) BONUS($)  OPTIONS(#)     ($)(2)
- ---------------------------         --------- -------- ------------ ------------
<S>                                 <C>       <C>      <C>          <C>
Benjamin F. McGraw, III, Pharm.D..  $258,174  $25,000     73,333        $509
 Chairman, Chief Executive Officer
 and President
Patrick G. Enright................   166,539   16,000     30,000         329
 Chief Financial Officer and Vice
 President
Rodney Pearlman, Ph.D.............   169,904   16,500     25,000         335
 Vice President, Research and
 Development
</TABLE>    
- --------
(1) In accordance with Securities and Exchange Commission ("Commission")
    rules, other annual compensation in the form of perquisites and other
    personal benefits has been omitted where the aggregate amount of such
    perquisites and other personal benefits constitutes less than the lesser
    of $50,000 or 10% of the total annual salary and bonus for the Named
    Executive Officer for the fiscal year.
(2) Represents insurance premiums paid by the Company with respect to group
    life insurance for the benefit of the Named Executive Officer.
 
                                      43
<PAGE>
 
OPTION GRANTS IN LAST FISCAL YEAR
 
  The following table sets forth each grant of stock options made during the
fiscal year ended June 30, 1997, to each of the Named Executive Officers:
 
<TABLE>   
<CAPTION>
                                          INDIVIDUAL GRANTS
                          -------------------------------------------------
                                                                             POTENTIAL REALIZABLE
                                         PERCENTAGE OF                         VALUE AT ASSUMED
                            NUMBER OF    TOTAL OPTIONS                       ANNUAL RATES OF STOCK
                            SECURITIES    GRANTED TO                        PRICE APPRECIATION FOR
                            UNDERLYING   EMPLOYEES IN  EXERCISE                 OPTION TERM(4)
                             OPTIONS      FISCAL YEAR    PRICE   EXPIRATION -----------------------
          NAME            GRANTED (#)(1)    (%)(2)     ($/SH)(3)    DATE      5% ($)      10% ($)
          ----            -------------- ------------- --------- ---------- ----------- -----------
<S>                       <C>            <C>           <C>       <C>        <C>         <C>
Benjamin F. McGraw, III,      73,333         18.9%       $1.50    02/28/07  $ 1,324,394 $ 2,169,199
 Pharm.D. ..............
 Chairman, Chief
 Executive
 Officer and President
Patrick G. Enright......      30,000          7.7         1.50    02/28/07      541,800     887,400
 Chief Financial Officer
 and Vice President
Rodney Pearlman, Ph.D...      25,000          6.4         1.50    02/28/07      451,400     739,500
 Vice President,
 Research and
 Development
</TABLE>    
- --------
(1) Twenty-five percent of such options granted vest one year from the vesting
    commencement date with remaining options vesting at a rate of 1/36th per
    month over three years. Options may be exercised immediately pursuant to
    early exercise provisions contained in option agreements. Any shares
    issued pursuant to such early exercise provisions are subject to
    repurchase upon termination of employment. Such repurchase option
    terminates at the rate of twenty five percent after one year from the
    vesting commencement date and thereafter at a rate of 1/36th per month
    over three years. The options expire 10 years from the date of grant, or
    earlier upon termination of employment.
(2) Based on an aggregate of 388,680 options granted to employees, consultants
    and directors of the Company during fiscal year ended June 30, 1997,
    including the Named Executive Officers.
(3) The exercise price per share of each option was equal to the fair market
    value of the Common Stock on the date of grant as determined by the Board
    of Directors.
(4) The 5% and 10% assumed annual rates of compounded stock price appreciation
    are mandated by rules of the Securities and Exchange Commission. There can
    be no assurance provided to any executive officer or any other holder of
    the Company's securities that the actual stock price appreciation over the
    10-year term will be at the assumed 5% or 10% levels or at any other
    defined level. Unless the market price of the Common Stock appreciates
    over the option term, no value will be realized from the option grants
    made to the executive officers. The potential realizable value is
    calculated by assuming that the assumed initial public offering price of
    $12.00 per share appreciates at the indicted rate for the entire term of
    the option and that the option is exercised at the exercise price and sold
    on the last day of its term at the appreciated price.
 
                                      44
<PAGE>
 
AGGREGATE OPTION EXERCISES IN FISCAL 1997 AND JUNE 30, 1997 OPTION VALUES
 
  The following table sets forth for each of the Named Executive Officers the
shares acquired and the value realized on each exercise of stock options
during the fiscal year ended June 30, 1997 and the number and value of
securities underlying unexercised options held by the Named Executive Officers
at June 30, 1997:
 
<TABLE>   
<CAPTION>
                                                         NUMBER OF SECURITIES  VALUE OF UNEXERCISED
                                                        UNDERLYING UNEXERCISED     IN-THE-MONEY
                                                              OPTIONS AT            OPTIONS AT
                                                         JUNE 30, 1997(#)(1)   JUNE 30, 1997($)(2)
                                                        ---------------------- --------------------
                              SHARES
                           ACQUIRED ON       VALUE           EXERCISABLE/          EXERCISABLE/
          NAME            EXERCISE(#)(1) REALIZED($)(2)     UNEXERCISABLE         UNEXERCISABLE
          ----            -------------- -------------- ---------------------- --------------------
<S>                       <C>            <C>            <C>                    <C>
Benjamin F. McGraw, III,         --              --            73,333/0             $769,997/0
 Pharm.D................
 Chairman, Chief
 Executive Officer
 and President
Patrick G. Enright......         --              --            30,000/0              315,000/0
 Chief Financial Officer
 and Vice President
Rodney Pearlman, Ph.D...      29,166        $341,242           25,000/0              262,500/0
 Vice President,
 Research and
 Development
</TABLE>    
- --------
(1) Options may be exercised immediately pursuant to early exercise provisions
    contained in option agreements. Any shares issued pursuant to such early
    exercise provisions are subject to repurchase at the original exercise
    price paid per share upon termination of employment. Such repurchase
    option terminates at the rate of twenty five percent after one year from
    the vesting commencement date and thereafter at a rate of 1/36th per month
    over three years.
(2) Value realized and value of unexercised in-the-money options is based on a
    value of $12.00 per share of the Company's Common Stock, the assumed
    initial public offering price, even though at the time of grant the fair
    market value of the Common Stock was determined by the Board of Directors
    to be $0.30 to $1.50 per share. Amounts reflected are based on the assumed
    value minus the exercise price multiplied by the number of shares acquired
    on exercise and do not indicate that the optionee sold such stock.
 
EMPLOYMENT AGREEMENTS
 
  In August 1994, the Company entered into an employment agreement with Dr.
McGraw providing for an annual compensation of $250,000, an option to purchase
up to 250,000 shares of Common Stock at $0.30 per share subject to a four-year
vesting schedule, a signing bonus of $65,000 payable in quarterly
installments, certain relocation expenses and a severance payment equal to
twelve months salary in the event of termination without cause.
 
  In February 1995, the Company entered into an employment agreement with Mr.
Enright providing for an annual compensation of $160,000, an option to
purchase up to 91,666 shares of Common Stock at an exercise price of $0.30 per
share subject to a four-year vesting schedule, a $10,000 signing bonus and
payment of certain relocation expenses.
 
  In November 1994, the Company entered into an employment agreement with Dr.
Pearlman providing for an annual compensation of $165,000, an option to
purchase up to 83,333 shares of Common Stock at an exercise price of $0.30 per
share subject to a four-year vesting schedule and a $30,000 bonus payable in
quarterly installments during 1995.
 
  In January 1996, the Board of Directors approved the Change of Control
Policy for the protection of the Company's executive officers. In the event of
a merger in which the Company is not the surviving entity or a transaction or
series of transactions in which more than 50% of the Company's voting power is
transferred or
 
                                      45
<PAGE>
 
the sale of all or substantially all the assets of the Company (each a "Change
of Control"), an executive officer will continue to receive salary and
benefits for twelve months from the date of his or her termination unless such
termination is for cause (or voluntary termination of his or her employment
for good cause). Further, in the event of a Change of Control, all outstanding
stock options of each executive officer shall automatically accelerate by the
greater of twelve months or the number of full months during which the officer
has been employed by the Company. However, the Board of Directors of the
Company may provide that options be assumed by the acquiror, remain
outstanding or provide for a replacement benefit equal in value.
 
STOCK PLANS
 
  Equity Incentive Plan. The Company's 1997 Equity Incentive Plan (the
"Incentive Plan") was adopted by the Board of Directors in July 1997 as an
amendment and restatement of the Company's 1993 Stock Option Plan (the "1993
Plan"). There are currently 2,100,000 shares of Common Stock authorized for
issuance under the Incentive Plan.
 
  The Incentive Plan provides for the grant of incentive stock options under
the Internal Revenue Code of 1986, as amended (the "Code"), to employees
(including officers and employee-directors) and nonstatutory stock options,
restricted stock purchase awards and stock bonuses to employees, directors and
consultants. The Incentive Plan is administered by the Board of Directors or a
committee appointed by the Board which determines recipients and types of
awards to be granted, including the exercise price, number of shares subject
to the award and the exercisability thereof.
 
  The terms of stock options granted under the Incentive Plan generally may
not exceed 10 years. The exercise price of options granted under the Incentive
Plan is determined by the Board of Directors, provided that the exercise price
for an incentive stock option cannot be less than 100% of the fair market
value of the Common Stock on the date of the option grant and the exercise
price for a nonstatutory stock option cannot be less than 85% of the fair
market value of the Common Stock on the date of option grant. Options granted
under the Incentive Plan vest at the rate specified in the option agreement.
No stock option may be transferred by the optionee other than by will or the
laws of descent or distribution, provided that a nonstatutory stock option may
be transferable if provided in the option agreement, and provided further that
an optionee may designate a beneficiary who may exercise the option following
the optionee's death. An optionee whose relationship with the Company or any
related corporation ceases for any reason (other than by death or permanent
and total disability) may exercise options in the three-month period following
such cessation (unless such options terminate or expire sooner or later by
their terms). Options may be exercised for up to twelve months after an
optionee's relationship with the Company and its affiliates ceases due to
death or disability (unless such options expire sooner or later by their
terms).
 
  No incentive stock option may be granted to any person who, at the time of
the grant, owns (or is deemed to own) stock possessing more than 10% of the
total combined voting power of the Company or any affiliate of the Company,
unless the option exercise price is at least 110% of the fair market value of
the stock subject to the option on the date of grant, and the term of the
option does not exceed five years from the date of grant. The aggregate fair
market value, determined at the time of grant, of the shares of Common Stock
with respect to which incentive stock options are exercisable for the first
time by an optionee during any calendar year (under all such plans of the
Company and its affiliates) may not exceed $100,000. Upon the expiration of
the transition rule extending the effective date of code section 162(m) for
newly public companies no person shall be eligible to receive options covering
more than 500,000 shares in any calendar year.
 
  Shares subject to stock awards that have expired or otherwise terminated
without having been exercised in full (or vested in the case of restricted
stock awards) shall again become available for the grant of awards under the
Incentive Plan.
 
  The Board of Directors has the authority to reprice outstanding options and
to offer optionees the opportunity to replace outstanding options with new
options for the same or a different number of shares.
 
                                      46
<PAGE>
 
  Restricted stock purchase awards granted under the Incentive Plan may be
granted pursuant to a repurchase option in favor of the Company in accordance
with a vesting schedule and at a price determined by the Board of Directors.
Restricted stock purchases must be at a price equal to at least 85% of the
stock's fair market value on the award date, but stock bonuses may be awarded
in consideration of past services without a purchase payment. Rights under a
stock bonus or restricted stock bonus agreement may not be transferred other
than by will, the laws of descent and distribution or a domestic relations
order while the stock awarded pursuant to such an agreement remains subject to
the agreement.
 
  Upon a change in control of the Company, the vesting of options held by
executive officers will accelerate by the greater of 12 months or the number
of months of the executive officer's employment, unless the Board of Directors
finds that it is in the best interest of the Company's stockholders and the
optionees to provide otherwise. If such a finding is made, the options shall
either remain outstanding or be assumed by the acquiror (with the optionee
being entitled to receive the same consideration as was received by the
Company's stockholders in the change of control transaction) or the Board of
Directors and/or the acquiror shall adopt a replacement benefit which shall
(at a minimum) provide value to the executive officer on the vesting dates of
the non-accelerated options substantially equal to the value the executive
officer would have received if the shares had participated in all steps of the
transaction. With respect to optionees who are not executive officers, upon a
change in control any options shall remain outstanding, be assumed by the
acquiror or be substituted with similar options. In the event the acquiror
refuses to assume, substitute or continue any options, then such options shall
be terminated if not exercised prior to the change of control. For purposes of
this Plan, "Change in Control" means: any consolidation or merger of the
Company with or into any other entity or person, or any other corporate
reorganization, in which the Company is not the continuing or surviving
entity, or any transaction or series of related transactions by the Company in
which in excess of 50% of the Company's voting power is transferred, or any
sale, lease, license or other disposition of all or substantially all of the
assets of the Company.
   
  As of June 30, 1997, 878,224 shares of Common Stock had been issued upon the
exercise of options granted under the 1993 Plan and the Incentive Plan (39,545
of which had been repurchased and of which were subject to repurchase),
options to purchase 479,622 shares of Common Stock at a weighted average
exercise price of $1.22 were outstanding and 121,699 shares remained available
for future grant. The Incentive Plan will terminate in July 2007 unless sooner
terminated by the Board of Directors. As of June 30, 1997, no stock bonuses or
restricted stock have been granted under the Incentive Plan.     
 
  Employee Stock Purchase Plan. In July 1997, the Company's Board of Directors
approved the Employee Stock Purchase Plan (the "Purchase Plan") covering an
aggregate of 200,000 shares of Common Stock. The Purchase Plan is intended to
qualify as an employee stock purchase plan within the meaning of Section 423
of the Code. Under the Purchase Plan, the Board of Directors may authorize
participation by eligible employees, including officers, in periodic offerings
following the adoption of the Purchase Plan. The offering period for any
offering will be no more than 27 months.
 
  Employees are eligible to participate if they are employed by the Company or
an affiliate of the Company designated by the Board of Directors and are
employed at least 20 hours per week and five months per year. Employees who
participate in an offering can have up to 15% of their earnings withheld
pursuant to the Purchase Plan and applied, on specified dates determined by
the Board of Directors, to the purchase of shares of Common Stock. The price
of Common Stock purchased under the Purchase Plan will be equal to 85% of the
lower of the fair market value of the Common Stock on the commencement date of
each offering period or the relevant purchase date. Employees may end their
participation in the offering at any time during the offering period, and
participation ends automatically on termination of employment with the
Company.
 
  In the event of certain changes of control, the Company and the Board of
Directors has discretion to provide that each right to purchase Common Stock
will be assumed or an equivalent right substituted by the successor
corporation, or the Board may shorten the offering period and provide for all
sums collected by payroll deductions to be applied to purchase stock
immediately prior to the change in control. The Purchase Plan will terminate
at the Board's discretion.
 
                                      47
<PAGE>
 
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
 
  The Company's Bylaws provide that the Company will indemnify its directors
and executive officers and may indemnify its other officers, employees and
other agents to the fullest extent permitted by Delaware law. The Company is
also empowered under its Bylaws to enter into indemnification contracts with
its directors and officers and to purchase insurance on behalf of any person
it is required to permitted to indemnify. Pursuant to this provision, the
Company expects to enter into indemnification agreements with each of its
directors and executive officers.
 
  The Company has obtained officer and director liability insurance with
respect to liabilities arising out of certain matters, including matters
arising under the Securities Act. In addition, the Company's Restated
Certificate of Incorporation provides that, to the fullest extent permitted by
Delaware law, the Company's directors will not be liable for monetary damages
for breach of the directors' fiduciary duty of care to the Company and its
stockholders. This provision in the Restated Certificate of Incorporation does
not eliminate the duty of care, and in appropriate circumstances equitable
remedies such as an injunction or other forms of non-monetary relief would
remain available under Delaware law. Under current Delaware law, a director's
liability to the Company or its stockholders may not be limited with respect
to any breach of the director's duty of loyalty to the Company or its
stockholders, for acts or omissions not in good faith or involving intentional
misconduct, for knowing violations of law, for any transaction from which the
director derived an improper personal benefit, for improper transactions
between the director and the Company and for improper distributions to
stockholders and loans to directors and officers. This provision also does not
affect a director's responsibilities under any other laws, such as the federal
securities laws or state or federal environmental laws.
 
  There is no pending litigation or proceeding involving a director or officer
of the Company as to which indemnification is being sought, nor is the Company
aware of any pending or threatened litigation that may result in claims for
indemnification by any director or officer.
 
                                      48
<PAGE>
 
                             CERTAIN TRANSACTIONS
   
  In August 1994, Mayfield VII, Mayfield Associates Fund II, William L. Brown,
a former director and a 5% stockholder of the Company, and Frank J. Caufield,
a director of the Company, extended bridge loans to the Company in an
aggregate principal amount of $250,000. Mr. Heidrich, a director of the
Company, is a member of Mayfield Fund, the general partner of Mayfield VII and
Mayfield Associates Fund II. The loans accrued interest at 5.8% per annum. The
outstanding principal balance and accrued interest of the loans automatically
converted into 64,442 shares of Series C Preferred Stock upon the first
closing of the Company's sale of Series C Preferred Stock in September 1994.
    
  The Company has entered into indemnification agreements with its directors
and executive officers for the indemnification of and advancement of expenses
to such persons to the full extent permitted by law. The Company also intends
to execute such agreements with its future directors and executive officers.
 
  The Company believes that the foregoing transactions were in its best
interest. As a matter of policy the transactions were, and all future
transactions between the Company and any of its officers, directors or
principal stockholders will be, approved by a majority of the independent and
disinterested members of the Board of Directors, will be on terms no less
favorable to the Company than could be obtained from unaffiliated third
parties and will be in connection with bona fide business purposes of the
Company.
 
                                      49
<PAGE>
 
                            PRINCIPAL STOCKHOLDERS
 
  The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of July 15, 1997 and as adjusted to
reflect the sale of the Common Stock being offered hereby by: (i) each
stockholder who is known by the Company to own beneficially more than 5% of
the Common Stock; (ii) each Named Executive Officer of the Company; (iii) each
director of the Company and (iv) all directors and executive officers of the
Company as a group. Unless otherwise indicated below, to the knowledge of the
Company, all persons listed below have sole voting and investment power with
respect to their shares of Common Stock, except to the extent authority is
shared by spouses under applicable law.
 
<TABLE>   
<CAPTION>
                                                         PERCENTAGE OF SHARES
                                                         BENEFICIALLY OWNED(1)
                                               SHARES    -----------------------
                                            BENEFICIALLY  PRIOR TO      AFTER
 BENEFICIAL OWNER                              OWNED      OFFERING     OFFERING
 ----------------                           ------------ ----------   ----------
<S>                                         <C>          <C>          <C>
Entities affiliated with Mayfield Fund(2).   1,287,668         13.2%        10.5%
 2800 Sand Hill Road
 Menlo Park, CA 94025
Lombard Odier & Cie(3)....................     693,332          7.1%         5.7%
 11 Rue de la Corraterie
 1211 Genevall
 Switzerland
Entities affiliated with
 Institutional Venture Partners(4)........     640,955          6.6%         5.2%
 3000 Sand Hill Road
 Suite Z-290
 Menlo Park, CA 94025
Entities affiliated with
 Burr, Egan, Deleage & Co(5)..............     581,665          6.0%         4.8%
 One Embarcadero Center, #4050
 San Francisco, CA 94111
William L. Brown..........................     531,817          5.5%         4.3%
 Two Embarcadero Center, #1660
 San Francisco, CA 94111
Frank J. Caufield.........................     495,468          5.0%         4.1%
 Four Embarcadero Center, #3520
 San Francisco, CA 94111
Benjamin F. McGraw, III, Pharm.D.(6)......     406,666          4.1%         3.3%
Patrick G. Enright(7).....................     144,499          1.5%         1.1%
Rodney Pearlman, Ph.D.(8).................     137,499          1.4%         1.1%
Edward Erickson(9)........................      13,333            *            *
A. Grant Heidrich(2)......................   1,287,668         13.2%        10.5%
Russell C. Hirsch, M.D., Ph.D.............           0            *            *
Raju Kucherlapati(10).....................      26,666            *            *
All directors and executive officers as a
 group (10 persons)(11)...................   2,511,799         25.4%        20.3%
</TABLE>    
- --------
 *  Represents beneficial ownership of less than 1% of the outstanding shares
    of the Company's Common Stock.
 (1) Beneficial ownership is determined in accordance with the rules of the
     Commission and generally includes voting or investment power with respect
     to securities. Beneficial ownership also includes shares of stock
 
                                      50
<PAGE>
 
     subject to options and warrants currently exercisable or convertible, or
     exercisable or convertible within 60 days of the date of this table.
     Percentage of beneficial ownership is based on 9,725,939 shares of Common
     Stock outstanding as of July 15, 1997 and 12,225,939 shares of Common
     Stock outstanding after completion of this offering.
 (2) Includes 1,226,505 shares held by Mayfield VII and 61,163 shares held by
     Mayfield Associates Fund II. Mr. Heidrich is a member of Mayfield Fund,
     the general partner of Mayfield Associates Fund II and Mayfield VII. Mr.
     Heidrich disclaims beneficial ownership of all such shares held by
     Mayfield VII or Mayfield Associates Fund II, except to the extent of his
     proportionate pecuniary interest therein.
 (3) Shares are held in the name of Ryco & Co, as nominee for Lombard Odier &
     Cie.
 (4) Includes 628,138 shares held by Institutional Venture Partners V and
     12,817 held by Institutional Venture Management V.
 (5) Includes 575,616 shares held by Alta V Limited Partnership and 6,049
     shares held by Customs House Partners. The principals of Burr, Egan,
     Deleage & Co. are general partners of Alta V Management Partners, L.P.
     (which is a general partner of Alta V Limited Partnership), and Customs
     House Partners. The principals of Burr, Egan, Deleage & Co. disclaim
     beneficial ownership of all such shares held by the foregoing funds,
     except to the extent of their proportionate pecuniary interests therein.
 (6) Includes 300,000 shares Dr. McGraw acquired pursuant to the exercise of
     stock options, 92,708 of which will be subject to repurchase by the
     Company as of September 13, 1997. Also includes 73,333 shares Dr. McGraw
     has the right to acquire pursuant to an option exercisable within 60
     days, all of which will be subject to repurchase by the Company at such
     date, if issued.
 (7) Includes 2,000 shares held by Enright Capital Advisors, an investment
     partnership of which Mr. Enright is a partner. Mr. Enright disclaims
     beneficial ownership of all such shares owned by the foregoing
     partnership, except to the extent of his proportionate pecuniary interest
     therein. Includes 112,499 shares Mr. Enright acquired pursuant to the
     exercise of stock options, 46,961 of which will be subject to repurchase
     by the Company as of September 13, 1997. Also includes 30,000 shares Mr.
     Enright has the right to acquire pursuant to an option exercisable within
     60 days, all of which will be subject to repurchase by the Company at
     such date, if issued.
 (8) Includes 112,499 shares Dr. Pearlman acquired pursuant to the exercise of
     stock options, 45,398 of which will be subject to repurchase by the
     Company as of September 13, 1997. Also includes 25,000 shares Dr.
     Pearlman has the right to acquire pursuant to options exercisable within
     60 days, all of which will be subject to repurchase by the Company at
     such date, if issued.
 (9) Includes 13,333 shares Mr. Erickson acquired pursuant to the exercise of
     stock options, 6,389 of which will be subject to repurchase by the
     Company as of September 13, 1997.
(10) Includes 26,666 shares Dr. Kucherlapati has the right to acquire pursuant
     to options exercisable within 60 days, 16,666 of which will be subject to
     repurchase by the Company at such date, if issued.
(11) Includes 1,287,668 shares held by entities affiliated with certain
     directors of the Company as described in footnote 2 above and 154,999
     shares subject to options exercisable within 60 days.
 
                                      51
<PAGE>

                         DESCRIPTION OF CAPITAL STOCK
 
  Upon completion of this offering, the authorized capital stock of the
Company will consist of 30,000,000 shares of Common Stock, $.001 par value,
and 10,000,000 shares of Preferred Stock, $.001 par value.
 
COMMON STOCK
   
  As of July 15, 1997, there were 1,567,727 shares of Common Stock outstanding
held of record by approximately 64 stockholders. There will be 12,225,939
shares of Common Stock outstanding after giving effect to the sale of
2,500,000 shares of Common Stock offered by the Company hereby and after
giving effect to the conversion of all shares of Preferred Stock into an
aggregate of 8,154,779 shares of Common Stock.     
 
  The holders of Common Stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. The holders of
Common Stock are entitled to receive ratably such dividends as may be declared
by the Board of Directors out of funds legally available therefor. See
"Dividend Policy." In the event of a liquidation, dissolution or winding up of
the Company, holders of the Common Stock are entitled to share ratably in all
assets remaining after payment of liabilities. Holders of Common Stock have no
preemptive rights and no right to convert their Common Stock into any other
securities. There are no redemption or sinking fund provisions applicable to
the Common Stock. All outstanding shares of Common Stock are, and all shares
of Common Stock to be outstanding upon completion of this offering will be,
fully paid and nonassessable.
 
PREFERRED STOCK
 
  The Board of Directors has the authority, without further action by the
stockholders, to issue up to 10,000,000 shares of Preferred Stock, $.001 par
value, in one or more series and to fix the rights, preferences, privileges
and restrictions thereof, including dividend rights, conversion rights, voting
rights, terms of redemption, liquidation preferences, sinking fund terms and
the number of shares constituting any series or the designation of such
series, without any further vote or action by stockholders. The issuance of
Preferred Stock could adversely affect the voting power of holders of Common
Stock and the likelihood that such holders will receive dividend payments and
payments upon liquidation and could have the effect of delaying, deferring or
preventing a change in control of the Company. The Company has no present plan
to issue any shares of Preferred Stock.
 
WARRANTS
   
  As of July 15, 1997, the Company had outstanding warrants to purchase 84,008
shares of Common Stock at an exercise price of $3.88 per share. The warrants
expire at various times from the day prior to the effectiveness of this
initial public offering to five years following the closing of this initial
public offering. Each warrant contains provisions for the adjustment of the
exercise price and the aggregate number of shares issuable upon the exercise
of the warrant under certain circumstances, including stock dividends, stock
splits, reorganizations, reclassification, consolidations and certain dilutive
sales of the securities for which the warrant is exercisable below the then
existing exercise price. Each warrant may be exercised, without the payment of
cash, for the number of shares of Common Stock purchasable, at the current
market value of the Common Stock, by the difference between the aggregate
exercise price of the warrant and the value, at the current market price per
share of Common Stock of the aggregate number of shares purchasable under the
warrant.     
 
REGISTRATION RIGHTS
   
  Following this offering, holders (or their permitted transferees)
("Holders") of 8,154,779 shares of Common Stock and warrants to purchase
84,008 shares of Common Stock will be entitled to certain rights with respect
to the registration of their shares under the Securities Act. Under the terms
of that certain Amended and Restated Investor Rights Agreement dated May 23,
1997 (the "Investor Rights Agreement"), if the Company proposes to register
any of its securities under the Securities Act, either for its own account or
the account of     
 
                                      52
<PAGE>
 
   
others, certain of the Holders are entitled to notice of such registration and
are entitled to include their shares of Common Stock; provided, among other
conditions, that the underwriters of any offering have the right to limit the
number of such shares included in such registration or exclude such shares
entirely. Certain of the Holders may also require the Company, at the
Company's expense, to register all or a portion of their shares of Common
Stock on form S-3 when such form becomes available to the Company, subject to
certain conditions and limitations. In addition, certain of the Holders may
also require the Company, beginning 180 days after the date of this
Prospectus, on not more than two occasions, to file a registration statement
under the Securities Act at the Company's expense with respect to their shares
of Common Stock, and the Company is required to use its best efforts to effect
such registration, subject to certain conditions and limitations. In addition,
one holder of 484,697 shares of Common Stock has a right to include its shares
of Common Stock only in connection with the first firm underwritten public
offering after May 30, 2001.     
 
DELAWARE LAW AND CERTAIN CHARTER PROVISIONS
 
  The Company is subject to the provisions of Section 203 of the Delaware Law,
an anti-takeover law. In general, the statute prohibits a publicly held
Delaware corporation from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder, unless the
business combination is approved in a prescribed manner. For purposes of
Section 203, a "business combination" includes a merger, asset sale or other
transaction resulting in a financial benefit to the interested stockholder,
and an "interested stockholder" is a person who, together with affiliates and
associates, owns (or within three years prior, did own) 15% or more of the
corporation's voting stock.
 
  The Company's Certificate of Incorporation and Bylaws also require that,
effective upon the closing of this offering, any action required or permitted
to be taken by stockholders of the Company must be effected at a duly called
annual or special meeting of the stockholders and may not be effected by a
consent in writing. In addition, special meetings of the stockholders of the
Company may be called only by the Board of Directors, the Chairman of the
Board, the Chief Executive Officer of the Company or by any person or persons
holding shares representing at least 10% of the outstanding capital stock. The
Company's Certificate of Incorporation also provides for a classified Board
and specifies that the authorized number of directors may be changed only by
resolution of the Board of Directors. See "Management--Board Composition."
These provisions may have the effect of deterring hostile takeovers or
delaying changes in control or management of the Company.
 
TRANSFER AGENT AND REGISTRAR
 
  First National Bank of Boston has been appointed as the transfer agent and
registrar for the Company's Common Stock.
 
                                      53
<PAGE>
 
                        SHARES ELIGIBLE FOR FUTURE SALE
 
  Prior to this offering, there has not been any public market for the Common
Stock of the Company. Further sales of substantial amounts of Common Stock in
the open market may adversely affect the market price of the Common Stock
offered hereby.
   
  Upon completion of this offering, based on the number of shares outstanding
as of July 15, 1997, the Company will have outstanding an aggregate of
12,247,569 shares of Common Stock assuming (i) the issuance by the Company of
2,500,000 shares of Common Stock offered hereby, (ii) the issuance of 21,630
shares of Common Stock relating to an outstanding warrant to purchase Common
Stock that expires upon this Offering and no issuance of 62,378 shares of
Common Stock relating to other outstanding warrants, (iii) no exercise of
exercisable vested options to purchase 64,371 shares of Common Stock, and (iv)
no exercise of the Underwriters' over-allotment option to purchase 375,000
shares of Common Stock. Of these shares, 2,500,000 shares sold in this
offering will be freely tradable without restriction or further registration
under the Securities Act, except for shares held by "affiliates" of the
Company as that term is defined in Rule 144 under the Securities Act (whose
sales would be subject to certain limitations and restrictions described
below) and the regulations promulgated thereunder.     
   
  The remaining 9,725,939 shares held by officers, directors, employees,
consultants and other stockholders of the Company were sold by the Company in
reliance on exemptions from registration requirements of the Securities Act
and are "restricted" securities within the meaning of Rule 144 under the
Securities Act. As a result, on the date of this prospectus, approximately
22,645 shares, other than the 2,500,000 shares offered hereby, will be
eligible for sale pursuant to subsection (k) of Rule 144 promulgated under the
Securities Act. An additional 8,045,052 shares and 96,709 shares issuable upon
exercise of outstanding vested options will be eligible for sale 180 days
after the date of this Prospectus upon expiration of the lock-up agreements
described below and in compliance with certain limitations set forth in the
Securities Act. An additional 1,385,706 shares held by existing shareholders
will become eligible for sale at various times over a period of less than one
year. The remaining 272,536 shares currently held by existing shareholders
will be subject to rights of repurchase in favor of the Company that expire at
various dates through May 2001 pursuant to monthly vesting.     
 
  Each officer, director and certain stockholders of the Company have agreed
that for a period of 180 days after the date of this Prospectus, they will
not, directly or indirectly, offer, sell, contract to sell, grant any option
to sell or otherwise dispose of, directly or indirectly, any shares of Common
Stock or securities convertible into or exchangeable for, or any rights to
purchase or acquire, Common Stock, without the prior written consent of the
Company or Montgomery Securities, as applicable. Montgomery Securities or the
Company, as applicable, at any time without notice, may release all or any
portion of the securities subject to the 180-day lock-up agreement. The
Company has agreed with Montgomery Securities not to release any stockholder
from such lock-up agreement between the stockholder and the Company without
the prior written consent of Montgomery Securities.
 
  In general, under rule 144 as currently in effect, beginning 90 days after
the date of this Prospectus, an affiliate of the Company, or person (or
persons whose shares are aggregated) who has beneficially owned Restricted
Shares that were not acquired from the Company or an affiliate of the Company
within the previous one year, will be entitled to sell in any three-month
period a number of shares that does not exceed the greater of (i) 1% of the
then outstanding shares of the Company's Common Stock (approximately 122,475
shares immediately after this offering) or (ii) the average weekly trading
volume of the Company's Common Stock in the Nasdaq National Market during the
four calendar weeks immediately preceding the date on which notice of the sale
is filed with the Securities and Exchange Commission. Sales pursuant to Rule
144 are subject to certain requirements relating to manner of sale, notice and
availability of current public information about the Company. A person (or
person whose shares are aggregated) who is not deemed to have been an
affiliate of the Company at any time during the 90 days immediately preceding
the sale and who beneficially owns Restricted Shares is entitled to sell such
shares pursuant to Rule 144(k) without regard to the limitations described
above; provided that at least two years have elapsed since the later of the
date the shares were acquired from the Company or from an affiliate of the
Company.
 
 
                                      54
<PAGE>
 
  An employee, officer or director of or consultant to the Company who
purchased or was awarded shares or options to purchase shares pursuant to a
written compensatory plan or contract is entitled to rely on the resale
provisions of Rule 701 under the Securities Act, which permits affiliates and
non-affiliates to sell their Rule 701 shares without having to comply with
Rule 144's holding period restrictions, in each case commencing 90 days after
the date of this Prospectus. In addition, non-affiliates may sell Rule 701
shares without complying with public information, volume and notice provisions
of Rule 144.
 
  The Company intends to file a registration statement under the Securities
Act to register shares of Common Stock reserved for issuance under the
Incentive Plan and the Purchase Plan, thus permitting the resale of such
shares by non-affiliates in the public market without restriction under the
Securities Act. Such registration statement will become effective immediately
upon filing.
   
  As of the date of this Prospectus, warrants to purchase an aggregate of
84,008 shares of Common Stock were outstanding, all of which are subject to
the 180-day lock-up.     
   
  In addition, after this offering, the holders of approximately 8,154,779
shares will be entitled to certain rights with respect to registration of such
shares under the Securities Act. Registration of such shares under the
Securities Act would result in such shares becoming freely tradable without
restriction under the Securities Act (except for shares purchased by
affiliates of the Company) immediately upon the effectiveness of such
registration. See "Description of Capital Stock--Registration Rights."     
 
                                      55
<PAGE>
 
                                 UNDERWRITING
 
  The Underwriters named below, represented by Montgomery Securities and
Hambrecht & Quist LLC (the "Representatives"), have severally agreed, subject
to the terms and conditions set forth in the Underwriting Agreement (the
"Underwriting Agreement") by and between the Company and the Underwriters, to
purchase from the Company the aggregate number of shares of Common Stock
indicated below opposite their respective names at the initial public offering
price less the underwriting discount set forth on the cover page of this
Prospectus. The Underwriting Agreement provides that the obligations of the
Underwriters to pay for and accept delivery of the shares of Common Stock are
subject to certain conditions precedent, and that the Underwriters are
committed to purchase all of such shares if they purchase any.
 
<TABLE>
<CAPTION>
                                                                        NUMBER
    UNDERWRITERS                                                       OF SHARES
    ------------                                                       ---------
   <S>                                                                 <C>
   Montgomery Securities..............................................
   Hambrecht & Quist LLC..............................................
                                                                       ---------
     Total............................................................ 2,500,000
                                                                       =========
</TABLE>
 
  The Representatives have advised the Company that the Underwriters propose
initially to offer the Common Stock to the public on the terms set forth on
the cover page of this Prospectus. The Underwriters may allow selected dealers
a concession of not more than $   per share, and the Underwriters may allow,
and such dealers may reallow, a concession of not more than $   per share to
certain other dealers. After the initial public offering, the offering price
and other selling terms may be changed by the Representatives. The Common
Stock is offered subject to receipt and acceptance by the Underwriters, and to
certain other conditions, including the right to reject orders in whole or in
part.
 
  The Company has granted an option to the Underwriters, exercisable during
the 30-day period after the date of this Prospectus, to purchase up to a
maximum of 375,000 additional shares of Common Stock to cover over-allotments,
if any, at the same price per share as the initial 2,500,000 shares to be
purchased by the Underwriters. To the extent that the Underwriters exercise
such option, each of the Underwriters will be committed, subject to certain
conditions, to purchase such additional shares in approximately the same
proportion as set forth in the above table. The Underwriters may purchase such
shares only to cover over-allotments made in connection with the initial
public offering.
 
  The Representatives have advised the Company that the Underwriters do not
expect to confirm sales to any accounts over which they exercise discretionary
authority in excess of 5% of the number of shares of Common Stock offered
hereby.
 
  The Underwriting Agreement provides that the Company will indemnify the
several Underwriters against certain liabilities, including civil liabilities
under the Securities Act, or will contribute to payments the Underwriters may
be required to make in respect thereof.
 
  For a period of 180 days after the effectiveness of the Registration
Statement, without the prior written consent of Montgomery Securities and/or
the Company, as applicable, the Company and holders of 9,562,429 shares of
Common Stock including the Company's directors and executive officers have
agreed not to offer, sell
 
                                      56
<PAGE>
 
or contract to sell, grant any option to purchase, make any short sale, pledge
or otherwise dispose of, directly or indirectly, any shares of Common Stock or
securities exchangeable or exercisable for or convertible into shares of, or
any other rights to purchase or acquire Common Stock of the Company other than
issuances pursuant to existing employee compensation plans and transfers into
trusts for the benefit of the original holder or members of the original
holder's immediate family.
 
  Prior to the initial public offering, there has been no public market for
the Common Stock of the Company. Consequently, the initial public offering
price for the Common Stock will be negotiated between the Company and the
Representatives. Among the factors to be considered in determining the initial
public offering price of the Common Stock will be prevailing market and
economic conditions, market valuations of other companies engaged in
activities similar to the Company, estimates of the business potential and
prospects of the Company, the present state of the Company's business
operations, the Company's management and other factors deemed relevant.
 
  The Representatives, on behalf of the Underwriters, may engage in over-
allotment, stabilizing transactions, syndicate covering transactions and
penalty bids in accordance with Regulation M under the Exchange Act. Over-
allotment involves syndicate sales in excess of the offering size, which
creates a syndicate short position. Stabilizing transactions permit bids to
purchase the underlying security so long as the stabilizing bids do not exceed
a specified maximum. Syndicate covering transactions involve purchases of the
Common Stock in the open market after the distribution has been completed in
order to cover syndicate short positions. Penalty bids permit the
Representatives to reclaim a selling concession from a syndicate member when
the Common Stock originally sold by such syndicate member is purchased in a
syndicate covering transaction to cover syndicate short positions. Such
stabilizing transactions, syndicate covering transactions and penalty bids may
cause the price of the Common stock to be higher than it would otherwise be in
the absence of such transactions. These transactions may be effected on the
Nasdaq National Market or otherwise and, if commenced, may be discontinued at
any time.
 
                                      57
<PAGE>
 
                                 LEGAL MATTERS
   
  The validity of the Common Stock offered hereby will be passed upon for the
Company by Cooley Godward LLP ("Cooley Godward"), Palo Alto, California.
Certain legal matters in connection with this offering will be passed upon for
the Underwriters by Gunderson Dettmer Stough Villeneuve Franklin & Hachigian,
LLP, Menlo Park, California. As of the date of this Prospectus, certain
members of Cooley Godward own an aggregate of 11,587 shares of Common Stock of
the Company.     
 
                                    EXPERTS
   
  The financial statements of Megabios Corp. as of June 30, 1996 and 1997, and
for each of the three years in the period ended June 30, 1997 appearing in
this Prospectus and Registration Statement have been audited by Ernst & Young
LLP, independent auditors and are included in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing.     
 
  The statements in this Prospectus under the captions "Risk Factors--
Uncertainty of Patent Position and Proprietary Rights" and "Business--Patents
and Proprietary Technology" have been reviewed and approved by McDonnell,
Boehnen, Hulbert, Berghoff Ltd., special patent counsel for the Company, as
experts in such matters, and are included herein in reliance upon such review
and approval.
 
                            ADDITIONAL INFORMATION
 
  A Registration Statement on Form S-1, including amendments thereto, relating
to the Common Stock offered hereby has been filed by the Company with the
Commission, Washington, D.C. This Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. Statements contained in this Prospectus as to the contents
of any contract or other document referred to are not necessarily complete,
and in each instance reference is made to the copy of such contract or other
document filed as an exhibit to the Registration Statement, each such
statement being qualified in all respects by such reference. For further
information with respect to the Company and the Common Stock offered hereby,
reference is made to the Registration Statement and the exhibits and schedules
thereto. A copy of the Registration Statement may be inspected by anyone
without charge at the Commission's principal office in Washington, D.C. and
copies of all or any part thereof may be obtained from the Public Reference
Section of the Commission, 450 Fifth Street, N.W., Judiciary Plaza,
Washington, D.C. 20549, upon payment of certain fees prescribed by the
Commission. In addition, the Commission maintains a Web site
(http://www.sec.gov) that contains reports, proxy and information statements
and other information regarding registrants that file electronically with the
Commission through the Electronic Data Gathering, Analysis, and Retrieval
system.
 
                                      58
<PAGE>
 
                                 MEGABIOS CORP.
 
                         INDEX TO FINANCIAL STATEMENTS
 
<TABLE>
<S>                                                                          <C>
Report of Independent Auditors.............................................. F-2
Financial Statements
  Balance Sheets............................................................ F-3
  Statements of Operations.................................................. F-4
  Statement of Shareholders' Equity......................................... F-5
  Statements of Cash Flows.................................................. F-6
Notes to Financial Statements............................................... F-7
</TABLE>
 
                                      F-1
<PAGE>
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors and Shareholders
 Megabios Corp.
   
  We have audited the accompanying balance sheets of Megabios Corp. as of June
30, 1996 and 1997, and the related statements of operations, shareholders'
equity and cash flows for each of the three years in the period ended June 30,
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.     
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
   
  In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Megabios Corp. as of June
30, 1996 and 1997, and the results of its operations and its cash flows for
each of the three years in the period ended June 30, 1997, in conformity with
generally accepted accounting principles.     
 
                                          ERNST & YOUNG LLP
Palo Alto, California
   
August 4, 1997, except for Note 11,as to which the date is       , 1997     
 
- -------------------------------------------------------------------------------
 
The foregoing report is in the form that will be signed upon the completion of
the 1-for-3 reverse stock split described in Note 11 to the financial
statements.
 
Palo Alto, California
   
August 15, 1997     
 
                                      F-2
<PAGE>
 
                                 MEGABIOS CORP.
 
                                 BALANCE SHEETS
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
 
<TABLE>   
<CAPTION>
                                                                    PRO FORMA
                                                                  SHAREHOLDERS'
                                                  JUNE 30,         EQUITY  AT
                                              ------------------    JUNE 30,
                                                1996      1997        1997
                                              --------  --------  -------------
                                                                   (UNAUDITED)
<S>                                           <C>       <C>       <C>
ASSETS
Current assets:
  Cash and cash equivalents.................. $  5,253  $  9,044
  Short-term investments.....................       --    15,225
  Other receivables..........................       16       238
  Prepaid expenses and other current assets..      275       390
                                              --------  --------
  Total current assets.......................    5,544    24,897
Property and equipment, net..................    4,091     4,733
Other receivables............................       35        27
Deposits and other assets....................      286       321
                                              --------  --------
                                              $  9,956  $ 29,978
                                              ========  ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Accounts payable........................... $    148  $    694
  Accrued compensation.......................      133       170
  Accrued construction-in-progress...........       --       249
  Other accrued liabilities..................       95        35
  Deferred revenue...........................      531       887
  Current portion of long-term debt..........    1,069     1,233
                                              --------  --------
      Total current liabilities..............    1,976     3,268
Long-term debt...............................    1,894     1,487
Commitments
Shareholders' equity:
  Preferred stock, no par value, issuable in
   series; 11,333,333 shares authorized;
   5,754,069 and 8,420,720 convertible shares
   issued and outstanding at June 30, 1996
   and 1997, respectively; aggregate
   liquidation preference of $51,200 at June
   30, 1997 (no shares outstanding pro
   forma)....................................   20,905    44,700    $     --
  Common stock, no par value, 15,000,000
   shares authorized; 1,368,148 and 1,567,727
   shares issued and outstanding at June 30,
   1996 and 1997, respectively (9,722,506
   shares outstanding pro forma).............      442     1,410      46,110
  Deferred compensation......................       --      (679)       (679)
  Accumulated deficit........................  (15,261)  (20,208)    (20,208)
                                              --------  --------    --------
      Total shareholders' equity.............    6,086    25,223    $ 25,223
                                              --------  --------    ========
                                              $  9,956  $ 29,978
                                              ========  ========
</TABLE>    
 
                            See accompanying notes.
 
                                      F-3
<PAGE>
 
                                 MEGABIOS CORP.
 
                            STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>   
<CAPTION>
                                                       YEAR ENDED JUNE 30,
                                                     -------------------------
                                                      1995     1996     1997
                                                     -------  -------  -------
<S>                                                  <C>      <C>      <C>
Collaborative research and development revenue...... $ 1,157  $ 1,890  $ 5,793
Operating expenses:
  Research and development..........................   4,691    6,487    8,598
  General and administrative........................   1,811    2,169    2,417
                                                     -------  -------  -------
    Total operating expenses........................   6,502    8,656   11,015
                                                     -------  -------  -------
Loss from operations................................  (5,345)  (6,766)  (5,222)
Interest income.....................................      56      230      656
Interest expense....................................    (140)    (365)    (381)
                                                     -------  -------  -------
Net loss............................................ $(5,429) $(6,901) $(4,947)
                                                     =======  =======  =======
Pro forma net loss per share........................                   $ (0.50)
                                                                       =======
Shares used in computing pro forma net loss per
 share..............................................                     9,926
                                                                       =======
</TABLE>    
 
 
                            See accompanying notes.
 
                                      F-4
<PAGE>
 
                                 MEGABIOS CORP.
 
                       STATEMENT OF SHAREHOLDERS' EQUITY
               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
 
<TABLE>   
<CAPTION>
                           PREFERRED STOCK     COMMON STOCK                                  TOTAL
                          -----------------  -----------------    DEFERRED   ACCUMULATED SHAREHOLDERS'
                           SHARES   AMOUNT    SHARES    AMOUNT  COMPENSATION   DEFICIT      EQUITY
                          --------- -------  ---------  ------  ------------ ----------- -------------
<S>                       <C>       <C>      <C>        <C>     <C>          <C>         <C>
Balances at June 30,
 1994...................  2,084,970 $ 5,150    613,941  $  217     $  --      $ (2,931)     $ 2,436
Exercise of stock
 options................         --      --     68,164      20        --            --           20
Issuance of Series C
 convertible preferred
 stock, net of issuance
 costs of $76...........  1,292,089   4,942         --      --        --            --        4,942
Conversion of notes
 payable of $250 into
 Series C convertible
 preferred stock........     64,442     250         --      --        --            --          250
Net loss................         --      --         --      --                  (5,429)      (5,429)
                          --------- -------  ---------  ------     -----      --------      -------
Balances at June 30,
 1995...................  3,441,501  10,342    682,105     237        --        (8,360)       2,219
Issuance of Series C
 convertible preferred
 stock, net of issuance
 costs of $36...........  1,827,871   7,063         --      --        --            --        7,063
Issuance of Series D
 convertible preferred
 stock..................    484,697   3,500         --      --        --            --        3,500
Exercise of stock
 options................         --      --    693,543     208        --            --          208
Repurchase of common
 stock from employee....         --      --     (7,500)     (3)       --            --           (3)
Net loss................         --      --         --      --        --        (6,901)      (6,901)
                          --------- -------  ---------  ------     -----      --------      -------
Balance at June 30,
 1996...................  5,754,069  20,905  1,368,148     442        --       (15,261)       6,086
Issuance of Series E
 convertible preferred
 stock, net of issuance
 costs of $15...........  1,333,325   9,985         --      --        --            --        9,985
Issuance of Series F
 convertible preferred
 stock, net of issuance
 costs of $11...........  1,333,326  13,989         --      --        --            --       13,989
Issuance of common stock
 in lieu of cash payment
 of Series E and F stock
 offering commissions...         --    (179)   119,046     179        --            --           --
Exercise of stock
 options................         --      --    116,517      56        --            --           56
Repurchase of common
 stock from employees...         --      --    (35,984)    (17)       --            --          (17)
Deferred compensation
 related to grant of
 certain stock options,
 net of amortization....         --      --         --     750      (679)           --           71
Net loss................         --      --         --      --        --        (4,947)      (4,947)
                          --------- -------  ---------  ------     -----      --------      -------
Balance at June 30,
 1997...................  8,420,720 $44,700  1,567,727  $1,410     $(679)     $(20,208)     $25,223
                          ========= =======  =========  ======     =====      ========      =======
</TABLE>    
 
 
                            See accompanying notes.
 
                                      F-5
<PAGE>
 
                                 MEGABIOS CORP.
 
                            STATEMENTS OF CASH FLOWS
        INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (IN THOUSANDS)
 
<TABLE>   
<CAPTION>
                                                       YEAR ENDED JUNE 30,
                                                     -------------------------
                                                      1995     1996     1997
                                                     -------  -------  -------
<S>                                                  <C>      <C>      <C>
Cash flows from operating activities
 Net loss........................................... $(5,429) $(6,901) $(4,947)
 Adjustments to reconcile net loss to net cash used
  in operations:
  Depreciation......................................     732    1,101    1,294
  Amortization of deferred compensation.............      --       --       71
  Changes in operating assets and liabilities:
   Other receivables................................     (85)      93     (214)
   Prepaid expenses and other assets................     163      (87)    (115)
   Deferred revenue.................................     250      281      356
   Accounts payable.................................    (334)     (33)     546
   Accrued liabilities..............................    (736)      95      (23)
                                                     -------  -------  -------
    Net cash used in operating activities...........  (5,439)  (5,451)  (3,032)
                                                     -------  -------  -------
Cash flow from investing activities
 Purchase of property and equipment.................  (2,829)  (1,111)  (1,687)
 Deposits and other assets..........................    (210)     (12)     (35)
 Purchases of short-term investments................      --       --  (15,725)
 Maturities of short-term investments...............      --       --      500
                                                     -------  -------  -------
    Net cash used in investing activities...........  (3,039)  (1,123) (16,947)
                                                     -------  -------  -------
Cash flows from financing activities
 Proceeds from issuance of notes payable -..........     250       --       --
 Proceeds from issuance of long-term debt...........   1,894    1,683      894
 Payments on long-term debt.........................    (232)    (906)  (1,137)
 Proceeds from issuance of convertible preferred
  stock, net of issuance costs......................   4,942   10,563   23,974
 Proceeds from issuance of common stock, net of
  purchases.........................................      20      205       39
                                                     -------  -------  -------
    Net cash provided by financing activities.......   6,874   11,545   23,770
                                                     -------  -------  -------
Net increase (decrease) in cash and cash
 equivalents........................................  (1,604)   4,971    3,791
Cash and cash equivalents, beginning of period......   1,886      282    5,253
                                                     -------  -------  -------
Cash and cash equivalents, end of period............ $   282  $ 5,253  $ 9,044
                                                     =======  =======  =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid....................................... $   158  $   357  $   381
                                                     =======  =======  =======
Schedule of noncash transactions
 Conversion of notes payable and related accrued
  interest into convertible preferred stock......... $   250  $    --  $    --
                                                     =======  =======  =======
 Construction-in-progress included in accrued
  liabilities....................................... $    --  $    --  $   249
                                                     =======  =======  =======
</TABLE>    
 
                            See accompanying notes.
 
                                      F-6
<PAGE>
 
                                MEGABIOS CORP.
 
                         NOTES TO FINANCIAL STATEMENTS
                                 
                              JUNE 30, 1997     
 
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Organization and Basis of Presentation
   
  Megabios Corp. ("Megabios" or the "Company") develops proprietary gene
delivery systems and provides preclinical development expertise to create
gene-based therapeutics designed for the treatment or prevention of genetic
and acquired diseases. The Company has developed several in vivo, non-viral
gene delivery systems to address a number of potential therapeutic
applications using a variety of therapeutic genes. The Company's clinical
development and commercialization strategy is to enter into collaborative
research and development agreements or "corporate partnerships" with
pharmaceutical and biotechnology companies.     
   
  Through June 30, 1995, the Company was in the development stage. During
fiscal 1996, the Company recognized significant revenues associated with its
collaborative agreements and expects to receive significant revenues under
these agreements in the future. Consequently, the Company is no longer
considered to be in the development stage. The Company will require additional
financial resources to complete development and commercialization of its
products. Management plans to continue to finance the Company primarily
through issuances of equity securities, collaborative research and development
arrangements and debt financing. If the financing arrangements contemplated by
management are not consummated, the Company may have to seek other sources of
capital or reevaluate its operating plans.     
       
  Revenue Recognition
   
  Revenue related to collaborative research agreements with the Company's
corporate partners are recognized over the related funding periods for each
contract. The Company is required to perform research and development
activities as specified in each respective agreement on a best-efforts basis.
The Company is reimbursed based on the costs associated with the research and
development activities, and revenue are recorded as earned in accordance with
the agreement. Deferred revenue may result when the Company does not incur the
required level of effort during a specific period in comparison to funds
received under the respective contracts. Milestone payments, if any, will be
recognized pursuant to collaborative agreements upon the achievement of
specified milestones, such as the filing of Investigational New Drug
Applications, commencement of clinical trials or receipt of regulatory
approvals. No milestone payments have been earned or recognized to date.     
 
  Research and Development Expenses
   
  Research and development expenses consist of costs incurred for independent
and collaborative research and development. These costs include direct and
research-related overhead expenses. Research and development expenses under
the collaborative research agreements approximate the revenue recognized under
such agreements over the term of the respective agreements.     
 
  Cash and Cash Equivalents
   
  Cash equivalents consist of highly liquid investments with maturities from
date of purchase of 90 days or less. At June 30, 1996 and 1997, the Company
had approximately $5,022,000 and $8,041,000, respectively, in a money market
mutual fund which invests in various U.S. government securities including
Treasury bills, notes and bonds. In addition, at June 30, 1997, the Company
had approximately $1,000,000 in a corporate note (none in fiscal 1996). These
amounts are included in cash and cash equivalents. The Company has not
recognized any gains or losses on the sale of cash equivalents and any
unrecognized gains and losses at June 30, 1996 and June 30, 1997 are not
material.     
 
 
                                      F-7
<PAGE>
 
                                MEGABIOS CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
       
  Depreciation and Amortization
 
  Property and equipment are stated at cost, less accumulated depreciation.
Depreciation is provided using the straight-line method over the estimated
useful lives of the respective assets (generally five years). Leasehold
improvements are amortized over five years which is the lease term and the
estimated useful life of the assets.
   
  Stock-Based Compensation     
          
  The Company generally grants stock options to employees for a fixed number
of shares with an exercise price equal to the fair value of the shares at the
date of grant. In accordance with the provisions of Statements of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS
123"), the Company has elected to follow Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees ("APB 25"), and related
interpretations in accounting for option grants to employees under its
employee stock option plan and to adopt the pro forma disclosure alternative
as described in SFAS 123 (see Note 9). Option grants to all others are
accounted for using the fair value method prescribed by SFAS 123.     
 
  Use of Estimates
 
  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
 
  Net Loss Per Share
 
  Except as noted below, net loss per share is computed using the weighted
average number of common shares outstanding. Common equivalent shares are
excluded from the computation as their effect is antidilutive, except that,
pursuant to the Securities and Exchange Commission ("SEC") Staff Accounting
Bulletins, common and common equivalent shares (stock options, warrants and
convertible preferred stock) issued during the period commencing 12 months
prior to the initial filing of a proposed public offering at prices below the
assumed public offering price have been included in the calculation as if they
were outstanding for all periods presented (using the treasury stock method
for stock options and warrants and the if-converted method of preferred
stock). Per share information calculated on the above noted basis is as
follows:
 
<TABLE>   
<CAPTION>
                                                        YEAR ENDED JUNE 30,
                                                        ----------------------
                                                         1995    1996    1997
                                                        ------  ------  ------
<S>                                                     <C>     <C>     <C>
Net loss per share..................................... $(1.49) $(1.81) $(1.11)
                                                        ======  ======  ======
Shares used in calculating net loss per share (in
 thousands)............................................  3,638   3,812   4,438
                                                        ======  ======  ======
</TABLE>    
 
  Pro forma net loss per share has been computed as described above and also
gives effect, pursuant to SEC policy, to common equivalent shares from
convertible preferred stock issued more than 12 months prior to the initial
filing of the proposed initial public offering (using the if-converted method)
from the original date of issuance.
   
  In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"). SFAS
128 requires that Company's present two measures of earnings per share, basic
and diluted. Basic earnings per share is computed by dividing the net loss
available to common shareholders by the weighted-average number of common
shares outstanding for the period while diluted earnings per share reflects
the potential dilution of securities that could share in the earnings of the
Company. SFAS 128 is effective for interim and annual periods ending after
December 15, 1997. The Company does not believe the adoption of SFAS 128 will
have a material impact on its loss per share calculations.     
 
 
                                      F-8
<PAGE>
 
                                MEGABIOS CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
       
  Fair Values of Financial Instruments
 
  The following methods and assumptions were used by the Company in estimating
its fair value disclosures for financial instruments:
 
    Cash and Cash Equivalents
 
      The carrying amount reported in the balance sheet for cash and cash
    equivalents approximates its fair value.
 
    Investments
 
      The Company determines fair values based on quoted market values.
 
    Long- and Short-Term Debt
 
      The carrying amounts of the Company's borrowings under its term loan
    and equipment financing agreements approximate their fair value. The
    fair values of the Company's long-term debt are estimated using
    discounted cash flow analyses, based on the Company's current
    incremental borrowing rates for similar types of borrowing
    arrangements.
 
 
2. COLLABORATIVE AGREEMENTS
 
  Glaxo Wellcome plc
   
  In April 1994, the Company entered into a five-year collaborative agreement
with Glaxo Wellcome plc ("Glaxo Wellcome") to develop a gene-based therapeutic
for the treatment of cystic fibrosis. In May 1996, the agreement was amended
such that it expired as of April 1, 1997. The agreement provided for quarterly
nonrefundable research and development fees. The Company has completed all of
its obligations under the Glaxo Wellcome agreement and will receive future
payments, if any, only through the achievement of a certain clinical milestone
and the payment of royalties. Revenue for research and development was
recorded as earned in accordance with the agreement. Revenue recognized under
agreement with Glaxo Wellcome was $1,157,000, $1,625,000 and $1,971,000 for
the years ended June 30, 1995, 1996 and 1997, respectively. These amounts
represent 100%, 86% and 34% of total collaborative research and development
funding recognized by the Company during the years ended June 30, 1995, 1996
and 1997, respectively.     
   
  Pfizer Inc     
   
  In May 1996, the Company entered into a four-year collaborative research
agreement, as well as a license and royalty agreement, with Pfizer Inc
("Pfizer") to develop a gene-based therapeutic for the treatment of solid
tumors via angiogenesis inhibition. Under the terms of the collaborative
research agreement, the Company is conducting research and preclinical
development activities and will receive funding for such activities through at
least June 1998. However, Pfizer can, at its option, terminate the program
after June 1998 upon six months prior notice to the Company. The agreements
also provide for royalty and milestone payments to the Company upon the
occurrence of specified events as set forth in the agreements. Pfizer will be
responsible for clinical development and regulatory functions, as well as
large scale clinical and commercial manufacturing and sales and marketing.
Pfizer has worldwide marketing rights to any products resulting from the
collaboration. Revenue recognized under the collaborative research agreement
with Pfizer was $265,000 (14% of total revenues) and $3,352,000 (58% of total
revenues) for the year ended June 30, 1996 and 1997, respectively. Deferred
revenue of $735,000 as of June 30, 1997 represents payment for research to be
performed in the following quarter.     
 
 
                                      F-9
<PAGE>
 
                                MEGABIOS CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
          
  In May 1996, in connection with the above agreements, Pfizer purchased
484,697 shares of the Company's Series D convertible preferred stock at $7.22
per share. Furthermore, should Pfizer decide to extend the research term
beyond two years, it will be required, prior to January 1998 to commit to
purchase within 60 days $10,000,000 of the Company's common stock at a premium
to the then current market value.     
   
  Eli Lilly and Company     
   
  In May 1997, the Company entered into a two-year collaborative research
agreement with Eli Lilly and Company ("Lilly") to develop gene-based
therapeutics using BRCA1, a gene which has been identified as a putative tumor
suppressor. The agreement provides for research and development funding fees
as well as funding to support manufacturing and process development efforts.
Lilly has the option to extend the initial term of the agreement by up to two
years. However, after 21 months from the commencement date of the
collaborative research agreement, Lilly can, at its option, extend the
collaborative research agreement upon three-months advance notice to the
Company. The agreement provides for certain royalty and milestone payments to
the Company upon the occurrence of specified events as set forth in the
agreement. Lilly will be responsible for clinical development and regulatory
functions, as well as large-scale clinical and commercial manufacturing and
sales and marketing. Revenue recognized under the collaborative research
agreement with Lilly was $270,000 (5% of total revenues) for the year ended
June 30, 1997. Deferred revenue of $152,000 as of June 30, 1997 represents
payment for research to be performed in the following quarter.     
   
  In June 1997, in connection with the Lilly agreement, Lilly purchased
285,714 shares of the Company's Series F convertible preferred stock at $10.50
per share.     
 
3. SPONSORED UNIVERSITY RESEARCH
   
  The Company has entered into several research agreements with universities.
These agreements are generally cancelable by either party upon written notice
and may be extended by mutual consent of both parties. Research and
development expenses are recognized as the related services are performed,
generally ratably over the period of service. Expenses under these agreements
were approximately $865,000, $1,100,000, and $496,000 for the years ended June
30, 1995, 1996 and 1997, respectively.     
 
4. INVESTMENTS
   
  Short-term investments consist of corporate notes with remaining maturities
at the date of purchase of greater than 90 days but less than one year.     
   
  The Company accounts for marketable investments in accordance with Statement
of Financial Accounting Standards No. 115, Accounting for Certain Investments
in Debt and Equity Securities ("Statement 115"). Under Statement 115,
management determines the appropriate classification of debt securities at the
time of purchase and reevaluates such designation as of each balance sheet
date. To date, all marketable securities have been classified as held to
maturity and are carried at amortized cost. The amortized cost of debt
securities in this category is adjusted for amortization of premiums and
accretion of discounts to maturity. Such amortization is included in interest
income. The cost of securities sold is based on the specific identification
method. Interest earned on securities are included in interest income.     
   
  A summary of the Company's investments at June 30, 1997 follows (in
thousands).     
 
<TABLE>   
<CAPTION>
                                                     GROSS      GROSS
                                         AMORTIZED UNREALIZED UNREALIZED  FAIR
                                           COST      GAINS      LOSSES    VALUE
                                         --------- ---------- ---------- -------
   <S>                                   <C>       <C>        <C>        <C>
   Short-term investments:
     Corporate notes....................  $15,225     $ 2        $(10)   $15,217
                                          =======     ===        ====    =======
</TABLE>    
 
 
                                     F-10
<PAGE>
 
                                MEGABIOS CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
          
  The Company held no such investments at June 30, 1995 or 1996. There have
been no realized gains or losses on short-term investments.     
 
5. PROPERTY AND EQUIPMENT
 
  Property and equipment consist of the following (in thousands):
 
<TABLE>   
<CAPTION>
                                                                   JUNE 30,
                                                                ---------------
                                                                 1996     1997
                                                                -------  ------
   <S>                                                          <C>      <C>
   Machinery and equipment..................................... $ 2,493  $3,239
   Furniture and fixtures......................................     250     481
   Leasehold improvements......................................   3,230   3,235
   Construction-in-progress....................................      --     954
                                                                -------  ------
                                                                  5,973   7,909
   Less accumulated depreciation...............................  (1,882) (3,176)
                                                                -------  ------
   Property and equipment, net................................. $ 4,091  $4,733
                                                                =======  ======
</TABLE>    
 
6. LONG-TERM DEBT
 
 Term Loan
   
  In 1995, the Company established a line of credit for $1,500,000 with a
commercial bank. As of June 30, 1995, the Company had drawn down $510,000
under the line of credit. In July and August 1995, the Company drew down the
remaining $990,000 available line of credit, and in accordance with the terms
of the agreement, the Company elected to convert the entire balance to a term
loan bearing interest at prime plus 2% (10.25% and 10.75% at June 30, 1996 and
1997, respectively) due in 36 equal monthly installments. The loan is secured
by all tangible personal property, accounts receivable and funds on deposit,
other than the assets securing the equipment financing. As a condition of the
term loan, the Company must maintain a minimum net worth of $3,000,000 and is
prohibited from paying dividends. In conjunction with this financing
arrangement, the Company issued the bank a warrant to purchase 24,140 shares
of the Company's Series C convertible preferred stock at $3.88 per share (see
Note 9).     
 
 Equipment Financing
   
  In December 1993, the Company entered into an equipment financing agreement
for up to $2,300,000 with a financing company. As of June 30, 1996 and 1997,
the Company had financed $1,922,000 in equipment purchases under this
agreement structured as loans. The equipment loans are to be repaid over 42
months at interest rates ranging from 13.8% to 16.2% and are secured by the
related equipment. In conjunction with the original agreement, the Company
issued the financing company a warrant to purchase 21,630 shares of Company's
Series B convertible preferred stock at $3.88 per share (see Note 9).     
   
  In May 1996, the Company entered into an equipment financing agreement for
up to $2,700,000 with another financing company. As of June 30, 1996 and 1997,
the Company had financed $693,000 and $1,587,000, respectively, in equipment
purchases under this agreement structured as loans. The equipment loans are to
be repaid over 48 months at interest rates ranging from 15.2% to 16.2% and are
secured by the related equipment. In conjunction with this equipment financing
agreement, the Company issued a warrant to purchase 38,238 shares of Series C
convertible preferred stock at $3.88 per share (see Note 9).     
 
                                     F-11
<PAGE>
 
                                MEGABIOS CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
          
  Following is a schedule of future minimum principal payments under the term
loan and equipment financing arrangements at June 30, 1997 (in thousands):
    
<TABLE>   
   <S>                                                                    <C>
   Year ended June 30,
     1998................................................................ $1,233
     1999................................................................    603
     2000................................................................    536
     2001................................................................    315
     2002................................................................     33
                                                                          ------
                                                                          $2,720
                                                                          ======
</TABLE>    
 
7. FACILITY LEASE
   
  The Company leases its facility under operating leases. These leases expire
in November 2004 and October 2007 with renewal options at the end of the
initial terms of the leases. Minimal annual rental commitments under the
operating leases at June 30, 1997 are as follows (in thousands):     
 
<TABLE>   
   <S>                                                                    <C>
   Year ended June 30,
     1998................................................................ $  459
     1999................................................................    496
     2000................................................................    521
     2001................................................................    537
     2002................................................................    540
     Thereafter..........................................................  2,085
                                                                          ------
                                                                          $4,638
                                                                          ======
</TABLE>    
   
  Rent expense for the years ended June 30, 1995, 1996 and 1997 was
approximately $221,000, $273,000, and $295,000, respectively.     
 
8. RELATED PARTY TRANSACTIONS
   
  The Company has issued loans to certain employees, of which $27,500 was
outstanding at June 30, 1997 ($46,000 as of June 30, 1996). These loans,
classified as other receivables on the balance sheet, bear interest at
approximately 4.8% to 6.0% per annum.     
 
                                     F-12
<PAGE>
 
                                MEGABIOS CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
       
9. SHAREHOLDERS' EQUITY
 
  Convertible Preferred Stock
   
  The following table describes information with respect to the various series
of convertible preferred stock outstanding as of June 30, 1997:     
 
<TABLE>   
<CAPTION>
                                         SHARES                     AGGREGATE
                              SHARES   ISSUED AND  ISSUANCE PRICE  LIQUIDATION
                            AUTHORIZED OUTSTANDING   PER SHARE      PREFERENCE
                            ---------- ----------- -------------- --------------
                                                                  (IN THOUSANDS)
   <S>                      <C>        <C>         <C>            <C>
   Series A................  1,029,222  1,029,222      $ 1.05        $ 1,050
   Series B................  1,089,083  1,055,748      $ 3.88          4,100
   Series C................  3,700,000  3,184,402      $ 3.88         18,550
   Series D................  2,515,028    484,697      $ 7.22          3,500
   Series E................  1,333,333  1,333,325      $ 7.50         10,000
   Series F................  1,333,333  1,333,326      $10.50         14,000
   Undesignated............    333,334         --          --             --
                            ----------  ---------                    -------
   Total................... 11,333,333  8,420,720                    $51,200
                            ==========  =========                    =======
</TABLE>    
   
  Series A, B, C, D, E and F convertible preferred shareholders are entitled
to noncumulative annual dividends, when and if declared by the board of
directors, of $0.0612, $0.2331, $0.2331, $0.2331, $0.2331 and $0.2331 per
share, respectively, payable in preference to common stock dividends. No
dividends have been declared or paid by the Company.     
   
  Series A, B, C, D, E and F convertible preferred shares have a liquidation
preference of $1.0203, $3.8835, $5.8254, $7.2210, $7.50 and $10.50 per share,
respectively, plus all declared but unpaid dividends. Upon liquidation, after
payment of the full liquidation preference has been made to the Series A, B,
C, D, E and F shareholders, the remaining assets of the Company, if any, shall
be distributed ratably among the common shareholders and Series C convertible
preferred shareholders.     
          
  Preferred stock is convertible at any time at the option of the shareholder.
Each share of Series A convertible preferred stock is convertible into 0.74161
shares of common stock plus any accumulated and unpaid dividends. Each share
of Series B, C, D, E and F convertible stock is convertible into one share of
common stock plus any accumulated and unpaid dividends. The conversion ratios
are subject to adjustment based upon certain events including the issuance of
additional shares of common stock. Each share of Series A, B, C, D, E and F
convertible preferred stock automatically converts into common stock at the
then effective conversion rate in the event of an underwritten public offering
of the Company's common stock at an offering price of not less than $7.50 per
share and with aggregate net proceeds to the Company, after deduction of
underwriting commissions and expenses, of at least $7,500,000. Each share of
convertible preferred stock votes equally with shares of common stock on an
"if-converted" basis.     
   
  In December 1996, in connection with the Series E preferred stock financing,
the board of directors approved the issuance of 66,666 shares of common stock
as commissions to certain financial advisors. The common stock was issued in
February 1997. Also, in connection with the Series F preferred stock
financing, the Company issued 52,380 shares of common stock as commissions to
certain financial advisors.     
 
 
                                     F-13
<PAGE>
 
                                MEGABIOS CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
       
       
  Warrants
   
  In connection with the equipment financing agreement entered into in
December 1993, the Company issued a warrant to purchase 21,630 shares of
Series B convertible preferred stock at an exercise price of $3.88 per share.
The warrant expires on the earliest of May 13, 2000, or the day prior to the
effectiveness of a registration statement covering an underwritten offering of
the Company's securities with aggregate proceeds of $7,500,000, or a merger or
sale of substantially all of the Company's assets. The warrant is exercisable
immediately.     
   
  The Company issued a warrant to purchase 28,969 shares of Series C
convertible stock at $3.88 per share to the commercial bank providing the line
of credit to the Company. In accordance with the terms of the warrant, the
number of shares subject to the warrant was reduced from 28,969 to 24,140 in
July 1995. The warrant provided for a reduction in the number of shares upon
securing a commitment of at least $7,000,000 in sales of Series C preferred
stock. The warrant is exercisable immediately and expires at the earlier of
June 1, 2000, or in the event of a merger or sale of substantially all of the
assets of the Company.     
   
  In connection with the equipment financing agreement in May 1996, the
Company issued a warrant to purchase 38,238 shares of Series C convertible
preferred stock at $3.88 per share. The warrant is exercisable immediately and
expires at the earlier of ten years from the date of issuance or five years
after an initial public offering of the Company's common stock.     
 
  Stock Option Plan
   
  On October 14, 1993, the board of directors approved a stock option plan
(the "Plan"). As of June 30, 1997, the Company had reserved 1,440,000 shares
of common stock for issuance under the plan. Under the plan, incentive stock
options may be granted to employees, and nonstatutory stock options may be
granted to employees, directors, and consultants. Options are granted at an
exercise price of not less than the fair value per share of the common stock
on the date of grant and expire no later than ten years from the date of
grant. The options may be exercised immediately upon grant, however, the
shares issuable upon exercise of the options are subject to repurchase by the
Company. Options under the Plan generally vest 25% one year after the date of
grant and on a pro rata basis over the following 36 months. An aggregate of
344,654 shares are subject to repurchase at an aggregate repurchase price of
$120,000 as of June 30, 1997. Such repurchase rights will lapse at a minimum
rate of 20% per annum and over a period of time not to exceed five years from
the date the option was granted.     
   
  In October 1994, the Company offered all option holders with per share
exercise prices above $0.30, the fair value on the date of the offer, the
opportunity to reprice their options to the fair value as determined by the
board of directors on the date of the offer. The new unvested options have a
vesting period three months longer than the original vesting terms under the
previous option. In response to the offer, options on 143,546 shares were
returned by employees and canceled, and a similar number of new options were
regranted with an exercise price of $0.30 per share.     
   
  The Company has elected to follow APB 25 and related interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under SFAS 123 requires use of
valuation models that were not developed for use in valuing employee stock
options. Under APB 25, because the exercise price of the Company's stock
options equal the price set by the Company's Board of Directors for the
underlying stock as of the grant date, no compensation expense is recognized.
       
  The fair value option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly speculative assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.     
 
                                     F-14
<PAGE>
 
                                MEGABIOS CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
          
  Pro forma information regarding net earnings and earnings per share is
required by SFAS 123 which also requires that the information be determined as
if the Company had accounted for its employee stock options granted subsequent
to December 31, 1994 under the fair value method of that statement. The fair
value of these options was estimated at the date of grant using a minimum
value option pricing model, with the following assumptions: risk-free interest
rates from 4.8% to 6.4% and from 5.7% to 6.5% for grants in fiscal 1996 and
1997, respectively; a weighted-average expected life of the option from grant
date of 2.5 years; and a dividend yield of zero. The effect of applying the
minimum value model to the stock option activity did not result in pro forma
net loss and loss per share that are materially different from historical
amounts reported. Therefore, such pro forma information is not separately
presented herein. Future pro forma net income or loss and earnings or loss per
share may be materially different from actual amounts reported. The Company
will not use the minimum value option pricing model once the Company becomes a
publicly traded company.     
 
  Activity under the plan was as follows:
 
<TABLE>   
<CAPTION>
                                       OUTSTANDING STOCK OPTIONS
                             SHARES    ----------------------------   WEIGHTED-
                            AVAILABLE   NUMBER OF        PRICE         AVERAGE
                            FOR GRANT    SHARES        PER SHARE    EXERCISE PRICE
                            ---------  ------------  -------------- --------------
   <S>                      <C>        <C>           <C>            <C>
   Balance at June 30,
    1994...................  221,340       111,994       $1.11          $1.11
     Additional
      authorization........  433,333            --         --             --
     Options granted....... (666,870)      666,870    $0.30-$1.11       $0.34
     Options exercised.....       --       (68,164)      $0.30          $0.30
     Options canceled......  153,879      (153,879)   $0.30-$1.11       $1.07
                            --------   -----------   --------------     -----
   Balance at June 30,
    1995...................  141,682       556,821       $0.30          $0.30
     Additional
      authorization........  320,000            --         --             --
     Options granted....... (387,329)      387,329       $0.30          $0.30
     Options exercised.....       --      (693,543)      $0.30          $0.30
     Options canceled......   16,582       (16,582)      $0.30          $0.30
     Options underlying
      shares repurchased...    7,500            --       $0.30          $0.30
                            --------   -----------   --------------     -----
   Balance at June 30,
    1996...................   98,435       234,025       $0.30          $0.30
     Additional
      authorization........  353,333            --         --             --
     Options granted....... (388,680)      388,680       $1.50          $1.50
     Options exercised.....       --      (116,517)   $0.30-$1.50       $0.45
     Options canceled......   26,566       (26,566)   $0.30-$1.50       $0.51
     Options underlying
      shares repurchased...   32,045            --    $0.30-$1.50       $0.39
                            --------   -----------   --------------     -----
   Balance at June 30,
    1997...................  121,699       479,622    $0.30-$1.50       $1.22
                            ========   ===========   ==============     =====
</TABLE>    
   
  The options outstanding and exercisable at June 30, 1997 have been
segregated into ranges for additional disclosure as follows:     
 
<TABLE>   
<CAPTION>
                                OPTIONS
                              OUTSTANDING               WEIGHTED             WEIGHTED
            EXERCISE        AND EXERCISABLE             AVERAGE              AVERAGE
              PRICE               AT                   REMAINING             EXERCISE
            PER SHARE        JUNE 30, 1997          CONTRACTUAL LIFE          PRICE
            ---------       ---------------         ----------------         --------
                                                       (IN YEARS)
            <S>             <C>                     <C>                      <C>
              $0.30             110,421                   8.26                $0.30
              $1.50             369,201                   9.65                $1.50
                                -------                                       -----
                                479,622                   9.33                $1.22
                                =======                                       =====
</TABLE>    
 
                                     F-15
<PAGE>
 
                                MEGABIOS CORP.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
          
  The weighted average fair value of options granted in fiscal 1996 and 1997
was $0.037 and $0.199 respectively. There were 61,025 shares vested and
unexercised at June 30, 1997 at a weighted average exercise price of $0.42.
    
  In December 1996, the Company increased the shares reserved for issuance
under the stock option plan to 1,440,000 shares.
   
  Through the year ended June 30, 1997, options to purchase 382,700 shares of
common stock were granted at $1.50 per share. Deferred compensation of
$750,000 was recorded on these options based on the deemed fair value of the
common stock at the dates of grant at prices ranging from $1.50 to $3.75 per
share, respectively. The Company recognized expense of $71,000 in the period
ended June 30, 1997 related to these options. In July and August 1997, the
Company granted options to purchase a total of 59,949 shares at exercise
prices ranging from $2.70 to $2.88 per share. Additional deferred compensation
of approximately $390,000 is expected to be recorded based on the deemed fair
values of common stock ranging from $9.00 to $9.60 per share. The deferred
compensation is being amortized to expense over the vesting period of the
options, generally four years.     
 
  Common Stock Reserved for Future Issuance
   
  At June 30, 1997, the Company had reserved shares of common stock for future
issuance as follows:     
 
<TABLE>   
   <S>                                                                 <C>
   Conversion of convertible preferred stock.........................  8,154,779
   1993 Stock Option Plan............................................    601,321
   Exercise of Series B convertible preferred stock purchase warrants
    convertible into common shares...................................     21,630
   Exercise of Series C convertible preferred stock purchase warrants
    convertible into common shares...................................     62,378
                                                                       ---------
                                                                       8,840,108
                                                                       =========
</TABLE>    
 
10. INCOME TAXES
   
  As of June 30, 1997, the Company had federal net operating loss
carryforwards and federal research credit carryforwards of approximately
$15,637,000 and $379,000, respectively. The net operating loss and credit
carryforwards will expire at various dates beginning in 2007 through 2012, if
not utilized.     
 
  Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the "change in ownership" provisions of
the Internal Revenue Code of 1986. The annual limitation may result in the
expiration of net operating losses and credits before utilization.
 
  Significant components of the Company's deferred tax assets and liabilities
for federal income taxes as of June 30 are as follows (in thousands):
 
<TABLE>   
<CAPTION>
                                                                1996     1997
                                                               -------  -------
   <S>                                                         <C>      <C>
   Net operating loss carryforwards........................... $ 4,101  $ 5,425
   Research and development credits...........................     429      625
   Capitalized research and development.......................     775      724
   Depreciation...............................................     460      840
   Other, net.................................................     311      467
                                                               -------  -------
   Net deferred tax assets....................................   6,076    8,081
   Valuation allowance........................................  (6,076)  (8,081)
                                                               -------  -------
                                                               $    --  $    --
                                                               =======  =======
</TABLE>    
   
  The net valuation allowance increased by $2,077,000 and $2,769,000 during
the years ended June 30, 1995 and 1996, respectively.     
 
                                     F-16
<PAGE>
 
                                 MEGABIOS CORP.
 
                   NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
       
11. SUBSEQUENT EVENTS
       
          
  In July 1997, the board of directors authorized management of the Company to
file a registration statement with the SEC permitting the Company to sell up to
2,875,000 shares of Common Stock to the public (the "Offering"). In connection
with the Offering, the board of directors approved, subject to shareholder
approval, a one-for-three reverse stock split covering each class and series of
the Company's capital stock, options and warrants outstanding. All share and
per share amounts, as well as the dividend and liquidation preferences for
Series A, B, C, D, E and F convertible preferred stock, included in the
accompanying financial statements have been retroactively adjusted to reflect
the reverse stock split. If the Offering is completed under the terms currently
contemplated, 8,420,760 shares of outstanding Series A, B, C, D, E and F
convertible preferred stock will convert into 8,154,781 shares of common stock.
In conjunction with the Offering, the board of directors authorized, subject to
shareholder approval, the reincorporation of the Company into Delaware. In
connection with the reincorporation the Company will adopt an Amended and
Restated Certificate of Incorporation which provides that the Company will be
authorized to issue 10,000,000 shares of $0.001 par value preferred stock and
30,000,000 shares of $0.001 par value common stock.     
       
  In July 1997, the board of directors also adopted, subject to shareholder
approval, the Company's 1997 Equity Incentive Plan (the "Incentive Plan") as an
amendment and restatement of the Company's 1993 stock option plan. There are
currently 2,100,000 shares of common stock authorized for issuance under the
Incentive Plan. Also in July 1997, the board of directors adopted, subject to
shareholder approval, the Company's Employee Stock Purchase Plan (the "Purchase
Plan") covering an aggregate of 200,000 shares of common stock. Under the
Purchase Plan, the board of directors may authorize participation by eligible
employees, including officers, in periodic offerings following the adoption of
the Purchase Plan.
   
  Unaudited pro forma shareholders' equity, as adjusted for the assumed
conversion of the Series A, B, C, D, E and F convertible preferred stock, is
set forth on the accompanying balance sheet.     
 
                                      F-17
<PAGE>
 
================================================================================
 
  No dealer, sales representative or any other person has been authorized to
give any information or to make any representations in connection with this
offering other than those contained in this Prospectus and, if given or made,
such information or representations must not be relied upon as having been
authorized by the Company or any of the Underwriters. This Prospectus does not
constitute an offer to sell or a solicitation of an offer to buy any
securities other than the shares of Common Stock to which it relates, or an
offer to, or a solicitation of, any person in any jurisdiction where such an
offer or solicitation would be unlawful. Neither the delivery of this
Prospectus nor any sale made hereunder shall, under any circumstances, create
an implication that there has been no change in the affairs of the Company
since the date hereof or that the information contained herein is correct as
of any time subsequent to the date hereof.
 
                             --------------------
 
                               TABLE OF CONTENTS
 
                             --------------------
 
<TABLE>   
<CAPTION>
                                                                            Page
                                                                            ----
<S>                                                                         <C>
Prospectus Summary........................................................    3
Risk Factors..............................................................    6
Special Note Regarding Forward-Looking Statements.........................   15
Use of Proceeds...........................................................   16
Dividend Policy...........................................................   16
Capitalization............................................................   17
Dilution..................................................................   18
Selected Financial Data...................................................   19
Management's Discussion and Analysis of Financial Condition and Results of
 Operations...............................................................   20
Business..................................................................   23
Management................................................................   40
Certain Transactions......................................................   49
Principal Stockholders....................................................   50
Description of Capital Stock..............................................   52
Shares Eligible for Future Sale...........................................   54
Underwriting..............................................................   56
Legal Matters.............................................................   58
Experts...................................................................   58
Additional Information....................................................   58
Index to Financial Statements.............................................  F-1
</TABLE>    
 
                             --------------------
 
  Until      , 1997 (25 days after the date of this Prospectus), all dealers
effecting transactions in the Common Stock, whether or not participating in
this distribution, may be required to deliver a Prospectus. This is in
addition to the obligation of dealers to deliver a Prospectus when acting as
underwriters and with respect to their unsold allotments or subscriptions.
 
================================================================================
 
                               2,500,000 SHARES
                                      

                             [LOGO OF MEGABIOS]    
 
                                 COMMON STOCK
 
                               -----------------
 
                                  PROSPECTUS
 
                               -----------------
 
                             MONTGOMERY SECURITIES
 
                               HAMBRECHT & QUIST
 
                                       , 1997
 
================================================================================
<PAGE>
 
                                    PART II
 
                    INFORMATION NOT REQUIRED IN PROSPECTUS
 
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
 
  The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the registrant in
connection with the distribution of the Common Stock being registered. All
amounts are estimated, except the SEC Registration Fee, the NASD Filing Fee
and the Nasdaq National Market Filing Fee:
 
<TABLE>
   <S>                                                                 <C>
   SEC Registration Fee...............................................   11,325
   NASD Filing Fee....................................................    4,240
   Nasdaq National Market Filing Fee..................................   48,065
   Blue Sky Fees and Expenses.........................................    5,000
   Accounting Fees....................................................  125,000
   Legal Fees and Expenses............................................  250,000
   Transfer Agent and Registrar Fees..................................   15,000
   Printing and Engraving.............................................  125,000
   Miscellaneous......................................................   16,370
                                                                       --------
     Total............................................................ $600,000
                                                                       ========
</TABLE>
 
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
 
  The Registrant's Certificate of Incorporation provides that directors of the
Registrant shall not be personally liable to the Registrant or its
stockholders for monetary damages for breach of fiduciary duty as a director,
to the fullest extent permitted by the General Corporation Law of the State of
Delaware. The Registrant's Bylaws provide for indemnification of officers and
directors to the full extent and in the manner permitted by Delaware law.
Section 145 of the Delaware General Corporation Law makes provision for such
indemnification in terms sufficiently broad to cover officers and directors
under certain circumstances for liabilities arising under the Securities Act
of 1933, as amended (the "Securities Act").
 
  The Registrant intends to enter into indemnification agreements with each
director and certain officers which provide indemnification under certain
circumstances for acts and omissions which may not be covered by any
directors' and officers' liability insurance.
 
  The form of Underwriting Agreement, filed as Exhibit 1.1 to the Registration
Statement, provides for indemnification of the Registrant and its controlling
persons against certain liabilities under the Securities Act.
 
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
 
  Since April 1, 1994, the Company has sold and issued the following
unregistered securities (share and dollar amounts do not reflect the 1 for 3
reverse stock split assumed elsewhere in this registration statement).
 
  (1) Since inception to June 30, 1997, the Registrant has granted stock
incentive stock options and nonstatutory stock options to employees, directors
and consultants under its 1993 Stock Option Plan covering an aggregate of
4,664,795 shares of the Registrant's Common Stock, at an average exercise
price of $0.225 per share. Options to purchase 591,127 shares of Common Stock
have been canceled or have lapsed without being exercised, and 118,643 shares
of Common Stock have been repurchased by the Registrant.
 
  (2) In May 1994, the Registrant issued a warrant exercisable for 64,890
shares of Series B Preferred Stock, convertible into 64,890 shares of Common
Stock, at an exercise price of $1.2945 per share to an accredited investor.
 
                                     II-1
<PAGE>
 
  (3) Between September 1994 and October 1995, the Registrant issued and sold
9,553,274 shares of Series C Preferred Stock, convertible into 9,553,274
shares of Common Stock, to a total of 37 accredited investors, including one
officer, for cash in the aggregate amount of $12,366,711.
 
  (4) In June 1995, the Registrant issued a warrant exercisable for 115,875
shares, which number was subsequently adjusted to 72,422 shares by agreement
of the parties, of Series C Preferred Stock, convertible into 72,422 shares of
Common Stock, at an exercise price of $1.2945 per share to an accredited
investor.
 
  (5) In April 1996, the Registrant issued a warrant exercisable for 114,716
shares of Series C Preferred Stock, convertible into 114,716 shares of Common
Stock, at an exercise price of $1.2945 per share to an accredited investor.
 
  (6) In May 1996, the Registrant issued and sold 1,454,092 shares of Series D
Preferred Stock, convertible into 1,454,092 shares of Common Stock, to an
accredited investor for cash in the amount of $3,500,000.
 
  (7) In October 1996, the Registrant issued and sold 4,000,000 shares of
Series E Preferred Stock, convertible into 4,000,000 shares of Common Stock to
24 investors for cash in the aggregate amount of $10,000,000. In connection
with the private placement, the Registrant issued 200,000 shares of Common
Stock to the placement agents equal in value to the aggregate amount of
$100,000.
   
  (8) In May and June 1997, the Registrant issued and sold 3,999,998 shares of
Series F Preferred Stock, convertible into 3,999,998 shares of Common Stock to
17 investors, for cash in the aggregate amount $14,000,000. In connection with
the private placement, the Registrant issued 157,142 shares of Common Stock to
the placement agents equal in value to the aggregate amount of $78,571.     
 
  The sales and issuances of securities in the transactions described in
paragraph (1) above were deemed to be exempt from registration under the
Securities Act by virtue of Rule 701 promulgated thereunder in that they were
offered and sold either pursuant to a written compensatory benefit plan or
pursuant to a written contract relating to compensation, as provided by Rule
701.
 
  The sales and issuances of securities in the transactions described in
paragraphs (2) through (8) above were deemed to be exempt from registration
under the Securities Act by virtue of Section 4(2), Regulation D or Regulation
S promulgated thereunder. The purchasers in each case represented their
intention to acquire the securities for investment only and not with a view to
the distribution thereof. Appropriate legends are affixed to the stock
certificates issued in such transactions. Similar legends were imposed in
connection with any subsequent sales of any such securities. All recipients
received either received adequate information about the Registrant or had
access, through employment or other relationships, to such information.
 
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
  (A) EXHIBITS.
 
<TABLE>   
   <C>   <S>
    1.1  Underwriting Agreement
    3.1  Fifth Amended and Restated Articles of Incorporation of the Registrant
         as filed May 14, 1997(1)
    3.2  Certificate of Correction of Fifth Amended and Restated Articles of
         Incorporation as filed July 25, 1997(1)
    3.3  Bylaws of the Registrant(1)
    3.4  Certificate of Incorporation to be effective upon closing of the
         offering
    3.5  Bylaws of the Registrant to be effective upon the closing of the
         offering
    4.1+ Specimen Common Stock Certificate
    5.1  Opinion of Cooley Godward llp as to legality of the Common Stock(1)
</TABLE>    
 
 
                                     II-2
<PAGE>
 
<TABLE>   
   <C>    <S>
   10.1   1997 Equity Incentive Plan
   10.2   Form of Incentive Stock Option Grant
   10.3   Form of Non-Incentive Stock Option Grant
   10.4   1997 Employee Stock Purchase Plan
   10.5   1997 Employee Stock Purchase Offering
   10.6   Form of Indemnification Agreement between the Registrant and its
          directors and executive officers
   10.7   Amended and Restated Investor Rights Agreement, dated as of May 23,
          1997 among the Registrant and the investors named therein(1)
   10.8   Letter Agreement between the Registrant and Benjamin F. McGraw, III,
          Pharm.D.(1)
   10.9   Letter Agreement between the Registrant and Patrick G. Enright(1)
   10.10  Letter Agreement between the Registrant and Rodney Pearlman, Ph.D.(1)
   10.11  Lease Agreement between the Registrant and Provident Life and
          Accident Insurance Company ("Provident"), dated December 21, 1993(1)
   10.12  First Amendment to Lease Agreement between the Registrant and SFO
          Associates LLC (successor in interest to Provident)(1)
   10.13  Lease Agreement between the Registrant and SFO Associates LLC, dated
          March 18, 1997(1)
   10.14  Credit Agreement between the Registrant and Imperial Bank, dated as
          of August 31, 1995(1)
   10.15  Lease Agreement between the Registrant and LMSI, dated May 13, 1994,
          as amended as of May 13, 1994(1)
   10.16  Senior Loan and Security Agreement No. L0016 between the Registrant
          and Phoenix Leasing Incorporated, dated as of April 22, 1996(1)
   10.17* Research and License Agreement between the Registrant and Glaxo
          Wellcome Group Limited, dated April 11, 1994, as amended as of May
          31, 1996(1)
   10.18* Collaborative Research Agreement between the Registrant and Pfizer
          Inc, dated May 31, 1996(1)
   10.19* License and Royalty Agreement between Registrant and Pfizer Inc,
          dated June 1, 1996(1)
   10.20  Stock Purchase Agreement between Registrant and Pfizer Inc, dated May
          30, 1996(1)
   10.21* Exclusive License Agreement between the Registrant and the Regents of
          the University of California, dated May 9, 1996 as amended May 15,
          1997(1)
   10.22* Research and License Agreement between the Registrant and Eli Lilly
          and Company, effective May 23, 1997(1)
   10.23  Preferred Stock Warrant issued to Lease Management Services, Inc.,
          dated May 13, 1994(1)
   10.24  Preferred Stock Warrant issued to Imperial Bank, dated June 1,
          1995(1)
   10.25  Series C Preferred Stock Warrant issued to Phoenix Leasing
          Incorporated, dated April 30, 1996(1)
   11.1   Statement re computation of net loss per share(1)
   23.1   Consent of Ernst & Young LLP, Independent Auditors (see page II-6)
   23.2   Consent of Cooley Godward LLP (included in Exhibit 5.1)(1)
   23.3   Consent of McDonnell, Boehnen, Hulbert, Berghoff, Ltd.
   24.1   Power of Attorney (see page II-5)(1)
   27.1   Financial Data Schedule
</TABLE>    
- --------
+To be filed by amendment.
*Confidential treatment being sought for portions of this document.
   
(1) Previously filed with the Registrant's Form S-1 Registration Statement on
    July 31, 1997.     
 
  (B) FINANCIAL STATEMENT SCHEDULES
 
  Schedules are omitted because they are not applicable, or because the
information is included in the Financial Statements or the Notes thereto.
       
                                     II-3
<PAGE>
 
ITEM 17. UNDERTAKINGS.
 
  A. The Registrant hereby undertakes to provide to the underwriters at the
closing specified in the underwriting agreement certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
 
  B. Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers, and controlling persons of the
Registrant pursuant to the provisions described in Item 14 above, or
otherwise, the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other
than the payment by the Registrant of expenses incurred or paid by a director,
officer or controlling person of the Registrant in the successful defense of
any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate
jurisdiction the question of whether such indemnification by it is against
public policy as expressed in the Securities Act and will be governed by the
final adjudication of such issue.
 
  C. The Registrant hereby undertakes that:
 
    (1) For purposes of determining any liability under the Securities Act,
  the information omitted from the form of prospectus filed as part of this
  registration statement in reliance upon Rule 430A and contained in a form
  of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
  497(h) under the Securities Act shall be deemed to be part of this
  registration statement as of the time it was declared effective.
 
    (2) For purposes of determining any liability under the Securities Act,
  each post-effective amendment that contains a form of prospectus shall be
  deemed to be a new registration statement relating to the securities
  offered therein, and the offering of such securities at that time shall be
  deemed to be the initial bona fide offering thereof.
 
                                     II-4
<PAGE>
 
                                  SIGNATURES
   
  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, MEGABIOS CORP.
HAS DULY CAUSED THIS AMENDMENT NUMBER 1 TO REGISTRATION STATEMENT TO BE SIGNED
ON ITS BEHALF, BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF
BURLINGAME, COUNTY OF SAN MATEO, STATE OF CALIFORNIA, ON AUGUST 15, 1997.     
                                             
                                          Megabios Corp.     
                                                
                                             /s/ Benjamin F. McGraw, III     
                                          By: _________________________________
                                             BENJAMIN F. MCGRAW III, PHARM.D.
                                             CHAIRMAN, CHIEF EXECUTIVE OFFICER
                                                       AND PRESIDENT
                                                   
          
  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT
NUMBER 1 TO REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN
THE CAPACITIES AND ON THE DATES INDICATED.     

   
<TABLE> 
<CAPTION> 
 
              SIGNATURE                        TITLE                 DATE

<S>                                    <C>                     <C>  
                                       Chairman, Chief         
  /s/ Benjamin F. McGraw, III           Executive Officer      August 15, 1997
- -------------------------------------   and President          
  BENJAMIN F. MCGRAW III, PHARM.D.      (Principal
                                        Executive Officer)
 
       /s/ Patrick G. Enright          Chief Financial         
- -------------------------------------   Officer and Vice       August 15, 1997
         PATRICK G. ENRIGHT             President              
                                        (Principal
                                        Financial and
                                        Accounting Officer)
 
                                       Director                
               *                                               August 15, 1997
- -------------------------------------                          
          FRANK J. CAUFIELD
 
                                       Director                
               *                                               August 15, 1997
- -------------------------------------                          
         EDWARD L. ERICKSON
 
                                       Director                
               *                                               August 15, 1997
- -------------------------------------                          
          A. GRANT HEIDRICH
 
                                       Director                
               *                                               August 15, 1997
- -------------------------------------                          
   RUSSELL C. HIRSCH, M.D., PH.D.
 
                                       Director                
               *                                               August 15, 1997
- -------------------------------------                          
      RAJU KUCHERLAPATI, PH.D.

   /s/ Benjamin F. McGraw, III 

*By: ___________________________ 

   BENJAMIN F. MCGRAW III, PHARM.D.

         ATTORNEY-IN-FACT 

      /s/ Patrick G. Enright 

*By: ___________________________ 

        PATRICK G. ENRIGHT 

         ATTORNEY-IN-FACT 

</TABLE>     
 
                                     II-5
<PAGE>
 
              CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
   
We consent to the references to our firm under the captions "Selected
Financial Data" and "Experts" and to the use of our report dated August 4,
1997, for Note 11, as to which the date is   , 1997, in Amendment No. 1 to the
Registration Statement (Form S-1, No. 333-32593) and related Prospectus of
Megabios Corporation for the registration of 2,875,000 shares of its common
stock.     
 
                                          ERNST & YOUNG LLP
 
Palo Alto, California
 
- -------------------------------------------------------------------------------
 
The foregoing consent is in the form that will be signed upon the completion
of the one-for-three reverse stock split described in Note 11 to the financial
statements.
 
                                          /s/ Ernst & Young LLP
 
Palo Alto, California
   
August 15, 1997     
 
                                     II-6
<PAGE>
 
                                 EXHIBIT INDEX
 
<TABLE>   
<CAPTION>
                                                                     SEQUENTIAL
 EXHIBIT                                                                PAGE
 NUMBER                     DOCUMENT DESCRIPTION                       NUMBER
 -------                    --------------------                     ----------
 <C>     <S>                                                         <C>
  1.1    Underwriting Agreement
  3.1    Fifth Amended and Restated Articles of Incorporation of
         the Registrant as filed May 14, 1997(1)
  3.2    Certificate of Correction of Fifth Amended and Restated
         Articles of Incorporation as filed July 25, 1997(1)
  3.3    Bylaws of the Registrant(1)
  3.4    Certificate of Incorporation to be effective upon closing
         of the offering
  3.5    Bylaws of the Registrant to be effective upon the closing
         of the offering
  4.1+   Specimen Common Stock Certificate
  5.1    Opinion of Cooley Godward llp as to legality of the
         Common Stock(1)
 10.1    1997 Equity Incentive Plan
 10.2    Form of Incentive Stock Option Grant
 10.3    Form of Non-Incentive Stock Option Grant
 10.4    1997 Employee Stock Purchase Plan
 10.5    1997 Employee Stock Purchase Offering
 10.6    Form of Indemnification Agreement between the Registrant
         and its directors and executive officers
 10.7    Amended and Restated Investor Rights Agreement, dated as
         of May 23, 1997 among the Registrant and the investors
         named therein(1)
 10.8    Letter Agreement between the Registrant and Benjamin F.
         McGraw, III, Pharm.D.(1)
 10.9    Letter Agreement between the Registrant and Patrick G.
         Enright(1)
 10.10   Letter Agreement between the Registrant and Rodney
         Pearlman, Ph.D.(1)
 10.11   Lease Agreement between the Registrant and Provident Life
         and Accident Insurance Company ("Provident"), dated
         December 21, 1993(1)
 10.12   First Amendment to Lease Agreement between the Registrant
         and SFO Associates LLC (successor in interest to
         Provident)(1)
 10.13   Lease Agreement between the Registrant and SFO Associates
         LLC, dated March 18, 1997(1)
 10.14   Credit Agreement between the Registrant and Imperial
         Bank, dated as of August 31, 1995(1)
 10.15   Lease Agreement between the Registrant and LMSI, dated
         May 13, 1994, as amended as of May 13, 1994(1)
 10.16   Senior Loan and Security Agreement No. L0016 between the
         Registrant and Phoenix Leasing Incorporated, dated as of
         April 22, 1996(1)
 10.17*  Research and License Agreement between the Registrant and
         Glaxo Wellcome Group Limited, dated April 11, 1994, as
         amended as of May 31, 1996(1)
 10.18*  Collaborative Research Agreement between the Registrant
         and Pfizer Inc, dated May 31, 1996(1)
 10.19*  License and Royalty Agreement between Registrant and
         Pfizer Inc, dated June 1, 1996(1)
</TABLE>    
 
<PAGE>
 
<TABLE>   
<CAPTION>
                                                                      SEQUENTIAL
 EXHIBIT                                                                 PAGE
 NUMBER                     DOCUMENT DESCRIPTION                        NUMBER
 -------                    --------------------                      ----------
 <C>     <S>                                                          <C>
 10.20   Stock Purchase Agreement between Registrant and Pfizer
         Inc, dated May 30, 1996(1)
 10.21*  Exclusive License Agreement between the Registrant and
         the Regents of the University of California, dated May 9,
         1996 as amended May 15, 1997(1)
 10.22*  Research and License Agreement between the Registrant and
         Eli Lilly and Company, effective May 23, 1997(1)
 10.23   Preferred Stock Warrant issued to Lease Management
         Services, Inc., dated May 13, 1994(1)
 10.24   Preferred Stock Warrant issued to Imperial Bank, dated
         June 1, 1995(1)
 10.25   Series C Preferred Stock Warrant issued to Phoenix
         Leasing Incorporated, dated April 30, 1996(1)
 11.1    Statement re computation of net loss per share(1)
 23.1    Consent of Ernst & Young LLP, Independent Auditors (see
         page II-6)
 23.2    Consent of Cooley Godward LLP (included in Exhibit 5.1)(1)
 23.3    Consent of McDonnell, Boehnen, Hulbert, Berghoff, Ltd.
 24.1    Power of Attorney (see page II-5)(1)
 27.1    Financial Data Schedule
</TABLE>    
- --------
+To be filed by amendment.
*Confidential treatment being sought for portions of this document.
   
(1) Previously filed with the Registrant's Form S-1 Registration Statement on
    July 31, 1997.     

<PAGE>
 
                                                                     EXHIBIT 1.1


                                2,500,000 SHARES



                                 MEGABIOS CORP.



                                  COMMON STOCK



                             UNDERWRITING AGREEMENT

                           DATED SEPTEMBER ___, 1997
<PAGE>
 
                               TABLE OF CONTENTS
<TABLE>
 
<S>                                                                                                      <C>
SECTION 1.  REPRESENTATIONS AND WARRANTIES OF THE COMPANY..........................................        2
     Compliance with Registration Requirements.....................................................        2
     Offering Materials Furnished to Underwriters..................................................        2
     Distribution of Offering Material By the Company..............................................        3
     The Underwriting Agreement....................................................................        3
     Authorization of the Common Shares............................................................        3
     No Applicable Registration or Other Similar Rights............................................        3
     No Material Adverse Change....................................................................        3
     Independent Accountants.......................................................................        3
     Preparation of the Financial Statements.......................................................        4
     Incorporation and Good Standing of the Company................................................        4
     Capitalization and Other Capital Stock Matters................................................        4
     Stock Exchange Listing........................................................................        5
     Non-Contravention of Existing Instruments; No Further Authorizations or Approvals Required....        5
     No Material Actions or Proceedings............................................................        5
     Intellectual Property Rights..................................................................        6
     All Necessary Permits, etc....................................................................        6
     Title to Properties...........................................................................        6
     Tax Law Compliance............................................................................        6
     Company Not an Investment Company..................................ERROR! Bookmark not defined
     Insurance.....................................................................................        7
     No Price Stabilization or Manipulation........................................................        7
     Related Party Transactions....................................................................        7
     Reincorporation...............................................................................        7
     No Unlawful Contributions or Other Payments...................................................        8
     Company's Accounting System...................................................................        8
     Compliance with Environmental Laws............................................................        8
     Periodic Review of Costs of Environmental Compliance..........................................        9
     ERISA Compliance..............................................................................        9
SECTION 2.  PURCHASE, SALE AND DELIVERY OF COMMON SHARES...........................................        9
     The Firm Common Shares........................................................................        9
     The First Closing Date........................................................................       10
     The Optional Common Shares; the Second Closing Date...........................................       10
     Public Offering of the Common Shares..........................................................       11
     Payment for the Common Shares.................................................................       11
     Delivery of the Common Shares.................................................................       11
     Delivery of Prospectus to the Underwriters....................................................       11
SECTION 3.  ADDITIONAL COVENANTS OF THE COMPANY....................................................       11
     Representatives' Review of Proposed Amendments and Supplements................................       11
</TABLE> 
                                       i
<PAGE>
 
<TABLE> 
<S>                                                                                                       <C> 
     Securities Act Compliance.....................................................................       12
     Amendments and Supplements to the Prospectus and Other Securities
       Act Matters.................................................................................       12
     Copies of any Amendments and Supplements to the Prospectus....................................       12
     Blue Sky Compliance...........................................................................       12
     Use of Proceeds...............................................................................       13
     Transfer Agent................................................................................       13
     Earnings Statement............................................................................       13
     Periodic Reporting Obligations................................................................       13
     Agreement Not To Offer or Sell Additional Securities..........................................       13
     Agreement Not To Release Lock-Ups.............................................................       14
     Future Reports to the Representatives.........................................................       14
SECTION 4.  PAYMENT OF EXPENSES....................................................................       14
SECTION 5.  CONDITIONS OF THE OBLIGATIONS OF THE UNDERWRITERS......................................       15
     Accountants' Comfort Letter...................................................................       15
     Compliance with Registration Requirements; No Stop Order; No Objection
       from NASD...................................................................................       15
     No Material Adverse Change or Ratings Agency Change...........................................       15
     Opinion of Counsel for the Company............................................................       16
     Opinion of Intellectual Property Counsel for the Company......................................       16
     Opinion of Counsel for the Underwriters.......................................................       16
     Officers' Certificate.........................................................................       16
     Bring-down Comfort Letter.....................................................................       16
     Lock-Up Agreement from Certain Stockholders of the Company....................................       17
     Additional Documents..........................................................................       17
SECTION 6.  REIMBURSEMENT OF UNDERWRITERS' EXPENSES................................................       17
SECTION 7.  EFFECTIVENESS OF THIS AGREEMENT........................................................       17
SECTION 8.  INDEMNIFICATION........................................................................       18
     Indemnification of the Underwriters...........................................................       18
     Indemnification of the Company, its Directors and Officers....................................       19
     Notifications and Other Indemnification Procedures............................................       19
     Settlements...................................................................................       20
SECTION 9.  CONTRIBUTION...........................................................................       21
SECTION 10.  DEFAULT OF ONE OR MORE OF THE SEVERAL UNDERWRITERS....................................       22
SECTION 11.  TERMINATION OF THIS AGREEMENT.........................................................       22
SECTION 12.  REPRESENTATIONS AND INDEMNITIES TO SURVIVE DELIVERY...................................       23
SECTION 13.  NOTICES...............................................................................       23
</TABLE> 

                                      ii
<PAGE>
 
<TABLE> 
<S>                                                                                                      <C> 
SECTION 14.  SUCCESSORS............................................................................       24
SECTION 15.  PARTIAL UNENFORCEABILITY..............................................................       24
SECTION 16.  GOVERNING LAW PROVISIONS..............................................................       24
SECTION 17.  GENERAL PROVISIONS....................................................................       25
</TABLE>

                                      iii
<PAGE>
 
                             UNDERWRITING AGREEMENT



                                                              September __, 1997


MONTGOMERY SECURITIES
HAMBRECHT & QUIST LLC
As Representatives of the several Underwriters
c/o MONTGOMERY SECURITIES
600 Montgomery Street
San Francisco, California  94111


Ladies and Gentlemen:

          INTRODUCTORY.  Megabios Corp., a Delaware corporation (the "Company"),
proposes to issue and sell to the several underwriters named in Schedule A (the
                                                                ----------     
"Underwriters") an aggregate of 2,500,000 shares (the "Firm Common Shares") of
its Common Stock, par value $0.001 per share (the "Common Stock").  In addition,
the Company has granted to the Underwriters an option to purchase up to an
additional 375,000 shares (the "Optional Common Shares") of Common Stock, as
provided in Section 2.  The Firm Common Shares and, if and to the extent such
option is exercised, the Optional Common Shares are collectively called the
"Common Shares."  Montgomery Securities and Hambrecht & Quist LLC have agreed to
act as representatives of the several Underwriters (in such capacity, the
"Representatives") in connection with the offering and sale of the Common
Shares.  The Company is successor by merger to Megabios Corp., a California
corporation (the "Predecessor"), as a result of a reincorporation transaction
that became effective on September [__,] 1997 (the "Reincorporation").

          The Company has prepared and filed with the Securities and Exchange
Commission (the "Commission") a registration statement on Form S-1 (File
No. 333-[___]), which contains a form of prospectus to be used in connection
with the public offering and sale of the Common Shares.  Such registration
statement, as amended, including the financial statements, exhibits and
schedules thereto, in the form in which it was declared effective by the
Commission under the Securities Act of 1933 and the rules and regulations
promulgated thereunder (collectively, the "Securities Act"), including any
information deemed to be a part thereof at the time of effectiveness pursuant to
Rule 430A or Rule 434 under the Securities Act, is called the "Registration
Statement."  Any registration statement filed by the Company pursuant to
Rule 462(b) under the Securities Act is called the "Rule 462(b) Registration
Statement," and from and after the date and time of filing of the Rule 462(b)
Registration Statement the term "Registration Statement" shall include the
Rule 462(b) Registration Statement.  Such prospectus, in the form first used by
the Underwriters to confirm sales of the Common Shares, is called the
"Prospectus"; provided, however, if the Company has, with the consent of
Montgomery Securities, elected to rely upon Rule 434 under the Securities Act,
the term "Prospectus" shall mean the Company's prospectus subject to completion
(each, 

                                       A
                                       
<PAGE>
 
a "preliminary prospectus") dated August [__], 1997 (such preliminary prospectus
is called the "Rule 434 preliminary prospectus"), together with the applicable
term sheet (the "Term Sheet") prepared and filed by the Company with the
Commission under Rules 434 and 424(b) under the Securities Act and all
references in this Agreement to the date of the Prospectus shall mean the date
of the Term Sheet. All references in this Agreement to the Registration
Statement, the Rule 462(b) Registration Statement, a preliminary prospectus, the
Prospectus or the Term Sheet, or any amendments or supplements to any of the
foregoing, shall include any copy thereof filed with the Commission pursuant to
its Electronic Data Gathering, Analysis and Retrieval System ("EDGAR").

          The Company hereby confirms its agreements with the Underwriters as
follows:

     SECTION 1.  REPRESENTATIONS AND WARRANTIES OF THE COMPANY.

     The Company hereby represents, warrants and covenants to each Underwriter
as follows:
 
     (a) Compliance with Registration Requirements. The Registration Statement
  and any Rule 462(b) Registration Statement have been declared effective by the
  Commission under the Securities Act. The Company has complied to the
  Commission's satisfaction with all requests of the Commission for additional
  or supplemental information. No stop order suspending the effectiveness of the
  Registration Statement or any Rule 462(b) Registration Statement is in effect
  and no proceedings for such purpose have been instituted or are pending or, to
  the best knowledge of the Company, are contemplated or threatened by the
  Commission.

     Each preliminary prospectus and the Prospectus when filed complied in all
  material respects with the Securities Act and, if filed by electronic
  transmission pursuant to EDGAR (except as may be permitted by Regulation S-T
  under the Securities Act), was identical to the copy thereof delivered to the
  Underwriters for use in connection with the offer and sale of the Common
  Shares.  Each of the Registration Statement, any Rule 462(b) Registration
  Statement and any post-effective amendment thereto, at the time it became
  effective and at all subsequent times, complied and will comply in all
  material respects with the Securities Act and did not and will not contain any
  untrue statement of a material fact or omit to state a material fact required
  to be stated therein or necessary to make the statements therein not
  misleading.  The Prospectus, as amended or supplemented, as of its date and at
  all subsequent times, did not and will not contain any untrue statement of a
  material fact or omit to state a material fact necessary in order to make the
  statements therein, in the light of the circumstances under which they were
  made, not misleading.  The representations and warranties set forth in the two
  immediately preceding sentences do not apply to statements in or omissions
  from the Registration Statement, any Rule 462(b) Registration Statement, or
  any post-effective amendment thereto, or the Prospectus, or any amendments or
  supplements thereto, made in reliance upon and in conformity with information
  relating to any Underwriter furnished to the Company in writing by the
  Representatives expressly for use therein.  There are no contracts or other
  documents required to be described in the Prospectus or to be filed as
  exhibits to the Registration Statement which have not been described or filed
  as required.

     (b) Offering Materials Furnished to Underwriters. The Company has delivered
  to the Representatives three complete manually signed copies of the
  Registration Statement and 

                                       2
<PAGE>
 
  of each consent and certificate of experts filed as a part thereof, and
  conformed copies of the Registration Statement (without exhibits) and
  preliminary prospectuses and the Prospectus, as amended or supplemented, in
  such quantities and at such places as the Representatives have reasonably
  requested for each of the Underwriters.

        (c) Distribution of Offering Material By the Company.  Neither the
  Company nor the Predecessor have distributed, nor will the Company distribute,
  prior to the later of the Second Closing Date (as defined below) and the
  completion of the Underwriters' distribution of the Common Shares, any
  offering material in connection with the offering and sale of the Common
  Shares other than a preliminary prospectus, the Prospectus or the Registration
  Statement.

        (d) The Underwriting Agreement.  This Agreement has been duly
  authorized, executed and delivered by, and is a valid and binding agreement
  of, the Company, enforceable in accordance with its terms, except as rights to
  indemnification hereunder may be limited by applicable law and except as the
  enforcement hereof may be limited by bankruptcy, insolvency, reorganization,
  moratorium or other similar laws relating to or affecting the rights and
  remedies of creditors or by general equitable principles.

        (e) Authorization of the Common Shares.  The Common Shares to be
  purchased by the Underwriters from the Company have been duly authorized for
  issuance and sale pursuant to this Agreement and, when issued and delivered by
  the Company pursuant to this Agreement, will be validly issued, fully paid and
  nonassessable.

        (f) No Applicable Registration or Other Similar Rights.  There are no
  persons with registration or other similar rights to have any equity or debt
  securities registered for sale under the Registration Statement or included in
  the offering contemplated by this Agreement, except for such rights as have
  been duly waived or have expired by reason of lapse of time.

        (g) No Material Adverse Change.  Except as otherwise disclosed in the
  Prospectus, subsequent to the respective dates as of which information is
  given in the Prospectus: (i) there has been no material adverse change, or any
  development that could reasonably be expected to result in a material adverse
  change, in the condition, financial or otherwise, or in the earnings,
  business, operations or prospects, whether or not arising from transactions in
  the ordinary course of business, of the Company (any such change is called a
  "Material Adverse Change"); (ii) neither the Company nor the Predecessor has
  incurred any material liability or obligation, indirect, direct or contingent,
  not in the ordinary course of business nor entered into any material
  transaction or agreement not in the ordinary course of business; and
  (iii) there has been no dividend or distribution of any kind declared, paid or
  made by the Company on any class of capital stock or repurchase or redemption
  by the Company of any class of capital stock.

        (h) Independent Accountants.  Ernst & Young LLP, who have expressed
  their opinion with respect to the financial statements (which term as used in
  this Agreement includes the related notes thereto) filed with the Commission
  as a part of the Registration Statement and included in the Prospectus, are
  independent public or certified public accountants as required by the
  Securities Act.

                                      3 
<PAGE>
 
        (i) Preparation of the Financial Statements.  The financial statements
  filed with the Commission as a part of the Registration Statement and included
  in the Prospectus present fairly the financial position of the Company as of
  and at the dates indicated and the results of their operations and cash flows
  for the periods specified.  Such financial statements have been prepared in
  conformity with generally accepted accounting principles applied on a
  consistent basis throughout the periods involved, except as may be expressly
  stated in the related notes thereto.  No other financial statements or
  supporting schedules are required to be included in the Registration
  Statement.  The financial data set forth in the Prospectus under the captions
  "Prospectus Summary--Summary Financial Data," "Selected Financial Data" and
  "Capitalization" fairly present the information set forth therein on a basis
  consistent with that of the audited financial statements contained in the
  Registration Statement.

        (j) Incorporation and Good Standing of the Company. The Company has been
  duly incorporated and is validly existing as a corporation in good standing
  under the laws of the jurisdiction of its incorporation and has corporate
  power and authority to own, lease and operate its properties and to conduct
  its business as described in the Prospectus and to enter into and perform its
  obligations under this Agreement.  The Company is duly qualified as a foreign
  corporation to transact business and is in good standing in the State of
  California and each other jurisdiction in which such qualification is
  required, whether by reason of the ownership or leasing of property or the
  conduct of business, except for such jurisdictions (other than the State of
  California) where the failure to so qualify or to be in good standing would
  not, individually or in the aggregate, result in a Material Adverse Change.
  Immediately prior to the Reincorporation, the Predecessor was duly
  incorporated and was validly existing as a corporation in good standing under
  the laws of the State of California and was duly qualified as a foreign
  corporation to transact business and was in good standing in each jurisdiction
  in which such qualification was required, whether by reason of the ownership
  or leasing of property or the conduct of business, except for such
  jurisdictions where the failure to so qualify or to be in good standing would
  not have resulted, individually or in the aggregate, in a material adverse
  change in the condition, financial or otherwise, or in the earnings, business,
  operations or prospects, whether or not arising from transactions in the
  ordinary course of business, of the Predecessor.  The Company does not own or
  control, directly or indirectly, any corporation, association or other entity
  and immediately prior to the Reincorporation the Predecessor had no
  subsidiaries other than the Company.

        (k) Capitalization and Other Capital Stock Matters.  The authorized,
  issued and outstanding capital stock of the Company is as set forth in the
  Prospectus under the caption "Capitalization" (other than for subsequent
  issuances, if any, pursuant to employee benefit plans described in the
  Prospectus, upon exercise of outstanding options or warrants described in the
  Prospectus or upon exercise of options granted after June 30, 1997, consistent
  with past practices, pursuant to employee benefit plans described in the
  Prospectus).  The Common Stock (including the Common Shares) conforms in all
  material respects to the description thereof contained in the Prospectus.
  Immediately prior to the Reincorporation, all of the issued and outstanding
  shares of capital stock of the Predecessor had been duly authorized and
  validly issued, were fully paid and nonassessable, had been issued in
  compliance with federal and state securities laws and none of such shares were
  issued in violation of any preemptive rights, rights of first refusal or other
  rights to subscribe for or purchase equity securities of the Predecessor. All
  of the issued and outstanding shares of

                                       4
<PAGE>
 
  Common Stock have been duly authorized and validly issued, are fully paid and
  nonassessable and have been issued in compliance with federal and state
  securities laws. None of the outstanding shares of Common Stock were issued in
  violation of any preemptive rights, rights of first refusal or other similar
  rights to subscribe for or purchase securities of the Company. There are no
  authorized or outstanding options, warrants, preemptive rights, rights of
  first refusal or other rights to purchase, or equity or debt securities
  convertible into or exchangeable or exercisable for, any capital stock of the
  Company other than those accurately described in the Prospectus. The
  description of the Company's stock option, stock bonus and other stock plans
  or arrangements, and the options or other rights granted thereunder, set forth
  in the Prospectus accurately and fairly presents the information required to
  be shown with respect to such plans, arrangements, options and rights.
  
        (l) Stock Exchange Listing.   The Common Shares have been approved for
  inclusion on the Nasdaq National Market subject only to official notice of
  issuance.

        (m) Non-Contravention of Existing Instruments; No Further Authorizations
  or Approvals Required.  The Company is not in violation of its charter or by-
  laws or is in default (or, with the giving of notice or lapse of time, would
  be in default) ("Default") under any indenture, mortgage, loan or credit
  agreement, note, contract, franchise, lease or other instrument to which the
  Company is a party or by which it may be bound (including, without limitation,
  any indenture, mortgage, loan or credit agreement, note, contract, franchise,
  lease or other instrument to which the Predecessor, immediately prior to the
  Reincorporation, was a party or by which it may have been bound), or to which
  any of the property or assets of the Company (including, without limitation,
  any property or assets of the Predecessor immediately prior to the
  Reincorporation) is subject (each, an "Existing Instrument"), except for such
  Defaults as would not, individually or in the aggregate, result in a Material
  Adverse Change.  The Company's execution, delivery and performance of this
  Agreement and consummation of the transactions contemplated hereby and by the
  Prospectus (i) have been duly authorized by all necessary corporate action and
  will not result in any violation of the provisions of the charter or by-laws
  of the Company, (ii) will not conflict with or constitute a breach of, or
  Default under, or result in the creation or imposition of any lien, charge or
  encumbrance upon any property or assets of the Company pursuant to, or require
  the consent of any other part to, any Existing Instrument, except for such
  conflicts, breaches, Defaults, liens, charges or encumbrances as would not,
  individually or in the aggregate, result in a Material Adverse Change and
  (iii) will not result in any violation of any law, administrative regulation
  or administrative or court decree applicable to the Company.  No consent,
  approval, authorization or other order of, or registration or filing with, any
  court or other governmental or regulatory authority or agency, is required for
  the Company's execution, delivery and performance of this Agreement and
  consummation of the transactions contemplated hereby and by the Prospectus,
  except such as have been obtained or made by the Company and are in full force
  and effect under the Securities Act, and except for such consents, approvals,
  authorizations, orders of or registrations or filings under applicable state
  securities or blue sky laws and with the National Association of Securities
  Dealers, Inc. (the "NASD").

        (n) No Material Actions or Proceedings.  There are no legal or
  governmental actions, suits or proceedings pending or, to the best of the
  Company's knowledge, threatened (i) against or affecting the Company or the
  Predecessor, (ii) which has as the subject thereof any officer or director of,
  or property owned or leased by, the Company or the Predecessor or

                                       5
<PAGE>
 
  (iii) relating to environmental or discrimination matters, where in any such
  case (A) there is a reasonable possibility that such action, suit or
  proceeding might be determined adversely to the Company and (B) any such
  action, suit or proceeding, if so determined adversely, would reasonably be
  expected to result in a Material Adverse Change or adversely affect the
  consummation of the transactions contemplated by this Agreement.  No material
  labor dispute with the employees of the Company exists or, to the best of the
  Company's knowledge, is threatened or imminent.

        (o) Intellectual Property Rights.  The Company owns or possesses
  sufficient trademarks, trade names, patent rights, copyrights, licenses,
  approvals, trade secrets and other similar rights (collectively, "Intellectual
  Property Rights") reasonably necessary to conduct its business as now
  conducted; and the expected expiration of any of such Intellectual Property
  Rights would not result in a Material Adverse Change, except as otherwise
  disclosed in the Prospectus.  Neither the Company nor the Predecessor has
  received any notice of infringement or conflict with asserted Intellectual
  Property Rights of others, which infringement or conflict, if the subject of
  an unfavorable decision, would result in a Material Adverse Change.

        (p) All Necessary Permits, etc.   The Company possesses such valid and
  current certificates, authorizations or permits issued by the appropriate
  state, federal or foreign regulatory agencies or bodies required to conduct
  its business except where the failure to possess such certificates,
  authorizations or permits would not result in a Material Adverse Change, and
  neither the Company nor the Predecessor has received any notice of proceedings
  relating to the revocation or modification of, or non-compliance with, any
  such certificate, authorization or permit which, singly or in the aggregate,
  if the subject of an unfavorable decision, ruling or finding, could result in
  a Material Adverse Change.

         (q) Title to Properties.  The Company has good and marketable title to
  all the properties and assets reflected as owned in the financial statements
  referred to in Section 1(i) above, in each case free and clear of any security
  interests, mortgages, liens, encumbrances, equities, claims and other defects,
  except such as do not materially and adversely affect the value of such
  property and do not materially interfere with the use made or proposed to be
  made of such property by the Company.  The real property, improvements,
  equipment and personal property held under lease by the Company are held under
  valid and enforceable leases, with such exceptions as are not material and do
  not materially interfere with the use made or proposed to be made of such real
  property, improvements, equipment or personal property by the Company.

         (r) Tax Law Compliance.  The Company and the Predecessor have filed all
  necessary federal, state and foreign income and franchise tax returns or have
  properly requested extensions thereof and have paid all taxes shown as due on
  such returns and extensions and, if due and payable, any related or similar
  assessment, fine or penalty levied against either of them.  Through June 30,
  1997, the Company has made adequate charges, accruals and reserves in the
  applicable financial statements referred to in Section 1(i) above in respect
  of all federal, state and foreign income and franchise taxes for all periods
  as to which the tax liability of the Company and the Predecessor have not been
  finally determined.

         (s) Company Not an Investment Company. The Company has been advised of
  the rules and requirements under the Investment Company Act of 1940, as
  amended (the 

                                       6
<PAGE>
 
  "Investment Company Act"). The Company is not, and after receipt of payment
  for the Common Shares will not be, an "investment company" within the meaning
  of Investment Company Act and will conduct its business in a manner so that it
  will not become subject to the Investment Company Act.

        (t) Insurance.  The Company is insured by recognized, financially sound
  and reputable institutions with policies in such amounts and with such
  deductibles and covering such risks as are generally deemed adequate and
  customary for its business including, but not limited to, policies covering
  real and personal property owned or leased by the Company against theft,
  damage, destruction and acts of vandalism.  The Company has no reason to
  believe that it will not be able (i) to renew its existing insurance coverage
  as and when such policies expire or (ii) to obtain comparable coverage from
  similar institutions as may be necessary or appropriate to conduct its
  business as now conducted and at a cost that would not result in a Material
  Adverse Change.  Neither the Company nor the Predecessor have been denied any
  insurance coverage which either of them have sought or for which either of
  them have applied.

         (u) No Price Stabilization or Manipulation.  The Company has not taken
  and will not take, directly or indirectly, any action designed to or that
  might be reasonably expected to cause or result in stabilization or
  manipulation of the price of the Common Stock to facilitate the sale or resale
  of the Common Shares.

        (v) Related Party Transactions.  There are no business relationships or
  related-party transactions involving the Company, the Predecessor or any other
  person required to be described in the Prospectus which have not been
  described as required.

        (w) Reincorporation.  The execution an delivery of the Agreement and
  Plan of Merger dated as of [September __, 1997] (the "Merger Agreement")
  between the Company and the Predecessor, effecting the reincorporation of the
  Predecessor under the laws of the State of Delaware, was duly authorized by
  all necessary corporate action on the part of each of the Company and the
  Predecessor.  Each of the Company and the Predecessor had all corporate power
  and authority to execute and deliver the Merger Agreement and the Certificate
  of Merger between the Company and the Predecessor complying with Section 251
  of the Delaware General Corporation Law and referencing the Merger Agreement
  (the "Certificate of Merger"), to file the Certificate of Merger with the
  Secretary of State of California and the Secretary of State of Delaware and to
  consummate the reincorporation contemplated by the Merger Agreement, and the
  Merger Agreement at the time of execution and filing constituted a valid and
  binding obligation of each of the Company and the Predecessor, enforceable in
  accordance with its terms.  The merger of the Predecessor with and into the
  Company has been consummated in compliance with applicable law.  The Company
  has succeeded to all of the rights, privileges, powers and franchises, and is
  subject to all of the restrictions, disabilities and duties, of the
  Predecessor.  The Company has succeeded to all of the contract rights of the
  Predecessor, and all required consents with respect to such contracts have
  been obtained.  All of the previously outstanding shares of capital stock of
  the Predecessor have been converted into that number of shares of capital
  stock of the Company having the same rights, preferences and privileges
  (except for differences resulting from applicable law and applicable bylaws)
  as described in the Prospectus.  All of the previously outstanding options and
  warrants of the Predecessor are exercisable for that number of shares of
  Common Stock of the Company as described in the 

                                       7
<PAGE>
 
  Prospectus. The consummation of the Reincorporation did not conflict with, or
  result in any breach of, or constitute a default under (nor constitute any
  event which with notice, lapse of time or both would constitute a breach of or
  default under), any Existing Instrument. The consummation of the
  Reincorporation did not and will not conflict with, or result in a violation
  of, any federal, state, local or foreign law, regulation or rule or any
  decree, judgment or order applicable to the Company, or immediately prior to
  the Reincorporation, the Predecessor, the result of which could have a
  Material Adverse Effect. The issuance of capital stock by the Company in the
  Reincorporation was in compliance with all applicable state securities or blue
  sky laws and was exempt from registration under the Securities Act.

        (x) No Unlawful Contributions or Other Payments.  Neither the Company,
  the Predecessor, nor, to the best of the Company's knowledge, any employee or
  agent of the Company or the Predecessor, has made any contribution or other
  payment to any official of, or candidate for, any federal, state or foreign
  office in violation of any law or of the character required to be disclosed in
  the Prospectus.

         (y) Company's Accounting System.  The Company maintains a system of
  accounting controls sufficient to provide reasonable assurances that
  (i) transactions are executed in accordance with management's general or
  specific authorization; (ii) transactions are recorded as necessary to permit
  preparation of financial statements in conformity with generally accepted
  accounting principles and to maintain accountability for assets; (iii) access
  to assets is permitted only in accordance with management's general or
  specific authorization; and (iv) the recorded accountability for assets is
  compared with existing assets at reasonable intervals and appropriate action
  is taken with respect to any differences.
 
        (z) Compliance with Environmental Laws.  Except as would not,
  individually or in the aggregate, result in a Material Adverse Change (i) the
  Company is not in violation of any federal, state, local or foreign law or
  regulation relating to pollution or protection of human health or the
  environment (including, without limitation, ambient air, surface water,
  groundwater, land surface or subsurface strata) or wildlife, including without
  limitation, laws and regulations relating to emissions, discharges, releases
  or threatened releases of chemicals, pollutants, contaminants, wastes, toxic
  substances, hazardous substances, petroleum and petroleum products
  (collectively, "Materials of Environmental Concern"), or otherwise relating to
  the manufacture, processing, distribution, use, treatment, storage, disposal,
  transport or handling of Materials of Environment Concern (collectively,
  "Environmental Laws"), which violation includes, but is not limited to,
  noncompliance with any permits or other governmental authorizations required
  for the operation of the business of the Company under applicable
  Environmental Laws, or noncompliance with the terms and conditions thereof,
  nor has the Company or the Predecessor received any written communication,
  whether from a governmental authority, citizens group, employee or otherwise,
  that alleges that the Company is or the Predecessor was immediately prior to
  the Reincorporation in violation of any Environmental Law; (ii) there is no
  claim, action or cause of action filed with a court or governmental authority,
  no investigation with respect to which the Company or the Predecessor has
  received written notice, and no written notice by any person or entity
  alleging potential liability for investigatory costs, cleanup costs,
  governmental responses costs, natural resources damages, property damages,
  personal injuries, attorneys' fees or penalties arising out of, based on or
  resulting from the presence, or release into the environment, of any Material
  of Environmental Concern at any location owned, leased or operated by the
  Company, now or in the past (collectively, "Environmental 

                                       8
<PAGE>
 
  Claims"), pending or, to the best of the Company's knowledge, threatened
  against the Company or any person or entity whose liability for any
  Environmental Claim the Company has retained or assumed either contractually
  or by operation of law; and (iii) to the best of the Company's knowledge,
  there are no past or present actions, activities, circumstances, conditions,
  events or incidents, including, without limitation, the release, emission,
  discharge, presence or disposal of any Material of Environmental Concern, that
  reasonably could result in a violation of any Environmental Law or form the
  basis of a potential Environmental Claim against the Company or against any
  person or entity whose liability for any Environmental Claim the Company has
  retained or assumed either contractually or by operation of law.

        (aa) Periodic Review of Costs of Environmental Compliance.  In the
  ordinary course of its business, the Company conducts and the Predecessor
  conducted periodic reviews of the effect of Environmental Laws on the
  business, operations and properties of the Company.  On the basis of such
  review and the amount of its established reserves, the Company has reasonably
  concluded that such associated costs and liabilities would not, individually
  or in the aggregate, result in a Material Adverse Change.

        (bb) ERISA Compliance.  The Company and any "employee benefit plan" (as
  defined under the Employee Retirement Income Security Act of 1974, as amended,
  and the regulations and published interpretations thereunder (collectively,
  "ERISA")) established or maintained by the Company or their "ERISA Affiliates"
  (as defined below) are in compliance in all material respects with ERISA.
  "ERISA Affiliate" means, with respect to the Company, any member of any group
  of organizations described in Sections 414(b),(c),(m) or (o) of the Internal
  Revenue Code of 1986, as amended, and the regulations and published
  interpretations thereunder (the "Code") of which the Company is a member.  No
  "reportable event" (as defined under ERISA) has occurred or is reasonably
  expected to occur with respect to any "employee benefit plan" established or
  maintained by the Company or any of their ERISA Affiliates.  No "employee
  benefit plan" established or maintained by the Company or any of their ERISA
  Affiliates, if such "employee benefit plan" were terminated, would have any
  "amount of unfunded benefit liabilities" (as defined under ERISA).  Neither
  the Company nor any of their ERISA Affiliates has incurred or reasonably
  expects to incur any material liability under (i) Title IV of ERISA with
  respect to termination of, or withdrawal from, any "employee benefit plan" or
  (ii) Sections 412, 4971, 4975 or 4980B of the Code.  Each "employee benefit
  plan" established or maintained by the Company or any of its ERISA Affiliates
  that is intended to be qualified under Section 401(a) of the Code has received
  a favorable determination letter from the Internal Revenue Service and to the
  Company's knowledge nothing has occurred, whether by action or failure to act,
  which would cause the loss of such qualification.

          Any certificate signed by an officer of the Company and delivered to
the Representatives or to counsel for the Underwriters shall be deemed to be a
representation and warranty by the Company to each Underwriter as to the matters
set forth therein.

          SECTION 2.  PURCHASE, SALE AND DELIVERY OF THE COMMON SHARES.

          The Firm Common Shares.  The Company agrees to issue and sell to the
several Underwriters the Firm Common Shares upon the terms herein set forth.  On
the basis of the 

                                       9
<PAGE>
 
representations, warranties and agreements herein contained, and upon the terms
but subject to the conditions herein set forth, the Underwriters agree,
severally and not jointly, to purchase from the Company the respective number of
Firm Common Shares set forth opposite their names on Schedule A. The purchase
                                                     ----------
price per Firm Common Share to be paid by the several Underwriters to the
Company shall be $[___] per share.

          The First Closing Date.  Delivery of certificates for the Firm Common
Shares to be purchased by the Underwriters and payment therefor shall be made at
the offices of Montgomery Securities, 600 Montgomery Street, San Francisco,
California (or such other place as may be agreed to by the Company and the
Representatives) at 6:00 a.m. San Francisco time, on [insert the fourth full
business day after the date of this Agreement] or such other time and date not
later than 10:30 a.m. San Francisco time, on [insert the date ten business days
following the original contemplated First Closing Date] as the Representatives
shall designate by notice to the Company (the time and date of such closing are
called the "First Closing Date").  The Company hereby acknowledges that
circumstances under which the Representatives may provide notice to postpone the
First Closing Date as originally scheduled include, but are in no way limited
to, any determination by the Company or the Representatives to recirculate to
the public copies of an amended or supplemented Prospectus or a delay as
contemplated by the provisions of Section 10.

          The Optional Common Shares; the Second Closing Date.  In addition, on
the basis of the representations, warranties and agreements herein contained,
and upon the terms but subject to the conditions herein set forth, the Company
hereby grants an option to the several Underwriters to purchase, severally and
not jointly, up to an aggregate of 375,000 Optional Common Shares from the
Company at the purchase price per share to be paid by the Underwriters for the
Firm Common Shares.  The option granted hereunder is for use by the Underwriters
solely in covering any over-allotments in connection with the sale and
distribution of the Firm Common Shares.  The option granted hereunder may be
exercised at any time (but not more than once) upon notice by the
Representatives to the Company, which notice may be given at any time within
30 days from the date of this Agreement.  Such notice shall set forth (i) the
aggregate number of Optional Common Shares as to which the Underwriters are
exercising the option, (ii) the names and denominations in which the
certificates for the Optional Common Shares are to be registered and (iii) the
time, date and place at which such certificates will be delivered (which time
and date may be simultaneous with, but not earlier than, the First Closing Date
if such notice is provided at least two days prior to the First Closing Date;
and in such case the term "First Closing Date" shall refer to the time and date
of delivery of certificates for the Firm Common Shares and the Optional Common
Shares).  Such time and date of delivery, if subsequent to the First Closing
Date, is called the "Second Closing Date" and shall be determined by the
Representatives and shall not be earlier than three nor later than five full
business days after delivery of such notice of exercise.  If any Optional Common
Shares are to be purchased, each Underwriter agrees, severally and not jointly,
to purchase the number of Optional Common Shares (subject to such adjustments to
eliminate fractional shares as the Representatives may determine) that bears the
same proportion to the total number of Optional Common Shares to be purchased as
the number of Firm Common Shares set forth on Schedule A opposite the name of
                                              ----------                     
such Underwriter bears to the total number of Firm Common Shares.  The
Representatives may cancel the option at any time prior to its expiration by
giving written notice of such cancellation to the Company.

                                      10
<PAGE>
 
          Public Offering of the Common Shares.  The Representatives hereby
advise the Company that the Underwriters intend to offer for sale to the public,
as described in the Prospectus, their respective portions of the Common Shares
as soon after this Agreement has been executed and the Registration Statement
has been declared effective as the Representatives, in their sole judgment, have
determined is advisable and practicable.

          Payment for the Common Shares.  Payment for the Common Shares shall be
made at the First Closing Date (and, if applicable, at the Second Closing Date)
by wire transfer of immediately available funds to the order of the Company.

          It is understood that the Representatives have been authorized, for
their own respective accounts and the accounts of the several Underwriters, to
accept delivery of and receipt for, and make payment of the purchase price for,
the Firm Common Shares and any Optional Common Shares the Underwriters have
agreed to purchase.  Except as specifically set forth in Section 10 hereof,
Montgomery Securities, individually and not as a Representative of the
Underwriters, may (but shall not be obligated to) make payment for any Common
Shares to be purchased by any Underwriter whose funds shall not have been
received by the Representatives by the First Closing Date or the Second Closing
Date, as the case may be, for the account of such Underwriter, and any such
payment shall not relieve such Underwriter from any of its obligations under
this Agreement.

          Delivery of the Common Shares.  The Company shall deliver, or cause to
be delivered, to the Representatives for the accounts of the several
Underwriters certificates for the Firm Common Shares at the First Closing Date,
against the irrevocable release of a wire transfer of immediately available
funds for the amount of the purchase price therefor.  The Company shall also
deliver, or cause to be delivered, to the Representatives for the accounts of
the several Underwriters, certificates for the Optional Common Shares the
Underwriters have agreed to purchase at the First Closing Date or the Second
Closing Date, as the case may be, against the irrevocable release of a wire
transfer of immediately available funds for the amount of the purchase price
therefor.  The certificates for the Common Shares shall be in definitive form
and registered in such names and denominations as the Representatives shall have
requested at least two full business days prior to the First Closing Date (or
the Second Closing Date, as the case may be) and shall be made available for
inspection on the business day preceding the First Closing Date (or the Second
Closing Date, as the case may be) at a location in New York City as the
Representatives may designate.  Time shall be of the essence, and delivery at
the time and place specified in this Agreement is a further condition to the
obligations of the Underwriters.

          Delivery of Prospectus to the Underwriters.  Not later than 12:00 p.m.
on the second business day following the date the Common Shares are released by
the Underwriters for sale to the public, the Company shall delivery or cause to
be delivered copies of the Prospectus in such quantities and at such places as
the Representatives shall request.

          SECTION 3.  ADDITIONAL COVENANTS OF THE COMPANY.

          The Company further covenants and agrees with each Underwriter as
follows:

        (a) Representatives' Review of Proposed Amendments and Supplements.
  During such period beginning on the date hereof and ending on the later of the
  First Closing Date or such date, as in the opinion of counsel for the
  Underwriters, the Prospectus is no longer 

                                      11
<PAGE>
 
  required by law to be delivered in connection with sales by an Underwriter or
  dealer (the "Prospectus Delivery Period"), prior to amending or supplementing
  the Registration Statement (including any registration statement filed under
  Rule 462(b) under the Securities Act) or the Prospectus, the Company shall
  furnish to each Representative for review a copy of each such proposed
  amendment or supplement, and the Company shall not file any such proposed
  amendment or supplement to which any Representative reasonably objects.

        (b) Securities Act Compliance.  After the date of this Agreement, the
  Company shall promptly advise the Representatives in writing (i) of the
  receipt of any comments of, or requests for additional or supplemental
  information from, the Commission, (ii) of the time and date of any filing of
  any post-effective amendment to the Registration Statement or any amendment or
  supplement to any preliminary prospectus or the Prospectus, (iii) of the time
  and date that any post-effective amendment to the Registration Statement
  becomes effective and (iv) of the issuance by the Commission of any stop order
  suspending the effectiveness of the Registration Statement or any post-
  effective amendment thereto or of any order preventing or suspending the use
  of any preliminary prospectus or the Prospectus, or, within two years of the
  date of this Agreement, of any proceedings to remove, suspend or terminate
  from listing or quotation the Common Stock from any securities exchange upon
  which it is listed for trading or included or designated for quotation, or of
  the threatening or initiation of any proceedings for any of such purposes.  If
  the Commission shall enter any such stop order at any time, the Company will
  use its best efforts to obtain the lifting of such order at the earliest
  possible moment.  Additionally, the Company agrees that it shall comply with
  the provisions of Rules 424(b), 430A and 434, as applicable, under the
  Securities Act and will use its reasonable efforts to confirm that any filings
  made by the Company under such Rule 424(b) were received in a timely manner by
  the Commission.
 
        (c) Amendments and Supplements to the Prospectus and Other Securities
  Act Matters.  If, during the Prospectus Delivery Period, any event shall occur
  or condition exist as a result of which it is necessary to amend or supplement
  the Prospectus in order to make the statements therein, in the light of the
  circumstances when the Prospectus is delivered to a purchaser, not misleading,
  or if in the reasonable opinion of the Representatives or counsel for the
  Underwriters it is otherwise necessary to amend or supplement the Prospectus
  to comply with law, the Company agrees to promptly prepare (subject to
  Section 3(A)(a) hereof), file with the Commission and furnish at its own
  expense to the Underwriters and to dealers, amendments or supplements to the
  Prospectus so that the statements in the Prospectus as so amended or
  supplemented will not, in the light of the circumstances when the Prospectus
  is delivered to a purchaser, be misleading or so that the Prospectus, as
  amended or supplemented, will comply with law.
 
        (d) Copies of any Amendments and Supplements to the Prospectus.  The
  Company agrees to furnish the Representatives, without charge, during the
  Prospectus Delivery Period, as many copies of the Prospectus and any
  amendments and supplements thereto as the Representatives may request.
 
        (e) Blue Sky Compliance.  The Company shall cooperate with the
  Representatives and counsel for the Underwriters to qualify or register the
  Common Shares for sale under (or obtain exemptions from the application of)
  the state securities or blue sky laws or Canadian provincial securities laws
  of those jurisdictions designated by the Representatives, shall comply with
  such laws and shall continue such qualifications, registrations and exemptions

                                      12
<PAGE>
 
  in effect so long as required for the distribution of the Common Shares.  The
  Company shall not be required to qualify as a foreign corporation or to take
  any action that would subject it to general service of process in any such
  jurisdiction where it is not presently qualified or where it would be subject
  to taxation as a foreign corporation.  The Company will advise the
  Representatives promptly of the suspension of the qualification or
  registration of (or any such exemption relating to) the Common Shares for
  offering, sale or trading in any jurisdiction or any initiation or, to its
  knowledge, any threat of any proceeding for any such purpose, and in the event
  of the issuance of any order suspending such qualification, registration or
  exemption, the Company shall use its best efforts to obtain the withdrawal
  thereof at the earliest possible moment.
 
        (f) Use of Proceeds.  The Company shall apply the net proceeds from the
  sale of the Common Shares sold by it substantially in the manner described
  under the caption "Use of Proceeds" in the Prospectus.
 
        (g) Transfer Agent.  The Company shall engage and maintain, at its
  expense, a registrar and transfer agent for the Common Stock.

        (h) Earnings Statement.  As soon as practicable, the Company will make
  generally available to its security holders and to the Representatives an
  earnings statement (which need not be audited) covering the twelve-month
  period ending [September 30, 1998] that satisfies the provisions of Section
  11(a) of the Securities Act.
 
        (i) Periodic Reporting Obligations.  During the Prospectus Delivery
  Period the Company shall file, on a timely basis, with the Commission and the
  Nasdaq National Market all reports and documents required to be filed under
  the Exchange Act.  Additionally, the Company shall file with the Commission
  all reports on Form SR as may be required under Rule 463 under the Securities
  Act.
 
        (j) Agreement Not To Offer or Sell Additional Securities.  During the
  period of 180 days following the date of the Prospectus, the Company will not,
  without the prior written consent of Montgomery Securities (which consent may
  be withheld at the sole discretion of Montgomery Securities), directly or
  indirectly, sell, offer, contract or grant any option to sell, pledge,
  transfer or establish an open "put equivalent position" within the meaning of
  Rule 16a-1(h) under the Exchange Act, or otherwise dispose of or transfer, or
  announce the offering of, or file any registration statement under the
  Securities Act in respect of, any shares of Common Stock, options or warrants
  to acquire shares of the Common Stock or securities exchangeable or
  exercisable for or convertible into shares of Common Stock (other than as
  contemplated by this Agreement with respect to the Common Shares); provided,
  however, that the Company may issue shares of its Common Stock or options to
  purchase its Common Stock, or Common Stock upon exercise of options, pursuant
  to any stock option, stock purchase, stock bonus or other stock plan or
  arrangement described in the Prospectus, but only if the holders of such
  shares, options, or shares issued upon exercise of such options, agree in
  writing not to sell, offer, dispose of or otherwise transfer any such shares,
  or options during such 180 day period without the prior written consent of the
  Company.  Notwithstanding the foregoing sentence, the Company need not obtain
  agreements regarding the sale, offer, disposition or other transfer of shares
  of the Company's Common Stock issued pursuant to the Company's Employee Stock
  Purchase Plan.

                                      13
<PAGE>
 
       (k) Agreement Not To Release Lock-Ups.  During the period of 180 days
  following the date of the Prospectus, the Company will not, without the
  prior written consent of Montgomery Securities (which consent may be
  withheld at the sole discretion of Montgomery Securities), release, waive,
  amend or modify Section 2.13 of the Company's Amended and Restated
  Investors' Rights Agreement dated May 23, 1997, Section 7(b)(ii) of the
  Company's standard Incentive Stock Option Stock Purchase Agreement with
  optionees, Section 7(a)(ii) of the Company's standard Non-statutory Stock
  Option Stock Purchase Agreement with optionees, or any contractual provision
  between the Company and any third party which limits such third party's
  rights, directly or indirectly, to sell, offer, contract or grant any option
  to sell, pledge, transfer or establish an open "put equivalent position"
  within the meaning of Rule 16a-1(h) under the Exchange Act, or otherwise
  dispose of or transfer, or announce the offering of any shares of Common
  Stock, options or warrants to acquire shares of the Common Stock or
  securities exchangeable or exercisable for or convertible into shares of
  Common Stock.

        (l) Future Reports to the Representatives.  During the period of three
  years hereafter the Company will furnish to the Representatives at: Montgomery
  Securities, 600 Montgomery Street, San Francisco, CA 94111 Attention: Michael
  Dovey; and Hambrecht & Quist, 230 Park Avenue, New York, NY 10169, Attention:
  Dennis J. Purcell: (i) as soon as practicable after the end of each fiscal
  year, copies of the Annual Report of the Company containing the balance sheet
  of the Company as of the close of such fiscal year and statements of income,
  stockholders' equity and cash flows for the year then ended and the opinion
  thereon of the Company's independent public or certified public accountants;
  (ii) as soon as practicable after the filing thereof, copies of each proxy
  statement, Annual Report on Form 10-K, Quarterly Report on Form 10-Q, Current
  Report on Form 8-K or other report filed by the Company with the Commission,
  the NASD or any securities exchange; and (iii) as soon as available, copies of
  any report or communication of the Company mailed generally to holders of its
  capital stock.

          SECTION 4.  PAYMENT OF EXPENSES.  The Company agrees to pay all costs,
fees and expenses incurred in connection with the performance of its obligations
hereunder and in connection with the transactions contemplated hereby, including
without limitation (i) all expenses incident to the issuance and delivery of the
Common Shares (including all printing and engraving costs), (ii) all fees and
expenses of the registrar and transfer agent of the Common Stock, (iii) all
necessary issue, transfer and other stamp taxes in connection with the issuance
and sale of the Common Shares to the Underwriters, (iv) all fees and expenses of
the Company's counsel, independent public or certified pubic accountants and
other advisors, (v) all costs and expenses incurred in connection with the
preparation, printing, filing, shipping and distribution of the Registration
Statement (including financial statements, exhibits, schedules, consents and
certificates of experts), each preliminary prospectus and the Prospectus, and
all amendments and supplements thereto, and this Agreement, (vi) all filing
fees, attorneys' fees and expenses incurred by the Company or the Underwriters
in connection with qualifying or registering (or obtaining exemptions from the
qualification or registration of) all or any part of the Common Shares for offer
and sale under the state securities or blue sky laws or the provincial
securities laws of Canada, and, if requested by the Representatives, preparing
and printing a "Blue Sky Survey" or memorandum, and any supplements thereto,
advising the Underwriters of such qualifications, registrations and exemptions,
(vii) the filing fees incident to, and the reasonable fees and expenses of
counsel for the Underwriters in connection with, the NASD's review and approval
of the Underwriters' participation in the offering and distribution of the
Common Shares, (viii) the fees and expenses associated with listing the Common
Shares on the Nasdaq 

                                      14
<PAGE>
 
National Market and (ix) all other fees, costs and expenses referred to in Item
13 of Part II of the Registration Statement. Except as provided in this Section
4, Section 6, Section 8 and Section 9 hereof, the Underwriters shall pay their
own expenses, including the fees and disbursements of their counsel.

          SECTION 5.  CONDITIONS OF THE OBLIGATIONS OF THE UNDERWRITERS.  The
obligations of the several Underwriters to purchase and pay for the Common
Shares as provided herein on the First Closing Date and, with respect to the
Optional Common Shares, the Second Closing Date, shall be subject to the
accuracy of the representations and warranties on the part of the Company set
forth in Section 1 hereof as of the date hereof and as of the First Closing Date
as though then made and, with respect to the Optional Common Shares, as of the
Second Closing Date as though then made, to the timely performance by the
Company of its covenants and other obligations hereunder, and to each of the
following additional conditions:

        (a) Accountants' Comfort Letter. On the date hereof, the Representatives
  shall have received from Ernst & Young LLP, independent public or certified
  public accountants for the Company, a letter dated the date hereof addressed
  to the Underwriters, in form and substance satisfactory to the
  Representatives, containing statements and information of the type ordinarily
  included in accountant's "comfort letters" to underwriters, delivered
  according to Statement of Auditing Standards No. 72 (or any successor
  bulletin), with respect to the audited and unaudited financial statements and
  certain financial information contained in the Registration Statement and the
  Prospectus (and the Representatives shall have received an additional [___]
  conformed copies of such accountants' letter for each of the several
  Underwriters).

        (b) Compliance with Registration Requirements; No Stop Order; No
  Objection from NASD.  For the period from and after effectiveness of this
  Agreement and prior to the First Closing Date and, with respect to the
  Optional Common Shares, the Second Closing Date:
 
          (i) the Company shall have filed the Prospectus with the Commission
     (including the information required by Rule 430A under the Securities Act)
     in the manner and within the time period required by Rule 424(b) under the
     Securities Act; or the Company shall have filed a post-effective amendment
     to the Registration Statement containing the information required by such
     Rule 430A, and such post-effective amendment shall have become effective;
     or, if the Company elected to rely upon Rule 434 under the Securities Act
     and obtained the Representatives' consent thereto, the Company shall have
     filed a Term Sheet with the Commission in the manner and within the time
     period required by such Rule 424(b);
 
          (ii) no stop order suspending the effectiveness of the Registration
     Statement, any Rule 462(b) Registration Statement, or any post-effective
     amendment to the Registration Statement, shall be in effect and no
     proceedings for such purpose shall have been instituted or threatened by
     the Commission; and
 
          (iii) the NASD shall have raised no objection to the fairness and
     reasonableness of the underwriting terms and arrangements.

       (c) No Material Adverse Change. For the period from and after the date of
  this Agreement and prior to the First Closing Date and, with respect to the
  Optional Common 

                                      15
<PAGE>
 
  Shares, the Second Closing Date, in the judgment of the Representatives there
  shall not have occurred any Material Adverse Change.

        (d) Opinion of Counsel for the Company.  On each of the First Closing
  Date and the Second Closing Date the Representatives shall have received the
  opinion of Cooley Godward LLP, counsel for the Company, dated as of such
  Closing Date, the form of which is attached as Exhibit A (and the
                                                 ---------         
  Representatives shall have received an additional [___] conformed copies of
  such counsel's legal opinion for each of the several Underwriters).

        (e) Opinion of Intellectual Property Counsel for the Company.  On each
  of the First Closing Date and the Second Closing Date the Representatives
  shall have received the opinion of McDonnell, Boehnen, Hulbert & Berghoff,
  Ltd., intellectual property counsel for the Company, dated as of such Closing
  Date, the form of which is attached as Exhibit B (and the Representatives
                                         ---------                         
  shall have received an additional [___] conformed copies of such counsel's
  legal opinion for each of the several Underwriters).

        (f) Opinion of Counsel for the Underwriters.  On each of the First
  Closing Date and the Second Closing Date the Representatives shall have
  received the opinion of Gunderson Dettmer Stough Villeneuve Franklin &
  Hachigian, LLP, counsel for the Underwriters, dated as of such Closing Date,
  with respect to the matters set forth in paragraphs [[(i), (vi) (with respect
  to subparagraph (i) only), (vii) (with respect to subparagraph (i) only),
  (viii), (ix) and (xii) (with respect to the captions "Description of Capital
  Stock" and "Underwriting" under subparagraph (i) only)] and [the next-to-last
  paragraph] of Exhibit A (and the Representatives shall have received an
                ---------                                                
  additional [___] conformed copies of such counsel's legal opinion for each of
  the several Underwriters).

        (g) Officers' Certificate.  On each of the First Closing Date and the
  Second Closing Date the Representatives shall have received a written
  certificate executed by the Chairman of the Board, Chief Executive Officer or
  President of the Company and the Chief Financial Officer or Chief Accounting
  Officer of the Company, dated as of such Closing Date, to the effect set forth
  in subsections (b)(ii) of this Section 5, and further to the effect that:

           (i) for the period from and after the date of this Agreement and
     prior to such Closing Date, there has not occurred any Material Adverse
     Change;

          (ii) the representations, warranties and covenants of the Company set
     forth in Section 1 of this Agreement are true and correct with the same
     force and effect as though expressly made on and as of such Closing Date;
     and
 
          (iii)  the Company has complied with all the agreements and satisfied
     all the conditions on its part to be performed or satisfied at or prior to
     such Closing Date.

       (h) Bring-down Comfort Letter.  On each of the First Closing Date and the
  Second Closing Date the Representatives shall have received from Ernst & Young
  LLP, independent public or certified public accountants for the Company, a
  letter dated such date, in form and substance satisfactory to the
  Representatives, to the effect that they reaffirm the statements made in the
  letter furnished by them pursuant to subsection (a) of this Section 5, except
  that the specified date referred to therein for the carrying out of procedures
  shall be no more than three business days prior to the First Closing Date or
  Second Closing Date, as the case may 

                                      16
<PAGE>
 
  be (and the Representatives shall have received an additional [___] conformed
  copies of such accountants' letter for each of the several Underwriters).

        (i) Lock-Up Agreement from Certain Stockholders of the Company.  On the
  date hereof, the Company shall have furnished to the Representatives an
  agreement in the form of Exhibit C hereto from each director, officer and
                           ---------                                       
  beneficial owner of Common Stock of the Company holding more than [1.0]% of
  the outstanding securities of the Company, and such agreement shall be in full
  force and effect on each of the First Closing Date and the Second Closing
  Date.

        (j) Additional Documents.  On or before each of the First Closing Date
  and the Second Closing Date, the Representatives and counsel for the
  Underwriters shall have received such information, documents and opinions as
  they may reasonably require for the purposes of enabling them to pass upon the
  issuance and sale of the Common Shares as contemplated herein, or in order to
  evidence the accuracy of any of the representations and warranties, or the
  satisfaction of any of the conditions or agreements, herein contained.

     If any condition specified in this Section 5 is not satisfied when and as
required to be satisfied, this Agreement may be terminated by the
Representatives by notice to the Company at any time on or prior to the First
Closing Date and, with respect to the Optional Common Shares, at any time prior
to the Second Closing Date, which termination shall be without liability on the
part of any party to any other party, except that Section 4, Section 6,
Section 8 and Section 9 shall at all times be effective and shall survive such
termination.

          SECTION 6.  REIMBURSEMENT OF UNDERWRITERS' EXPENSES.  If this
Agreement is terminated by the Representatives pursuant to Section 5, Section 7
or Section 11, or if the sale to the Underwriters of the Common Shares on the
First Closing Date is not consummated because of any refusal, inability or
failure on the part of the Company to perform any agreement herein or to comply
with any provision hereof, the Company agrees to reimburse the Representatives
and the other Underwriters (or such Underwriters as have terminated this
Agreement with respect to themselves), severally, upon demand for all out-of-
pocket expenses that shall have been reasonably incurred by the Representatives
and the Underwriters in connection with the proposed purchase and the offering
and sale of the Common Shares, including but not limited to fees and
disbursements of counsel, printing expenses, travel expenses, postage, facsimile
and telephone charges.

          SECTION 7.  EFFECTIVENESS OF THIS AGREEMENT.

          This Agreement shall not become effective until the later of (i) the
execution of this Agreement by the parties hereto and (ii) notification by the
Commission to the Company and the Representatives of the effectiveness of the
Registration Statement under the Securities Act.

          Prior to such effectiveness of the Registration Statement, this
Agreement may be terminated by any party by notice to each of the other parties
hereto, and any such termination shall be without liability on the part of
(a) the Company to any Underwriter, except that the Company shall be obligated
to reimburse the expenses of the Representatives and the Underwriters pursuant
to Sections 4 and 6 hereof, (b) of any Underwriter to the Company, or 

                                      17
<PAGE>
 
(c) of any party hereto to any other party except that the provisions of Section
8 and Section 9 shall at all times be effective and shall survive such
termination.


          SECTION 8.  INDEMNIFICATION.

        (a) Indemnification of the Underwriters.  The Company agrees to
  indemnify and hold harmless each Underwriter, its officers and employees, and
  each person, if any, who controls any Underwriter within the meaning of the
  Securities Act and the Exchange Act against any loss, claim, damage, liability
  or expense, as incurred, to which such Underwriter or such controlling person
  may become subject, under the Securities Act, the Exchange Act or other
  federal or state statutory law or regulation, or at common law or otherwise
  (including in settlement of any litigation, if such settlement is effected
  with the written consent of the Company), insofar as such loss, claim, damage,
  liability or expense (or actions in respect thereof as contemplated below)
  arises out of or is based (i) upon any untrue statement or alleged untrue
  statement of a material fact contained in the Registration Statement, or any
  amendment thereto, including any information deemed to be a part thereof
  pursuant to Rule 430A or Rule 434 under the Securities Act, or the omission or
  alleged omission therefrom of a material fact required to be stated therein or
  necessary to make the statements therein not misleading; or (ii) upon any
  untrue statement or alleged untrue statement of a material fact contained in
  any preliminary prospectus or the Prospectus (or any amendment or supplement
  thereto), or the omission or alleged omission therefrom of a material fact
  necessary in order to make the statements therein, in the light of the
  circumstances under which they were made, not misleading; or (iii) in whole or
  in part upon any inaccuracy in the representations and warranties of the
  Company contained herein; or (iv) in whole or in part upon any failure of the
  Company to perform its obligations hereunder or under law; or (v) any act or
  failure to act or any alleged act or failure to act by any Underwriter in
  connection with, or relating in any manner to, the Common Stock or the
  offering contemplated hereby, and which is included as part of or referred to
  in any loss, claim, damage, liability or action arising out of or based upon
  any matter covered by clause (i) or (ii) above, provided that the Company
  shall not be liable under this clause (v) to the extent that a court of
  competent jurisdiction shall have determined by a final judgment that such
  loss, claim, damage, liability or action resulted directly from any such acts
  or failures to act undertaken or omitted to be taken by such Underwriter
  through its bad faith or willful misconduct; and to reimburse each Underwriter
  and each such controlling person for any and all expenses (including the fees
  and disbursements of counsel chosen by Montgomery Securities) as such expenses
  are reasonably incurred by such Underwriter or such controlling person in
  connection with investigating, defending, settling, compromising or paying any
  such loss, claim, damage, liability, expense or action; provided, however,
  that the foregoing indemnity agreement shall not apply to any loss, claim,
  damage, liability or expense to the extent, but only to the extent, arising
  out of or based upon any untrue statement or alleged untrue statement or
  omission or alleged omission made in reliance upon and in conformity with
  written information furnished to the Company by the Representatives expressly
  for use in the Registration Statement, any preliminary prospectus or the
  Prospectus (or any amendment or supplement thereto); and provided, further,
  that with respect to any preliminary prospectus, the foregoing indemnity
  agreement shall not inure to the benefit of any Underwriter from whom the
  person asserting any loss, claim, damage, liability or expense purchased
  Common Shares, or any person controlling such Underwriter, if copies of the
  Prospectus were timely delivered to the Underwriter pursuant to Section 2 and
  a copy of 

                                      18
<PAGE>
 
  the Prospectus (as then amended or supplemented if the Company shall have
  furnished any amendments or supplements thereto) was not sent or given by or
  on behalf of such Underwriter to such person, if required by law so to have
  been delivered, at or prior to the written confirmation of the sale of the
  Common Shares to such person, and if the Prospectus (as so amended or
  supplemented) would have cured the defect giving rise to such loss, claim,
  damage, liability or expense. The indemnity agreement set forth in this
  Section 8(a) shall be in addition to any liabilities that the Company may
  otherwise have.

        (b) Indemnification of the Company, its Directors and Officers.  Each
  Underwriter agrees, severally and not jointly, to indemnify and hold harmless
  the Company, each of its directors, each of its officers who signed the
  Registration Statement and each person, if any, who controls the Company
  within the meaning of the Securities Act or the Exchange Act, against any
  loss, claim, damage, liability or expense, as incurred, to which the Company,
  or any such director, officer or controlling person may become subject, under
  the Securities Act, the Exchange Act, or other federal or state statutory law
  or regulation, or at common law or otherwise (including in settlement of any
  litigation, if such settlement is effected with the written consent of such
  Underwriter), insofar as such loss, claim, damage, liability or expense (or
  actions in respect thereof as contemplated below) arises out of or is based
  upon any untrue or alleged untrue statement of a material fact contained in
  the Registration Statement, any preliminary prospectus or the Prospectus (or
  any amendment or supplement thereto), or arises out of or is based upon the
  omission or alleged omission to state therein a material fact required to be
  stated therein or necessary to make the statements therein not misleading, in
  each case to the extent, but only to the extent, that such untrue statement or
  alleged untrue statement or omission or alleged omission was made in the
  Registration Statement, any preliminary prospectus, the Prospectus (or any
  amendment or supplement thereto), in reliance upon and in conformity with
  written information furnished to the Company by the Representatives expressly
  for use therein; and to reimburse the Company, or any such director, officer
  or controlling person for any legal and other expense reasonably incurred by
  the Company, or any such director, officer or controlling person in connection
  with investigating, defending, settling, compromising or paying any such loss,
  claim, damage, liability, expense or action.  The Company hereby acknowledges
  that the only information that the Underwriters have furnished to the
  expressly for use in the Registration Statement, any preliminary prospectus or
  the Prospectus (or any amendment or supplement thereto) are the statements set
  forth (A) as the paragraph on the inside front cover page of the Prospectus
  concerning stabilization by the Underwriters and (B) in the table in the first
  paragraph and as the second, fourth and eighth paragraphs under the caption
  "Underwriting" in the Prospectus; and the Underwriters confirm that such
  statements are correct. The indemnity agreement set forth in this Section 8(b)
  shall be in addition to any liabilities that each Underwriter may otherwise
  have.

        (c) Notifications and Other Indemnification Procedures.  Promptly after
  receipt by an indemnified party under this Section 8 of notice of the
  commencement of any action, such indemnified party will, if a claim in respect
  thereof is to be made against an indemnifying party under this Section 8,
  notify the indemnifying party in writing of the commencement thereof, but the
  omission so to notify the indemnifying party will not relieve it from any
  liability which it may have to any indemnified party for contribution or
  otherwise than under the indemnity agreement contained in this Section 8 or to
  the extent it is not prejudiced as a proximate result of such failure.  In
  case any such action is brought against any indemnified party and such
  indemnified party seeks or intends to seek indemnity from an indemnifying

                                      19
<PAGE>
 
  party, the indemnifying party will be entitled to participate in, and, to the
  extent that it shall elect, jointly with all other indemnifying parties
  similarly notified, by written notice delivered to the indemnified party
  promptly after receiving the aforesaid notice from such indemnified party, to
  assume the defense thereof with counsel reasonably satisfactory to such
  indemnified party; provided, however, if the defendants in any such action
  include both the indemnified party and the indemnifying party and the
  indemnified party shall have reasonably concluded that a conflict may arise
  between the positions of the indemnifying party and the indemnified party in
  conducting the defense of any such action or that there may be legal defenses
  available to it and/or other indemnified parties which are different from or
  additional to those available to the indemnifying party, the indemnified party
  or parties shall have the right to select separate counsel to assume such
  legal defenses and to otherwise participate in the defense of such action on
  behalf of such indemnified party or parties.  Upon receipt of notice from the
  indemnifying party to such indemnified party of such indemnifying party's
  election so to assume the defense of such action and approval by the
  indemnified party of counsel, the indemnifying party will not be liable to
  such indemnified party under this Section8 for any legal or other expenses
  subsequently incurred by such indemnified party in connection with the defense
  thereof unless (i) the indemnified party shall have employed separate counsel
  in accordance with the proviso to the next preceding sentence (it being
  understood, however, that the indemnifying party shall not be liable for the
  expenses of more than one separate counsel (together with local counsel),
  approved by the indemnifying party (Montgomery Securities in the case of
  Section 8(b) and Section 9), representing the indemnified parties who are
  parties to such action) or (ii) the indemnifying party shall not have employed
  counsel satisfactory to the indemnified party to represent the indemnified
  party within a reasonable time after notice of commencement of the action, in
  each of which cases the reasonable fees and expenses of counsel shall be at
  the expense of the indemnifying party.

       (d) Settlements.  The indemnifying party under this Section 8 shall not
 be liable for any settlement of any proceeding effected without its written
 consent, but if settled with such consent or if there be a final judgment for
 the plaintiff, the indemnifying party agrees to indemnify the indemnified party
 against any loss, claim, damage, liability or expense by reason of such
 settlement or judgment.  Notwithstanding the foregoing sentence, if at any time
 an indemnified party shall have requested an indemnifying party to reimburse
 the indemnified party for the reasonable fees and expenses of counsel as
 contemplated by Section 8(a) and Section 8(c) hereof, the indemnifying party
 agrees that it shall be liable for any settlement of any proceeding effected
 without its written consent if (i) such settlement is entered into more than
 90 days after receipt by such indemnifying party of the aforesaid request and
 (ii) such indemnifying party shall not have reimbursed the indemnified party in
 accordance with such request prior to the date of such settlement.  No
 indemnifying party shall, without the prior written consent of the indemnified
 party, effect any settlement, compromise or consent to the entry of judgment in
 any pending or threatened action, suit or proceeding in respect of which any
 indemnified party is or could have been a party and indemnity was or could have
 been sought hereunder by such indemnified party, unless such settlement,
 compromise or consent includes an unconditional release of such indemnified
 party from all liability on claims that are the subject matter of such action,
 suit or proceeding.

                                      20
<PAGE>
 
          SECTION 9.  CONTRIBUTION.

          If the indemnification provided for in Section 8 is for any reason
held to be unavailable to or otherwise insufficient to hold harmless an
indemnified party in respect of any losses, claims, damages, liabilities or
expenses referred to therein, then each indemnifying party shall contribute to
the aggregate amount paid or payable by such indemnified party, as incurred, as
a result of any losses, claims, damages, liabilities or expenses referred to
therein (i) in such proportion as is appropriate to reflect the relative
benefits received by the Company, on the one hand, and the Underwriters, on the
other hand, from the offering of the Common Shares pursuant to this Agreement or
(ii) if the allocation provided by clause (i) above is not permitted by
applicable law, in such proportion as is appropriate to reflect not only the
relative benefits referred to in clause (i) above but also the relative fault of
the Company, on the one hand, and the Underwriters, on the other hand, in
connection with the statements or omissions or inaccuracies in the
representations and warranties herein which resulted in such losses, claims,
damages, liabilities or expenses, as well as any other relevant equitable
considerations.  The relative benefits received by the Company, on the one hand,
and the Underwriters, on the other hand, in connection with the offering of the
Common Shares pursuant to this Agreement shall be deemed to be in the same
respective proportions as the total net proceeds from the offering of the Common
Shares pursuant to this Agreement (before deducting expenses) received by the
Company, and the total underwriting discount received by the Underwriters, in
each case as set forth on the front cover page of the Prospectus (or, if
Rule 434 under the Securities Act is used, the corresponding location on the
Term Sheet) bear to the aggregate initial public offering price of the Common
Shares as set forth on such cover.  The relative fault of the Company, on the
one hand, and the Underwriters, on the other hand, shall be determined by
reference to, among other things, whether any such untrue or alleged untrue
statement of a material fact or omission or alleged omission to state a material
fact or any such inaccurate or alleged inaccurate representation or warranty
relates to information supplied by the Company, on the one hand, or the
Underwriters, on the other hand, and the parties' relative intent, knowledge,
access to information and opportunity to correct or prevent such statement or
omission.

          The amount paid or payable by a party as a result of the losses,
claims, damages, liabilities and expenses referred to above shall be deemed to
include, subject to the limitations set forth in Section 8(c), any legal or
other fees or expenses reasonably incurred by such party in connection with
investigating or defending any action or claim.  The provisions set forth in
Section 8(c) with respect to notice of commencement of any action shall apply if
a claim for contribution is to be made under this Section 9; provided, however,
that no additional notice shall be required with respect to any action for which
notice has been given under Section 8(c) for purposes of indemnification.

          The Company and the Underwriters agree that it would not be just and
equitable if contribution pursuant to this Section 9 were determined by pro rata
allocation (even if the Underwriters were treated as one entity for such
purpose) or by any other method of allocation which does not take account of the
equitable considerations referred to in this Section 9.

          Notwithstanding the provisions of this Section 9, no Underwriter shall
be required to contribute any amount in excess of the underwriting commissions
received by such Underwriter in connection with the Common Shares underwritten
by it and distributed to the public.  No person guilty of fraudulent
misrepresentation (within the meaning of Section 11(f) of the Securities Act)
shall be entitled to contribution from any person who was not guilty of such

                                      21
<PAGE>
 
fraudulent misrepresentation.  The Underwriters' obligations to contribute
pursuant to this Section 9 are several, and not joint, in proportion to their
respective underwriting commitments as set forth opposite their names in
Schedule A.  For purposes of this Section 9, each officer and employee of an
- ----------                                                                  
Underwriter and each person, if any, who controls an Underwriter within the
meaning of the Securities Act and the Exchange Act shall have the same rights to
contribution as such Underwriter, and each director of the Company, each officer
of the Company who signed the Registration Statement, and each person, if any,
who controls the Company with the meaning of the Securities Act and the Exchange
Act shall have the same rights to contribution as the Company.

          SECTION 10. DEFAULT OF ONE OR MORE OF THE SEVERAL UNDERWRITERS.  If,
on the First Closing Date or the Second Closing Date, as the case may be, any
one or more of the several Underwriters shall fail or refuse to purchase Common
Shares that it or they have agreed to purchase hereunder on such date, and the
aggregate number of Common Shares which such defaulting Underwriter or
Underwriters agreed but failed or refused to purchase does not exceed 10% of the
aggregate number of the Common Shares to be purchased on such date, the other
Underwriters shall be obligated, severally, in the proportions that the number
of Firm Common Shares set forth opposite their respective names on Schedule A
                                                                   ----------
bears to the aggregate number of Firm Common Shares set forth opposite the names
of all such non-defaulting Underwriters, or in such other proportions as may be
specified by the Representatives with the consent of the non-defaulting
Underwriters, to purchase the Common Shares which such defaulting Underwriter or
Underwriters agreed but failed or refused to purchase on such date. If, on the
First Closing Date or the Second Closing Date, as the case may be, any one or
more of the Underwriters shall fail or refuse to purchase Common Shares and the
aggregate number of Common Shares with respect to which such default occurs
exceeds 10% of the aggregate number of Common Shares to be purchased on such
date, and arrangements satisfactory to the Representatives and the Company for
the purchase of such Common Shares are not made within 48 hours after such
default, this Agreement shall terminate without liability of any party to any
other party except that the provisions of Section 4, Section 8 and Section 9
shall at all times be effective and shall survive such termination.  In any such
case either the Representatives or the Company shall have the right to postpone
the First Closing Date or the Second Closing Date, as the case may be, but in no
event for longer than seven days in order that the required changes, if any, to
the Registration Statement and the Prospectus or any other documents or
arrangements may be effected.

          As used in this Agreement, the term "Underwriter" shall be deemed to
include any person substituted for a defaulting Underwriter under this
Section 10.  Any action taken under this Section 10 shall not relieve any
defaulting Underwriter from liability in respect of any default of such
Underwriter under this Agreement.

          SECTION 11. TERMINATION OF THIS AGREEMENT.  Prior to the First Closing
Date this Agreement maybe terminated by the Representatives by notice given to
the Company if at any time (i) trading or quotation in any of the Company's
securities shall have been suspended or limited by the Commission or by the
Nasdaq Stock Market, or trading in securities generally on either the Nasdaq
Stock Market or the New York Stock Exchange shall have been suspended or
limited, or minimum or maximum prices shall have been generally established on
any of such stock exchanges by the Commission or the NASD; (ii) a general
banking moratorium shall have been declared by any of federal, New York ,
Delaware or California authorities; (iii) there shall have occurred any outbreak
or escalation of national or international hostilities or any crisis or

                                      22
<PAGE>
 
calamity, or any change in the United States or international financial markets,
or any substantial change or development involving a prospective substantial
change in United States' or international political, financial or economic
conditions, as in the judgment of the Representatives is material and adverse
and makes it impracticable to market the Common Shares in the manner and on the
terms described in the Prospectus or to enforce contracts for the sale of
securities; (iv) in the judgment of the Representatives there shall have
occurred any Material Adverse Change; or (v) the Company shall have sustained a
loss by strike, fire, flood, earthquake, accident or other calamity of such
character as in the judgment of the Representatives may interfere materially
with the conduct of the business and operations of the Company regardless of
whether or not such loss shall have been insured.  Any termination pursuant to
this Section 11 shall be without liability on the part of (a) the Company to any
Underwriter, except that the Company shall be obligated to reimburse the
expenses of the Representatives and the Underwriters pursuant to Sections 4
and 6 hereof, (b) any Underwriter to the Company, or (c) of any party hereto to
any other party except that the provisions of Section 8 and Section 9 shall at
all times be effective and shall survive such termination.

          SECTION 12. REPRESENTATIONS AND INDEMNITIES TO SURVIVE DELIVERY.  The
respective indemnities, agreements, representations, warranties and other
statements of the Company, of its officers and of the several Underwriters set
forth in or made pursuant to this Agreement will remain in full force and
effect, regardless of any investigation made by or on behalf of any Underwriter
or the Company or any of its or their partners, officers or directors or any
controlling person, as the case may be, and will survive delivery of and payment
for the Common Shares sold hereunder and any termination of this Agreement.

          SECTION 13. NOTICES.    All communications hereunder shall be in
writing and shall be mailed, hand delivered or telecopied and confirmed to the
parties hereto as follows:

If to the Representatives:

     Montgomery Securities
     600 Montgomery Street
     San Francisco, California  94111
     Facsimile:  415-249-5558
     Attention:  Richard A. Smith

 with a copy to:

     Montgomery Securities
     600 Montgomery Street
     San Francisco, California  94111
     Facsimile:  (415) 249-5553
     Attention:  David A. Baylor, Esq.

                                      23
<PAGE>
 
If to the Company:

     Megabios Corp.
     863 A Mitten Road
     Burlingame, California  94010
     Facsimile:  (650) 652-1990
     Attention:  Patrick G. Enright

Any party hereto may change the address for receipt of communications by giving
written notice to the others.

          SECTION 14.  SUCCESSORS.    This Agreement will inure to the benefit
of and be binding upon the parties hereto, including any substitute Underwriters
pursuant to Section 10 hereof, and to the benefit of the employees, officers and
directors and controlling persons referred to in Section 8 and Section 9, and in
each case their respective successors, and no other person will have any right
or obligation hereunder.  The term "successors" shall not include any purchaser
of the Common Shares as such from any of the Underwriters merely by reason of
such purchase.

          SECTION 15.  PARTIAL UNENFORCEABILITY.  The invalidity or
unenforceability of any Section, paragraph or provision of this Agreement shall
not affect the validity or enforceability of any other Section, paragraph or
provision hereof.  If any Section, paragraph or provision of this Agreement is
for any reason determined to be invalid or unenforceable, there shall be deemed
to be made such minor changes (and only such minor changes) as are necessary to
make it valid and enforceable.

          SECTION 16.  GOVERNING LAW PROVISIONS.  THIS AGREEMENT SHALL BE
GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS OF THE STATE OF
CALIFORNIA APPLICABLE TO AGREEMENTS MADE AND TO BE PERFORMED IN SUCH STATE.

          Consent to Jurisdiction. Any legal suit, action or proceeding arising
out of or based upon this Agreement or the transactions contemplated hereby
("Related Proceedings") may be instituted in the federal courts of the United
States of America located in the City and County of San Francisco or the courts
of the State of California in each case located in the City and County of San
Francisco (collectively, the "Specified Courts"), and each party irrevocably
submits to the exclusive jurisdiction (except for proceedings instituted in
regard to the enforcement of a judgment of any such court (a "Related
Judgment"), as to which such jurisdiction is non-exclusive) of such courts in
any such suit, action or proceeding.  Service of any process, summons, notice or
document by mail to such party's address set forth above shall be effective
service of process for any suit, action or other proceeding brought in any such
court.  The parties irrevocably and unconditionally waive any objection to the
laying of venue of any suit, action or other proceeding in the Specified Courts
and irrevocably and unconditionally waive and agree not to plead or claim in any
such court that any such suit, action or other proceeding brought in any such
court has been brought in an inconvenient forum.

                                      24
<PAGE>
 
          SECTION 17.  GENERAL PROVISIONS.  This Agreement constitutes the
entire agreement of the parties to this Agreement and supersedes all prior
written or oral and all contemporaneous oral agreements, understandings and
negotiations with respect to the subject matter hereof.  This Agreement may be
executed in two or more counterparts, each one of which shall be an original,
with the same effect as if the signatures thereto and hereto were upon the same
instrument.  This Agreement may not be amended or modified unless in writing by
all of the parties hereto, and no condition herein (express or implied) may be
waived unless waived in writing by each party whom the condition is meant to
benefit.  The Table of Contents and the Section headings herein are for the
convenience of the parties only and shall not affect the construction or
interpretation of this Agreement.

          Each of the parties hereto acknowledges that it is a sophisticated
business person who was adequately represented by counsel during negotiations
regarding the provisions hereof, including, without limitation, the
indemnification provisions of Section 8 and the contribution provisions of
Section 9, and is fully informed regarding said provisions.  Each of the parties
hereto further acknowledges that the provisions of Sections 8 and 9 hereto
fairly allocate the risks in light of the ability of the parties to investigate
the Company, its affairs and its business in order to assure that adequate
disclosure has been made in the Registration Statement, any preliminary
prospectus and the Prospectus (and any amendments and supplements thereto), as
required by the Securities Act and the Exchange Act.

                                      25
<PAGE>
 
     If the foregoing is in accordance with your understanding of our agreement,
kindly sign and return to the Company the enclosed copies hereof, whereupon this
instrument, along with all counterparts hereof, shall become a binding agreement
in accordance with its terms.

                              Very truly yours,

                              MEGABIOS CORP.



                               By:__________________________
                                         [Title]


     The foregoing Underwriting Agreement is hereby confirmed and accepted by
the Representatives in San Francisco, California as of the date first above
written.

MONTGOMERY SECURITIES
HAMBRECHT & QUIST LLC
Acting as Representatives of the
several Underwriters named in
the attached Schedule A.

By MONTGOMERY SECURITIES



By:_____________________________

                                      26
<PAGE>
 
                                   SCHEDULE A



                               NUMBER OF
UNDERWRITERS               FIRM COMMON SHARES
                            TO BE PURCHASED

Montgomery Securities......      [___]
Hambrecht & Quist LLC......      [___]
[___]......................      [___]
[___]......................      [___]
 
     Total.................     2,500,000

<PAGE>
 
                                                                     EXHIBIT 3.4

                              AMENDED AND RESTATED
                          CERTIFICATE OF INCORPORATION
                                       OF
                                 MEGABIOS CORP.


                                       I.

     The name of the Corporation is:

                                 MEGABIOS Corp.

                                      II.

     The address of the registered office of the Corporation in the State of
Delaware is 1013 Centre Road, City of Wilmington, County of New Castle, and the
name of the registered agent of the Corporation in the State of Delaware at such
address is Corporation Service Company.

                                      III.

     The purpose of the Corporation is to engage in any lawful act or activity
for which a corporation may be organized under the General Corporation Law of
the State of Delaware.

                                      IV.

     The Corporation is authorized to issue two classes of stock to be
designated, respectively, "Common Stock" and "Preferred Stock."  The total
number of shares which the corporation is authorized to issue is Forty Million
(40,000,000) shares.  Thirty Million (30,000,000) shares shall be Common Stock,
each having a par value of one tenth of one cent ($.001).  Ten Million
(10,000,000) shares shall be Preferred Stock, each having a par value of one
tenth of one cent ($.001).

     The Board of Directors is authorized to provide by resolution or
resolutions for the issuance of shares of stock of any class or of any series of
any class at any time and from time to time and, by filing a Certificate of
Designation in the manner prescribed under the laws of the State of Delaware, to
fix and amend the voting powers, full or limited, or no voting powers, and the
designations, preferences and relative, participating, optional or other special
rights, if any, and qualifications, limitations or restrictions thereof.  Unless
otherwise provided in any such resolution or resolutions, the number of shares
of stock of any such series to which such resolution or resolutions apply may be
increased (but not above the total number of authorized shares of the class) or
decreased (but not below the number of shares thereof then outstanding) by
filing a Certificate of Designation in the manner prescribed under the laws of
the State of Delaware.  In case the number of shares of any series shall be
decreased in accordance with the
<PAGE>
 
foregoing sentence, the shares constituting such decrease shall resume the
status that they had prior to the adoption of the resolution originally fixing
the number of shares of such series.

     Shares of Common Stock and Preferred Stock may be issued from time to time
as the Board of Directors of the corporation shall determine and on such terms
and for such consideration as shall be fixed by the Board of Directors.

     No holder of any shares of stock of the Corporation of any class shall be
entitled as such, as a matter of right, to subscribe for or purchase any shares
of stock of the Corporation of any class, whether now or hereafter authorized or
whether issued for cash, property or services or as a dividend or otherwise, or
to subscribe for or purchase any obligations, bonds, notes, debentures, other
securities or stock convertible into shares of stock of the Corporation of any
class or carrying or evidencing any right to purchase shares of stock of any
class.

     Except as may be required by law, each holder of Common Stock shall have
one vote in respect of each share of Common Stock held by such person on all
matters voted upon by the stockholders.

                                       V.

     A.  For the management of the business and for the conduct of the affairs
of the Corporation, and in further definition, limitation and regulation of the
powers of the Corporation, of its directors and of its stockholders or any class
thereof, as the case may be, it is further provided that:

     (1) The management of the business and the conduct of the affairs of the
Corporation shall be vested in its Board of Directors.  The number of directors
which shall constitute the whole Board of Directors shall be fixed exclusively
by one or more resolutions adopted by the Board of Directors.

     (2) A majority of the whole Board of Directors shall constitute a quorum
for the transaction of business, and, except as otherwise provided in this
Restated Certificate of Incorporation or the Bylaws, the vote of a majority of
the directors present at a meeting at which a quorum is then present shall be
the act of the Board.  As used in this Restated Certificate of Incorporation,
the terms "whole Board" and "whole Board of Directors" are hereby exclusively
defined and limited to mean the total number of directors which the Corporation
would have if the Board had no vacancies.

     (3) Subject to the rights of the holders of any series of Preferred Stock
to elect additional directors under specified circumstances, following the
closing of the initial public offering pursuant to an effective registration
statement under the Securities Act of 1933, as amended, covering the offer and
sale of Common Stock to the public (the "Initial Public Offering"), the
directors shall be divided into three classes (to be designated as Class I,
Class II and Class III, respectively), as nearly equal in number as the then
total number of Directors constituting the whole Board of Directors permits,
with the terms of office of one class expiring each year.  Benjamin F. McGraw,
III and Frank J. Caufield are hereby named as Class I

                                       2
<PAGE>
 
Directors to hold office for a term expiring at the annual meeting of
stockholders in 1998 and until their respective successors are duly elected and
qualified or until their respective earlier resignation or removal; A. Grant
Heidrich and Edward L. Erickson are hereby named as Class II Directors to hold
office for a term expiring at the annual meeting of stockholders in 1999 and
until their respective successors are duly elected and qualified or until their
earlier resignation or removal; Raju Kucherlapati and Russell C. Hirsch are
hereby named as Class III Directors to hold office for a term expiring at the
annual meeting of stockholders in 2000 and until their respective successors are
duly elected and qualified or until their respective earlier resignation or
removal.  Notwithstanding the foregoing, and except as otherwise required by
law, whenever the holders of any one or more series of Preferred Stock shall
have the right, voting separately as a class, to elect one or more Directors of
the Corporation, the terms of the Director or Directors elected by such holders
shall expire at the next succeeding annual meeting of stockholders.  Subject to
the foregoing, at each annual meeting of stockholders the successors to the
class of directors whose term shall then expire shall be elected to hold office
for a term expiring at the third succeeding annual meeting.  Notwithstanding the
foregoing, each director shall serve until his successor shall have been duly
elected and qualified, unless he or she shall resign, become disqualified,
disabled or shall otherwise be removed.  No decrease in the number of directors
constituting the Board of Directors shall shorten the term of any incumbent
director.

     (4) Subject to the rights of the holders of any series of Preferred Stock,
and notwithstanding the fact that some lesser percentage may be specified by
law, this Restated Certificate of Incorporation or the Bylaws, the Board of
Directors or any individual director may be removed from office at any time (i)
with cause by the affirmative vote of the holders of a majority of the voting
power of all the then-outstanding shares of voting stock of the Corporation,
entitled to vote at an election of directors (the "Voting Stock") or (ii)
without cause by the affirmative vote of the holders of at least sixty-six and
two-thirds percent (66 2/3%) of the voting power of all the then-outstanding
shares of the Voting Stock.  As used in this Restated Certificate of
Incorporation, the term "with cause" is hereby exclusively defined and limited
to mean commission of a felony or a finding by a court of competent jurisdiction
of liability for negligence, or misconduct, in the performance of the director's
duty to the Corporation in a matter of substantial importance to the
Corporation, where such adjudication is no longer subject to direct appeal.

     (5) Subject to the rights of the holders of any series of Preferred Stock,
any vacancies on the Board of Directors resulting from death, resignation,
disqualification, removal or other causes and any newly created directorships
resulting from any increase in the number of directors, shall, unless the Board
of Directors determines by resolution that any such vacancies or newly created
directorships shall be filled by the stockholders, except as otherwise provided
by law, be filled only by the affirmative vote of a majority of the directors
then in office, even though less than a quorum of the Board of Directors, and
not by the stockholders.  Any director elected in accordance with the preceding
sentence shall hold office for the remainder of the full term of the director
for which the vacancy was created or occurred and until such director's
successor shall have been elected and qualified.

     B.  (1)  Subject to paragraph (h) of Section 43 of the Bylaws, and
notwithstanding the fact that some lesser percentage may be specified law, the
Bylaws may be altered or

                                       3
<PAGE>
 
amended or new Bylaws adopted by the affirmative vote of at least sixty-six and
two-thirds percent (66-2/3%) of the voting power of all of the then-outstanding
shares of the Voting Stock.  The Board of Directors shall also have the power to
adopt, amend, or repeal Bylaws.

     (2) The directors of the Corporation need not be elected by written ballot
unless the Bylaws so provide.

     (3) No action shall be taken by the stockholders of the Corporation except
at an annual or special meeting of stockholders called in accordance with the
Bylaws and following the closing of the Initial Public Offering no action shall
be taken by the stockholders by written consent.

     (4) Advance notice of stockholder nominations for the election of directors
and of business to be brought by stockholders before any meeting of the
stockholders of the Corporation shall be given in the manner provided in the
Bylaws of the Corporation.

     (5) Special meetings of the stockholders of the Corporation may be called,
for any purpose or purposes, by (i) the Chairman of the Board of Directors, (ii)
the President, (iii) the Board of Directors pursuant to a resolution adopted by
a majority of the total number of authorized directors (whether or not there
exist any vacancies in previously authorized directorships at the time any such
resolution is presented to the Board of Directors for adoption) or (iv) by the
holders of the shares entitled to cast not less that ten percent (10%) of the
votes at the meeting, and shall be held at such place, on such date, and at such
time as the Board of Directors shall fix.

                                      VI.

     A.  The Corporation may agree to the terms and conditions upon which any
director, officer, employee or agent accepts his office or position and in its
Bylaws, by contract or in any other manner may agree to indemnify and protect
any director, officer, employee or agent of the Corporation, or any person who
serves at the request of the Corporation as a director, officer, employee or
agent of another corporation, partnership, joint ventures, trust, employee
benefit plan or other enterprise, to the fullest extent permitted by the laws
(including, without limitation, the statutes, case law and principles of equity)
of the State of Delaware.  If the laws (including, without limitation, the
statutes, case law or principles of equity, as the case may be) of the State of
Delaware are amended or changed to permit or authorize broader rights of
indemnification to any of the persons referred to in the immediately preceding
sentence, then the Corporation shall be automatically authorized to agree to
indemnify such respective persons to the fullest extent permitted or authorized
by such law, as so amended or changed, without the need for amendment or
modification of this Article VI and without further action by the directors or
stockholders of the Corporation.

     B.   A director of the Corporation shall not be personally liable to the
Corporation or its stockholders for monetary damages for any breach of fiduciary
duty as a director, except for liability (i) for any breach of the director's
duty of loyalty to the Corporation or its stockholders, (ii) for acts or
omissions not in good faith or which involve intentional misconduct or a knowing

                                       4
<PAGE>
 
violation of law, (iii) under Section 174 of the Delaware General Corporation
Law, or (iv) for any transaction from which the director derived an improper
personal benefit.  If the Delaware General Corporation Law is amended after
approval by the stockholders of this Article to authorize corporate action
further eliminating or limiting the personal liability of directors, then the
liability of a director shall be eliminated or limited to the fullest extent
permitted by the Delaware General Corporation Law, as so amended.

     C.  Any repeal or modification of this Article VI shall be prospective and
shall not affect the rights under this Article VI in effect at the time of the
alleged occurrence of any act or omission to act giving rise to liability or
indemnification.

                                      VII.

     Whenever a compromise or arrangement is proposed between this Corporation
and its creditors or any class of them and/or between this Corporation and its
stockholders or any class of them, any court of equitable jurisdiction within
the State of Delaware may, on the application in a summary way of this
Corporation or of any creditor or stockholder thereof or on the application of
any receivers appointed for this Corporation under the provisions of Section 291
of Title 8 of the Delaware Code or on the application of trustees in dissolution
or of nay receiver or receivers appointed for this Corporation under the
provisions of Section 279 of Title 8 of the Delaware Code order a meeting of the
creditors or class of creditors, and/or the stockholders or class of
stockholders of this Corporation, as the case may be, to be summoned in such
manner as the said court directs.  If a majority in number representing three-
fourths in value of the creditors or class of creditors, and/or of the
stockholders or class of stockholders of this Corporation, as the case may be,
agree to any compromise or arrangement and to any reorganization of this
Corporation as consequence of such compromise or arrangement, the said
compromise or arrangement and the said reorganization shall, if sanctioned by
the court to which the said application has been made, be binding on all the
creditors or class of creditors, or on all the stockholders or class of
stockholders, of this Corporation, as the case may be, and also on this
Corporation.

                                     VIII.

     A.  The Corporation reserves the right to amend, alter, change or repeal
any provision contained in this Restated Certificate of Incorporation, in the
manner now or hereafter prescribed by statute, except as provided in paragraph
B. of this Article VIII, and all rights conferred upon the stockholders herein
are granted subject to this reservation.

     B.  Notwithstanding any other provisions of this Restated Certificate of
Incorporation or any provision of law which might otherwise permit a lesser vote
or no vote, but in addition to any affirmative vote of the holders of any
particular class or series of the Voting Stock required by law, this Restated
Certificate of Incorporation or any Preferred Stock Designation, the affirmative
vote of the holders of at least sixty-six and two-thirds percent (66-2/3%) of
the voting power of all of the then-outstanding shares of the Voting Stock,
voting together as a single class, shall be required to alter, amend or repeal
Articles V, VI, and VIII.

                                       5

<PAGE>

                                                                     EXHIBIT 3.5

                                    BYLAWS

                                      OF

                         MEGABIOS MERGER CORPORATION

                           (A DELAWARE CORPORATION)
<PAGE>
 
                               TABLE OF CONTENTS
<TABLE>
<CAPTION>
 
                                                                            PAGE

<S>                                                                          <C>
Article I    Offices........................................................  1
     Section 1.  Registered Office..........................................  1
     Section 2.  Other Offices..............................................  1

Article II   Corporate Seal.................................................  1
     Section 3.  Corporate Seal.............................................  1

Article III  Stockholders' Meetings.........................................  1
     Section 4.  Place of Meetings..........................................  1
     Section 5.  Annual Meeting.............................................  1
     Section 6.  Special Meetings...........................................  3
     Section 7.  Notice of Meetings.........................................  4
     Section 8.  Quorum.....................................................  4
     Section 9.  Adjournment and Notice of Adjourned Meetings...............  5
     Section 10. Voting Rights..............................................  5
     Section 11. Joint Owners of Stock......................................  5
     Section 12. List of Stockholders.......................................  5
     Section 13. Action Without Meeting.....................................  6
     Section 14. Organization...............................................  6

Article IV   Directors......................................................  7
     Section 15. Number and Term of Office..................................  7
     Section 16. Powers.....................................................  7
     Section 17. Classes of Directors.......................................  7
     Section 18. Vacancies..................................................  7
     Section 19. Resignation................................................  8
     Section 20. Removal....................................................  8
     Section 21. Meetings...................................................  8
            (a)  Annual Meetings............................................  8
            (b)  Regular Meetings...........................................  8
            (c)  Special Meetings...........................................  8
            (d)  Telephone Meetings.........................................  8
            (e)  Notice of Meetings.........................................  9
            (f)  Waiver of Notice...........................................  9
     Section 22. Quorum and Voting..........................................  9
     Section 23. Action Without Meeting.....................................  9
     Section 24. Fees and Compensation......................................  9
     Section 25. Committees................................................. 10
            (a)  Executive Committee........................................ 10
            (b)  Other Committees........................................... 10
            (c)  Term....................................................... 10
            (d)  Meetings................................................... 11
</TABLE>


                                      i.
<PAGE>
 
                               TABLE OF CONTENTS
                                  (CONTINUED)

<TABLE>
<CAPTION>
                                                                            Page
<S>                                                                          <C>
     Section 26. Organization............................................... 11

Article V    Officers....................................................... 11
     Section 27. Officers Designated........................................ 11
     Section 28. Tenure and Duties of Officers.............................. 11
            (a)  General.................................................... 12
            (b)  Duties of Chairman of the Board of Directors............... 12
            (c)  Duties of Chief Executive Officer.......................... 12
            (d)  Duties of President........................................ 12
            (e)  Duties of Vice Presidents.................................. 12
            (f)  Duties of Secretary........................................ 12
            (g)  Duties of Chief Financial Officer.......................... 13
     Section 29. Delegation of Authority.................................... 13
     Section 30. Resignations............................................... 13
     Section 31. Removal.................................................... 13

Article VI   Execution Of Corporate Instruments And Voting
             Of Securities Owned By The Corporation......................... 13
     Section 32. Execution of Corporate Instruments......................... 13
     Section 33. Voting of Securities Owned by the Corporation.............. 14

Article VII  Shares Of Stock................................................ 15
     Section 34. Form and Execution of Certificates......................... 15
     Section 35. Lost Certificates.......................................... 15
     Section 36. Transfers.................................................. 15
     Section 37. Fixing Record Dates........................................ 16
     Section 38. Registered Stockholders.................................... 17

Article VIII Other Securities Of The Corporation............................ 17
     Section 39. Execution of Other Securities.............................. 17

Article IX   Dividends...................................................... 17
     Section 40. Declaration of Dividends................................... 17
     Section 41. Dividend Reserve........................................... 18

Article X    Fiscal Year.................................................... 18
     Section 42. Fiscal Year................................................ 18
</TABLE>


                                      ii.
<PAGE>
 
                               TABLE OF CONTENTS
                                  (CONTINUED)

<TABLE>
<CAPTION> 
                                                                            Page
<S>                                                                          <C>
Article XI   Indemnification................................................ 18
     Section 43. Indemnification of Directors, Executive Officers, Other
                 Officers, Employees and Other Agents....................... 18
            (a)  Directors and Officers..................................... 18
            (b)  Employees and Other Agents................................. 18
            (c)  Expenses................................................... 18
            (d)  Enforcement................................................ 19
            (e)  Non-Exclusivity of Rights.................................. 20
            (f)  Survival of Rights......................................... 20
            (g)  Insurance.................................................. 20
            (h)  Amendments................................................. 20
            (i)  Saving Clause.............................................. 20
            (j)  Certain Definitions........................................ 20

Article XII  Notices........................................................ 21
     Section 44. Notices.................................................... 21
            (a)  Notice to Stockholders..................................... 21
            (b)  Notice to Directors........................................ 21
            (c)  Affidavit of Mailing....................................... 21
            (d)  Time Notices Deemed Given.................................. 22
            (e)  Methods of Notice.......................................... 22
            (f)  Failure to Receive Notice.................................. 22
            (g)  Notice to Person with Whom Communication Is Unlawful....... 22
            (h)  Notice to Person with Undeliverable Address................ 22

Article XIII Amendments..................................................... 23
     Section 45. Amendments................................................. 23

Article XIV  Loans To Officers.............................................. 23
     Section 46. Loans to Officers.......................................... 23

Article XV   Miscellaneous.................................................. 23
     Section 47. Annual Report.............................................. 23
</TABLE>


                                     iii.
<PAGE>
 
                                    BYLAWS

                                      OF

                          MEGABIOS MERGER CORPORATION

                           (A DELAWARE CORPORATION)



                                   ARTICLE I

                                    OFFICES

          SECTION 1.  REGISTERED OFFICE.  The registered office of the
corporation in the State of Delaware shall be in the City of Wilmington, County
of New Castle.

          SECTION 2.  OTHER OFFICES.  The corporation shall also have and
maintain an office or principal place of business at such place as may be fixed
by the Board of Directors, and may also have offices at such other places, both
within and without the State of Delaware as the Board of Directors may from time
to time determine or the business of the corporation may require.

                                  ARTICLE II

                                CORPORATE SEAL

          SECTION 3.  CORPORATE SEAL.  The corporate seal shall consist of a die
bearing the name of the corporation and the inscription, "Corporate Seal-
Delaware."  Said seal may be used by causing it or a facsimile thereof to be
impressed or affixed or reproduced or otherwise.

                                  ARTICLE III

                            STOCKHOLDERS' MEETINGS

          SECTION 4.  PLACE OF MEETINGS.  Meetings of the stockholders of the
corporation shall be held at such place, either within or without the State of
Delaware, as may be designated from time to time by the Board of Directors, or,
if not so designated, then at the office of the corporation required to be
maintained pursuant to Section 2 hereof.

          SECTION 5.  ANNUAL MEETING.

          (A) The annual meeting of the stockholders of the corporation, for the
purpose of election of directors and for such other business as may lawfully
come before it, shall be held

                                      1.
<PAGE>
 
on such date and at such time as may be designated from time to time by the
Board of Directors.

          (B) At an annual meeting of the stockholders, only such business shall
be conducted as shall have been properly brought before the meeting.  To be
properly brought before an annual meeting, business must be:  (A) specified in
the notice of meeting (or any supplement thereto) given by or at the direction
of the Board of Directors, (B) otherwise properly brought before the meeting by
or at the direction of the Board of Directors, or (C) otherwise properly brought
before the meeting by a stockholder.  For business to be properly brought before
an annual meeting by a stockholder, the stockholder must have given timely
notice thereof in writing to the Secretary of the corporation.  To be timely, a
stockholder's notice must be delivered to or mailed and received at the
principal executive offices of the corporation not later than the close of
business on the sixtieth (60th) day nor earlier than the close of business on
the ninetieth (90th) day prior to the first anniversary of the preceding year's
annual meeting; provided, however, that in the event that no annual meeting was
held in the previous year or the date of the annual meeting has been changed by
more than thirty (30) days from the date contemplated at the time of the
previous year's proxy statement, notice by the stockholder to be timely must be
so received not earlier than the close of business on the ninetieth (90th) day
prior to such annual meeting and not later than the close of business on the
later of the sixtieth (60th) day prior to such annual meeting or, in the event
public announcement of the date of such annual meeting is first made by the
corporation fewer than seventy (70) days prior to the date of such annual
meeting, the close of business on the tenth (10th) day following the day on
which public announcement of the date of such meeting is first made by the
corporation. A stockholder's notice to the Secretary shall set forth as to each
matter the stockholder proposes to bring before the annual meeting:  (i) a brief
description of the business desired to be brought before the annual meeting and
the reasons for conducting such business at the annual meeting, (ii) the name
and address, as they appear on the corporation's books, of the stockholder
proposing such business, (iii) the class and number of shares of the corporation
which are beneficially owned by the stockholder, (iv) any material interest of
the stockholder in such business and (v) any other information that is required
to be provided by the stockholder pursuant to Regulation 14A under the
Securities Exchange Act of 1934, as amended (the "1934 Act"), in his capacity as
a proponent to a stockholder proposal.  Notwithstanding the foregoing, in order
to include information with respect to a stockholder proposal in the proxy
statement and form of proxy for a stockholder's meeting, stockholders must
provide notice as required by the regulations promulgated under the 1934 Act.
Notwithstanding anything in these Bylaws to the contrary, no business shall be
conducted at any annual meeting except in accordance with the procedures set
forth in this paragraph (b).  The chairman of the annual meeting shall, if the
facts warrant, determine and declare at the meeting that business was not
properly brought before the meeting and in accordance with the provisions of
this paragraph (b), and, if he should so determine, he shall so declare at the
meeting that any such business not properly brought before the meeting shall not
be transacted.

          (C) Only persons who are nominated in accordance with the procedures
set forth in this paragraph (c) shall be eligible for election as directors.
Nominations of persons for election to the Board of Directors of the corporation
may be made at a meeting of stockholders by or at the direction of the Board of
Directors or by any stockholder of the corporation entitled

                                      2.
<PAGE>
 
to vote in the election of directors at the meeting who complies with the notice
procedures set forth in this paragraph (c).  Such nominations, other than those
made by or at the direction of the Board of Directors, shall be made pursuant to
timely notice in writing to the Secretary of the corporation in accordance with
the provisions of paragraph (b) of this Section 5.  Such stockholder's notice
shall set forth (i) as to each person, if any, whom the stockholder proposes to
nominate for election or re-election as a director:  (A) the name, age, business
address and residence address of such person, (B) the principal occupation or
employment of such person, (C) the class and number of shares of the corporation
which are beneficially owned by such person, (D) a description of all
arrangements or understandings between the stockholder and each nominee and any
other person or persons (naming such person or persons) pursuant to which the
nominations are to be made by the stockholder, and (E) any other information
relating to such person that is required to be disclosed in solicitations of
proxies for election of directors, or is otherwise required, in each case
pursuant to Regulation 14A under the 1934 Act (including without limitation such
person's written consent to being named in the proxy statement, if any, as a
nominee and to serving as a director if elected); and (ii) as to such
stockholder giving notice, the information required to be provided pursuant to
paragraph (b) of this Section 5.  At the request of the Board of Directors, any
person nominated by a stockholder for election as a director shall furnish to
the Secretary of the corporation that information required to be set forth in
the stockholder's notice of nomination which pertains to the nominee.  No person
shall be eligible for election as a director of the corporation unless nominated
in accordance with the procedures set forth in this paragraph (c).  The chairman
of the meeting shall, if the facts warrant, determine and declare at the meeting
that a nomination was not made in accordance with the procedures prescribed by
these Bylaws, and if he should so determine, he shall so declare at the meeting,
and the defective nomination shall be disregarded.

          (D) For purposes of this Section 5, "public announcement" shall mean
disclosure in a press release reported by the Dow Jones News Service, Associated
Press or comparable national news service or in a document publicly filed by the
corporation with the Securities and Exchange Commission pursuant to Section 13,
14 or 15(d) of the Exchange Act.

          SECTION 6.  SPECIAL MEETINGS.

          (A) Special meetings of the stockholders of the corporation may be
called, for any purpose or purposes, by (i) the Chairman of the Board of
Directors, (ii) the Chief Executive Officer, (iii) the Board of Directors
pursuant to a resolution adopted by a majority of the total number of authorized
directors (whether or not there exist any vacancies in previously authorized
directorships at the time any such resolution is presented to the Board of
Directors for adoption) or (iv) by the holders of shares entitled to cast not
less than ten percent (10%) of the votes at the meeting, and shall be held at
such place, on such date, and at such time as the Board of Directors, shall fix.

          (B) If a special meeting is called by any person or persons other than
the Board of Directors, the request shall be in writing, specifying the general
nature of the business proposed to be transacted, and shall be delivered
personally or sent by registered mail or by telegraphic or other facsimile
transmission to the Chairman of the Board of Directors, the Chief Executive
Officer, or the Secretary of the corporation.  No business may be transacted at
such

                                       3.
<PAGE>
 
special meeting otherwise than specified in such notice.  The Board of Directors
shall determine the time and place of such special meeting, which shall be held
not less than thirty-five (35) nor more than one hundred twenty (120) days after
the date of the receipt of the request.  Upon determination of the time and
place of the meeting, the officer receiving the request shall cause notice to be
given to the stockholders entitled to vote, in accordance with the provisions of
Section 7 of these Bylaws.  If the notice is not given within sixty (60) days
after the receipt of the request, the person or persons requesting the meeting
may set the time and place of the meeting and give the notice.  Nothing
contained in this paragraph (b) shall be construed as limiting, fixing, or
affecting the time when a meeting of stockholders called by action of the Board
of Directors may be held.

          SECTION 7.  NOTICE OF MEETINGS.  Except as otherwise provided by law
or the Certificate of Incorporation, written notice of each meeting of
stockholders shall be given not less than ten (10) nor more than sixty (60) days
before the date of the meeting to each stockholder entitled to vote at such
meeting, such notice to specify the place, date and hour and purpose or purposes
of the meeting.  Notice of the time, place and purpose of any meeting of
stockholders may be waived in writing, signed by the person entitled to notice
thereof, either before or after such meeting, and will be waived by any
stockholder by his attendance thereat in person or by proxy, except when the
stockholder attends a meeting for the express purpose of objecting, at the
beginning of the meeting, to the transaction of any business because the meeting
is not lawfully called or convened.  Any stockholder so waiving notice of such
meeting shall be bound by the proceedings of any such meeting in all respects as
if due notice thereof had been given.

          SECTION 8.  QUORUM.  At all meetings of stockholders, except where
otherwise provided by statute or by the Certificate of Incorporation, or by
these Bylaws, the presence, in person or by proxy duly authorized, of the
holders of a majority of the outstanding shares of stock entitled to vote shall
constitute a quorum for the transaction of business.  In the absence of a
quorum, any meeting of stockholders may be adjourned, from time to time, either
by the chairman of the meeting or by vote of the holders of a majority of the
shares represented thereat, but no other business shall be transacted at such
meeting.  The stockholders present at a duly called or convened meeting, at
which a quorum is present, may continue to transact business until adjournment,
notwithstanding the withdrawal of enough stockholders to leave less than a
quorum.  Except as otherwise provided by law, the Certificate of Incorporation
or these Bylaws, all action taken by the holders of a majority of the vote cast,
excluding abstentions, at any meeting at which a quorum is present shall be
valid and binding upon the corporation; provided, however, that directors shall
be elected by a plurality of the votes of the shares present in person or
represented by proxy at the meeting and entitled to vote on the election of
directors.  Where a separate vote by a class or classes or series is required,
except where otherwise provided by the statute or by the Certificate of
Incorporation or these Bylaws, a majority of the outstanding shares of such
class or classes or series, present in person or represented by proxy, shall
constitute a quorum entitled to take action with respect to that vote on that
matter and, except where otherwise provided by the statute or by the Certificate
of Incorporation or these Bylaws, the affirmative vote of the majority
(plurality, in the case of the election of directors) of the votes cast,
including abstentions, by the holders of shares of such class or classes or
series shall be the act of such class or classes or series.

                                       4.
<PAGE>
 
          SECTION 9.  ADJOURNMENT AND NOTICE OF ADJOURNED MEETINGS.  Any meeting
of stockholders, whether annual or special, may be adjourned from time to time
either by the chairman of the meeting or by the vote of a majority of the shares
casting votes, excluding abstentions.  When a meeting is adjourned to another
time or place, notice need not be given of the adjourned meeting if the time and
place thereof are announced at the meeting at which the adjournment is taken.
At the adjourned meeting, the corporation may transact any business which might
have been transacted at the original meeting.  If the adjournment is for more
than thirty (30) days or if after the adjournment a new record date is fixed for
the adjourned meeting, a notice of the adjourned meeting shall be given to each
stockholder of record entitled to vote at the meeting.

          SECTION 10.  VOTING RIGHTS.  For the purpose of determining those
stockholders entitled to vote at any meeting of the stockholders, except as
otherwise provided by law, only persons in whose names shares stand on the stock
records of the corporation on the record date, as provided in Section 12 of
these Bylaws, shall be entitled to vote at any meeting of stockholders.  Every
person entitled to vote or execute consents (if such consents are allowed
pursuant to these Bylaws) shall have the right to do so either in person or by
an agent or agents authorized by a proxy granted in accordance with Delaware
law.  An agent so appointed need not be a stockholder.  No proxy shall be voted
after three (3) years from its date of creation unless the proxy provides for a
longer period.

          SECTION 11.  JOINT OWNERS OF STOCK.  If shares or other securities
having voting power stand of record in the names of two (2) or more persons,
whether fiduciaries, members of a partnership, joint tenants, tenants in common,
tenants by the entirety, or otherwise, or if two (2) or more persons have the
same fiduciary relationship respecting the same shares, unless the Secretary is
given written notice to the contrary and is furnished with a copy of the
instrument or order appointing them or creating the relationship wherein it is
so provided, their acts with respect to voting shall have the following effect:
(a) if only one (1) votes, his act binds all; (b) if more than one (1) votes,
the act of the majority so voting binds all; (c) if more than one (1) votes, but
the vote is evenly split on any particular matter, each faction may vote the
securities in question proportionally, or may apply to the Delaware Court of
Chancery for relief as provided in the General Corporation Law of Delaware,
Section 217(b).  If the instrument filed with the Secretary shows that any such
tenancy is held in unequal interests, a majority or even-split for the purpose
of subsection (c) shall be a majority or even-split in interest.

          SECTION 12.  LIST OF STOCKHOLDERS.  The Secretary shall prepare and
make, at least ten (10) days before every meeting of stockholders, a complete
list of the stockholders entitled to vote at said meeting, arranged in
alphabetical order, showing the address of each stockholder and the number of
shares registered in the name of each stockholder.  Such list shall be open to
the examination of any stockholder, for any purpose germane to the meeting,
during ordinary business hours, for a period of at least ten (10) days prior to
the meeting, either at a place within the city where the meeting is to be held,
which place shall be specified in the notice of the meeting, or, if not
specified, at the place where the meeting is to be held.  The list shall be
produced and kept at the time and place of meeting during the whole time thereof
and may be inspected by any stockholder who is present.

                                      5.
<PAGE>
 
          SECTION 13.  ACTION WITHOUT MEETING.

          (a) Unless otherwise provided in the Certificate of Incorporation, any
action required by statute to be taken at any annual or special meeting of the
stockholders, or any action which may be taken at any annual or special meeting
of the stockholders, may be taken without a meeting, without prior notice and
without a vote, if a consent in writing, setting forth the action so taken,
shall be signed by the holders of outstanding stock having not less than the
minimum number of votes that would be necessary to authorize or take such action
at a meeting at which all shares entitled to vote thereon were present and
voted.

          (b) Every written consent shall bear the date of signature of each
stockholder who signs the consent, and no written consent shall be effective to
take the corporate action referred to therein unless, within sixty (60) days of
the earliest dated consent delivered to the corporation in the manner herein
required, written consents signed by a sufficient number of stockholders to take
action are delivered to the corporation by delivery to its registered office in
the State of Delaware, its principal place of business or an officer or agent of
the corporation having custody of the book in which proceedings of meetings of
stockholders are recorded.  Delivery made to a corporation's registered office
shall be by hand or by certified or registered mail, return receipt requested.

          (c) Prompt notice of the taking of the corporate action without a
meeting by less than unanimous written consent shall be given to those
stockholders who have not consented in writing.  If the action which is
consented to is such as would have required the filing of a certificate under
any section of the General Corporation Law of the State of Delaware if such
action had been voted on by stockholders at a meeting thereof, then the
certificate filed under such section shall state, in lieu of any statement
required by such section concerning any vote of stockholders, that written
notice and written consent have been given as provided in Section 228 of the
General Corporation Law of Delaware.

          (d) Notwithstanding the foregoing, no such action by written consent
may be taken following the closing of the initial public offering pursuant to an
effective registration statement under the Securities Act of 1933, as amended
(the "1933 Act"), covering the offer and sale of Common Stock of the corporation
(the "Initial Public Offering").

          SECTION 14.  ORGANIZATION.

          (A) At every meeting of stockholders, the Chairman of the Board of
Directors, or, if a Chairman has not been appointed or is absent, the Chief
Executive Officer, or, if the Chief Executive Officer is absent, a chairman of
the meeting chosen by a majority in interest of the stockholders entitled to
vote, present in person or by proxy, shall act as chairman.  The Secretary, or,
in his absence, an Assistant Secretary directed to do so by the Chairman, shall
act as secretary of the meeting.

          (B) The Board of Directors of the corporation shall be entitled to
make such rules or regulations for the conduct of meetings of stockholders as it
shall deem necessary, appropriate or convenient.  Subject to such rules and
regulations of the Board of Directors, if

                                      6.
<PAGE>
 
any, the chairman of the meeting shall have the right and authority to prescribe
such rules, regulations and procedures and to do all such acts as, in the
judgment of such chairman, are necessary, appropriate or convenient for the
proper conduct of the meeting, including, without limitation, establishing an
agenda or order of business for the meeting, rules and procedures for
maintaining order at the meeting and the safety of those present, limitations on
participation in such meeting to stockholders of record of the corporation and
their duly authorized and constituted proxies and such other persons as the
chairman shall permit, restrictions on entry to the meeting after the time fixed
for the commencement thereof, limitations on the time allotted to questions or
comments by participants and regulation of the opening and closing of the polls
for balloting on matters which are to be voted on by ballot.  Unless and to the
extent determined by the Board of Directors or the chairman of the meeting,
meetings of stockholders shall not be required to be held in accordance with
rules of parliamentary procedure.

                                   ARTICLE IV

                                   DIRECTORS

          SECTION 15.  NUMBER AND TERM OF OFFICE.  The authorized number of
directors of the corporation shall be fixed in accordance with the Certificate
of Incorporation.  Directors need not be stockholders unless so required by the
Certificate of Incorporation.  If for any cause, the directors shall not have
been elected at an annual meeting, they may be elected as soon thereafter as
convenient at a special meeting of the stockholders called for that purpose in
the manner provided in these Bylaws.

          SECTION 16.  POWERS.  The powers of the corporation shall be
exercised, its business conducted and its property controlled by the Board of
Directors, except as may be otherwise provided by statute or by the Certificate
of Incorporation.

          SECTION 17.  CLASSES OF DIRECTORS.  Subject to the rights of the
holders of any series of Preferred Stock to elect additional directors under
specified circumstances, following the closing of the Initial Public Offering,
the directors shall be divided into three classes in accordance with the
provisions of the Certificate of Incorporation.

          SECTION 18.  VACANCIES.  Unless otherwise provided in the Certificate
of Incorporation, any vacancies on the Board of Directors resulting from death,
resignation, disqualification, removal or other causes and any newly created
directorships resulting from any increase in the number of directors, shall
unless the Board of Directors determines by resolution that any such vacancies
or newly created directorships shall be filled by stockholders, be filled only
by the affirmative vote of a majority of the directors then in office, even
though less than a quorum of the Board of Directors.  Any director elected in
accordance with the preceding sentence shall hold office for the remainder of
the full term of the director for which the vacancy was created or occurred and
until such director's successor shall have been elected and qualified.  A
vacancy in the Board of Directors shall be deemed to exist under this Bylaw in
the case of the death, removal or resignation of any director.

                                      7.
<PAGE>
 
          SECTION 19.  RESIGNATION.  Any director may resign at any time by
delivering his written resignation to the Secretary, such resignation to specify
whether it will be effective at a particular time, upon receipt by the Secretary
or at the pleasure of the Board of Directors.  If no such specification is made,
it shall be deemed effective at the pleasure of the Board of Directors.  When
one or more directors shall resign from the Board of Directors, effective at a
future date, a majority of the directors then in office, including those who
have so resigned, shall have power to fill such vacancy or vacancies, the vote
thereon to take effect when such resignation or resignations shall become
effective, and each Director so chosen shall hold office for the unexpired
portion of the term of the Director whose place shall be vacated and until his
successor shall have been duly elected and qualified.

          SECTION 20.  REMOVAL.  Subject to the rights of the holders of any
series of Preferred Stock, the Board of Directors or any individual director may
be removed from office at any time (i) with cause by the affirmative vote of the
holders of a majority of the voting power of all the then-outstanding shares of
voting stock of the corporation, entitled to vote at an election of directors
(the "Voting Stock") or (ii) without cause by the affirmative vote of the
holders of at least sixty-six and two-thirds percent (66 2/3%) of the voting
power of all the then-outstanding shares of the Voting Stock.

          SECTION 21.  MEETINGS.

          (A) ANNUAL MEETINGS.  The annual meeting of the Board of Directors
shall be held immediately before or after the annual meeting of stockholders and
at the place where such meeting is held.  No notice of an annual meeting of the
Board of Directors shall be necessary and such meeting shall be held for the
purpose of electing officers and transacting such other business as may lawfully
come before it.

          (B) REGULAR MEETINGS.  Except as hereinafter otherwise provided,
regular meetings of the Board of Directors shall be held in the office of the
corporation required to be maintained pursuant to Section 2 hereof.  Unless
otherwise restricted by the Certificate of Incorporation, regular meetings of
the Board of Directors may also be held at any place within or without the State
of Delaware which has been designated by resolution of the Board of Directors or
the written consent of all directors.

          (C) SPECIAL MEETINGS.  Unless otherwise restricted by the Certificate
of Incorporation, special meetings of the Board of Directors may be held at any
time and place within or without the State of Delaware whenever called by the
Chairman of the Board, the Chief Executive Officer or any two of the directors.

          (D) TELEPHONE MEETINGS.  Any member of the Board of Directors, or of
any committee thereof, may participate in a meeting by means of conference
telephone or similar communications equipment by means of which all persons
participating in the meeting can hear each other, and participation in a meeting
by such means shall constitute presence in person at such meeting.

                                      8.
<PAGE>
 
          (E) NOTICE OF MEETINGS.  Notice of the time and place of all special
meetings of the Board of Directors shall be orally or in writing, by telephone,
facsimile, telegraph or telex, during normal business hours, at least twenty-
four (24) hours before the date and time of the meeting, or sent in writing to
each director by first class mail, charges prepaid, at least three (3) days
before the date of the meeting.  Notice of any meeting may be waived in writing
at any time before or after the meeting and will be waived by any director by
attendance thereat, except when the director attends the meeting for the express
purpose of objecting, at the beginning of the meeting, to the transaction of any
business because the meeting is not lawfully called or convened.

          (F) WAIVER OF NOTICE.  The transaction of all business at any meeting
of the Board of Directors, or any committee thereof, however called or noticed,
or wherever held, shall be as valid as though had at a meeting duly held after
regular call and notice, if a quorum be present and if, either before or after
the meeting, each of the directors not present shall sign a written waiver of
notice.  All such waivers shall be filed with the corporate records or made a
part of the minutes of the meeting.

          SECTION 22.  QUORUM AND VOTING.

          (A) Unless the Certificate of Incorporation requires a greater number
and except with respect to indemnification questions arising under Section 43
hereof, for which a quorum shall be one-third of the exact number of directors
fixed from time to time in accordance with the Certificate of Incorporation, a
quorum of the Board of Directors shall consist of a majority of the exact number
of directors fixed from time to time by the Board of Directors in accordance
with the Certificate of Incorporation; provided, however, at any meeting whether
a quorum be present or otherwise, a majority of the directors present may
adjourn from time to time until the time fixed for the next regular meeting of
the Board of Directors, without notice other than by announcement at the
meeting.

          (B) At each meeting of the Board of Directors at which a quorum is
present, all questions and business shall be determined by the affirmative vote
of a majority of the directors present, unless a different vote be required by
law, the Certificate of Incorporation or these Bylaws.

          SECTION 23.  ACTION WITHOUT MEETING.  Unless otherwise restricted by
the Certificate of Incorporation or these Bylaws, any action required or
permitted to be taken at any meeting of the Board of Directors or of any
committee thereof may be taken without a meeting, if all members of the Board of
Directors or committee, as the case may be, consent thereto in writing, and such
writing or writings are filed with the minutes of proceedings of the Board of
Directors or committee.

          SECTION 24.  FEES AND COMPENSATION.  Directors shall be entitled to
such compensation for their services as may be approved by the Board of
Directors, including, if so approved, by resolution of the Board of Directors, a
fixed sum and expenses of attendance, if any, for attendance at each regular or
special meeting of the Board of Directors and at any meeting of a committee of
the Board of Directors.  Nothing herein contained shall be construed to preclude

                                      9.
<PAGE>
 
any director from serving the corporation in any other capacity as an officer,
agent, employee, or otherwise and receiving compensation therefor.

          SECTION 25.  COMMITTEES.

          (A) EXECUTIVE COMMITTEE.  The Board of Directors may by resolution
passed by a majority of the whole Board of Directors appoint an Executive
Committee to consist of one (1) or more members of the Board of Directors.  The
Executive Committee, to the extent permitted by law and provided in the
resolution of the Board of Directors shall have and may exercise all the powers
and authority of the Board of Directors in the management of the business and
affairs of the corporation, including without limitation the power or authority
to declare a dividend, to authorize the issuance of stock and to adopt a
certificate of ownership and merger, and may authorize the seal of the
corporation to be affixed to all papers which may require it; but no such
committee shall have the power or authority in reference to amending the
Certificate of Incorporation (except that a committee may, to the extent
authorized in the resolution or resolutions providing for the issuance of shares
of stock adopted by the Board of Directors fix the designations and any of the
preferences or rights of such shares relating to dividends, redemption,
dissolution, any distribution of assets of the corporation or the conversion
into, or the exchange of such shares for, shares of any other class or classes
or any other series of the same or any other class or classes of stock of the
corporation or fix the number of shares of any series of stock or authorize the
increase or decrease of the shares of any series), adopting an agreement of
merger or consolidation, recommending to the stockholders the sale, lease or
exchange of all or substantially all of the corporation's property and assets,
recommending to the stockholders a dissolution of the corporation or a
revocation of a dissolution, or amending the bylaws of the corporation.

          (B) OTHER COMMITTEES.  The Board of Directors may, by resolution
passed by a majority of the whole Board of Directors, from time to time appoint
such other committees as may be permitted by law.  Such other committees
appointed by the Board of Directors shall consist of one (1) or more members of
the Board of Directors and shall have such powers and perform such duties as may
be prescribed by the resolution or resolutions creating such committees, but in
no event shall such committee have the powers denied to the Executive Committee
in these Bylaws.

          (C) TERM.  Each member of a committee of the Board of Directors shall
serve a term on the committee coexistent with such member's term on the Board of
Directors.  The Board of Directors, subject to the provisions of subsections (a)
or (b) of this Bylaw may at any time increase or decrease the number of members
of a committee or terminate the existence of a committee.  The membership of a
committee member shall terminate on the date of his death or voluntary
resignation from the committee or from the Board of Directors.  The Board of
Directors may at any time for any reason remove any individual committee member
and the Board of Directors may fill any committee vacancy created by death,
resignation, removal or increase in the number of members of the committee.  The
Board of Directors may designate one or more directors as alternate members of
any committee, who may replace any absent or disqualified member at any meeting
of the committee, and, in addition, in the absence or disqualification of any
member of a committee, the member or members thereof present at any

                                      10.
<PAGE>
 
meeting and not disqualified from voting, whether or not he or they constitute a
quorum, may unanimously appoint another member of the Board of Directors to act
at the meeting in the place of any such absent or disqualified member.

          (D) MEETINGS.  Unless the Board of Directors shall otherwise provide,
regular meetings of the Executive Committee or any other committee appointed
pursuant to this Section 25 shall be held at such times and places as are
determined by the Board of Directors, or by any such committee, and when notice
thereof has been given to each member of such committee, no further notice of
such regular meetings need be given thereafter.  Special meetings of any such
committee may be held at any place which has been determined from time to time
by such committee, and may be called by any director who is a member of such
committee, upon written notice to the members of such committee of the time and
place of such special meeting given in the manner provided for the giving of
written notice to members of the Board of Directors of the time and place of
special meetings of the Board of Directors.  Notice of any special meeting of
any committee may be waived in writing at any time before or after the meeting
and will be waived by any director by attendance thereat, except when the
director attends such special meeting for the express purpose of objecting, at
the beginning of the meeting, to the transaction of any business because the
meeting is not lawfully called or convened.  A majority of the authorized number
of members of any such committee shall constitute a quorum for the transaction
of business, and the act of a majority of those present at any meeting at which
a quorum is present shall be the act of such committee.

          SECTION 26.  ORGANIZATION.  At every meeting of the directors, the
Chairman of the Board of Directors, or, if a Chairman has not been appointed or
is absent, the Chief Executive Officer, or if the Chief Executive Officer is
absent, the President, or, in the absence of any such officer, a chairman of the
meeting chosen by a majority of the directors present, shall preside over the
meeting.  The Secretary, or in his absence, an Assistant Secretary directed to
do so by the Chief Executive Officer, shall act as secretary of the meeting.

                                   ARTICLE V

                                    OFFICERS

          SECTION 27.  OFFICERS DESIGNATED.  The officers of the corporation
shall include, if and when designated by the Board of Directors, the Chairman of
the Board of Directors, the Chief Executive Officer, the President, one or more
Vice Presidents, the Secretary, the Chief Financial Officer, the Treasurer, the
Controller, all of whom shall be elected at the annual organizational meeting of
the Board of Directors.  The Board of Directors may also appoint one or more
Assistant Secretaries, Assistant Treasurers, Assistant Controllers and such
other officers and agents with such powers and duties as it shall deem
necessary.  The Board of Directors may assign such additional titles to one or
more of the officers as it shall deem appropriate.  Any one person may hold any
number of offices of the corporation at any one time unless specifically
prohibited therefrom by law.  The salaries and other compensation of the
officers of the corporation shall be fixed by or in the manner designated by the
Board of Directors.

          SECTION 28.  TENURE AND DUTIES OF OFFICERS.

                                      11.
<PAGE>
 
          (A) GENERAL.  All officers shall hold office at the pleasure of the
Board of Directors and until their successors shall have been duly elected and
qualified, unless sooner removed.  Any officer elected or appointed by the Board
of Directors may be removed at any time by the Board of Directors.  If the
office of any officer becomes vacant for any reason, the vacancy may be filled
by the Board of Directors.

          (B) DUTIES OF CHAIRMAN OF THE BOARD OF DIRECTORS.  The Chairman of the
Board of Directors, when present, shall preside at all meetings of the
stockholders and the Board of Directors.  The Chairman of the Board of Directors
shall perform other duties commonly incident to his office and shall also
perform such other duties and have such other powers as the Board of Directors
shall designate from time to time.

          (C) DUTIES OF CHIEF EXECUTIVE OFFICER.  The Chief Executive Officer
shall preside at all meetings of the stockholders and at all meetings of the
Board of Directors, unless the Chairman of the Board of Directors has been
appointed and is present.  The Chief Executive Officer shall, subject to the
control of the Board of Directors, have general supervision, direction and
control of the business and officers of the corporation.  The Chief Executive
Officer shall perform other duties commonly incident to his office and shall
also perform such other duties and have such other powers as the Board of
Directors shall designate from time to time.

          (D) DUTIES OF PRESIDENT.  The President may assume and perform the
duties of the Chief Executive Officer in the absence or disability of the Chief
Executive Officer or whenever the office of Chief Executive Officer is vacant.
The President shall perform other duties commonly incident to his office and
shall also perform such other duties and have such other powers as the Board of
Directors or the Chief Executive Officer shall designate from time to time.

          (E) DUTIES OF VICE PRESIDENTS.  The Vice Presidents may assume and
perform the duties of the President in the absence or disability of the
President or whenever the office of President is vacant.  The Vice Presidents
shall perform other duties commonly incident to their office and shall also
perform such other duties and have such other powers as the Board of Directors,
the Chief Executive Officer or the President shall designate from time to time.

          (F) DUTIES OF SECRETARY.  The Secretary shall attend all meetings of
the stockholders and of the Board of Directors and shall record all acts and
proceedings thereof in the minute book of the corporation.  The Secretary shall
give notice in conformity with these Bylaws of all meetings of the stockholders
and of all meetings of the Board of Directors and any committee thereof
requiring notice.  The Secretary shall perform all other duties given him in
these Bylaws and other duties commonly incident to his office and shall also
perform such other duties and have such other powers as the Board of Directors
shall designate from time to time.  The Chief Executive Officer may direct any
Assistant Secretary to assume and perform the duties of the Secretary in the
absence or disability of the Secretary, and each Assistant Secretary shall
perform other duties commonly incident to his office and shall also perform such
other duties and have such other powers as the Board of Directors or the Chief
Executive Officer shall designate from time to time.

                                      12.
<PAGE>
 
          (G) DUTIES OF CHIEF FINANCIAL OFFICER.  The Chief Financial Officer
shall keep or cause to be kept the books of account of the corporation in a
thorough and proper manner and shall render statements of the financial affairs
of the corporation in such form and as often as required by the Board of
Directors or the Chief Executive Officer.  The Chief Financial Officer, subject
to the order of the Board of Directors, shall have the custody of all funds and
securities of the corporation.  The Chief Financial Officer shall perform other
duties commonly incident to his office and shall also perform such other duties
and have such other powers as the Board of Directors or the Chief Executive
Officer shall designate from time to time.  The Chief Executive Officer may
direct the Treasurer or any Assistant Treasurer, or the Controller or any
Assistant Controller to assume and perform the duties of the Chief Financial
Officer in the absence or disability of the Chief Financial Officer, and each
Treasurer and Assistant Treasurer and each Controller and Assistant Controller
shall perform other duties commonly incident to his office and shall also
perform such other duties and have such other powers as the Board of Directors
or the Chief Executive Officer shall designate from time to time.

          SECTION 29.  DELEGATION OF AUTHORITY.  The Board of Directors may from
time to time delegate the powers or duties of any officer to any other officer
or agent, notwithstanding any provision hereof.

          SECTION 30.  RESIGNATIONS.  Any officer may resign at any time by
giving written notice to the Board of Directors or to the Chief Executive
Officer or to the Secretary.  Any such resignation shall be effective when
received by the person or persons to whom such notice is given, unless a later
time is specified therein, in which event the resignation shall become effective
at such later time.  Unless otherwise specified in such notice, the acceptance
of any such resignation shall not be necessary to make it effective.  Any
resignation shall be without prejudice to the rights, if any, of the corporation
under any contract with the resigning officer.

          SECTION 31.  REMOVAL.  Any officer may be removed from office at any
time, either with or without cause, by the affirmative vote of a majority of the
directors in office at the time, or by the unanimous written consent of the
directors in office at the time, or by any committee or superior officers upon
whom such power of removal may have been conferred by the Board of Directors.

                                   ARTICLE VI

                 EXECUTION OF CORPORATE INSTRUMENTS AND VOTING
                     OF SECURITIES OWNED BY THE CORPORATION

          SECTION 32.  EXECUTION OF CORPORATE INSTRUMENTS.  The Board of
Directors may, in its discretion, determine the method and designate the
signatory officer or officers, or other person or persons, to execute on behalf
of the corporation any corporate instrument or document, or to sign on behalf of
the corporation the corporate name without limitation, or to enter into
contracts on behalf of the corporation, except where otherwise provided by law
or these Bylaws, and such execution or signature shall be binding upon the
corporation.

                                      13.
<PAGE>
 
          Unless otherwise specifically determined by the Board of Directors or
otherwise required by law, promissory notes, deeds of trust, mortgages and other
evidences of indebtedness of the corporation, and other corporate instruments or
documents requiring the corporate seal, and certificates of shares of stock
owned by the corporation, shall be executed, signed or endorsed by the Chairman
of the Board of Directors, or the President or any Vice President, and by the
Secretary or Treasurer or any Assistant Secretary or Assistant Treasurer.  All
other instruments and documents requiring the corporate signature, but not
requiring the corporate seal, may be executed as aforesaid or in such other
manner as may be directed by the Board of Directors.

          All checks and drafts drawn on banks or other depositaries on funds to
the credit of the corporation or in special accounts of the corporation shall be
signed by such person or persons as the Board of Directors shall authorize so to
do.

          Unless authorized or ratified by the Board of Directors or within the
agency power of an officer, no officer, agent or employee shall have any power
or authority to bind the corporation by any contract or engagement or to pledge
its credit or to render it liable for any purpose or for any amount.

          SECTION 33.  VOTING OF SECURITIES OWNED BY THE CORPORATION.  All stock
and other securities of other corporations owned or held by the corporation for
itself, or for other parties in any capacity, shall be voted, and all proxies
with respect thereto shall be executed, by the person authorized so to do by
resolution of the Board of Directors, or, in the absence of such authorization,
by the Chairman of the Board of Directors, the Chief Executive Officer, the
President, or any Vice President.

                                      14.
<PAGE>
 
                                  ARTICLE VII

                                SHARES OF STOCK

          SECTION 34.  FORM AND EXECUTION OF CERTIFICATES.  Certificates for the
shares of stock of the corporation shall be in such form as is consistent with
the Certificate of Incorporation and applicable law.  Every holder of stock in
the corporation shall be entitled to have a certificate signed by or in the name
of the corporation by the Chairman of the Board of Directors, or the President
or any Vice President and by the Treasurer or Assistant Treasurer or the
Secretary or Assistant Secretary, certifying the number of shares owned by him
in the corporation.  Any or all of the signatures on the certificate may be
facsimiles.  In case any officer, transfer agent, or registrar who has signed or
whose facsimile signature has been placed upon a certificate shall have ceased
to be such officer, transfer agent, or registrar before such certificate is
issued, it may be issued with the same effect as if he were such officer,
transfer agent, or registrar at the date of issue.  Each certificate shall state
upon the face or back thereof, in full or in summary, all of the powers,
designations, preferences, and rights, and the limitations or restrictions of
the shares authorized to be issued or shall, except as otherwise required by
law, set forth on the face or back a statement that the corporation will furnish
without charge to each stockholder who so requests the powers, designations,
preferences and relative, participating, optional, or other special rights of
each class of stock or series thereof and the qualifications, limitations or
restrictions of such preferences and/or rights.  Within a reasonable time after
the issuance or transfer of uncertificated stock, the corporation shall send to
the registered owner thereof a written notice containing the information
required to be set forth or stated on certificates pursuant to this section or
otherwise required by law or with respect to this section a statement that the
corporation will furnish without charge to each stockholder who so requests the
powers, designations, preferences and relative participating, optional or other
special rights of each class of stock or series thereof and the qualifications,
limitations or restrictions of such preferences and/or rights.  Except as
otherwise expressly provided by law, the rights and obligations of the holders
of certificates representing stock of the same class and series shall be
identical.

          SECTION 35.  LOST CERTIFICATES.  A new certificate or certificates
shall be issued in place of any certificate or certificates theretofore issued
by the corporation alleged to have been lost, stolen, or destroyed, upon the
making of an affidavit of that fact by the person claiming the certificate of
stock to be lost, stolen, or destroyed.  The corporation may require, as a
condition precedent to the issuance of a new certificate or certificates, the
owner of such lost, stolen, or destroyed certificate or certificates, or his
legal representative, to advertise the same in such manner as it shall require
or to give the corporation a surety bond in such form and amount as it may
direct as indemnity against any claim that may be made against the corporation
with respect to the certificate alleged to have been lost, stolen, or destroyed.

          SECTION 36.  TRANSFERS.

          (A) Transfers of record of shares of stock of the corporation shall be
made only upon its books by the holders thereof, in person or by attorney duly
authorized, and upon the surrender of a properly endorsed certificate or
certificates for a like number of shares.

                                      15.
<PAGE>
 
          (B) The corporation shall have power to enter into and perform any
agreement with any number of stockholders of any one or more classes of stock of
the corporation to restrict the transfer of shares of stock of the corporation
of any one or more classes owned by such stockholders in any manner not
prohibited by the General Corporation Law of Delaware.

          SECTION 37.  FIXING RECORD DATES.

          (A) In order that the corporation may determine the stockholders
entitled to notice of or to vote at any meeting of stockholders or any
adjournment thereof, the Board of Directors may fix, in advance, a record date,
which record date shall not precede the date upon which the resolution fixing
the record date is adopted by the Board of Directors, and which record date
shall not be more than sixty (60) nor less than ten (10) days before the date of
such meeting.  If no record date is fixed by the Board of Directors, the record
date for determining stockholders entitled to notice of or to vote at a meeting
of stockholders shall be at the close of business on the day next preceding the
day on which notice is given, or if notice is waived, at the close of business
on the day next preceding the day on which the meeting is held.  A determination
of stockholders of record entitled to notice of or to vote at a meeting of
stockholders shall apply to any adjournment of the meeting; provided, however,
that the Board of Directors may fix a new record date for the adjourned meeting.

          (B) Prior to the Initial Public Offering, in order that the
corporation may determine the stockholders entitled to consent to corporate
action in writing without a meeting, the Board of Directors may fix a record
date, which record date shall not precede the date upon which the resolution
fixing the record date is adopted by the Board of Directors, and which date
shall not be more than 10 days after the date upon which the resolution fixing
the record date is adopted by the Board of Directors.  Any stockholder of record
seeking to have the stockholders authorize or take corporate action by written
consent shall, by written notice to the Secretary, request the Board of
Directors to fix a record date.  The Board of Directors shall promptly, but in
all events within 10 days after the date on which such a request is received,
adopt a resolution fixing the record date.  If no record date has been fixed by
the Board of Directors within 10 days of the date on which such a request is
received, the record date for determining stockholders entitled to consent to
corporate action in writing without a meeting, when no prior action by the Board
of Directors is required by applicable law, shall be the first date on which a
signed written consent setting forth the action taken or proposed to be taken is
delivered to the corporation by delivery to its registered office in the State
of Delaware, its principal place of business or an officer or agent of the
corporation having custody of the book in which proceedings of meetings of
stockholders are recorded.  Delivery made to the corporation's registered office
shall be by hand or by certified or registered mail, return receipt requested.
If no record date has been fixed by the Board of Directors and prior action by
the Board of Directors is required by law, the record date for determining
stockholders entitled to consent to corporate action in writing without a
meeting shall be at the close of business on the day on which the Board of
Directors adopts the resolution taking such prior action.

          (C) In order that the corporation may determine the stockholders
entitled to receive payment of any dividend or other distribution or allotment
of any rights or the stockholders entitled to exercise any rights in respect of
any change, conversion or exchange of

                                      16.
<PAGE>
 
stock, or for the purpose of any other lawful action, the Board of Directors may
fix, in advance, a record date, which record date shall not precede the date
upon which the resolution fixing the record date is adopted, and which record
date shall be not more than sixty (60) days prior to such action.  If no record
date is fixed, the record date for determining stockholders for any such purpose
shall be at the close of business on the day on which the Board of Directors
adopts the resolution relating thereto.

          SECTION 38.  REGISTERED STOCKHOLDERS.  The corporation shall be
entitled to recognize the exclusive right of a person registered on its books as
the owner of shares to receive dividends, and to vote as such owner, and shall
not be bound to recognize any equitable or other claim to or interest in such
share or shares on the part of any other person whether or not it shall have
express or other notice thereof, except as otherwise provided by the laws of
Delaware.

                                  ARTICLE VIII

                      OTHER SECURITIES OF THE CORPORATION

          SECTION 39.  EXECUTION OF OTHER SECURITIES.  All bonds, debentures and
other corporate securities of the corporation, other than stock certificates
(covered in Section 34), may be signed by the Chairman of the Board of
Directors, the Chief Executive Officer, the President or any Vice President, or
such other person as may be authorized by the Board of Directors, and the
corporate seal impressed thereon or a facsimile of such seal imprinted thereon
and attested by the signature of the Secretary or an Assistant Secretary, or the
Chief Financial Officer or Treasurer or an Assistant Treasurer; provided,
however, that where any such bond, debenture or other corporate security shall
be authenticated by the manual signature, or where permissible facsimile
signature, of a trustee under an indenture pursuant to which such bond,
debenture or other corporate security shall be issued, the signatures of the
persons signing and attesting the corporate seal on such bond, debenture or
other corporate security may be the imprinted facsimile of the signatures of
such persons.  Interest coupons appertaining to any such bond, debenture or
other corporate security, authenticated by a trustee as aforesaid, shall be
signed by the Treasurer or an Assistant Treasurer of the corporation or such
other person as may be authorized by the Board of Directors, or bear imprinted
thereon the facsimile signature of such person.  In case any officer who shall
have signed or attested any bond, debenture or other corporate security, or
whose facsimile signature shall appear thereon or on any such interest coupon,
shall have ceased to be such officer before the bond, debenture or other
corporate security so signed or attested shall have been delivered, such bond,
debenture or other corporate security nevertheless may be adopted by the
corporation and issued and delivered as though the person who signed the same or
whose facsimile signature shall have been used thereon had not ceased to be such
officer of the corporation.

                                   ARTICLE IX

                                   DIVIDENDS

          SECTION 40.  DECLARATION OF DIVIDENDS.  Dividends upon the capital
stock of the corporation, subject to the provisions of the Certificate of
Incorporation, if any, may be declared

                                      17.
<PAGE>
 
by the Board of Directors pursuant to law at any regular or special meeting.
Dividends may be paid in cash, in property, or in shares of the capital stock,
subject to the provisions of the Certificate of Incorporation.

          SECTION 41.  DIVIDEND RESERVE.  Before payment of any dividend, there
may be set aside out of any funds of the corporation available for dividends
such sum or sums as the Board of Directors from time to time, in their absolute
discretion, think proper as a reserve or reserves to meet contingencies, or for
equalizing dividends, or for repairing or maintaining any property of the
corporation, or for such other purpose as the Board of Directors shall think
conducive to the interests of the corporation, and the Board of Directors may
modify or abolish any such reserve in the manner in which it was created.

                                   ARTICLE X

                                  FISCAL YEAR

          SECTION 42.  FISCAL YEAR.  The fiscal year of the corporation shall be
fixed by resolution of the Board of Directors.

                                   ARTICLE XI

                                INDEMNIFICATION

          SECTION 43.  INDEMNIFICATION OF DIRECTORS, EXECUTIVE OFFICERS, OTHER
                       OFFICERS, EMPLOYEES AND OTHER AGENTS.

          (A) DIRECTORS AND OFFICERS.  The corporation shall indemnify its
directors and officers to the fullest extent not prohibited by the Delaware
General Corporation Law; provided, however, that the corporation may modify the
extent of such indemnification by individual contracts with its directors and
executive officers and, provided, further, that the corporation shall not be
required to indemnify any director or officer in connection with any proceeding
(or part thereof) initiated by such person unless (i) such indemnification is
expressly required to be made by law, (ii) the proceeding was authorized by the
Board of Directors of the corporation, (iii) such indemnification is provided by
the corporation, in its sole discretion, pursuant to the powers vested in the
corporation under the Delaware General Corporation Law or (iv) such
indemnification is required to be made under subsection (d).

          (B) EMPLOYEES AND OTHER AGENTS.  The corporation shall have power to
indemnify its employees and other agents as set forth in the Delaware General
Corporation Law.

          (C) EXPENSES.  The corporation shall advance to any person who was or
is a party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding, whether civil, criminal, administrative or
investigative, by reason of the fact that he is or was a director or officer, of
the corporation, or is or was serving at the request of the corporation as a
director or officer of another corporation, partnership, joint venture, trust or
other enterprise, prior to the final disposition of the proceeding, promptly
following request

                                      18.
<PAGE>
 
therefor, all expenses incurred by any director or officer in connection with
such proceeding upon receipt of an undertaking by or on behalf of such person to
repay said amounts if it should be determined ultimately that such person is not
entitled to be indemnified under this Bylaw or otherwise.

Notwithstanding the foregoing, unless otherwise determined pursuant to paragraph
(e) of this Bylaw, no advance shall be made by the corporation to an officer of
the corporation (except by reason of the fact that such officer is or was a
director of the corporation in which event this paragraph shall not apply) in
any action, suit or proceeding, whether civil, criminal, administrative or
investigative, if a determination is reasonably and promptly made (i) by the
Board of Directors by a majority vote of a quorum consisting of directors who
were not parties to the proceeding, or (ii) if such quorum is not obtainable,
or, even if obtainable, a quorum of disinterested directors so directs, by
independent legal counsel in a written opinion, that the facts known to the
decision-making party at the time such determination is made demonstrate clearly
and convincingly that such person acted in bad faith or in a manner that such
person did not believe to be in or not opposed to the best interests of the
corporation.

          (D) ENFORCEMENT.  Without the necessity of entering into an express
contract, all rights to indemnification and advances to directors and officers
and officers under this Bylaw shall be deemed to be contractual rights and be
effective to the same extent and as if provided for in a contract between the
corporation and the director or officer.   Any right to indemnification or
advances granted by this Bylaw to a director or officer shall be enforceable by
or on behalf of the person holding such right in any court of competent
jurisdiction if (i) the claim for indemnification or advances is denied, in
whole or in part, or (ii) no disposition of such claim is made within ninety
(90) days of request therefor.  The claimant in such enforcement action, if
successful in whole or in part, shall be entitled to be paid also the expense of
prosecuting his claim.  In connection with any claim for indemnification, the
corporation shall be entitled to raise as a defense to any such action that the
claimant has not met the standards of conduct that make it permissible under the
Delaware General Corporation Law for the corporation to indemnify the claimant
for the amount claimed.  In connection with any claim by an officer of the
corporation (except in any action, suit or proceeding, whether civil, criminal,
administrative or investigative, by reason of the fact that such officer is or
was a director of the corporation) for advances, the corporation shall be
entitled to raise a defense as to any such action clear and convincing evidence
that such person acted in bad faith or in a manner that such person did not
believe to be in or not opposed to the best interests of the corporation, or
with respect to any criminal action or proceeding that such person acted without
reasonable cause to believe that his conduct was lawful.  Neither the failure of
the corporation (including its Board of Directors, independent legal counsel or
its stockholders) to have made a determination prior to the commencement of such
action that indemnification of the claimant is proper in the circumstances
because he has met the applicable standard of conduct set forth in the Delaware
General Corporation Law, nor an actual determination by the corporation
(including its Board of Directors, independent legal counsel or its
stockholders) that the claimant has not met such applicable standard of conduct,
shall be a defense to the action or create a presumption that claimant has not
met the applicable standard of conduct.

                                      19.
<PAGE>
 
          (E) NON-EXCLUSIVITY OF RIGHTS.  The rights conferred on any person by
this Bylaw shall not be exclusive of any other right which such person may have
or hereafter acquire under any statute, provision of the Certificate of
Incorporation, Bylaws, agreement, vote of stockholders or disinterested
directors or otherwise, both as to action in his official capacity and as to
action in another capacity while holding office.  The corporation is
specifically authorized to enter into individual contracts with any or all of
its directors, officers, employees or agents respecting indemnification and
advances, to the fullest extent not prohibited by the Delaware General
Corporation Law.

          (F) SURVIVAL OF RIGHTS.  The rights conferred on any person by this
Bylaw shall continue as to a person who has ceased to be a director, officer,
employee or other agent and shall inure to the benefit of the heirs, executors
and administrators of such a person.

          (G) INSURANCE.  To the fullest extent permitted by the Delaware
General Corporation Law, the corporation, upon approval by the Board of
Directors, may purchase insurance on behalf of any person required or permitted
to be indemnified pursuant to this Bylaw.

          (H) AMENDMENTS.  Any repeal or modification of this Bylaw shall only
be prospective and shall not affect the rights under this Bylaw in effect at the
time of the alleged occurrence of any action or omission to act that is the
cause of any proceeding against any agent of the corporation.

          (I) SAVING CLAUSE.  If this Bylaw or any portion hereof shall be
invalidated on any ground by any court of competent jurisdiction, then the
corporation shall nevertheless indemnify each director and officer to the full
extent not prohibited by any applicable portion of this Bylaw that shall not
have been invalidated, or by any other applicable law.

          (J) CERTAIN DEFINITIONS.  For the purposes of this Bylaw, the
following definitions shall apply:

               (i) The term "proceeding" shall be broadly construed and shall
     include, without limitation, the investigation, preparation, prosecution,
     defense, settlement, arbitration and appeal of, and the giving of testimony
     in, any threatened, pending or completed action, suit or proceeding,
     whether civil, criminal, administrative or investigative.

               (ii) The term "expenses" shall be broadly construed and shall
     include, without limitation, court costs, attorneys' fees, witness fees,
     fines, amounts paid in settlement or judgment and any other costs and
     expenses of any nature or kind incurred in connection with any proceeding.

               (iii)  The term the "corporation" shall include, in addition to
     the resulting corporation, any constituent corporation (including any
     constituent of a constituent) absorbed in a consolidation or merger which,
     if its separate existence had continued, would have had power and authority
     to indemnify its directors, officers, and

                                      20.
<PAGE>
 
     employees or agents, so that any person who is or was a director, officer,
     employee or agent of such constituent corporation, or is or was serving at
     the request of such constituent corporation as a director, officer,
     employee or agent of another corporation, partnership, joint venture, trust
     or other enterprise, shall stand in the same position under the provisions
     of this Bylaw with respect to the resulting or surviving corporation as he
     would have with respect to such constituent corporation if its separate
     existence had continued.

               (iv) References to a "director," "executive officer," "officer,"
     "employee," or "agent" of the corporation shall include, without
     limitation, situations where such person is serving at the request of the
     corporation as, respectively, a director, executive officer, officer,
     employee, trustee or agent of another corporation, partnership, joint
     venture, trust or other enterprise.

               (v) References to "other enterprises" shall include employee
     benefit plans; references to "fines" shall include any excise taxes
     assessed on a person with respect to an employee benefit plan; and
     references to "serving at the request of the corporation" shall include any
     service as a director, officer, employee or agent of the corporation which
     imposes duties on, or involves services by, such director, officer,
     employee, or agent with respect to an employee benefit plan, its
     participants, or beneficiaries; and a person who acted in good faith and in
     a manner he reasonably believed to be in the interest of the participants
     and beneficiaries of an employee benefit plan shall be deemed to have acted
     in a manner "not opposed to the best interests of the corporation" as
     referred to in this Bylaw.

                                  ARTICLE XII

                                    NOTICES

          SECTION 44.  NOTICES.

          (A) NOTICE TO STOCKHOLDERS.  Whenever, under any provisions of these
Bylaws, notice is required to be given to any stockholder, it shall be given in
writing, timely and duly deposited in the United States mail, postage prepaid,
and addressed to his last known post office address as shown by the stock record
of the corporation or its transfer agent.

          (B) NOTICE TO DIRECTORS.  Any notice required to be given to any
director may be given by the method stated in subsection (a), or by facsimile,
telex or telegram, except that such notice other than one which is delivered
personally shall be sent to such address as such director shall have filed in
writing with the Secretary, or, in the absence of such filing, to the last known
post office address of such director.

          (C) AFFIDAVIT OF MAILING.  An affidavit of mailing, executed by a duly
authorized and competent employee of the corporation or its transfer agent
appointed with respect to the class of stock affected, specifying the name and
address or the names and addresses of the stockholder or stockholders, or
director or directors, to whom any such notice

                                      21.
<PAGE>
 
or notices was or were given, and the time and method of giving the same, shall
in the absence of fraud, be prima facie evidence of the facts therein contained.

          (D) TIME NOTICES DEEMED GIVEN.  All notices given by mail, as above
provided, shall be deemed to have been given as at the time of mailing, and all
notices given by facsimile, telex or telegram shall be deemed to have been given
as of the sending time recorded at time of transmission.

          (E) METHODS OF NOTICE.  It shall not be necessary that the same method
of giving notice be employed in respect of all directors, but one permissible
method may be employed in respect of any one or more, and any other permissible
method or methods may be employed in respect of any other or others.

          (F) FAILURE TO RECEIVE NOTICE.  The period or limitation of time
within which any stockholder may exercise any option or right, or enjoy any
privilege or benefit, or be required to act, or within which any director may
exercise any power or right, or enjoy any privilege, pursuant to any notice sent
him in the manner above provided, shall not be affected or extended in any
manner by the failure of such stockholder or such director to receive such
notice.

          (G) NOTICE TO PERSON WITH WHOM COMMUNICATION IS UNLAWFUL.  Whenever
notice is required to be given, under any provision of law or of the Certificate
of Incorporation or Bylaws of the corporation, to any person with whom
communication is unlawful, the giving of such notice to such person shall not be
required and there shall be no duty to apply to any governmental authority or
agency for a license or permit to give such notice to such person.  Any action
or meeting which shall be taken or held without notice to any such person with
whom communication is unlawful shall have the same force and effect as if such
notice had been duly given.  In the event that the action taken by the
corporation is such as to require the filing of a certificate under any
provision of the Delaware General Corporation Law, the certificate shall state,
if such is the fact and if notice is required, that notice was given to all
persons entitled to receive notice except such persons with whom communication
is unlawful.

          (H) NOTICE TO PERSON WITH UNDELIVERABLE ADDRESS.  Whenever notice is
required to be given, under any provision of law or the Certificate of
Incorporation or Bylaws of the corporation, to any stockholder to whom (i)
notice of two consecutive annual meetings, and all notices of meetings or of the
taking of action by written consent without a meeting to such person during the
period between such two consecutive annual meetings, or (ii) all, and at least
two, payments (if sent by first class mail) of dividends or interest on
securities during a twelve-month period, have been mailed addressed to such
person at his address as shown on the records of the corporation and have been
returned undeliverable, the giving of such notice to such person shall not be
required.  Any action or meeting which shall be taken or held without notice to
such person shall have the same force and effect as if such notice had been duly
given.  If any such person shall deliver to the corporation a written notice
setting forth his then current address, the requirement that notice be given to
such person shall be reinstated.  In the event that the action taken by the
corporation is such as to require the filing of a certificate under any
provision of the Delaware General Corporation Law, the certificate need not
state that notice was

                                      22.
<PAGE>
 
not given to persons to whom notice was not required to be given pursuant to
this paragraph.

                                  ARTICLE XIII

                                   AMENDMENTS

          SECTION 45.  AMENDMENTS.  Subject to paragraph (h) of Section 43 of
the Bylaws, the Bylaws may be altered or amended or new Bylaws adopted by the
affirmative vote of at least sixty-six and two-thirds percent (66-2/3%) of the
voting power of all of the then-outstanding shares of the Voting Stock. The
Board of Directors shall also have the power to adopt, amend, or repeal Bylaws.

                                  ARTICLE XIV

                               LOANS TO OFFICERS

          SECTION 46.  LOANS TO OFFICERS.  The corporation may lend money to, or
guarantee any obligation of, or otherwise assist any officer or other employee
of the corporation or of its subsidiaries, including any officer or employee who
is a Director of the corporation or its subsidiaries, whenever, in the judgment
of the Board of Directors, such loan, guarantee or assistance may reasonably be
expected to benefit the corporation. The loan, guarantee or other assistance may
be with or without interest and may be unsecured, or secured in such manner as
the Board of Directors shall approve, including, without limitation, a pledge of
shares of stock of the corporation. Nothing in these Bylaws shall be deemed to
deny, limit or restrict the powers of guaranty or warranty of the corporation at
common law or under any statute.


                                   ARTICLE XV

                                 MISCELLANEOUS

          SECTION 47.      ANNUAL REPORT.

          (A) Subject to the provisions of paragraph (b) of this Bylaw, the
Board of Directors shall cause an annual report to be sent to each stockholder
of the corporation not later than one hundred twenty (120) days after the close
of the corporation's fiscal year.  Such report shall include a balance sheet as
of the end of such fiscal year and an income statement and statement of changes
in financial position for such fiscal year, accompanied by any report thereon of
independent accounts or, if there is no such report, the certificate of an
authorized officer of the corporation that such statements were prepared without
audit from the books and records of the corporation.  When there are more than
100 stockholders of record of the corporation's shares, as determined by Section
605 of the California Corporations Code, additional information as required by
Section 1501(b) of the California Corporations Code shall also be contained in
such report, provided that if the corporation has a class of securities
registered under Section 12 of the 1934 Act, that Act shall take precedence.
Such report shall

                                      23.
<PAGE>
 
be sent to stockholders at least fifteen (15) days prior to the next annual
meeting of stockholders after the end of the fiscal year to which it relates.

          (B) If and so long as there are fewer than 100 holders of record of
the corporation's shares, the requirement of sending of an annual report to the
stockholders of the corporation is hereby expressly waived.

                                      24.

<PAGE>
 
                                                                    EXHIBIT 10.1

                                MEGABIOS CORP.

                          1997 EQUITY INCENTIVE PLAN

                             ADOPTED JULY 25, 1997

                  APPROVED BY STOCKHOLDERS ____________, 1997



     INTRODUCTION.

     In October 1993, the Board of Directors adopted the MEGABIOS Corp. 1993
Stock Option Plan, and it was subsequently amended in August 1994 and January
1996. In July 1997, the Board of Directors amended and restated the 1993 Stock
Option Plan to read as set forth herein.

1.   PURPOSES.

     (a)  The purpose of the Plan is to provide a means by which selected
Employees and Directors of and Consultants to the Company and its Affiliates may
be given an opportunity to benefit from increases in value of the common stock
of the Company ("Common Stock") through the granting of (i) Incentive Stock
Options, (ii) Nonstatutory Stock Options, (iii) stock bonuses and (iv) rights to
purchase restricted stock.

     (b)  The Company, by means of the Plan, seeks to retain the services of
persons who are now Employees, Directors or Consultants, to secure and retain
the services of new Employees, Directors and Consultants, and to provide
incentives for such persons to exert maximum efforts for the success of the
Company and its Affiliates.

     (c)  The Company intends that the Stock Awards issued under the Plan shall,
in the discretion of the Board or any Committee to which responsibility for
administration of the Plan has been delegated pursuant to subsection 3(c), be
either (i) Options granted pursuant to Section 6 hereof, including Incentive
Stock Options and Nonstatutory Stock Options, or (ii) stock bonuses or rights to
purchase restricted stock granted pursuant to Section 7 hereof. All Options
shall be separately designated Incentive Stock Options or Nonstatutory Stock
Options at the time of grant, and in such form as issued pursuant to Section 6,
and a separate certificate or certificates will be issued for shares purchased
on exercise of each type of Option.

2.   DEFINITIONS.

     (a)  "AFFILIATE" means any parent corporation or subsidiary corporation,
whether now or hereafter existing, as those terms are defined in Sections 424(e)
and (f) respectively, of the Code.

     (b)  "BOARD" means the Board of Directors of the Company.

                                       1.
<PAGE>
 
     (c)  "CODE" means the Internal Revenue Code of 1986, as amended.

     (d)  "COMMITTEE" means a Committee appointed by the Board in accordance
with subsection 3(c) of the Plan.

     (e)  "COMPANY" means MEGABIOS Corp., a Delaware corporation.

     (f)  "CONSULTANT" means any person, including an advisor, engaged by the
Company or an Affiliate to render consulting services and who is compensated for
such services, provided that the term "Consultant" shall not include Directors
who are paid only a director's fee by the Company or who are not compensated by
the Company for their services as Directors.

     (g)  "CONTINUOUS STATUS AS AN EMPLOYEE, DIRECTOR OR CONSULTANT" means the
employment or relationship as a Director or Consultant is not interrupted or
terminated. The Board, in its sole discretion, may determine whether Continuous
Status as an Employee, Director or Consultant shall be considered interrupted in
the case of: (i) any leave of absence approved by the Board, including sick
leave, military leave, or any other personal leave; or (ii) transfers between
locations of the Company or between the Company, Affiliates or their successors.

     (h)  "DIRECTOR" means a member of the Board.

     (i)  "EMPLOYEE" means any person, including Officers and Directors,
employed by the Company or any Affiliate of the Company. Neither service as a
Director nor payment of a director's fee by the Company shall be sufficient to
constitute "employment" by the Company.

     (j)  "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended.

     (k)  "FAIR MARKET VALUE" means, as of any date, the value of the Common
Stock of the Company determined as follows:

          (1)  If the Common Stock is listed on any established stock exchange,
or traded on the Nasdaq National Market or the Nasdaq SmallCap Market, the Fair
Market Value of a share of Common Stock shall be the closing sales price for
such stock (or the closing bid, if no sales were reported) as quoted on such
exchange or market (or the exchange or market with the greatest volume of
trading in Common Stock) on the day of determination, as reported in the Wall
Street Journal or such other source as the Board deems reliable;

          (2)  In the absence of such markets for the Common Stock, the Fair
Market Value shall be determined in good faith by the Board.

     (l)  "INCENTIVE STOCK OPTION" means an Option intended to qualify as an
incentive stock option within the meaning of Section 422 of the Code and the
regulations promulgated thereunder.

                                       2.
<PAGE>
 
     (m) "NON-EMPLOYEE DIRECTOR" means a Director who either (i) is not a
current Employee or Officer of the Company or its parent or subsidiary, does not
receive compensation (directly or indirectly) from the Company or its parent or
subsidiary for services rendered as a consultant or in any capacity other than
as a Director (except for an amount as to which disclosure would not be required
under Item 404(a) of Regulation S-K promulgated pursuant to the Securities Act
of 1933 ("Regulation S-K"), does not possess an interest in any other
transaction as to which disclosure would be required under Item 404(a) of
Regulation S-K, and is not engaged in a business relationship as to which
disclosure would be required under Item 404(b) of Regulation S-K; or (ii) is
otherwise considered a "non-employee director" for purposes of Rule 16b-3.

     (n)  "NONSTATUTORY STOCK OPTION" means an Option not intended to qualify as
an Incentive Stock Option.

     (o)  "OFFICER" means a person who is an officer of the Company within the
meaning of Section 16 of the Exchange Act and the rules and regulations
promulgated thereunder.

     (p)  "OPTION" means a stock option granted pursuant to the Plan.

     (q)  "OPTION AGREEMENT" means a written agreement between the Company and
an Optionee evidencing the terms and conditions of an individual Option grant.
Each Option Agreement shall be subject to the terms and conditions of the Plan.

     (r)  "OPTIONEE" means a person to whom an Option is granted pursuant to the
Plan.

     (s)  "OUTSIDE DIRECTOR" means a Director who either (i) is not a current
employee of the Company or an "affiliated corporation" (within the meaning of
Treasury regulations promulgated under Section 162(m) of the Code), is not a
former employee of the Company or an "affiliated corporation" receiving
compensation for prior services (other than benefits under a tax qualified
pension plan), was not an officer of the Company or an "affiliated corporation"
at any time, and is not currently receiving direct or indirect remuneration from
the Company or an "affiliated corporation" for services in any capacity other
than as a Director, or (ii) is otherwise considered an "outside director" for
purposes of Section 162(m) of the Code.

     (t)  "PLAN" means this Megabios Corporation 1997 Equity Incentive Plan.

     (u)  "RULE 16B-3" means Rule 16b-3 of the Exchange Act or any successor to
Rule 16b-3, as in effect when discretion is being exercised with respect to the
Plan.

     (v)  "STOCK AWARD" means any right granted under the Plan, including any
Option, any stock bonus, and any right to purchase restricted stock.

     (w)  "STOCK AWARD AGREEMENT" means a written agreement between the Company
and a holder of a Stock Award evidencing the terms and conditions of an
individual Stock Award grant. Each Stock Award Agreement shall be subject to the
terms and conditions of the Plan.

                                       3.
<PAGE>
 
3.   ADMINISTRATION.

     (a)  The Plan shall be administered by the Board unless and until the Board
delegates administration to a Committee, as provided in subsection 3(c).

     (b)  The Board shall have the power, subject to, and within the limitations
of, the express provisions of the Plan:

          (1)  To determine from time to time which of the persons eligible
under the Plan shall be granted Stock Awards; when and how each Stock Award
shall be granted; whether a Stock Award will be an Incentive Stock Option, a
Nonstatutory Stock Option, a stock bonus, a right to purchase restricted stock,
or a combination of the foregoing; the provisions of each Stock Award granted
(which need not be identical), including the time or times when a person shall
be permitted to receive stock pursuant to a Stock Award and the number of shares
with respect to which a Stock Award shall be granted to each such person.

          (2)  To construe and interpret the Plan and Stock Awards granted under
it, and to establish, amend and revoke rules and regulations for its
administration.  The Board, in the exercise of this power, may correct any
defect, omission or inconsistency in the Plan or in any Stock Award Agreement,
in a manner and to the extent it shall deem necessary or expedient to make the
Plan fully effective.

          (3)  To amend the Plan or a Stock Award as provided in Section 13.

          (4)  Generally, to exercise such powers and to perform such acts as
the Board deems necessary or expedient to promote the best interests of the
Company which are not in conflict with the provisions of the Plan.

     (C)  The Board may delegate administration of the Plan to a committee or
committees ("Committee") of one or more members of the board. In the discretion
of the Board, a Committee may consist solely of two or more Outside Directors,
in accordance with Code Section 162(m), or solely of two or more Non-Employee
Directors, in accordance with Rule 16b-3. If administration is delegated to a
Committee, the Committee shall have, in connection with the administration of
the Plan, the powers theretofore possessed by the Board (and references in this
Plan to the Board shall thereafter be to the Committee), subject, however, to
such resolutions, not inconsistent with the provisions of the Plan, as may be
adopted from time to time by the Board. The Board may abolish the Committee at
any time and revest in the Board the administration of the Plan.

4.   SHARES SUBJECT TO THE PLAN.

     (a)  Subject to the provisions of Section 12 relating to adjustments upon
changes in stock, the stock that may be issued pursuant to Stock Awards shall
not exceed in the aggregate two million one hundred thousand (2,100,000) shares
of the Company's Common Stock. If any Stock Award shall for any reason expire or
otherwise terminate, in whole or in part, without having been exercised in full
(or vested in the case of Restricted Stock), the stock not acquired

                                       4.
<PAGE>
 
under such Stock Award shall revert to and again become available for issuance
under the Plan.

     (b)  The stock subject to the Plan may be unissued shares or reacquired
shares, bought on the market or otherwise.

5.   ELIGIBILITY.

     (a)  Incentive Stock Options may be granted only to Employees. Stock Awards
other than Incentive Stock Options may be granted only to Employees, Directors
or Consultants.

     (b)  No person shall be eligible for the grant of an Incentive Stock Option
if, at the time of grant, such person owns (or is deemed to own pursuant to
Section 424(d) of the Code) stock possessing more than ten percent (10%) of the
total combined voting power of all classes of stock of the Company or of any of
its Affiliates unless the exercise price of such Option is at least one hundred
ten percent (110%) of the Fair Market Value of such stock at the date of grant
and the Option is not exercisable after the expiration of five (5) years from
the date of grant.

     (c)  Subject to the provisions of Section 12 relating to adjustments upon
changes in stock, no person shall be eligible to be granted Options covering
more than five hundred thousand (500,000) shares of the Common Stock in any
calendar year. This subsection 5(c) shall not apply until (i) the earliest of:
(A) the first material modification of the Plan (including any increase to the
number of shares reserved for issuance under the Plan in accordance with Section
4); (B) the issuance of all of the shares of Common Stock reserved for issuance
under the Plan; (C) the expiration of the Plan; or (D) the first meeting of
stockholders at which directors are to be elected that occurs after the close of
the third calendar year following the calendar year in which occurred the first
registration of an equity security under Section 12 of the Exchange Act; or (ii)
such other date required by Section 162(m) of the Code and the rules and
regulations promulgated thereunder.

6.   OPTION PROVISIONS.

     Each Option shall be in such form and shall contain such terms and
conditions as the Board shall deem appropriate. The provisions of separate
Options need not be identical, but each Option shall include (through
incorporation of provisions hereof by reference in the Option or otherwise) the
substance of each of the following provisions:

     (a)  TERM. No Option shall be exercisable after the expiration of ten (10)
years from the date it was granted.

     (b)  PRICE. The exercise price of each Incentive Stock Option shall be not
less than one hundred percent (100%) of the Fair Market Value of the stock
subject to the Option on the date the Option is granted, and the exercise price
of each Nonstatutory Stock Option shall be not less than eighty-five percent
(85%) of the Fair Market Value of the stock subject to the Option on the date
the Option is granted. Notwithstanding the foregoing, an Option may be granted

                                       5.
<PAGE>
 
with an exercise price lower than that set forth in the preceding sentence if
such Option is granted pursuant to an assumption or substitution for another
option in a manner satisfying the provisions of Section 424(a) of the Code.

     (c)  CONSIDERATION. The purchase price of stock acquired pursuant to an
Option shall be paid, to the extent permitted by applicable statutes and
regulations, either (i) in cash at the time the Option is exercised, or (ii) at
the discretion of the Board or the Committee, at the time of the grant of the
Option, (A) by delivery to the Company of other Common Stock of the Company, (B)
according to a deferred payment or other arrangement (which may include, without
limiting the generality of the foregoing, the use of other Common Stock of the
Company) with the person to whom the Option is granted or to whom the Option is
transferred pursuant to subsection 6(d), or (C) in any other form of legal
consideration that may be acceptable to the Board.

     In the case of any deferred payment arrangement, interest shall be payable
at least annually and shall be charged at the minimum rate of interest necessary
to avoid the treatment as interest, under any applicable provisions of the Code,
of any amounts other than amounts stated to be interest under the deferred
payment arrangement.

     (d)  TRANSFERABILITY. An Incentive Stock Option shall not be transferable
except by will or by the laws of descent and distribution, and shall be
exercisable during the lifetime of the person to whom the Incentive Stock Option
is granted only by such person. A Nonstatutory Stock Option may be transferred
to the extent provided in the Option Agreement; provided that if the Option
Agreement does not expressly permit the transfer of a Nonstatutory Stock Option,
the Nonstatutory Stock Option shall not be transferable except by will or by the
laws of descent and distribution, and shall be exercisable during the lifetime
of the person to whom the Option is granted only by such person or any
transferee pursuant to a domestic relations order. Notwithstanding the
foregoing, the person to whom the Option is granted may, by delivering written
notice to the Company, in a form satisfactory to the Company, designate a third
party who, in the event of the death of the Optionee, shall thereafter be
entitled to exercise the Option.

     (E)  VESTING. The total number of shares of stock subject to an Option may,
but need not, be allotted in periodic installments (which may, but need not, be
equal). The Option Agreement may provide that from time to time during each of
such installment periods, the Option may become exercisable ("vest") with
respect to some or all of the shares allotted to that period, and may be
exercised with respect to some or all of the shares allotted to such period
and/or any prior period as to which the Option became vested but was not fully
exercised. The Option may be subject to such other terms and conditions on the
time or times when it may be exercised (which may be based on performance or
other criteria) as the Board may deem appropriate. The provisions of this
subsection 6(e) are subject to any Option provisions governing the minimum
number of shares as to which an Option may be exercised.

     (F)  TERMINATION OF EMPLOYMENT OR RELATIONSHIP AS A DIRECTOR OR CONSULTANT.
In the event an Optionee's Continuous Status as an Employee, Director or
Consultant terminates (other than upon the Optionee's death or disability), the
Optionee may exercise his or her Option (to the extent that the Optionee was
entitled to exercise it at the date of termination) but only

                                       6.
<PAGE>
 
within such period of time ending on the earlier of (i) the date three (3)
months after the termination of the Optionee's Continuous Status as an Employee,
Director or Consultant (or such longer or shorter period specified in the Option
Agreement), or (ii) the expiration of the term of the Option as set forth in the
Option Agreement.  If, after termination, the Optionee does not exercise his or
her Option within the time specified in the Option Agreement, the Option shall
terminate, and the shares covered by such Option shall revert to and again
become available for issuance under the Plan.

     An Optionee's Option Agreement may also provide that if the exercise of the
Option following the termination of the Optionee's Continuous Status as an
Employee, Director, or Consultant (other than upon the Optionee's death or
disability) would result in liability under Section 16(b) of the Exchange Act,
then the Option shall terminate on the earlier of (i) the expiration of the term
of the Option set forth in the Option Agreement, or (ii) the tenth (10th) day
after the last date on which such exercise would result in such liability under
Section 16(b) of the Exchange Act. Finally, an Optionee's Option Agreement may
also provide that if the exercise of the Option following the termination of the
Optionee's Continuous Status as an Employee, Director or Consultant (other than
upon the Optionee's death or disability) would be prohibited at any time solely
because the issuance of shares would violate the registration requirements under
the Act, then the Option shall terminate on the earlier of (i) the expiration of
the term of the Option set forth in the first paragraph of this subsection 6(f),
or (ii) the expiration of a period of three (3) months after the termination of
the Optionee's Continuous Status as an Employee, Director or Consultant during
which the exercise of the Option would not be in violation of such registration
requirements.

     (g)  DISABILITY OF OPTIONEE. In the event an Optionee's Continuous Status
as an Employee, Director or Consultant terminates as a result of the Optionee's
disability, the Optionee may exercise his or her Option (to the extent that the
Optionee was entitled to exercise it at the date of termination), but only
within such period of time ending on the earlier of (i) the date twelve (12)
months following such termination (or such longer or shorter period specified in
the Option Agreement), or (ii) the expiration of the term of the Option as set
forth in the Option Agreement. If, at the date of termination, the Optionee is
not entitled to exercise his or her entire Option, the shares covered by the
unexercisable portion of the Option shall revert to and again become available
for issuance under the Plan. If, after termination, the Optionee does not
exercise his or her Option within the time specified herein, the Option shall
terminate, and the shares covered by such Option shall revert to and again
become available for issuance under the Plan.

     (h)  DEATH OF OPTIONEE. In the event of the death of an Optionee during, or
within a period specified in the Option after the termination of, the Optionee's
Continuous Status as an Employee, Director or Consultant, the Option may be
exercised (to the extent the Optionee was entitled to exercise the Option at the
date of death) by the Optionee's estate, by a person who acquired the right to
exercise the Option by bequest or inheritance or by a person designated to
exercise the option upon the Optionee's death pursuant to subsection 6(d), but
only within the period ending on the earlier of (i) the date twelve (12) months
following the date of death (or such longer or shorter period specified in the
Option Agreement), or (ii) the expiration of the term of such Option as set
forth in the Option Agreement. If, at the time of death, the Optionee

                                       7.
<PAGE>
 
was not entitled to exercise his or her entire Option, the shares covered by the
unexercisable portion of the Option shall revert to and again become available
for issuance under the Plan.  If, after death, the Option is not exercised
within the time specified herein, the Option shall terminate, and the shares
covered by such Option shall revert to and again become available for issuance
under the Plan.

     (i)  EARLY EXERCISE. The Option may, but need not, include a provision
whereby the Optionee may elect at any time while an Employee, Director or
Consultant to exercise the Option as to any part or all of the shares subject to
the Option prior to the full vesting of the Option. Any unvested shares so
purchased may be subject to a repurchase right in favor of the Company or to any
other restriction the Board determines to be appropriate.

     (j)  RE-LOAD OPTIONS. Without in any way limiting the authority of the
Board or Committee to make or not to make grants of Options hereunder, the Board
or Committee shall have the authority (but not an obligation) to include as part
of any Option Agreement a provision entitling the Optionee to a further Option
(a "Re-Load Option") in the event the Optionee exercises the Option evidenced by
the Option Agreement, in whole or in part, by surrendering other shares of
Common Stock in accordance with this Plan and the terms and conditions of the
Option Agreement. Any such Re-Load Option (i) shall be for a number of shares
equal to the number of shares surrendered as part or all of the exercise price
of such Option; (ii) shall have an expiration date which is the same as the
expiration date of the Option the exercise of which gave rise to such Re-Load
Option; and (iii) shall have an exercise price which is equal to one hundred
percent (100%) of the Fair Market Value of the Common Stock subject to the Re-
Load Option on the date of exercise of the original Option. Notwithstanding the
foregoing, a Re-Load Option which is an Incentive Stock Option and which is
granted to a 10% stockholder (as described in subsection 5(b)), shall have an
exercise price which is equal to one hundred ten percent (110%) of the Fair
Market Value of the stock subject to the Re-Load Option on the date of exercise
of the original Option and shall have a term which is no longer than five (5)
years.

     Any such Re-Load Option may be an Incentive Stock Option or a Nonstatutory
Stock Option, as the Board or Committee may designate at the time of the grant
of the original Option; provided, however, that the designation of any Re-Load
Option as an Incentive Stock Option shall be subject to the one hundred thousand
dollars ($100,000) annual limitation on exercisability of Incentive Stock
Options described in subsection 11(d) of the Plan and in Section 422(d) of the
Code. There shall be no Re-Load Options on a Re-Load Option. Any such Re-Load
Option shall be subject to the availability of sufficient shares under
subsection 4(a) and shall be subject to such other terms and conditions as the
Board or Committee may determine which are not inconsistent with the express
provisions of the Plan regarding the terms of Options.

7.   TERMS OF STOCK BONUSES AND PURCHASES OF RESTRICTED STOCK.

     Each stock bonus or restricted stock purchase agreement shall be in such
form and shall contain such terms and conditions as the Board or the Committee
shall deem appropriate.  The terms and conditions of stock bonus or restricted
stock purchase agreements may change from time to time, and the terms and
conditions of separate agreements need not be identical, but each

                                       8.
<PAGE>
 
stock bonus or restricted stock purchase agreement shall include (through
incorporation of provisions hereof by reference in the agreement or otherwise)
the substance of each of the following provisions as appropriate:

     (a)  PURCHASE PRICE.  The purchase price under each restricted stock
purchase agreement shall be such amount as the Board or Committee shall
determine and designate in such agreement but in no event shall the purchase
price be less than eighty-five percent (85%) of the stock's Fair Market Value on
the date such award is made.  Notwithstanding the foregoing, the Board or the
Committee may determine that eligible participants in the Plan may be awarded
stock pursuant to a stock bonus agreement in consideration for past services
actually rendered to the Company for its benefit.

     (b)  TRANSFERABILITY.  No rights under a stock bonus or restricted stock
purchase agreement shall be transferable except by will or the laws of descent
and distribution or, if the agreement so provides, pursuant to a domestic
relations order satisfying the requirements of Rule 16b-3, so long as stock
awarded under such agreement remains subject to the terms of the agreement.

     (c)  CONSIDERATION.  The purchase price of stock acquired pursuant to a
stock purchase agreement shall be paid either:  (i) in cash at the time of
purchase; (ii) at the discretion of the Board or the Committee, according to a
deferred payment or other arrangement with the person to whom the stock is sold;
or (iii) in any other form of legal consideration that may be acceptable to the
Board or the Committee in its discretion.  Notwithstanding the foregoing, the
Board or the Committee to which administration of the Plan has been delegated
may award stock pursuant to a stock bonus agreement in consideration for past
services actually rendered to the Company or for its benefit.

     (d)  VESTING.  Shares of stock sold or awarded under the Plan may, but need
not, be subject to a repurchase option in favor of the Company in accordance
with a vesting schedule to be determined by the Board or the Committee.

     (e)  TERMINATION OF CONTINUOUS STATUS AS AN EMPLOYEE, DIRECTOR OR
CONSULTANT.  In the event a Participant's Continuous Status as an Employee,
Director or Consultant terminates, the Company may repurchase or otherwise
reacquire any or all of the shares of stock held by that person which have not
vested as of the date of termination under the terms of the stock bonus or
restricted stock purchase agreement between the Company and such person.

8.   CANCELLATION AND RE-GRANT OF OPTIONS.

     (a)  The Board or the Committee shall have the authority to effect, at any
time and from time to time,  (i) the repricing of any outstanding Options under
the Plan and/or (ii) with the consent of any adversely affected holders of
Options, the cancellation of any outstanding Options under the Plan and the
grant in substitution therefor of new Options under the Plan covering the same
or different numbers of shares of stock, but having an exercise price per share
not less than eighty-five percent (85%) of the Fair Market Value for a
Nonstatutory Stock Option, one hundred percent (100%) of the Fair Market Value
for an Incentive Stock Option or,

                                       9.
<PAGE>
 
in the case of an Incentive Stock Option held by a 10% stockholder (as described
in subsection 5(b)), not less than one hundred ten percent (110%) of the Fair
Market Value per share of stock on the new grant date.  Notwithstanding the
foregoing, the Board or the Committee may grant an Option with an exercise price
lower than that set forth above if such Option is granted as part of a
transaction to which section 424(a) of the Code applies.

     (b)  Shares subject to an Option canceled under this Section 8 shall
continue to be counted against the maximum award of Options permitted to be
granted pursuant to subsection 5(c) of the Plan.  The repricing of an Option
under this Section 8, resulting in a reduction of the exercise price, shall be
deemed to be a cancellation of the original Option and the grant of a substitute
Option; in the event of such repricing, both the original and the substituted
Options shall be counted against the maximum awards of Options permitted to be
granted pursuant to subsection 5(c) of the Plan.  The provisions of this
subsection 8(b) shall be applicable only to the extent required by Section
162(m) of the Code.

9.   COVENANTS OF THE COMPANY.

     (a)  During the terms of the Stock Awards, the Company shall keep available
at all times the number of shares of stock required to satisfy such Stock
Awards.

     (b)  The Company shall seek to obtain from each regulatory commission or
agency having jurisdiction over the Plan such authority as may be required to
issue and sell shares under Stock Awards; provided, however, that this
undertaking shall not require the Company to register under the Securities Act
of 1933, as amended (the "Securities Act") either the Plan, any Stock Award or
any stock issued or issuable pursuant to any such Stock Award.  If, after
reasonable efforts, the Company is unable to obtain from any such regulatory
commission or agency the authority which counsel for the Company deems necessary
for the lawful issuance and sale of stock under the Plan, the Company shall be
relieved from any liability for failure to issue and sell stock upon exercise of
such Stock Awards unless and until such authority is obtained.

10.  USE OF PROCEEDS FROM STOCK.

     Proceeds from the sale of stock pursuant to Stock Awards shall constitute
general funds of the Company.

11.  MISCELLANEOUS.

     (a)  The Board shall have the power to accelerate the time at which a Stock
Award may first be exercised or the time during which a Stock Award or any part
thereof will vest pursuant to subsection 6(e) or 7(d), notwithstanding the
provisions in the Stock Award stating the time at which it may first be
exercised or the time during which it will vest.

     (b)  Neither an Employee, Director nor a Consultant nor any person to whom
a Stock Award is transferred in accordance with the Plan shall be deemed to be
the holder of, or to have any of the rights of a holder with respect to, any
shares subject to such Stock Award unless and

                                      10.
<PAGE>
 
until such person has satisfied all requirements for exercise of the Stock Award
pursuant to its terms.

     (c)  Nothing in the Plan or any instrument executed or Stock Award granted
pursuant thereto shall confer upon any Employee, Consultant or other holder of
Stock Awards any right to continue in the employ of the Company or any
Affiliate, or to continue serving as a Consultant and Director, or shall affect
the right of the Company or any Affiliate to terminate the employment of any
Employee with or without notice and with or without cause, or the right to
terminate the relationship of any Consultant pursuant to the terms of such
Consultant's agreement with the Company or Affiliate or service as a Director
pursuant to the Company's By-Laws.

     (d)  To the extent that the aggregate Fair Market Value (determined at the
time of grant) of stock with respect to which Incentive Stock Options are
exercisable for the first time by any Optionee during any calendar year under
all plans of the Company and its Affiliates exceeds one hundred thousand dollars
($100,000), the Options or portions thereof which exceed such limit (according
to the order in which they were granted) shall be treated as Nonstatutory Stock
Options.

     (e)  The Company may require any person to whom a Stock Award is granted,
or any person to whom a Stock Award is transferred in accordance with the Plan,
as a condition of exercising or acquiring stock under any Stock Award, (1) to
give written assurances satisfactory to the Company as to such person's
knowledge and experience in financial and business matters and/or to employ a
purchaser representative reasonably satisfactory to the Company who is
knowledgeable and experienced in financial and business matters, and that he or
she is capable of evaluating, alone or together with the purchaser
representative, the merits and risks of exercising the Stock Award; and (2) to
give written assurances satisfactory to the Company stating that such person is
acquiring the stock subject to the Stock Award for such person's own account and
not with any present intention of selling or otherwise distributing the stock.
The foregoing requirements, and any assurances given pursuant to such
requirements, shall be inoperative if (i) the issuance of the shares upon the
exercise or acquisition of stock under the Stock Award has been registered under
a then currently effective registration statement under the Securities Act, or
(ii) as to any particular requirement, a determination is made by counsel for
the Company that such requirement need not be met in the circumstances under the
then applicable securities laws. The Company may, upon advice of counsel to the
Company, place legends on stock certificates issued under the Plan as such
counsel deems necessary or appropriate in order to comply with applicable
securities laws, including, but not limited to, legends restricting the transfer
of the stock.

     (f)  To the extent provided by the terms of a Stock Award Agreement, the
person to whom a Stock Award is granted may satisfy any federal, state or local
tax withholding obligation relating to the exercise or acquisition of stock
under a Stock Award by any of the following means or by a combination of such
means: (1) tendering a cash payment; (2) authorizing the Company to withhold
shares from the shares of the Common Stock otherwise issuable to the participant
as a result of the exercise or acquisition of stock under the Stock Award; or
(3)

                                      11.
<PAGE>
 
delivering to the Company owned and unencumbered shares of the Common Stock of
the Company.

12.  ADJUSTMENTS UPON CHANGES IN STOCK.

     (a)  If any change is made in the stock subject to the Plan, or subject to
any Stock Award, without the receipt of consideration by the Company (through
merger, consolidation, reorganization, recapitalization, reincorporation, stock
dividend, dividend in property other than cash, stock split, liquidating
dividend, combination of shares, exchange of shares, change in corporate
structure or other transaction not involving the receipt of consideration by the
Company), the Plan will be appropriately adjusted in the class(es) and maximum
number of shares subject to the Plan pursuant to subsection 4(a) and the maximum
number of shares subject to award to any person during any calendar year
pursuant to subsection 5(c), and the outstanding Stock Awards will be
appropriately adjusted in the class(es) and number of shares and price per share
of stock subject to such outstanding Stock Awards. Such adjustments shall be
made by the Board or the Committee, the determination of which shall be final,
binding and conclusive. (The conversion of any convertible securities of the
Company shall not be treated as a "transaction not involving the receipt of
consideration by the Company".)

     (b)  In the event of Change of Control:

          (1)  with respect to each Optionee who is an executive officer, the
vesting under all outstanding Options shall automatically accelerate by the
greater of (i) 12 months (e.g., that number of shares shall be immediately
vested as would have been vested on the date 12 months after the date of the
Change of Control) or (ii) that number of months equal to the number of full
months during which such executive officer has been employed by the Company;
provided, however, that the Board does not find that it is in the collective
interest of the Company's stockholders and the Optionees to provide otherwise.
If such a finding is made, the Options shall either remain outstanding or be
assumed by the acquiror (with the Optionee being entitled to receive the same
consideration as was received by the Common Stock stockholders in the Change of
Control transaction) or the Board and/or the acquiror shall adopt a replacement
benefit which shall (at a minimum) provide value to the executive officer on the
vesting dates of the non-accelerated Options substantially equal to the value
the executive officer would have received if the shares had participated in all
steps of the transaction; and

          (2)  with respect to each Stock Award other than an Option held by an
executive officer, any Stock Award shall remain outstanding under the Plan, be
assumed by the acquiror or be substituted with similar Stock Awards.  In the
event the acquiror refuses to assume, substitute or continue such Stock Awards,
then such Stock Awards shall be terminate if not exercised or vested, as
applicable, prior to the Change of Control.

     For purposes of this Plan, "Change of Control" shall mean: any
consolidation or merger of the Company with or into any other entity or person,
or any other corporate reorganization in which the Company shall not be the
continuing or surviving entity, or any transaction or series of related
transactions by the Company in which in excess of 50% of the Company's voting
power is transferred, or any sale, lease, license or other disposition of all or
substantially

                                      12.
<PAGE>
 
all of the assets of the Company.  The continuing or surviving organization
entity shall be deemed the acquiror for purposes of this subsection of the Plan.

13.  AMENDMENT OF THE PLAN AND STOCK AWARDS.

     (a)  The Board at any time, and from time to time, may amend the Plan.
However, except as provided in Section 12 relating to adjustments upon changes
in stock, no amendment shall be effective unless approved by the stockholders of
the Company where stockholder is necessary for the Plan to satisfy the
requirements of Section 422 of the Code, Rule 16b-3 or any Nasdaq or securities
exchange listing requirements.

     (b)  The Board may in its sole discretion submit any other amendment to the
Plan for stockholder approval, including, but not limited to, amendments to the
Plan intended to satisfy the requirements of Section 162(m) of the Code and the
regulations thereunder regarding the exclusion of performance-based compensation
from the limit on corporate deductibility of compensation paid to certain
executive officers.

     (c)  It is expressly contemplated that the Board may amend the Plan in any
respect the Board deems necessary or advisable to provide eligible Employees,
Directors or Consultants with the maximum benefits provided or to be provided
under the provisions of the Code and the regulations promulgated thereunder
relating to Incentive Stock Options and/or to bring the Plan and/or Incentive
Stock Options granted under it into compliance therewith.

     (d)  Rights and obligations under any Stock Award granted before amendment
of the Plan shall not be impaired by any amendment of the Plan unless (i) the
Company requests the consent of the person to whom the Stock Award was granted
and (ii) such person consents in writing.

     (e)  The Board at any time, and from time to time, may amend the terms of
any one or more Stock Awards; provided, however, that the rights and obligations
under any Stock Award shall not be impaired by any such amendment unless (i) the
Company requests the consent of the person to whom the Stock Award was granted
and (ii) such person consents in writing.

14.  TERMINATION OR SUSPENSION OF THE PLAN.

     (a)  The Board may suspend or terminate the Plan at any time. Unless sooner
terminated, the Plan shall terminate ten (10) years from the date the Plan is
adopted by the Board or approved by the stockholders of the Company, whichever
is earlier. No Stock Awards may be granted under the Plan while the Plan is
suspended or after it is terminated.

     (b)  Rights and obligations under any Stock Award granted while the Plan is
in effect shall not be impaired by suspension or termination of the Plan, except
with the consent of the person to whom the Stock Award was granted.

                                      13.
<PAGE>
 
15.  EFFECTIVE DATE OF PLAN.

     This amendment and restatement of the Plan shall become effective on the
effective date of the registration statement with respect to the Company's
initial public offering of shares of Common Stock, but no Stock Awards granted
under the Plan shall be exercised unless and until the Plan has been approved by
the stockholders of the Company, which approval shall be within twelve (12)
months before or after the date the Plan is adopted by the Board.

                                      14.

<PAGE>
 
                                                                    EXHIBIT 10.2

                             INCENTIVE STOCK OPTION

_________________________, Optionee:

     MEGABIOS Corp. (the "Company"), pursuant to its 1997 Equity Incentive Plan
(the "Plan"), has this day granted to you, the optionee named above, an option
to purchase shares of the common stock of the Company ("Common Stock").  This
option is intended to qualify as an "incentive stock option" within the meaning
of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code").

     The details of your option are as follows:


     1.   The total number of shares of Common Stock subject to this option is
____________________ (__________).  Subject to the limitations contained herein,
this option shall be exercisable with respect to each installment of shares
subject to this option on or after the date of vesting applicable to such
installment.  The shares subject to this option shall vest as follows:

          (a) Twenty-five percent (25%) of the total number of shares subject to
this option shall vest one year after the Vesting Commencement Date, which is
______________ __, 19__; and

          (b) One thirty-sixth (1/36) of the remaining seventy-five percent
(75%) of the shares subject to this option shall vest at the end of each
additional one-month period following the vesting of the first 25% pursuant to
subsection (a) above.

     2.   (a)  The exercise price of this option is _______________________
($____) per share, being not less than the fair market value of the Common Stock
on the date of grant of this option.

          (b) Payment of the exercise price per share is due in full upon
exercise of all or any part of each installment which has accrued to you.  You
may elect, to the extent permitted by applicable statutes and regulations, to
make payment of the exercise price under one of the following alternatives:

               (i)  Payment of the exercise price per share in cash (including
check) at the time of exercise;

               (ii) Payment pursuant to a program developed under Regulation T
as promulgated by the Federal Reserve Board which results in the receipt of cash
(or check) by the Company prior to the issuance of Common Stock;

                                       1.
<PAGE>
 
                (iii) Provided that at the time of exercise the Company's Common
Stock is publicly traded and quoted regularly in the Wall Street Journal,
payment by delivery of already-owned shares of Common Stock, held for the period
required to avoid a charge to the Company's reported earnings, and owned free
and clear of any liens, claims, encumbrances or security interests, which Common
Stock shall be valued at its fair market value on the date of exercise; or

               (iv) Payment by a combination of the methods of payment permitted
by subparagraph 2(b)(i) through 2(b)(iii) above.

 
     3.   This option may not be exercised for any number of shares which would
require the issuance of anything other than whole shares.

     4.   Notwithstanding anything to the contrary contained herein, this option
may not be exercised unless the shares issuable upon exercise of this option are
then registered under the Act or, if such shares are not then so registered, the
Company has determined that such exercise and issuance would be exempt from the
registration requirements of the Act.

     5.   The term of this option commences on the date hereof and, unless
sooner terminated as set forth below or in the Plan, terminates on
______________________ (which date shall be no more than ten (10) years from
date this option is granted).  In no event may this option be exercised on or
after the date on which it terminates.  This option shall terminate prior to the
expiration of its term as follows:  three (3) months after the termination of
your employment with the Company or an affiliate of the Company (as defined in
the Plan) for any reason or for no reason unless:

          (a) such termination of employment is due to your permanent and total
disability (within the meaning of Section 422(c)(6) of the Code), in which event
the option shall terminate on the earlier of the termination date set forth
above or twelve (12) months following such termination of employment; or

          (b) such termination of employment is due to your death, in which
event the option shall terminate on the earlier of the termination date set
forth above or twelve (12) months after your death; or

          (c) during any part of such three (3) month period the option is not
exercisable solely because of the condition set forth in paragraph 4 above, in
which event the option shall not terminate until the earlier of the termination
date set forth above or until it shall have been exercisable for an aggregate
period of three (3) months after the termination of employment.

     However, this option may be exercised following termination of employment
only as to that number of shares as to which it was exercisable on the date of
termination of employment under the provisions of paragraph 1 of this option.

                                       2.
<PAGE>
 
     In order to obtain the federal income tax advantages associated with an
"incentive stock option," the Code requires that at all times beginning on the
date of grant of the option and ending on the day three (3) months before the
date of the option's exercise, you must be an employee of the Company or an
Affiliate, except in the event of your death or permanent and total disability.
The Company has provided for continued vesting or extended exercisability of
this option under certain circumstances for your benefit, but cannot guarantee
that this option will necessarily be treated as an "incentive stock option" if
you provide services to the Company or an Affiliate as a consultant or if your
exercise your option more than three (3) months after the date your employment
with the Company and all Affiliates terminates.
 
     6.   (a)  This option may be exercised, to the extent specified above, by
delivering a notice of exercise (in a form designated by the Company) together
with the exercise price to the Secretary of the Company, or to such other person
as the Company may designate, during regular business hours, together with such
additional documents as the Company may then require pursuant to subparagraph
11(e) of the Plan.

          (b) By exercising this option you agree that:

                (i)     the Company may require you to enter an arrangement
providing for the payment by you to the Company of any tax withholding
obligation of the Company arising by reason of (1) the exercise of this option;
(2) the lapse of any substantial risk of forfeiture to which the shares are
subject at the time of exercise; or (3) the disposition of shares acquired upon
such exercise;

                (ii)    you will notify the Company in writing within fifteen
(15) days after the date of any disposition of any of the shares of the Common
Stock issued upon exercise of this option that occurs within two (2) years after
the date of this option grant or within one (1) year after such shares of Common
Stock are transferred upon exercise of this option; and

                (iii)   the Company (or a representative of the underwriters)
may, in connection with the first underwritten registration of the offering of
any securities of the Company under the Act, require that you not sell or
otherwise transfer or dispose of any shares of Common Stock or other securities
of the Company during such period (not to exceed one hundred eighty (180) days)
following the effective date (the "Effective Date") of the registration
statement of the Company filed under the Act as may be requested by the Company
or the representative of the underwriters. For purposes of this restriction you
will be deemed to own securities which (i) are owned directly or indirectly by
you, including securities held for your benefit by nominees, custodians, brokers
or pledgees; (ii) may be acquired by you within sixty (60) days of the Effective
Date; (iii) are owned directly or indirectly, by or for your brothers or sisters
(whether by whole or half blood) spouse, ancestors and lineal descendants; or
(iv) are owned, directly or indirectly, by or for a corporation, partnership,
estate or trust of which you are a shareholder, partner or beneficiary, but only
to the extent of your proportionate interest therein as a shareholder, partner
or beneficiary thereof. You further agree that the Company

                                       3.
<PAGE>
 
may impose stop-transfer instructions with respect to securities subject to the
foregoing restrictions until the end of such period.

     7.   This option is not transferable, except by will or by the laws of
descent and distribution, and is exercisable during your life only by you.

     8.   This option is not an employment contract and nothing in this option
shall be deemed to create in any way whatsoever any obligation on your part to
continue in the employ of the Company, or of the Company to continue your
employment with the Company.

     9.   Any notices provided for in this option or the Plan shall be given in
writing and shall be deemed effectively given upon receipt or, in the case of
notices delivered by the Company to you, five (5) days after deposit in the
United States mail, postage prepaid, addressed to you at the address specified
below or at such other address as you hereafter designate by written notice to
the Company.

     10.  This option is subject to all the provisions of the Plan, a copy of
which is attached hereto and its provisions are hereby made a part of this
option, including without limitation the provisions of paragraph 6 of the Plan
relating to option provisions, and is further subject to all interpretations,
amendments, rules and regulations which may from time to time be promulgated and
adopted pursuant to the Plan.  In the event of any conflict between the
provisions of this option and those of the Plan, the provisions of the Plan
shall control.

     Dated the ____ day of __________________, 19__.

                                Very truly yours,

 
                                ______________________________________________


                                By ___________________________________________
                                   Duly authorized on behalf
                                   of the Board of Directors


ATTACHMENTS:

     1997 Equity Incentive Plan
     Notice of Exercise

                                       4.
<PAGE>
 
The undersigned:

     (a) Acknowledges receipt of the foregoing option and the attachments
referenced therein and understands that all rights and liabilities with respect
to this option are set forth in the option and the Plan; and

     (b) Acknowledges that as of the date of grant of this option, it sets forth
the entire understanding between the undersigned optionee and the Company and
its affiliates regarding the acquisition of stock in the Company and supersedes
all prior oral and written agreements on that subject with the exception of (i)
the options previously granted and delivered to the undersigned under stock
option plans of the Company, and (ii) the following agreements only:

     NONE       __________________
                (Initial)

     OTHER      ______________________________________
                ______________________________________
                ______________________________________
 
 
                                ______________________________________
                                OPTIONEE

                                Address: _____________________________
                                         _____________________________
 

                                       5.

<PAGE>
 
                                                                    EXHIBIT 10.3

                           NONSTATUTORY STOCK OPTION


_________________________, Optionee:

     MEGABIOS Corp. (the "Company"), pursuant to its 1997 Equity Incentive Plan
(the "Plan") has this day granted to you, the optionee named above, an option to
purchase shares of the common stock of the Company ("Common Stock").  This
option is not intended to qualify as and will not be treated as an "incentive
stock option" within the meaning of Section 422 of the Internal Revenue Code of
1986, as amended (the "Code").

     The details of your option are as follows:

     1.   The total number of shares of Common Stock subject to this option is
____________________ (__________).  Subject to the limitations contained herein,
this option shall be exercisable with respect to each installment of shares
subject to this option on or after the date of vesting applicable to such
installment.  The shares subject to this option shall vest as follows:

          (a) Twenty-five percent (25%) of the total number of shares subject to
this option shall vest one year after the Vesting Commencement Date, which is
______________ __, 19__; and

          (b) One thirty-sixth (1/36) of the remaining seventy-five percent
(75%) of the shares subject to this option shall vest at the end of each
additional one-month period following the vesting of the first 25% pursuant to
subsection (a) above.

     2.   (a)  The exercise price of this option is ___________________________
($___________) per share, being not less than 85% of the fair market value of
the Common Stock on the date of grant of this option.

          (b) Payment of the exercise price per share is due in full upon
exercise of all or any part of each installment which has accrued to you.  You
may elect, to the extent permitted by applicable statutes and regulations, to
make payment of the exercise price under one of the following alternatives:

               (i)   Payment of the exercise price per share in cash (including
check) at the time of exercise;

                                       1.
<PAGE>
 
               (ii)  Payment pursuant to a program developed under Regulation T
as promulgated by the Federal Reserve Board which results in the receipt of cash
(or check) by the Company prior to the issuance of Common Stock;

               (iii) Provided that at the time of exercise the Company's
Common Stock is publicly traded and quoted regularly in the Wall Street Journal,
payment by delivery of already-owned shares of Common Stock, held for the period
required to avoid a charge to the Company's reported earnings, and owned free
and clear of any liens, claims, encumbrances or security interests, which Common
Stock shall be valued at its fair market value on the date of exercise; or

               (iv)  Payment by a combination of the methods of payment
permitted by subparagraph 2(b)(i) through 2(b)(iii) above.

     3.   This option may not be exercised for any number of shares which would
require the issuance of anything other than whole shares.

     4.   Notwithstanding anything to the contrary contained herein, this option
may not be exercised unless the shares issuable upon exercise of this option are
then registered under the Act or, if such Shares are not then so registered, the
Company has determined that such exercise and issuance would be exempt from the
registration requirements of the Act.

     5.   The term of this option commences on the date hereof and, unless
sooner terminated as set forth below or in the Plan, terminates on
_______________________ (which date shall be no more than ten (10) years from
the date this option is granted).  In no event may this option be exercised on
or after the date on which it terminates.  This option shall terminate prior to
the expiration of its term as follows:  three (3) months after the termination
of your employment with the Company or an affiliate of the Company (as defined
in the Plan) for any reason or for no reason unless:

          (a) such termination of employment is due to your permanent and total
disability (within the meaning of Section 422(c)(6) of the Code), in which event
the option shall terminate on the earlier of the termination date set forth
above or twelve (12) months following such termination of employment; or

          (b) such termination of employment is due to your death, in which
event the option shall terminate on the earlier of the termination date set
forth above or twelve (12) months after your death; or

          (c) during any part of such three (3) month period the option is not
exercisable solely because of the condition set forth in paragraph 4 above, in
which event the option shall not terminate until the earlier of the termination
date set forth above or until it shall have been exercisable for an aggregate
period of three (3) months after the termination of employment.
 

                                       2.
<PAGE>
 
     However, this option may be exercised following termination of employment
only as to that number of shares as to which it was exercisable on the date of
termination of employment under the provisions of paragraph 1 of this option.

     6.   (a)  This option may be exercised, to the extent specified above, by
delivering a notice of exercise (in a form designated by the Company) together
with the exercise price to the Secretary of the Company, or to such other person
as the Company may designate, during regular business hours, together with such
additional documents as the Company may then require pursuant to subparagraph
11(e) of the Plan.

          (b) By exercising this option you agree that:

                (i)   the Company may require you to enter an arrangement
providing for the cash payment by you to the Company of any tax withholding
obligation of the Company arising by reason of: (1) the exercise of this option;
(2) the lapse of any substantial risk of forfeiture to which the shares are
subject at the time of exercise; or (3) the disposition of shares acquired upon
such exercise; and

                (ii)  the Company (or a representative of the underwriters) may,
in connection with the first underwritten registration of the offering of any
securities of the Company under the Act, require that you not sell or otherwise
transfer or dispose of any shares of Common Stock or other securities of the
Company during such period (not to exceed one hundred eighty (180) days)
following the effective date (the "Effective Date") of the registration
statement of the Company filed under the Act as may be requested by the Company
or the representative of the underwriters. For purposes of this restriction you
will be deemed to own securities which (i) are owned directly or indirectly by
you, including securities held for your benefit by nominees, custodians, brokers
or pledgees; (ii) may be acquired by you within sixty (60) days of the Effective
Date; (iii) are owned directly or indirectly, by or for your brothers or sisters
(whether by whole or half blood) spouse, ancestors and lineal descendants; or
(iv) are owned, directly or indirectly, by or for a corporation, partnership,
estate or trust of which you are a shareholder, partner or beneficiary, but only
to the extent of your proportionate interest therein as a shareholder, partner
or beneficiary thereof. You further agree that the Company may impose stop-
transfer instructions with respect to securities subject to the foregoing
restrictions until the end of such period.

     7.   This option is not transferable, except by will or by the laws of
descent and distribution or pursuant to a qualified domestic relations order as
defined in the Code or Title I of the Employee Retirement Income Security Act (a
"QDRO"), and is exercisable during your life only by you or a transferee
pursuant to a QDRO.

     8.   This option is not an employment contract and nothing in this option
shall be deemed to create in any way whatsoever any obligation on your part to
continue in the employ of the Company, or of the Company to continue your
employment with the Company.  In the event that this option is granted to you in
connection with the performance of services as a consultant or director,
references to employment, employee and similar terms shall be deemed

                                       3.
<PAGE>
 
to include the performance of services as a consultant or a director, as the
case may be, provided, however, that no rights as an employee shall arise by
reason of the use of such terms.

     9.   Any notices provided for in this option or the Plan shall be given in
writing and shall be deemed effectively given upon receipt or, in the case of
notices delivered by the Company to you, five (5) days after deposit in the
United States mail, postage prepaid, addressed to you at the address specified
below or at such other address as you hereafter designate by written notice to
the Company.

     10.  This option is subject to all the provisions of the Plan, a copy of
which is attached hereto and its provisions are hereby made a part of this
option, including without limitation the provisions of paragraph 6 of the Plan
relating to option provisions, and is further subject to all interpretations,
amendments, rules and regulations which may from time to time be promulgated and
adopted pursuant to the Plan.  In the event of any conflict between the
provisions of this option and those of the Plan, the provisions of the Plan
shall control.

     Dated the ____ day of __________________, 19__.

                                        Very truly yours,

 
                                        ____________________________________


                                        By _________________________________
                                            Duly authorized on behalf
                                            of the Board of Directors

ATTACHMENTS:

     1997 Equity Incentive Plan
     Notice of Exercise
 

                                       4.
<PAGE>
 
The undersigned:

     (a) Acknowledges receipt of the foregoing option and the attachments
referenced therein and understands that all rights and liabilities with respect
to this option are set forth in the option and the Plan; and

     (b) Acknowledges that as of the date of grant of this option, it sets forth
the entire understanding between the undersigned optionee and the Company and
its affiliates regarding the acquisition of stock in the Company and supersedes
all prior oral and written agreements on that subject with the exception of (i)
the options previously granted and delivered to the undersigned under stock
option plans of the Company, and (ii) the following agreements only:

     NONE     ____________________
               (Initial)

     OTHER    ____________________________________
              ____________________________________
              ____________________________________


                                ________________________________________ 
                                OPTIONEE

                                Address: _______________________________
                                         _______________________________ 

                                       5.

<PAGE>
 
                                                                    EXHIBIT 10.4
 
                                MEGABIOS CORP.

                         EMPLOYEE STOCK PURCHASE PLAN

                             ADOPTED JULY 25, 1997

                 APPROVED BY STOCKHOLDERS  _____________, 1997




1.   PURPOSE.

     (a)  The purpose of the Employee Stock Purchase Plan (the "Plan") is to
provide a means by which employees of MEGABIOS Corp., a Delaware corporation
(the "Company"), and its Affiliates, as defined in subparagraph 1(b), which are
designated as provided in subparagraph 2(b), may be given an opportunity to
purchase stock of the Company.

     (b)  The word "Affiliate" as used in the Plan means any parent corporation
or subsidiary corporation of the Company, as those terms are defined in Sections
424(e) and (f), respectively, of the Internal Revenue Code of 1986, as amended
(the "Code").

     (c)  The Company, by means of the Plan, seeks to retain the services of its
employees, to secure and retain the services of new employees, and to provide
incentives for such persons to exert maximum efforts for the success of the
Company.

     (d)  The Company intends that the rights to purchase stock of the Company
granted under the Plan be considered options issued under an "employee stock
purchase plan" as that term is defined in Section 423(b) of the Code.

2.   ADMINISTRATION.

     (a)  The Plan shall be administered by the Board of Directors (the "Board")
of the Company unless and until the Board delegates administration to a
Committee, as provided in subparagraph 2(c).  Whether or not the Board has
delegated administration, the Board shall have the final power to determine all
questions of policy and expediency that may arise in the administration of the
Plan.

     (b)  The Board shall have the power, subject to, and within the limitations
of, the express provisions of the Plan:

          (i)  To determine when and how rights to purchase stock of the Company
shall be granted and the provisions of each offering of such rights (which need
not be identical).

          (ii) To designate from time to time which Affiliates of the Company
shall be eligible to participate in the Plan.

                                       1.
<PAGE>
 
          (iii) To construe and interpret the Plan and rights granted under it,
and to establish, amend and revoke rules and regulations for its administration.
The Board, in the exercise of this power, may correct any defect, omission or
inconsistency in the Plan, in a manner and to the extent it shall deem necessary
or expedient to make the Plan fully effective.

           (iv) To amend the Plan as provided in paragraph 13.

           (v) Generally, to exercise such powers and to perform such acts as
the Board deems necessary or expedient to promote the best interests of the
Company and its Affiliates and to carry out the intent that the Plan be treated
as an "employee stock purchase plan" within the meaning of Section 423 of the
Code.

     (c)  The Board may delegate administration of the Plan to a committee
comprised of one or more members of the Board.  If administration is delegated
to a Committee, the Committee shall have, in connection with the administration
of the Plan, the powers theretofore possessed by the Board, subject, however, to
such resolutions, not inconsistent with the provisions of the Plan, as may be
adopted from time to time by the Board.  The Board may abolish the Committee at
any time and revest in the Board the administration of the Plan.

3.   SHARES SUBJECT TO THE PLAN.

     (a)  Subject to the provisions of paragraph 12 relating to adjustments upon
changes in stock, the stock that may be sold pursuant to rights granted under
the Plan shall not exceed in the aggregate two hundred thousand (200,000) shares
of the Company's common stock (the "Common Stock").  If any right granted under
the Plan shall for any reason terminate without having been exercised, the
Common Stock not purchased under such right shall again become available for the
Plan.

     (b)  The stock subject to the Plan may be unissued shares or reacquired
shares, bought on the market or otherwise.

4.   GRANT OF RIGHTS; OFFERING.

     (a)  The Board or the Committee may from time to time grant or provide for
the grant of rights to purchase Common Stock of the Company under the Plan to
eligible employees (an "Offering") on a date or dates (the "Offering Date(s)")
selected by the Board or the Committee.  Each Offering shall be in such form and
shall contain such terms and conditions as the Board or the Committee shall deem
appropriate, which shall comply with the requirements of Section 423(b)(5) of
the Code that all employees granted rights to purchase stock under the Plan
shall have the same rights and privileges.  The terms and conditions of an
Offering shall be incorporated by reference into the Plan and treated as part of
the Plan.  The provisions of separate Offerings need not be identical, but each
Offering shall include (through incorporation of the provisions of this Plan by
reference in the document comprising the Offering or otherwise) the period
during which the Offering shall be effective, which period shall not exceed
twenty-seven (27) months beginning with the Offering Date, and the substance of
the provisions contained in paragraphs 5 through 8, inclusive.

                                       2.
<PAGE>
 
     (b) If an employee has more than one right outstanding under the Plan,
unless he or she otherwise indicates in agreements or notices delivered
hereunder:  (1) each agreement or notice delivered by that employee will be
deemed to apply to all of his or her rights under the Plan, and (2) a right with
a lower exercise price (or an earlier-granted right, if two rights have
identical exercise prices), will be exercised to the fullest possible extent
before a right with a higher exercise price (or a later-granted right, if two
rights have identical exercise prices) will be exercised.

5.   ELIGIBILITY.

     (a)  Rights may be granted only to employees of the Company or, as the
Board or the Committee may designate as provided in subparagraph 2(b), to
employees of any Affiliate of the Company. Except as provided in subparagraph
5(b), an employee of the Company or any Affiliate shall not be eligible to be
granted rights under the Plan, unless, on the Offering Date, such employee has
been in the employ of the Company or any Affiliate for such continuous period
preceding such grant as the Board or the Committee may require, but in no event
shall the required period of continuous employment be equal to or greater than
two (2) years. In addition, unless otherwise determined by the Board or the
Committee and set forth in the terms of the applicable Offering, no employee of
the Company or any Affiliate shall be eligible to be granted rights under the
Plan, unless, on the Offering Date, such employee's customary employment with
the Company or such Affiliate is for at least twenty (20) hours per week and at
least five (5) months per calendar year.

     (b) The Board or the Committee may provide that, each person who, during
the course of an Offering, first becomes an eligible employee of the Company or
designated Affiliate will, on a date or dates specified in the Offering which
coincides with the day on which such person becomes an eligible employee or
occurs thereafter, receive a right under that Offering, which right shall
thereafter be deemed to be a part of that Offering.  Such right shall have the
same characteristics as any rights originally granted under that Offering, as
described herein, except that:

          (i) the date on which such right is granted shall be the "Offering
Date" of such right for all purposes, including determination of the exercise
price of such right;

          (ii) the period of the Offering with respect to such right shall begin
on its Offering Date and end coincident with the end of such Offering; and

          (iii) the Board or the Committee may provide that if such person first
becomes an eligible employee within a specified period of time before the end of
the Offering, he or she will not receive any right under that Offering.

     (c)  No employee shall be eligible for the grant of any rights under the
Plan if, immediately after any such rights are granted, such employee owns stock
possessing five percent (5%) or more of the total combined voting power or value
of all classes of stock of the Company or of any Affiliate.  For purposes of
this subparagraph 5(c), the rules of Section 424(d) of the Code shall apply in
determining the stock ownership of any employee, and stock

                                       3.
<PAGE>
 
which such employee may purchase under all outstanding rights and options shall
be treated as stock owned by such employee.

     (d) An eligible employee may be granted rights under the Plan only if such
rights, together with any other rights granted under "employee stock purchase
plans" of the Company and any Affiliates, as specified by Section 423(b)(8) of
the Code, do not permit such employee's rights to purchase stock of the Company
or any Affiliate to accrue at a rate which exceeds twenty-five thousand dollars
($25,000) of fair market value of such stock (determined at the time such rights
are granted) for each calendar year in which such rights are outstanding at any
time.

     (e)  Officers of the Company and any designated Affiliate shall be eligible
to participate in Offerings under the Plan, provided, however, that the Board
may provide in an Offering that certain employees who are highly compensated
employees within the meaning of Section 423(b)(4)(D) of the Code shall not be
eligible to participate.

6.   RIGHTS; PURCHASE PRICE.

     (a)  On each Offering Date, each eligible employee, pursuant to an Offering
made under the Plan, shall be granted the right to purchase up to the number of
shares of Common Stock of the Company purchasable with a percentage designated
by the Board or the Committee not exceeding fifteen percent (15%) of such
employee's Earnings (as defined by the Board or the Committee in each Offering)
during the period which begins on the Offering Date (or such later date as the
Board or the Committee determines for a particular Offering) and ends on the
date stated in the Offering, which date shall be no later than the end of the
Offering.  The Board or the Committee shall establish one or more dates during
an Offering (the "Purchase Date(s)") on which rights granted under the Plan
shall be exercised and purchases of Common Stock carried out in accordance with
such Offering.

     (b)  In connection with each Offering made under the Plan, the Board or the
Committee may specify a maximum number of shares that may be purchased by any
employee as well as a maximum aggregate number of shares that may be purchased
by all eligible employees pursuant to such Offering.  In addition, in connection
with each Offering that contains more than one Purchase Date, the Board or the
Committee may specify a maximum aggregate number of shares which may be
purchased by all eligible employees on any given Purchase Date under the
Offering.  If the aggregate purchase of shares upon exercise of rights granted
under the Offering would exceed any such maximum aggregate number, the Board or
the Committee shall make a pro rata allocation of the shares available in as
nearly a uniform manner as shall be practicable and as it shall deem to be
equitable.

     (c)  The purchase price of stock acquired pursuant to rights granted under
the Plan shall be not less than the lesser of:

          (i) an amount equal to eighty-five percent (85%) of the fair market
value of the stock on the Offering Date; or

                                       4.
<PAGE>
 
          (ii) an amount equal to eighty-five percent (85%) of the fair market
value of the stock on the Purchase Date.

7.   PARTICIPATION; WITHDRAWAL; TERMINATION.

     (a)  An eligible employee may become a participant in the Plan pursuant to
an Offering by delivering a participation agreement to the Company within the
time specified in the Offering, in such form as the Company provides.  Each such
agreement shall authorize payroll deductions of up to the maximum percentage
specified by the Board or the Committee of such employee's Earnings during the
Offering (as defined by the Board or Committee in each Offering).  The payroll
deductions made for each participant shall be credited to an account for such
participant under the Plan and shall be deposited with the general funds of the
Company.  A participant may reduce (including to zero) or increase such payroll
deductions, and an eligible employee may begin such payroll deductions, after
the beginning of any Offering only as provided for in the Offering.  A
participant may make additional payments into his or her account only if
specifically provided for in the Offering and only if the participant has not
had the maximum amount withheld during the Offering.

     (b)  At any time during an Offering, a participant may terminate his or her
payroll deductions under the Plan and withdraw from the Offering by delivering
to the Company a notice of withdrawal in such form as the Company provides.
Such withdrawal may be elected at any time prior to the end of the Offering
except as provided by the Board or the Committee in the Offering.  Upon such
withdrawal from the Offering by a participant, the Company shall distribute to
such participant all of his or her accumulated payroll deductions (reduced to
the extent, if any, such deductions have been used to acquire stock for the
participant) under the Offering, without interest, and such participant's
interest in that Offering shall be automatically terminated.  A participant's
withdrawal from an Offering will have no effect upon such participant's
eligibility to participate in any other Offerings under the Plan but such
participant will be required to deliver a new participation agreement in order
to participate in subsequent Offerings under the Plan.

     (c)  Rights granted pursuant to any Offering under the Plan shall terminate
immediately upon cessation of any participating employee's employment with the
Company and any designated Affiliate, for any reason, and the Company shall
distribute to such terminated employee all of his or her accumulated payroll
deductions (reduced to the extent, if any, such deductions have been used to
acquire stock for the terminated employee) under the Offering, without interest.

     (d)  Rights granted under the Plan shall not be transferable by a
participant otherwise than by will or the laws of descent and distribution, or
by a beneficiary designation as provided in paragraph 14 and, otherwise during
his or her lifetime, shall be exercisable only by the person to whom such rights
are granted.

                                       5.
<PAGE>
 
8.   EXERCISE.

     (a)  On each Purchase Date specified therefor in the relevant Offering,
each participant's accumulated payroll deductions and other additional payments
specifically provided for in the Offering (without any increase for interest)
will be applied to the purchase of whole shares of stock of the Company, up to
the maximum number of shares permitted pursuant to the terms of the Plan and the
applicable Offering, at the purchase price specified in the Offering. No
fractional shares shall be issued upon the exercise of rights granted under the
Plan. The amount, if any, of accumulated payroll deductions remaining in each
participant's account after the purchase of shares which is less than the amount
required to purchase one share of stock on the final Purchase Date of an
Offering shall be held in each such participant's account for the purchase of
shares under the next Offering under the Plan, unless such participant withdraws
from such next Offering, as provided in subparagraph 7(b), or is no longer
eligible to be granted rights under the Plan, as provided in paragraph 5, in
which case such amount shall be distributed to the participant after such final
Purchase Date, without interest. The amount, if any, of accumulated payroll
deductions remaining in any participant's account after the purchase of shares
which is equal to the amount required to purchase whole shares of stock on the
final Purchase Date of an Offering shall be distributed in full to the
participant after such Purchase Date, without interest.

     (b)  No rights granted under the Plan may be exercised to any extent unless
the shares to be issued upon such exercise under the Plan (including rights
granted thereunder) are covered by an effective registration statement pursuant
to the Securities Act of 1933, as amended (the "Securities Act") and the Plan is
in material compliance with all applicable state, foreign and other securities
and other laws applicable to the Plan.  If on a Purchase Date in any Offering
hereunder the Plan is not so registered or in such compliance, no rights granted
under the Plan or any Offering shall be exercised on such Purchase Date, and the
Purchase Date shall be delayed until the Plan is subject to such an effective
registration statement and such compliance, except that the Purchase Date shall
not be delayed more than twelve (12) months and the Purchase Date shall in no
event be more than twenty-seven (27) months from the Offering Date.  If on the
Purchase Date of any Offering hereunder, as delayed to the maximum extent
permissible, the Plan is not registered and in such compliance, no rights
granted under the Plan or any Offering shall be exercised and all payroll
deductions accumulated during the Offering (reduced to the extent, if any, such
deductions have been used to acquire stock) shall be distributed to the
participants, without interest.

9.   COVENANTS OF THE COMPANY.

     (a)  During the terms of the rights granted under the Plan, the Company
shall keep available at all times the number of shares of stock required to
satisfy such rights.

     (b)  The Company shall seek to obtain from each federal, state, foreign or
other regulatory commission or agency having jurisdiction over the Plan such
authority as may be required to issue and sell shares of stock upon exercise of
the rights granted under the Plan.  If, after reasonable efforts, the Company is
unable to obtain from any such regulatory commission or agency the authority
which counsel for the Company deems necessary for the lawful issuance

                                       6.
<PAGE>
 
and sale of stock under the Plan, the Company shall be relieved from any
liability for failure to issue and sell stock upon exercise of such rights
unless and until such authority is obtained.

10.  USE OF PROCEEDS FROM STOCK.

     Proceeds from the sale of stock pursuant to rights granted under the Plan
shall constitute general funds of the Company.

11.  RIGHTS AS A STOCKHOLDER.

     A participant shall not be deemed to be the holder of, or to have any of
the rights of a holder with respect to, any shares subject to rights granted
under the Plan unless and until the participant's shareholdings acquired upon
exercise of rights under the Plan are recorded in the books of the Company.

12.  ADJUSTMENTS UPON CHANGES IN STOCK.

     (a)  If any change is made in the stock subject to the Plan, or subject to
any rights granted under the Plan (through merger, consolidation,
reorganization, recapitalization, reincorporation, stock dividend, dividend in
property other than cash, stock split, liquidating dividend, combination of
shares, exchange of shares, change in corporate structure or other transaction
not involving the receipt of consideration by the Company), the Plan and
outstanding rights will be appropriately adjusted in the class(es) and maximum
number of shares subject to the Plan and the class(es) and number of shares and
price per share of stock subject to outstanding rights.  Such adjustments shall
be made by the Board or the Committee, the determination of which shall be
final, binding and conclusive.  (The conversion of any convertible securities of
the Company shall not be treated as a "transaction not involving the receipt of
consideration by the Company.")

     (b)  In the event of:  (1) a dissolution or liquidation of the Company; (2)
a merger or consolidation in which the Company is not the surviving corporation;
(3) a reverse merger in which the Company is the surviving corporation but the
shares of the Company's Common Stock outstanding immediately preceding the
merger are converted by virtue of the merger into other property, whether in the
form of securities, cash or otherwise; or (4) the acquisition by any person,
entity or group within the meaning of Section 13(d) or 14(d) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act") or any comparable
successor provisions (excluding any employee benefit plan, or related trust,
sponsored or maintained by the Company or any Affiliate of the Company) of the
beneficial ownership (within the meaning of Rule 13d-3 promulgated under the
Exchange Act, or comparable successor rule) of securities of the Company
representing at least fifty percent (50%) of the combined voting power entitled
to vote in the election of directors, then, as determined by the Board in its
sole discretion (i) any surviving or acquiring corporation may assume
outstanding rights or substitute similar rights for those under the Plan, (ii)
such rights may continue in full force and effect, or (iii) participants'
accumulated payroll deductions may be used to purchase Common Stock immediately
prior to the transaction described above and the participants' rights under the
ongoing Offering terminated.

                                       7.
<PAGE>
 
13.  AMENDMENT OF THE PLAN.

     (a)  The Board at any time, and from time to time, may amend the Plan.
However, except as provided in paragraph 12 relating to adjustments upon changes
in stock, no amendment shall be effective unless approved by the stockholders of
the Company within twelve (12) months before or after the adoption of the
amendment, where the amendment will:

          (i)  Increase the number of shares reserved for rights under the Plan;

          (ii) Modify the provisions as to eligibility for participation in the
     Plan (to the extent such modification requires stockholder approval in
     order for the Plan to obtain employee stock purchase plan treatment under
     Section 423 of the Code; or

          (iii)   Modify the Plan in any other way if such modification requires
     stockholder approval in order for the Plan to obtain employee stock
     purchase plan treatment under Section 423 of the Code.

It is expressly contemplated that the Board may amend the Plan in any respect
the Board deems necessary or advisable to provide eligible employees with the
maximum benefits provided or to be provided under the provisions of the Code and
the regulations promulgated thereunder relating to employee stock purchase plans
and/or to bring the Plan and/or rights granted under it into compliance
therewith.

     (b)  Rights and obligations under any rights granted before amendment of
the Plan shall not be impaired by any amendment of the Plan, except with the
consent of the person to whom such rights were granted, or except as necessary
to comply with any laws or governmental regulations, or except as necessary to
ensure that the Plan and/or rights granted under the Plan comply with the
requirements of Section 423 of the Code.

14.  DESIGNATION OF BENEFICIARY.

     (a)  A participant may file a written designation of a beneficiary who is
to receive any shares and cash, if any, from the participant's account under the
Plan in the event of such participant's death subsequent to the end of an
Offering but prior to delivery to the participant of such shares and cash. In
addition, a participant may file a written designation of a beneficiary who is
to receive any cash from the participant's account under the Plan in the event
of such participant's death during an Offering.

     (b)  Such designation of beneficiary may be changed by the participant at
any time by written notice.  In the event of the death of a participant and in
the absence of a beneficiary validly designated under the Plan who is living at
the time of such participant's death, the Company shall deliver such shares
and/or cash to the executor or administrator of the estate of the participant,
or if no such executor or administrator has been appointed (to the knowledge of
the Company), the Company, in its sole discretion, may deliver such shares
and/or cash to the spouse or to any one or more dependents or relatives of the
participant, or if no spouse, dependent or relative is known to the Company,
then to such other person as the Company may

                                       8.
<PAGE>
 
designate.

15.  TERMINATION OR SUSPENSION OF THE PLAN.

     (a)  The Board in its discretion, may suspend or terminate the Plan at any
time.  No rights may be granted under the Plan while the Plan is suspended or
after it is terminated.

     (b)  Rights and obligations under any rights granted while the Plan is in
effect shall not be impaired by suspension or termination of the Plan, except as
expressly provided in the Plan or with the consent of the person to whom such
rights were granted, or except as necessary to comply with any laws or
governmental regulation, or except as necessary to ensure that the Plan and/or
rights granted under the Plan comply with the requirements of Section 423 of the
Code.

16.  EFFECTIVE DATE OF PLAN.

     The Plan shall become effective on the same day that the Company's initial
public offering of shares of common stock becomes effective, but no rights
granted under the Plan shall be exercised unless and until the Plan has been
approved by the stockholders of the Company within twelve (12) months before or
after the date the Plan is adopted by the Board or the Committee, which date may
be prior to such effective date.

                                       9.

<PAGE>
 
                                                                    EXHIBIT 10.5

                                MEGABIOS CORP.

                     EMPLOYEE STOCK PURCHASE PLAN OFFERING

                             ADOPTED JULY 25, 1997



1.   GRANT; OFFERING DATE.

     (a)  The Board of Directors of MEGABIOS Corp., a Delaware corporation (the
"Company"), pursuant to the Company's Employee Stock Purchase Plan (the "Plan"),
hereby authorizes the grant of rights to purchase shares of the common stock of
the Company ("Common Stock") to all Eligible Employees (an "Offering").  The
first Offering shall begin on the effective date of the initial public offering
of the Company's Common Stock and end on August 15, 1999 (the "Initial
Offering").  Thereafter, an Offering shall begin on August 16 every two (2)
years, beginning with calendar year 1999, and shall end on the day prior to the
second anniversary of its Offering Date.  The first day of an Offering is that
Offering's "Offering Date."

     (b)  In the event that the fair market value of a share of Common Stock on
a Purchase Date during an Offering is less than the fair market value on the
Offering Date of the Offering, then following the purchase of Common Stock on
the Purchase Date (i) the Offering shall terminate, (ii) a new Offering shall
commence on the day following the Purchase Date that shall extend for the
duration of the original Offering, and (iii) participants shall automatically be
enrolled in the new Offering.

     (c)  Prior to the commencement of any Offering, the Board of Directors (or
the Committee described in subparagraph 2(c) of the Plan, if any) may change any
or all terms of such Offering and any subsequent Offerings.  The granting of
rights pursuant to each Offering hereunder shall occur on each respective
Offering Date unless, prior to such date (a) the Board of Directors (or such
Committee) determines that such Offering shall not occur, or (b) no shares
remain available for issuance under the Plan in connection with the Offering.

2.   ELIGIBLE EMPLOYEES.

     (a)  All employees of the Company and each of its Affiliates (as defined in
the Plan) incorporated in the United States shall be granted rights to purchase
Common Stock under each Offering on the Offering Date of such Offering, provided
that each such employee otherwise meets the employment requirements of
subparagraph 5(a) of the Plan and has been continuously employed for at least
ten (10) days on the Offering Date of such Offering (an "Eligible Employee");
provided, however, that the 10-day eligibility requirement shall be waived with
respect to the Initial Offering.  Notwithstanding the foregoing, the following
employees shall not be Eligible Employees or be granted rights under an
Offering: (i) part-time or seasonal

                                       1.
<PAGE>
 
employees whose customary employment is less than 20 hours per week or 5 months
per calendar year or (ii) 5% stockholders (including ownership through
unexercised options) described in subparagraph 5(c) of the Plan.

     (b)  Each person who first becomes an Eligible Employee during any Offering
and at least six (6) months prior to the final Purchase Date of the Offering
will, on the next February 16 or August 16 during that Offering, receive a right
under such Offering, which right shall thereafter be deemed to be a part of the
Offering.  Such right shall have the same characteristics as any rights
originally granted under the Offering except that:

          (1) the date on which such right is granted shall be the "Offering
Date" of such right for all purposes, including determination of the exercise
price of such right; and

          (2) the Offering for such right shall begin on its Offering Date and
end coincident with the end of the ongoing Offering.

3.   RIGHTS.

     (a)  Subject to the limitations contained herein and in the Plan, on each
Offering Date each Eligible Employee shall be granted the right to purchase the
number of shares of Common Stock purchasable with up to fifteen percent (15%) of
such employee's Earnings paid during the period of such Offering beginning after
such Eligible Employee first commences participation; provided, however, that no
employee may purchase Common Stock on a particular Purchase Date that would
result in more than fifteen percent (15%) of such employee's Earnings in the
period from the Offering Date to such Purchase Date having been applied to
purchase shares under all ongoing Offerings under the Plan and all other Company
plans intended to qualify as "employee stock purchase plans" under Section 423
of the Internal Revenue Code of 1986, as amended (the "Code").  For this
Offering, "Earnings" means the total compensation paid to an employee, including
all salary, wages (including amounts elected to be deferred by the employee,
that would otherwise have been paid, under any cash or deferred arrangement
established by the Company), overtime pay, commissions, bonuses, and other
remuneration paid directly to the employee, but excluding profit sharing, the
cost of employee benefits paid for by the Company, education or tuition
reimbursements, imputed income arising under any Company group insurance or
benefit program, traveling expenses, business and moving expense reimbursements,
income received in connection with stock options, contributions made by the
Company under any employee benefit plan, and similar items of compensation.

     (b)  Notwithstanding the foregoing, the maximum number of shares of Common
Stock an Eligible Employee may purchase on any Purchase Date in an Offering
shall be such number of shares as has a fair market value (determined as of the
Offering Date for such Offering) equal to (x) $25,000 multiplied by the number
of calendar years in which the right under such Offering has been outstanding at
any time, minus (y) the fair market value of any other shares of Common Stock
(determined as of the relevant Offering Date with respect to such shares) which,
for purposes of the limitation of Section 423(b)(8) of the Code, are attributed
to any of such

                                       2.
<PAGE>
 
calendar years in which the right is outstanding. The amount in clause (y) of
the previous sentence shall be determined in accordance with regulations
applicable under Section 423(b)(8) of the Code based on (i) the number of shares
previously purchased with respect to such calendar years pursuant to such
Offering or any other Offering under the Plan, or pursuant to any other Company
plans intended to qualify as "employee stock purchase plans" under Section 423
of the Code, and (ii) the number of shares subject to other rights outstanding
on the Offering Date for such Offering pursuant to the Plan or any other such
Company plan.

     (c)  The maximum aggregate number of shares available to be purchased by
all Eligible Employees under an Offering shall be the number of shares remaining
available under the Plan on the Offering Date. If the aggregate purchase of
shares of Common Stock upon exercise of rights granted under the Offering would
exceed the maximum aggregate number of shares available, the Board shall make a
pro rata allocation of the shares available in a uniform and equitable manner.

4.   PURCHASE PRICE.

     The purchase price of the Common Stock under the Offering shall be the
lesser of eighty-five percent (85%) of the fair market value of the Common Stock
on the Offering Date or eighty-five percent (85%) of the fair market value of
the Common Stock on the Purchase Date, in each case rounded up to the nearest
whole cent per share.  For the Initial Offering, the fair market value of the
Common Stock at the time when the Offering commences shall be the price per
share at which shares of Common Stock are first sold to the public in the
Company's initial public offering as specified in the final prospectus with
respect to that offering.

5.   PARTICIPATION.

     (a)  Except as otherwise provided in this paragraph 5 or in the Plan, an
Eligible Employee may elect to participate in an Offering only at the beginning
of the Offering or as of the day following the Purchase Date during such
Offering.  An Eligible Employee shall become a participant in an Offering by
delivering an agreement authorizing payroll deductions.  Such deductions must be
in whole percentages of Earnings, with a minimum percentage of one percent (1%)
and a maximum percentage of fifteen percent (15%).  A participant may not make
additional payments into his or her account.  The agreement shall be made on
such enrollment form as the Company provides, and must be delivered to the
Company at least ten (10) days in advance of the date participation is to be
effective, unless a later time for filing the enrollment form is set by the
Company for all Eligible Employees with respect to a given participation date.
For the Initial Offering, the time for filing an enrollment form and commencing
participation for individuals who are Eligible Employees on the Offering Date
for the Initial Offering shall be determined by the Company and communicated to
such Eligible Employees.

     (b)  A participant increase or decrease his or her participation level
during the course of an Offering only as of the day following a Purchase Date,
and only by delivering notice to the Company at least ten (10) days in advance
of the Purchase Date in such form as the

                                       3.
<PAGE>
 
Company prescribes; provided that a participant may (i) reduce his or her
deductions to zero percent (0%) upon ten (10) days' prior notice by delivering a
notice in such form as the Company provides, or (ii) may withdraw from an
Offering and receive his or her accumulated payroll deductions from the Offering
(reduced to the extent, if any, such deductions have been used to acquire Common
Stock for the participant on any prior Purchase Dates) without interest, at any
time prior to the end of the Offering, excluding only each ten (10) day period
immediately preceding a Purchase Date, by delivering a withdrawal notice to the
Company in such form as the Company provides.  A participant who has withdrawn
from an Offering shall not again participate in such Offering, but may
participant in subsequent Offerings under the Plan in accordance with the terms
thereof.

6.   PURCHASES.

     Subject to the limitations contained herein, on each Purchase Date, each
participant's accumulated payroll deductions (without any increase for interest)
shall be applied to the purchase of whole shares of Common Stock, up to the
maximum number of shares permitted under the Plan and the Offering.  "Purchase
Date" shall be defined as each February 15 and August 15, except that February
15, 1997 shall not constitute a Purchase Date.

7.   NOTICES AND AGREEMENTS.

     Any notices or agreements provided for in an Offering or the Plan shall be
given in writing, in a form provided by the Company, and unless specifically
provided for in the Plan or this Offering shall be deemed effectively given upon
receipt or, in the case of notices and agreements delivered by the Company, five
(5) days after deposit in the United States mail, postage prepaid.

8.   EXERCISE CONTINGENT ON STOCKHOLDER APPROVAL.

     The rights granted under an Offering are subject to the approval of the
Plan by the stockholders as required for the Plan to obtain treatment as a tax-
qualified employee stock purchase plan under Section 423 of the Code.

9.   OFFERING SUBJECT TO PLAN.

     Each Offering is subject to all the provisions of the Plan, and its
provisions are hereby made a part of the Offering, and is further subject to all
interpretations, amendments, rules and regulations which may from time to time
be promulgated and adopted pursuant to the Plan.  In the event of any conflict
between the provisions of an Offering and those of the Plan (including
interpretations, amendments, rules and regulations which may from time to time
be promulgated and adopted pursuant to the Plan), the provisions of the Plan
shall control.

                                       4.

<PAGE>
 
                                                                    EXHIBIT 10.6

                              INDEMNITY AGREEMENT


     THIS AGREEMENT is made and entered into this ____ day of _________, 1997 by
and between MEGABIOS MERGER CORPORATION, a Delaware corporation (the
"Corporation"), and ____________ ("Agent").

                                    RECITALS

     WHEREAS, Agent performs a valuable service to the Corporation in his/her
capacity as _______________ of the Corporation;

     WHEREAS, the stockholders of the Corporation have adopted bylaws (the
"Bylaws") providing for the indemnification of the directors, officers,
employees and other agents of the Corporation, including persons serving at the
request of the Corporation in such capacities with other corporations or
enterprises, as authorized by the Delaware General Corporation Law, as amended
(the "Code");

     WHEREAS, the Bylaws and the Code, by their non-exclusive nature, permit
contracts between the Corporation and its agents, officers, employees and other
agents with respect to indemnification of such persons; and

     WHEREAS, in order to induce Agent to continue to serve as ______________ of
the Corporation, the Corporation has determined and agreed to enter into this
Agreement with Agent;

     NOW, THEREFORE, in consideration of Agent's continued service as
_______________ after the date hereof, the parties hereto agree as follows:

                                   AGREEMENT

     1.  SERVICES TO THE CORPORATION.  Agent will serve, at the will of the
Corporation or under separate contract, if any such contract exists, as
______________ of the Corporation or as a director, officer or other fiduciary
of an affiliate of the Corporation (including any employee benefit plan of the
Corporation) faithfully and to the best of his ability so long as he is duly
elected and qualified in accordance with the provisions of the Bylaws or other
applicable charter documents of the Corporation or such affiliate; provided,
however, that Agent may at any time and for any reason resign from such position
(subject to any contractual obligation that Agent may have assumed apart from
this Agreement) and that the Corporation or any affiliate shall have no
obligation under this Agreement to continue Agent in any such position.

     2.  INDEMNITY OF AGENT.  The Corporation hereby agrees to hold harmless and
indemnify Agent to the fullest extent authorized or permitted by the provisions
of the Bylaws and the Code, as the same may be amended from time to time (but,
only to the extent that such 

                                       1
<PAGE>
 
amendment permits the Corporation to provide broader indemnification rights than
the Bylaws or the Code permitted prior to adoption of such amendment).

     3.   ADDITIONAL INDEMNITY.  In addition to and not in limitation of the
indemnification otherwise provided for herein, and subject only to the
exclusions set forth in Section 4 hereof, the Corporation hereby further agrees
to hold harmless and indemnify Agent:

          (a) against any and all expenses (including attorneys' fees), witness
fees, damages, judgments, fines and amounts paid in settlement and any other
amounts that Agent becomes legally obligated to pay because of any claim or
claims made against or by him in connection with any threatened, pending or
completed action, suit or proceeding, whether civil, criminal, arbitrational,
administrative or investigative (including an action by or in the right of the
Corporation) to which Agent is, was or at any time becomes a party, or is
threatened to be made a party, by reason of the fact that Agent is, was or at
any time becomes a director, officer, employee or other agent of Corporation, or
is or was serving or at any time serves at the request of the Corporation as a
director, officer, employee or other agent of another corporation, partnership,
joint venture, trust, employee benefit plan or other enterprise; and

          (b) otherwise to the fullest extent as may be provided to Agent by the
Corporation under the non-exclusivity provisions of the Code and Section 43 of
the Bylaws.

     4.   LIMITATIONS ON ADDITIONAL INDEMNITY.  No indemnity pursuant to Section
3 hereof shall be paid by the Corporation:

          (a) on account of any claim against Agent for an accounting of profits
made from the purchase or sale by Agent of securities of the Corporation
pursuant to the provisions of Section 16(b) of the Securities Exchange Act of
1934 and amendments thereto or similar provisions of any federal, state or local
statutory law;

          (b) on account of Agent's conduct that was knowingly fraudulent or
deliberately dishonest or that constituted willful misconduct;

          (c) on account of Agent's conduct that constituted a breach of Agent's
duty of loyalty to the Corporation or resulted in any personal profit or
advantage to which Agent was not legally entitled;

          (d) for which payment is actually made to Agent under a valid and
collectible insurance policy or under a valid and enforceable indemnity clause,
bylaw or agreement, except in respect of any excess beyond payment under such
insurance, clause, bylaw or agreement;

          (e) if indemnification is not lawful (and, in this respect, both the
Corporation and Agent have been advised that the Securities and Exchange
Commission believes that indemnification for liabilities arising under the
federal securities laws is against public policy and is, therefore,
unenforceable and that claims for indemnification should be submitted to
appropriate courts for adjudication); or

                                       2
<PAGE>
 
          (f) in connection with any proceeding (or part thereof) initiated by
Agent, or any proceeding by Agent against the Corporation or its directors,
officers, employees or other agents, unless (i) such indemnification is
expressly required to be made by law, (ii) the proceeding was authorized by the
Board of Directors of the Corporation, (iii) such indemnification is provided by
the Corporation, in its sole discretion, pursuant to the powers vested in the
Corporation under the Code, or (iv) the proceeding is initiated pursuant to
Section 9 hereof.

     5.   CONTINUATION OF INDEMNITY.  All agreements and obligations of the
Corporation contained herein shall continue during the period Agent is a
director, officer, employee or other agent of the Corporation (or is or was
serving at the request of the Corporation as a director, officer, employee or
other agent of another corporation, partnership, joint venture, trust, employee
benefit plan or other enterprise) and shall continue thereafter so long as Agent
shall be subject to any possible claim or threatened, pending or completed
action, suit or proceeding, whether civil, criminal, arbitrational,
administrative or investigative, by reason of the fact that Agent was serving in
the capacity referred to herein.

     6.   PARTIAL INDEMNIFICATION.  Agent shall be entitled under this Agreement
to indemnification by the Corporation for a portion of the expenses (including
attorneys' fees), witness fees, damages, judgments, fines and amounts paid in
settlement and any other amounts that Agent becomes legally obligated to pay in
connection with any action, suit or proceeding referred to in Section 3 hereof
even if not entitled hereunder to indemnification for the total amount thereof,
and the Corporation shall indemnify Agent for the portion thereof to which Agent
is entitled.

     7.   NOTIFICATION AND DEFENSE OF CLAIM.  Not later than thirty (30) days
after receipt by Agent of notice of the commencement of any action, suit or
proceeding, Agent will, if a claim in respect thereof is to be made against the
Corporation under this Agreement, notify the Corporation of the commencement
thereof; but the omission so to notify the Corporation will not relieve it from
any liability which it may have to Agent otherwise than under this Agreement.
With respect to any such action, suit or proceeding as to which Agent notifies
the Corporation of the commencement thereof:

          (a) the Corporation will be entitled to participate therein at its own
expense;

          (b) except as otherwise provided below, the Corporation may, at its
option and jointly with any other indemnifying party similarly notified and
electing to assume such defense, assume the defense thereof, with counsel
reasonably satisfactory to Agent.  After notice from the Corporation to Agent of
its election to assume the defense thereof, the Corporation will not be liable
to Agent under this Agreement for any legal or other expenses subsequently
incurred by Agent in connection with the defense thereof except for reasonable
costs of investigation or otherwise as provided below.  Agent shall have the
right to employ separate counsel in such action, suit or proceeding but the fees
and expenses of such counsel incurred after notice from the Corporation of its
assumption of the defense thereof shall be at the expense of Agent unless (i)
the employment of counsel by Agent has been authorized by the Corporation, (ii)
Agent shall 

                                       3
<PAGE>
 
have reasonably concluded that there may be a conflict of interest between the
Corporation and Agent in the conduct of the defense of such action or (iii) the
Corporation shall not in fact have employed counsel to assume the defense of
such action, in each of which cases the fees and expenses of Agent's separate
counsel shall be at the expense of the Corporation. The Corporation shall not be
entitled to assume the defense of any action, suit or proceeding brought by or
on behalf of the Corporation or as to which Agent shall have made the conclusion
provided for in clause (ii) above; and

          (c) the Corporation shall not be liable to indemnify Agent under this
Agreement for any amounts paid in settlement of any action or claim effected
without its written consent, which shall not be unreasonably withheld.  The
Corporation shall be permitted to settle any action except that it shall not
settle any action or claim in any manner which would impose any penalty or
limitation on Agent without Agent's written consent, which may be given or
withheld in Agent's sole discretion.

     8.   EXPENSES.  The Corporation shall advance, prior to the final
disposition of any proceeding, promptly following request therefor, all expenses
incurred by Agent in connection with such proceeding upon receipt of an
undertaking by or on behalf of Agent to repay said amounts if it shall be
determined ultimately that Agent is not entitled to be indemnified under the
provisions of this Agreement, the Bylaws, the Code or otherwise.

     9.   ENFORCEMENT.  Any right to indemnification or advances granted by this
Agreement to Agent shall be enforceable by or on behalf of Agent in any court of
competent jurisdiction if (i) the claim for indemnification or advances is
denied, in whole or in part, or (ii) no disposition of such claim is made within
ninety (90) days of request therefor.  Agent, in such enforcement action, if
successful in whole or in part, shall be entitled to be paid also the expense of
prosecuting his claim.  It shall be a defense to any action for which a claim
for indemnification is made under Section 3 hereof (other than an action brought
to enforce a claim for expenses pursuant to Section 8 hereof, provided that the
required undertaking has been tendered to the Corporation) that Agent is not
entitled to indemnification because of the limitations set forth in Section 4
hereof.  Neither the failure of the Corporation (including its Board of
Directors or its stockholders) to have made a determination prior to the
commencement of such enforcement action that indemnification of Agent is proper
in the circumstances, nor an actual determination by the Corporation (including
its Board of Directors or its stockholders) that such indemnification is
improper shall be a defense to the action or create a presumption that Agent is
not entitled to indemnification under this Agreement or otherwise.

     10.  SUBROGATION.  In the event of payment under this Agreement, the
Corporation shall be subrogated to the extent of such payment to all of the
rights of recovery of Agent, who shall execute all documents required and shall
do all acts that may be necessary to secure such rights and to enable the
Corporation effectively to bring suit to enforce such rights.

     11.  NON-EXCLUSIVITY OF RIGHTS.  The rights conferred on Agent by this
Agreement shall not be exclusive of any other right which Agent may have or
hereafter acquire under any statute, provision of the Corporation's Certificate
of Incorporation or Bylaws, agreement, vote 

                                       4
<PAGE>
 
of stockholders or directors, or otherwise, both as to action in his official
capacity and as to action in another capacity while holding office.

     12.  SURVIVAL OF RIGHTS.

          (a) The rights conferred on Agent by this Agreement shall continue
after Agent has ceased to be a director, officer, employee or other agent of the
Corporation or to serve at the request of the Corporation as a director,
officer, employee or other agent of another corporation, partnership, joint
venture, trust, employee benefit plan or other enterprise and shall inure to the
benefit of Agent's heirs, executors and administrators.

          (b) The Corporation shall require any successor (whether direct or
indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business or assets of the Corporation, expressly to
assume and agree to perform this Agreement in the same manner and to the same
extent that the Corporation would be required to perform if no such succession
had taken place.

     13.  SEPARABILITY.  Each of the provisions of this Agreement is a separate
and distinct agreement and independent of the others, so that if any provision
hereof shall be held to be inva lid for any reason, such invalidity or
unenforceability shall not affect the validity or enforceability of the other
provisions hereof.  Furthermore, if this Agreement shall be invalidated in its
entirety on any ground, then the Corporation shall nevertheless indemnify Agent
to the fullest extent provided by the Bylaws, the Code or any other applicable
law.

     14.  GOVERNING LAW.  This Agreement shall be interpreted and enforced in
accordance with the laws of the State of Delaware.

     15.  AMENDMENT AND TERMINATION.  No amendment, modification, termination or
cancellation of this Agreement shall be effective unless in writing signed by
both parties hereto.

     16.  IDENTICAL COUNTERPARTS.  This Agreement may be executed in one or more
counterparts, each of which shall for all purposes be deemed to be an original
but all of which together shall constitute but one and the same Agreement.  Only
one such counterpart need be produced to evidence the existence of this
Agreement.

     17.  HEADINGS.  The headings of the sections of this Agreement are inserted
for convenience only and shall not be deemed to constitute part of this
Agreement or to affect the construction hereof.


     18.  NOTICES.  All notices, requests, demands and other communications
hereunder shall be in writing and shall be deemed to have been duly given (i)
upon delivery if delivered by hand to the party to whom such communication was
directed or (ii) upon the third business day after the date on which such
communication was mailed if mailed by certified or registered mail with postage
prepaid:

                                       5
<PAGE>
 
          (a) If to Agent, at the address indicated on the signature page
hereof.

          (b) If to the Corporation, to

              Megabios Merger Corporation
              863A Mitten Road
              Burlingame, CA 94010

or to such other address as may have been furnished to Agent by the Corporation.


     IN WITNESS WHEREOF, the parties hereto have executed this Agreement on and
as of the day and year first above written.

                                     MEGABIOS MERGER CORPORATION



                                     By:__________________________

                                     Title:_______________________


                                     AGENT



                                     _____________________________ 
 

                                     Address:

                                     _____________________________ 

                                     _____________________________
 

                                       6

<PAGE>
 
                                                                    EXHIBIT 23.3
             
             CONSENT OF MCDONNELL, BOEHNEN, HULBERT, BERGHOFF LTD.

      We hereby consent to the reference to our firm contained in the 
Registration Statement on Form S-1 of Megabios Corp. under the caption 
"Experts."


                                      MCDONNELL, BOEHNEN, HULBERT,
                                       BERGHOFF LTD.


                  
                                      By:/s/ John McDonnell
                                         ------------------------
                                         John McDonnell


August 15, 1997


           

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<PAGE>
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<FISCAL-YEAR-END>                          JUN-30-1996             JUN-30-1997
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<PERIOD-END>                               JUN-30-1996             JUN-30-1997
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                                0                       0
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