Form 424(B)(4)

This is an initial public offering of our American depository shares, or ADSs. We are offering 7,187,500 ADSs. Each ADS represents 20 ordinary shares, par value US$0.00002 per share.

Prior to this offering, there has been no public market for the ADSs or our ordinary shares. The initial public offering price is US$9.0 per ADS. We have received approval for listing the ADSs on the New York Stock Exchange under the symbol “TAOM.”

The underwriters have an option to purchase up to 1,078,125 additional ADSs from us at the initial public offering price, less the underwriting discounts and commissions, to cover over-allotments of ADSs.

Investing in our ADSs involves risks. See “Risk Factors” beginning on page 11.

Neither the United States Securities and Exchange Commission nor any state securities commission or other regulatory body has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

You should rely only on the information contained in this document or in any free writing prospectus we may authorize to be delivered or made available to you. We have not authorized anyone to provide you with information that is different. This document may only be used where it is legal to sell these securities. The information in this document is only accurate on the date of this document.

Until July 5, 2011, all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and financial statements appearing elsewhere in this prospectus. In addition to this summary, we urge you to read the entire prospectus carefully, especially the risks of investing in our ADSs discussed under “Risk Factor,” before deciding whether to buy our ADSs.

Our Business

We are one of the leading children’s entertainment and media companies in China. Our mission is to create exceptional entertainment experiences for children that are fun, safe and trusted by parents. We attribute our market leading position to our content development capabilities that leverage our innovative culture, experience in the children’s entertainment market in China, and knowledge of virtual worlds to create enduring and iconic characters, images and story lines that attract a loyal following among children of the targeted age groups. In 2010, we ranked as the largest online entertainment community for children in China, measured by market share and active accounts, according to iResearch, an independent research company, in a January 2011 report commissioned by us, or the iResearch Report. Our success online has translated into growing demand for our content offline in print media, merchandising, television, film and live performances.

Our children’s online entertainment community is the largest such community in China where, in June 2010, an estimated 89.6 million children in the five to 15 age group used the Internet, primarily to visit virtual worlds and/or other entertainment communities for children, according to the iResearch Report. In the first quarter of 2011, we had approximately 27.3 million active accounts, defined as registered accounts that were accessed at least once during the quarter. Our online entertainment community, www.61.com, hosts four of the top six most visited virtual worlds by children in the five to 15 age group in China, based on a July 2010 survey conducted by iResearch and included in the iResearch Report.

We have a proven track record in creating leading virtual worlds for children in China. The “Seer” and “Mole’s World” virtual worlds we developed ranked as the most and second most visited virtual worlds for children in China, respectively, according to the iResearch Report. In our virtual worlds, children adopt avatars and learn through interactive games and group activities set in imaginative landscapes with evolving story lines of exploration and adventure.

We offer a wide range of children’s books and magazines, based on our franchises developed either by our staff writers or by partnering with authors and publishers. Two books based on our franchises were among the top five best-selling children’s books sold in 2010 according to a ranking compiled by Beijing OpenBook, an independent information services provider for the publishing industry in China.

We also license our franchises to leading makers of consumer products for children in China, such as “Mengniu” in beverages and “Roly China” in apparel. We believe there is significant demand to license our content, but we seek to selectively enter into licensing arrangements in order to ensure the quality and integrity of our brand and franchises.

We have expanded to film and television through the co-production of, or investments in, two animation series with over 100 planned episodes and two feature films, based on our “Mole’s World” and “Seer” franchises, which we expect to release in 2011. We also stage, with event organizers, carnivals and live performances featuring our franchises.

Our success is in part due to our efforts to reinforce parental trust by creating a safe and enjoyable entertainment environment with wholesome, age-appropriate content and standard-setting security safeguards.

We believe we were the first children’s entertainment company in China to launch a separate online monitoring portal, “Taomee Mom,” which we believe increases online safety for children through parental engagement.

Our online business achieved significant scale through the strength of our robust technology platform and targeted distribution network. Our reliable and flexible proprietary technology platform, coupled with our experienced research team, allows us to quickly expand our user base, gather user feedback, enhance the online experience of our users and shorten development cycles. Our distribution network of over 65,000 retail outlets were located near schools or other places frequented by target users in over 2,100 towns and cities across 31 provinces in China as of March 31, 2011.

We have achieved substantial growth since we launched our first virtual world, Mole’s World, in September 2008. Our net revenues grew from US$0.1 million in 2008 to US$7.1 million in 2009 and US$36.0 million in 2010, and amounted to US$12.4 million in the first quarter of 2011. For 2009, 2010 and the first quarter of 2011, 97.3%, 93.6% and 95.0% of our net revenues, respectively, were generated primarily from subscription fees that allow users to access premium features and from sales of virtual items, and the remaining 2.7%, 6.4% and 5.0% of our net revenues, respectively, were generated primarily from royalties and license fees from our offline business. Our gross profit grew from US$0.01 million in 2008 to US$5.1 million in 2009 and US$30.1 million in 2010, and amounted to US$10.4 million in the first quarter of 2011. We incurred a net loss of US$0.9 million in 2008. Our net income grew from US$1.3 million in 2009 to US$21.6 million in 2010, and amounted to US$9.1 million in the first quarter of 2011.

Our Market

The children’s entertainment and media market consists of print, television, film, online entertainment and other media formats specifically targeting children. These market sectors of children’s entertainment and media have achieved significant growth over the past decade in China.

According to the iResearch Report, children’s online entertainment communities have become a dominant form of entertainment for children. 67.7% of Internet users between the ages of five to 15 choose the Internet as their favorite media format, over all other traditional media formats. Approximately 89.6 million children in China, or 51.2% of the total number of children in the five to 15 age group in China, use the Internet, primarily to participate in virtual worlds and/or other entertainment communities for children, according to the iResearch Report.

Our Strengths

We believe that the following competitive strengths contribute to our leading position in the children’s entertainment and media industry in China:

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our position as the largest children’s online entertainment community in China;

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proven abilities in creating popular content for children based on innovative culture;

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strong brand and franchises that offer multiple monetization opportunities;

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trust established through commitment to online safety;

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robust, scalable and advanced technology platform; and

•

visionary and experienced management team.

Our Strategy

Our goal is to leverage our leading position in the children’s online entertainment community to become the top children’s entertainment and media brand across multiple media formats in China. To achieve our objective, we intend to pursue the following strategies:

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extending our leading position in children’s online entertainment in China;

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further strengthening our content development capabilities;

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enhancing our brand and diversifying our franchise portfolio across multiple media formats;

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maintaining technological advantages and optimizing online infrastructure; and

•

capturing investment and strategic cooperation opportunities.

Our Challenges

We believe that the following are some of the major risks and uncertainties that may materially adversely affect us:

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our limited operating history;

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our dependence on a limited number of virtual worlds for substantially all of our revenues;

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our ability to develop and operate new virtual worlds that are commercially successful;

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our ability to respond to competitive pressure;

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our ability to protect our intellectual property rights;

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our ability to implement our growth strategies successfully;

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our ability to maintain an effective system of internal control over financial reporting; and

•

regulatory environment in China.

See “Risk Factors” and other information included in this prospectus for a discussion of these and other risks and uncertainties.

Corporate History and Structure

We commenced operations of our business of children’s online entertainment through Shanghai Taomee Network Technology Co., Ltd., or Shanghai Taomee, a limited liability company established in China, in October 2007. To enable us to raise capital from international investors, our holding company, Taomee Holdings Limited, was incorporated under the laws of the Cayman Islands in September 2008.

Foreign ownership in Internet related businesses is subject to restrictions under current PRC laws, rules and regulations. To comply with the applicable PRC laws, rules and regulations, we conduct our operations in China primarily through Shanghai Taomee, our significant variable interest entity, or VIE, in China via a series of contractual arrangements entered into with it and its shareholders. We exercise effective control through these arrangements and receive economic benefits generated from them.

However, these contractual arrangements may not be as effective in providing us with control over the significant VIE as direct ownership of it. In addition, the significant VIE or its shareholders may breach the contractual arrangements with us. In such cases, we would have to rely on legal remedies under PRC law, which may not always be effective, particularly in light of uncertainties in the PRC legal system. For detailed analysis of risks associated with these contractual arrangements, see “Risk Factors—Risks Related to Our Corporate Structure.”

The following diagram illustrates our principal shareholding and corporate structure and the place of incorporation of each of our significant subsidiaries and significant VIE immediately following this offering, assuming no exercise of the over-allotment option granted to the underwriters:

LOGO


		Direct ownership

		Contractual arrangements: See “Corporate History and Structure—Our Corporate Structure—Contractual Arrangements with Shanghai Taomee and its Shareholders.”

(1)		Qiming Venture Partners II, L.P., Qiming Venture Partners II-C, L.P. and Qiming Managing Directors Fund II, L.P., together, the Qiming Funds.

(2)		Shanghai Taomee is our VIE in China and is 30% owned by Mr. Jason Liqing Zeng, our chairman, 23.75% owned by Mr. Benson Haibing Wang, our co-founder, director and chief executive officer, 17.375% owned by Mr. Crow Zhen Wei, our co-founder, director and chief technology officer, 15.75% owned by Mr. Roc Yunpeng Cheng, our co-founder, director and chief operating officer, 8.125% owned by Mr. Bin Wang and 5% owned by Mr. Yuliang Feng.

Corporate Information

Our principal executive offices are located at 16/F, Building No. A-2, No. 1528 Gumei Road, Xuhui District, Shanghai 200233, People’s Republic of China. Our telephone number at this address is (86-21) 6128-0056 and our fax number is (86-21) 3367-4012. Our registered office in the Cayman Islands is at the offices of Maples Corporate Services Limited, PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands.

Investor inquiries should be directed to us at the address and telephone number of our principal executive offices set forth above. Our corporate information website is located at www.taomee.com. The information contained on our corporate information website is not part of this prospectus. Our agent for service of process in the United States is CT Corporation System located at 111 Eighth Avenue, New York, NY 10011.

Conventions Used in This Prospectus

Unless otherwise indicated, references in this prospectus to:

•

“ADRs” are to the American depositary receipts, which, if issued, evidence our ADSs;

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“ADSs” are to our American depositary shares, each of which represents 20 ordinary shares;

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“China” and the “PRC” are to the People’s Republic of China, excluding, for the purpose of this prospectus only, Taiwan and the special administrative regions of Hong Kong and Macau;

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“shares” or “ordinary shares” are to our ordinary shares, par value US$0.00002 per share;

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“RMB” and “Renminbi” are to the legal currency of China;

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“US$” and “U.S. dollars” are to the legal currency of the United States;

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“we,” “us,” “our company,” “our” or “Taomee” are to Taomee Holdings Limited, a Cayman Islands company, its predecessor entities, subsidiaries and consolidated VIE controlled by us.

References to share information and per share data reflect the 50-for-1 share split effected on February 14, 2011, in which every ordinary share and Series A preferred share was subdivided into 50 ordinary shares and 50 Series A preferred shares, respectively, and the par value of the shares was changed from US$0.001 per share to US$0.00002 per share for each ordinary share and Series A preferred share.

Unless otherwise indicated, information in this prospectus: (i) assumes that the underwriters do not exercise their option to purchase up to an aggregate of 1,078,125 additional ADSs representing 21,562,500 ordinary shares from us, and (ii) does not include 100,000,000 ordinary shares issuable upon exercise of outstanding options or reserved for future issuance under our share incentive plans.

This prospectus contains translations of certain Renminbi amounts into U.S. dollars at specified rates. For amounts not recorded in our consolidated combined financial statements included elsewhere in this prospectus, unless otherwise stated, all translation of financial data from Renminbi into U.S. dollars has been made at RMB6.5483 to US$1.00, the noon buying rate in effect on March 31, 2011 as set forth in the H.10 Statistical Release of the Federal Reserve Board. We make no representation that the Renminbi or U.S. dollar amounts referred to in this prospectus could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. See “Risk Factors—Risks Related to Doing Business in China—Fluctuation in the value of the RMB may have a material adverse effect on the value of your investment.” On June 3, 2011, the noon buying rate was RMB6.4796 to US$1.00.

THE OFFERING

ADS offered by us

7,187,500 ADSs

The ADSs

Each ADS represents 20 ordinary shares, par value US$0.00002 per share. The ADSs may be evidenced by an ADR.

•

The depositary will hold the ordinary shares underlying your ADSs. You will have rights as provided in the deposit agreement.

•

If, however, we declare dividends on our ordinary shares, the depositary will pay you the cash dividends and other distributions it receives on our ordinary shares, after deducting its fees and expenses.

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You may turn in your ADSs to the depositary in exchange for ordinary shares. The depositary will charge you fees for any exchange.

•

We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs, you agree to be bound by the deposit agreement as amended.

To better understand the terms of the ADSs, you should carefully read the section in this prospectus entitled “Description of American Depositary Shares.” We also encourage you to read the deposit agreement, which is an exhibit to the registration statement that includes this prospectus.

Option to purchase additional shares

We have granted the underwriters an option, exercisable within 30 days from the date of this prospectus, to purchase up to an aggregate of 1,078,125 additional ADSs representing 21,562,500 ordinary shares.

Offering Price

US$9.0 per ADS.

Ordinary shares outstanding immediately after the offering

723,250,000 ordinary shares (or 744,812,500 ordinary shares if the underwriters exercise the option to purchase additional ADSs in full).

ADSs outstanding immediately after the offering

7,187,500 ADSs (or 8,265,625 ADSs if the underwriters exercise the option to purchase additional ADSs in full).

Use of proceeds

We will receive net proceeds from this offering of approximately US$57.5 million, after deducting the underwriting discounts and commissions and estimated aggregate offering expenses payable by

us. We intend to use a portion of the net proceeds we receive from this offering for the following purposes:

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approximately US$10.0 million to further develop and expand our online business;

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approximately US$10.0 million to further develop and expand our offline business; and

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the balance to fund our working capital and for general corporate purposes, including potential acquisitions, partnerships, alliances and licensing opportunities.

NYSE trading symbol

TAOM

Lock-up

We, our directors, executive officers, all of our existing shareholders, option holders and Saban Media Ventures LLC, or Saban, have agreed with the underwriters, subject to certain exceptions, not to sell, transfer or dispose of any of our ADSs, ordinary shares or similar securities for 180 days after the date of this prospectus. See “Underwriting.”

Reserved ADSs

At our request, the underwriters have reserved for sale, at the initial public offering price, up to an aggregate of 503,100 ADSs offered by this prospectus to our directors, officers, employees, business associates and related persons through a directed share program.

Depositary

JPMorgan Chase Bank, N.A.

Risk factors

See “Risk Factors” and other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in the ADSs.

Saban Investment

Subject to the completion of this offering of our ADSs, three of our shareholders have agreed to sell to Saban an aggregate of such number of ordinary shares equal to US$10.0 million divided by the price per ordinary share, which is the initial public offering price per ADS divided by the number of ordinary shares in each ADS. See “Corporate History and Structure” and “Principal Shareholders.”

Summary Consolidated Financial Data

The following summary consolidated combined statements of operations data for the years ended December 31, 2008, 2009 and 2010 and the summary consolidated combined balance sheet data as of December 31, 2008, 2009 and 2010 have been derived from our audited consolidated combined financial statements, which are included elsewhere in this prospectus. The following summary consolidated combined statement of operations data for the three-month periods ended March 31, 2010 and 2011 and the summary consolidated combined balance sheet data as of March 31, 2011 have been derived from our unaudited consolidated combined financial statements included elsewhere in this prospectus. Our summary consolidated combined balance sheet data as of December 31, 2007 and the summary consolidated combined statement of operations data for the period from October 8, 2007 (inception date) to December 31, 2007 have been derived from our unaudited consolidated combined financial statements that are not included in this prospectus.

You should read the summary consolidated combined financial data in conjunction with those financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. Our consolidated combined financial statements are prepared and presented in accordance with U.S. GAAP. The unaudited condensed consolidated financial statements were prepared on a basis consistent with our audited consolidated financial statements and include, in the opinion of management, all adjustments necessary, which include only normal recurring adjustments, for the fair statement of the financial information contained in those statements. Our historical results are not necessarily indicative of our results expected for future periods.


	For Period from October 8, 2007 (inception date) to December 31, 2007			For Years Ended December 31,									For Three Months Ended March 31,
				2008			2009			2010			2010			2011
													(unaudited)			(unaudited)
	(US$ in thousands, except share and per share data)
Consolidated Combined Statement of Operations Data:
Net revenues:
Online business		—			125			6,877			33,683			6,116			11,776
Offline business		—			—			189			2,290			396			623

Total net revenues		—			125			7,066			35,973			6,512			12,399
Cost of services⁽¹⁾:
Online business		—			(115	)		(1,913	)		(5,166	)		(995	)		(1,668	)
Offline business		—			—			(90	)		(686	)		(47	)		(288	)

Gross profit		—			10			5,063			30,122			5,470			10,444

Operating expenses:
Product development expenses⁽¹⁾		(7	)		(314	)		(1,444	)		(4,649	)		(759	)		(2,092	)
Sales and marketing expenses⁽¹⁾		(14	)		(183	)		(893	)		(1,570	)		(275	)		(1,035	)
General and administrative expenses⁽¹⁾		(39	)		(407	)		(1,161	)		(5,729	)		(1,256	)		(1,649	)
Other operating income		—			—			—			278			—			174

Total operating expenses		(60	)		(904	)		(3,498	)		(11,670	)		(2,290	)		(4,602	)

Income (loss) from operations		(60	)		(894	)		1,565			18,452			3,180			5,842
Interest income, net		3			4			7			240			10			105
Other income (expenses), net		—			2			(10	)		(115	)		—			5

Income (loss) before income taxes and share of profit in equity investments		(57	)		(888	)		1,562			18,577			3,190			5,952

Income tax (expense)/benefit:
Current		—			—			(22	)		(7	)		—			(933	)
Deferred		—			—			(271	)		2,511			421			134

Total income tax (expense)/benefit		—			—			(293	)		2,504			421			(799	)

Net income (loss) before share of profit in equity investments		(57	)		(888	)		1,269			21,081			3,611			5,153
Share of profit in equity investments		—			—			49			494			17			3,977

Net income (loss)		(57	)		(888	)		1,318			21,574			3,628			9,130
Deemed dividend on Series A convertible redeemable preferred shares		—			—			(210	)		(469	)		(117	)		(120	)

Net income (loss) attributable to holders of ordinary shares		(57	)		(888	)		1,108			21,105			3,511			9,010

Earnings (loss) per share:
Basic		—		$	(0.0018	)	$	0.0020		$	0.0367		$	0.0061		$	0.0157
Diluted		—		$	(0.0018	)	$	0.0020		$	0.0360		$	0.0061		$	0.0146
Weighted average number of shares used in calculating earnings (loss) per share⁽²⁾:
Basic		500,000,000			500,000,000			467,123,300			450,000,000			450,000,000			450,000,000
Diluted		500,000,000			500,000,000			467,123,300			458,482,370			450,140,050			482,579,336
Pro forma earnings per share⁽³⁾:
Basic										$	0.0367					$	0.0157
Diluted										$	0.0362					$	0.0148
Weighted average number of shares used in calculating pro forma earnings per share:
Basic											575,000,000						575,000,000
Diluted											583,482,370						607,579,336
Cash dividends declared per share											0.0174

(1)	Includes share-based compensation expenses as follows:


	For Period from October 8, 2007 (inception date) to December 31, 2007		For Years Ended December 31,						For Three Months Ended March 31,
			2008		2009		2010		2010		2011
									(unaudited)		(unaudited)
	(US$ in thousands)
Share-based compensation expenses:
Cost of services		—		—		1.0		14.8		0.7		50.0
Product development expenses		—		—		10.1		80.9		1.7		114.2
Sales and marketing expenses		—		—		0.2		69.1		0.1		13.8
General and administrative expenses		—		—		61.9		5.6		1.9		95.6

Total		—		—		73.2		170.4		4.4		273.6

(2)	Calculated based on the number of ordinary shares of our company after the recapitalization transaction in April 2009, which has been retrospectively reflected as if the recapitalization transaction occurred at the beginning of the first period presented.

(3)

Pro forma basic and diluted earnings per share is computed by dividing net income attributable to holders of ordinary shares by the weighted average number of ordinary shares outstanding for the year plus the weighted average number of ordinary shares resulting from the assumed conversion upon the closing of the planned initial public offering of the outstanding convertible redeemable preferred shares.



	As of December 31,										As of March 31, 2011
	2007			2008			2009		2010		Actual		Pro Forma⁽¹⁾
											(unaudited)		(unaudited)
	(US$ in thousands)
Consolidated Combined Balance Sheet Data:
Cash and cash equivalents		664			348			10,835		43,087		54,101		54,101
Accounts receivable, net		—			135			800		438		253		253
Total current assets		946			642			12,338		47,684		60,054		60,054
Total assets		984			900			13,461		53,032		66,512		66,512
Total current liabilities		15			764			7,063		34,297		38,097		38,097
Advances from customers		—			47			3,497		8,684		11,097		11,097
Deferred revenue		—			46			1,904		10,783		13,638		13,638
Dividends payable		—			—			—		8,950		6,400		6,400
Mezzanine equity:
Series A convertible redeemable preferred shares		—			—			5,159		5,628		5,747		—
Ordinary shares		10			10			9		9		9		12
Additional paid-in capital		993			993			988		1,158		1,432		7,716
(Accumulated deficit) retained earnings		(67	)		(955	)		153		11,258		959		959
Total equity		969			136			1,239		13,107		22,668		28,415
Total liabilities, mezzanine equity and equity		984			900			13,461		53,032		66,512		66,512

(1)	The pro forma balance sheet information as of March 31, 2011 assumes the conversion upon completion of the initial public offering of all convertible preferred shares outstanding as of March 31, 2011 into ordinary shares.

You should carefully consider the risks described below in conjunction with the other information and the financial statements and related notes included elsewhere in this prospectus before making an investment decision. Our business, financial condition or results of operations could be materially and adversely affected by any of these risks. The trading price of our ADSs could decline due to any of these risks, and you may lose all or part of your investment. This prospectus also contains forward-looking statements relating to events subject to risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements due to the material risks that we face as described below.

Our limited relevant operating history makes it difficult to evaluate our business and prospects. We have incurred net losses in the past and may experience net losses or earnings declines in the future and we may not sustain our historical revenue growth rate or profitability.

We commercially launched our first virtual world, Mole’s World, in September 2008. Our limited operating history may not be able to provide a meaningful basis for you to evaluate our business. It is also difficult to evaluate our prospective business, because we may not have sufficient experience to address the risks frequently encountered by early stage companies operating in a new and rapidly evolving industry, which may adversely affect our business and results of operations. These risks may include our potential failure to:

We incurred net losses of US$57,386 and US$887,591 for the period from October 8, 2007 (inception date) to December 31, 2007 and for the year ended 2008, respectively. We cannot assure you that we will not incur net losses in the future. We have experienced significant revenue growth in a relatively short period of time. Our net revenues increased from US$0.1 million in 2008 to US$7.1 million in 2009 and US$36.0 million in 2010, and amounted to US$12.4 million in the first quarter of 2011. We may not sustain our historical levels of revenue growth in future periods due to a number of factors, including, among others, economic factors out of our control, competition in the virtual world industry, in which market share can be quickly acquired or lost, and the greater difficulty of growing at sustained rates from a larger net revenue base. We expect that our total operating expenses will increase as we further grow our business. We incur substantial costs and expenses to develop, market and operate a virtual world and may not collect revenues in connection with the virtual world for some time after its commercial launch or at all. Any failure or delay in generating revenues could result in material operating losses and harm our financial condition. Accordingly, you should not rely on the results of any prior period as an indication of our future operating performance.

As we currently depend on a limited number of virtual worlds for substantially all of our revenues, if any of these virtual worlds incur any adverse developments or if we are unable to develop, purchase or license additional virtual worlds that are attractive to users and result in overall revenue growth, our business, financial condition and results of operations may be materially and adversely affected.

Two of our virtual worlds, Seer and Mole’s World, contributed to the majority of our revenues in 2010. We anticipate that these and other existing virtual worlds of ours will continue to account for a substantial portion of

our revenues in the near term. Accordingly, any of the following could materially and adversely affect our business, financial condition and results of operations:

In addition, in order to achieve our long-term profitability and financial and operational success, we must continually develop, purchase or license new virtual worlds that are attractive to users. Although we currently have new virtual worlds in development, such as Mole Hero, they may not be released on time, may not be profitable or popular among children in China.

The success of our internally developed virtual worlds will require additional investment prior to commercial launch. Furthermore, our ability to purchase or license successful virtual worlds will depend on their availability on acceptable terms, including price, our ability to compete effectively against other potential purchasers or licensees to attract the developers of these virtual worlds, and our ability to obtain government approvals required for the purchase or licensing and operation of these virtual worlds.

The virtual worlds that we develop, purchase or license may not be attractive to users, may be viewed by the regulatory authorities as not complying with content restrictions, may not be launched as scheduled or may not compete effectively with our competitors’ products. If we are not able to successfully develop, purchase or license virtual worlds appealing to users, our future profitability and growth prospects will decline.

We may not be able to maintain our revenues and profitability as we operate in a competitive industry and compete against many companies.

We believe that there are a number of competing developers and operators in China providing virtual worlds and other forms of online and offline entertainment to children. Given the relatively low capital requirements and entry barriers to operating virtual worlds, we expect more companies to enter the children’s online entertainment industry in China and a wider range of virtual worlds targeting children to be introduced to the China market in a relatively short period of time. We believe our principal competitor in online children’s entertainment in China is Tencent Holdings Limited, or Tencent, the developer of Roco Kingdom. Our other competitors include BaitianInfo Co., Ltd., the developer of Aobi Island, and Zhejiang Bcast Education Software Co., Ltd., the developer of Hezi World. Potential competitors also include major Internet portal operators, other domestic and foreign virtual world developers and operators, media companies focused on children’s entertainment and alliances between our existing and new competitors. Some of our competitors, especially major foreign and China-based publicly listed media and virtual world operators, have significantly greater financial and marketing resources and name recognition than we have. Our competitors may adopt loss-leading pricing or other tactics or business models, and if these prove to be more attractive to children on a temporary or permanent basis, our users may switch to our competitors’ services and products at our expense. For example, when Tencent introduced Roco Kingdom on July 15, 2010, it offered a six-month free trial period and did not charge users until January 9, 2011. We believe Roco Kingdom targeted the same user base as our virtual worlds and the free trial period may have attracted some of our users to try their product. We cannot assure you that we will be able to compete successfully against any new or existing competitors, or maintain our user base and number of active paying

accounts when competitors launch promotional campaigns targeting our user base, which could have a material adverse effect on our revenues and profitability.

We face risks and uncertainties regarding the growth of the virtual world industry for children and market acceptance of our virtual worlds and virtual items.

The virtual world industry for children, from which we currently derive most of our revenues, is a relatively new and evolving industry and concept. The growth of the virtual world industry for children and the level of demand and market acceptance of our virtual worlds are subject to a high degree of uncertainty. Our future operating results will depend on numerous factors, some of which are beyond our control. These factors include:

If we fail to anticipate and effectively manage these risks and uncertainties, our market share may decrease, our business, financial condition and results of operations may be materially and adversely affected.

Our new virtual worlds may attract our users away from our established virtual worlds, and enhancements and updates to our established virtual worlds may result in certain users deciding not to participate in them, which could materially and adversely affect our business, results of operations and financial condition.

Our new virtual worlds may attract our users away from our established virtual worlds, particularly with respect to virtual worlds with similar story lines. Although we intend to target different types of users with new virtual worlds and therefore minimize users of our existing virtual worlds migrating to later launched virtual worlds, such movement may nevertheless occur and may lead to fewer active users, reduced network effect and lower spending on subscriptions and virtual items.

In addition, in order to retain our existing users and to attract new users, we periodically introduce new features and make changes to our established virtual worlds based on feedback gathered from our users. However, these changes may result in some of our exiting users deciding not to participate in our virtual worlds, either temporarily or permanently. Our users may not respond well to enhancements to our virtual worlds or policy changes in our online entertainment community, which could materially and adversely affect our business, results of operations and financial condition.

We have no control over our distributors or licensees except through agreements we entered into with them. Our brands and reputation could be harmed and our results of operations could suffer if our distributors or licensees fail to comply with our agreements with them.

We rely on our distributors to distribute our prepaid cards, through which our users pay subscription fees and purchase online virtual items. We also rely on our licensees to manufacture and distribute products of our licensed franchises. We have limited ability to manage the activities of our distributors and licensees, who are independent from us, except through the enforcement of agreements with them. If a significant number of our

distributors or licensees fail to comply with our agreements with them, such as distribution targets, brand and service promotion arrangements, quality control standards, or protocols on approving the presentation or portrayal of our franchises, our brands and reputation could be harmed and our results of operations could suffer as a result.

We may not be successful in effectively promoting our brand or enhancing our brand recognition, and any negative publicity, regardless of its veracity, may harm our brand.

Promoting the “Taomee” brand and enhancing its recognition as a family-friendly brand dedicated to children’s entertainment is an integral part of our growth strategy. There is no assurance that we will be able to effectively promote or develop our brand and if we fail to do so, our growth may be adversely affected. In addition, negative publicity or disputes regarding our brand, products and services, company or management could materially and adversely affect public perception of our brand and the virtual worlds and other products and services we offer. Any negative publicity in relation to our services or products, regardless of its veracity, could harm our brand image among children and their parents and, in turn, result in decreases in the number of users and average net revenues per paying account from the operation of our online business. Any impact on our ability to effectively promote our brand and any significant damage to the public perception of the “Taomee” brand or our virtual worlds could materially and adversely affect our prospects and results of operations.

Unauthorized use of our intellectual property by our distributors, licensees or third parties, and the expenses incurred in protecting our intellectual property rights, may harm our brands and reputation and adversely affect our business.

We regard our copyrights, trademarks and other intellectual property as critical to our success. Unauthorized use of our intellectual properties may harm our brands and reputation and adversely affect our business.

We have historically relied on a combination of trademark and copyright law, trade secret protection, restrictions on disclosure and other agreements that restrict the use of our intellectual properties to protect our intellectual property rights. Although our contracts with distributors and licensees prohibit the unauthorized use of our franchises, brands and other intellectual property rights, we cannot assure you that they will always comply with these terms. Although we presently enter into confidentiality agreements with most of our employees, we cannot assure you that these confidentiality agreements will not be breached, that we will have adequate remedies for any breach, or that our proprietary technology, know-how or other intellectual property will not otherwise become known to, or be independently developed by, third parties.

As of May 31, 2011, we received approval for 131 and five trademark registrations in China and Taiwan, respectively, and are in the process of applying for registration of an additional 126 and one trademarks in China and Taiwan, respectively. In addition, we have obtained 14 copyright registrations for software we developed, two of which were jointly developed and owned by us and other parties unrelated to us, and 103 copyright registrations for artworks owned by us. We also registered 30 domain names, including www.61.com, our primary operation website. While we actively take steps to protect our proprietary rights, such steps may not be adequate to prevent the infringement or misappropriation of our intellectual property. In addition, we cannot assure you that any of the above trademark applications will ultimately proceed to registration or will result in registration with adequate scope for our business. Some of our pending applications or registrations may be successfully challenged or invalidated by others. If our trademark applications are not successful, we may have to use different marks for affected products or services, or seek to enter into arrangements with any third parties who may have prior registrations, applications or rights, which might not be available on commercially reasonable terms, if at all.

Implementation of intellectual property laws in China has historically been lacking, primarily because of ambiguities in the laws and difficulties in enforcement. Accordingly, intellectual property right protection in China may not be as effective as in the United States or other countries. Policing unauthorized use of our

proprietary technology, trademarks and other intellectual property is difficult and expensive, and litigation may be necessary in the future to enforce our intellectual property rights. Future litigation could result in substantial costs and diversion of our resources, and could disrupt our business, as well as have a material adverse effect on our financial condition and results of operations.

We rely on our nationwide distribution network for a significant portion of our net revenues. If we fail to effectively manage our distributor relationships or our distributors fail to adhere to our agreements with them, our results of operations could suffer as a result.

Although we no longer rely on any single distributor as we did before 2010, we do rely on a number of provincial and regional distributors to sell our prepaid cards. Online payment systems in China are still in a relatively early stage of development and are not as widely acceptable to users in China as compared to the United States. Also, compared to adult online users, children have fewer means to make payment through online payment channels. As a result, although we make our prepaid cards available for purchase online using an online payment system, our business is dependent on the performance of our regional distributors. In 2008, 2009, 2010 and the first quarter of 2011, 83.5%, 80.1%, 87.1% and 85.1%, respectively, of our net sales proceeds collected were from the sales of prepaid cards to our distributors, respectively. Our largest distributor accounted for 92.0%, 83.6%, 25.9% and 9.8% of our net sales proceeds generated from prepaid card sales in 2008, 2009, 2010 and the first quarter of 2011, respectively. Although we typically enter into annual contracts with and provide performance based incentives to our distributors, our distribution agreements are not exclusive and do not prohibit our distributors from selling our competitors’ game cards. We plan to enter into contracts with distributors at the city level, as opposed to provincial or nation-wide level. Maintaining relationships with a significant number of distributors may be difficult and time-consuming. If we fail to maintain good relationships with, or to effectively manage, our distributors, if these new distributors may not strictly adhere to our agreements with them or provide targeted distribution in locations frequented by target users, or if the distributors promote our competitors’ service and products at our expense, our results of operations could suffer as a result.

Unauthorized character enhancements, other hacking or cheating activities, and undetected programming errors or defects in our virtual worlds could harm our online business and reputation and materially and adversely affect our results of operations.

With the increase in the number of virtual world users in China, virtual world operators have increasingly encountered problems arising from the use of unauthorized character enhancements, theft of user account passwords and other hacking or cheating activities. We have from time to time detected a number of users who have gained an unfair advantage by installing hacking or cheating tools to facilitate character progression. In response to these activities, we have installed detection mechanisms in our virtual worlds to identify various hacking and cheating activities, and have expanded our technical team dedicated to detecting unauthorized character enhancements and resolving other hacking issues.

In addition, our virtual worlds may contain undetected programming errors or other defects. Continued occurrences of unauthorized character enhancements, other hacking or cheating activities, and undetected errors or defects in our virtual worlds may negatively impact the image of our virtual worlds and users’ perception of their reliability, decrease the number of users, reduce the users’ interest in purchasing virtual items, shorten the life span of the virtual worlds and adversely affect our results of operations. A constant recurrence of these activities may require us to shift our management’s and personnel’s attention from research and development and other operations to focus instead primarily on anti-hacking programs and activities, which could hurt our ability to develop and launch new virtual worlds and could materially and adversely affect our business, financial condition and results of operations.

If we fail to successfully execute our growth strategies, including our current expansion into print media, merchandising, film, television and live performance, our future results of operations and growth prospects may be materially and adversely affected.

As part of our growth strategy, we have expanded from the online business to the offline business, such as film and television. We may enter into more media fields or license to makers of broader categories of consumer products targeting children. We may adopt the business model of procuring and re-selling products bearing our franchises, instead of licensing our franchises. Expansion into these or other new businesses or adoption of these and other new business models present operating and marketing challenges that are different from those that we currently encounter. We face competition from existing players within these markets who may have more experience and resources. We may need to satisfy different regulatory requirements and obtain additional licenses or permits from relevant regulatory authorities. If we cannot successfully address these new challenges and compete effectively in these markets or under these business models, we may not be able to enter into or operate these offline businesses, attract a sufficiently large number of audience or customers, or recover costs incurred for developing and marketing these products or services, and our future results of operations and growth strategies could be materially and adversely affected as a result. For example, if the films currently in production cannot be released for any reason, or if the releases do not generate sufficient sales, we may not be able to recover our costs and fail to achieve growth through film production as a result. Pursuing these and other growth strategies may also require us to expand our operations through internal development efforts and through partnerships, joint ventures, investments and acquisitions. If we are unable to successfully implement our growth strategies, our revenue and profitability may not grow as we expect, and our competitiveness may be materially and adversely affected.

We may undertake acquisitions, investments, joint ventures or other strategic alliances, which could have a material adverse effect on our ability to manage our business. In addition, such undertakings may not be successful.

Our strategy includes plans to grow both organically and through acquisitions, joint ventures or other strategic alliances, such as the investment we made in December 2009 in Elyn Corporation, a Cayman Islands company, which operates our virtual worlds in Taiwan, Hong Kong and Macau through its subsidiary in Taiwan. Joint ventures and strategic alliances may expose us to new operational, regulatory and market risks, as well as risks associated with additional capital requirements. We may not be able to identify suitable future acquisition candidates or alliance partners. Even if we identify suitable candidates or partners, we may be unable to complete an acquisition or alliance on terms commercially acceptable to us. If we fail to identify appropriate candidates or partners, or complete desired acquisitions, we may not be able to implement our strategies effectively or efficiently.

In addition, our ability to successfully integrate acquired companies may be adversely affected by a number of factors. These factors include diversion of management’s attention, difficulties in retaining personnel of the acquired companies, unanticipated legal liabilities, and tax and accounting issues in association with the acquisition and business combination. If we fail to integrate acquired companies efficiently, our earnings, revenues growth and business could be negatively affected.

Furthermore, the acquired companies may not perform to our expectations for various reasons, including legislative or regulatory changes that affect the products in which the acquired companies specialize, and the loss of personnel. If we are not able to realize the benefits envisioned for such acquisitions, our business and results of operations could be materially and adversely affected.

Our growth to date has placed, and our anticipated further expansion will continue to place, a significant strain on our management, systems and resources. For example, during the period following the commercial launch of our first virtual world in September 2008 to March 31, 2011, the total number of our employees

increased from 52 to 467. We intend to increase our employee headcount even further by adding research and development personnel and customer service representatives. To accommodate our growth pursuant to our strategies, we anticipate that we may need to implement and maintain a variety of new and upgraded operational and financial systems, procedures and controls, and to improve our accounting and other internal management systems, all of which require substantial management efforts. We also will need to continue to expand, train, manage and motivate our workforce, and manage our relationships with our users, our distributors and third-party product and service providers. All of these endeavors will require substantial management effort and skill and the incurrence of additional expenditures. We cannot assure you that we will be able to efficiently or effectively implement our growth strategies and manage the growth of our operations, and any failure to do so may limit our future growth and hamper our business strategy.

Our failure to anticipate or successfully implement new technologies could render our game engines, development platforms or virtual worlds unattractive or obsolete, and reduce our revenues and market share.

Our proprietary engines for powering our virtual worlds, our flexible and secure software framework and anti-cheating expertise are critical to our success. The virtual world industry is subject to rapid technological changes. We need to anticipate the emergence of new technologies and assess their market acceptance. We also need to invest significant resources, including financial resources, in research and development to keep pace with technological advances in order to make our development capabilities and our virtual worlds competitive in the market. However, development activities are inherently uncertain, and we might encounter practical difficulties in commercializing our development results. Our significant expenditures on research and development may not generate corresponding benefits. Given the fast pace with which virtual world technology has been and will continue to be developed, we may not be able to timely upgrade our engines or the software framework for our virtual world development in an efficient and cost-effective manner, or at all. New technologies in virtual world programming or operations could render our technologies, our existing virtual worlds or the virtual worlds that we are developing or expect to develop in the future obsolete or unattractive, thereby limiting our ability to recover related product development costs, purchase costs and licensing fees, which could result in a decline in our revenues and market share.

We may be subject to intellectual property infringement claims, which could be time-consuming and costly to defend and may result in diversion of our financial and management resources and our inability to continue providing some of our existing virtual worlds.

We cannot assure you that our virtual world characters, our plots, or other content posted on our websites, has not infringed or will not infringe upon patents, valid copyrights or other intellectual property rights held by third parties. We may be subject to legal proceedings and claims from time to time relating to the intellectual property of others in the ordinary course of our business within the relevant statute of limitation. If we are found to have violated the intellectual property rights of others, we may be enjoined from using such intellectual property, be forced to pay fines and damages, and we may incur licensing fees or be forced to develop alternatives. In addition, we may incur substantial expenses and diversion of our financial and management resources in defending against these third-party infringement claims, regardless of their merit. Successful infringement or other intellectual property rights claims against us may result in substantial monetary liabilities, which may disrupt our operations and materially adversely affect our business, results of operations and prospects.

Some of our employees were previously employed at other companies, including our current and potential competitors. We also intend to hire additional personnel to expand our development team and technical support team. To the extent these employees are involved in the development of content or technology similar to ours at their former employers, we may become subject to claims that such employees or we may have appropriated proprietary information or intellectual properties of the former employers of our employees. If we fail to successfully defend such claims against us, our results of operations could be materially and adversely affected.

We could be liable for our users’ privacy being compromised, which may have a material adverse effect on our reputation and business.

Although we seek to provide a safe playing environment for our users by implementing a sophisticated security mechanism, our virtual worlds are subject to infiltrating behaviors from child predators and others who hack the accounts of our users to gain progression advantages, access these users’ accounts, or for other purposes. Despite our efforts to employ security features to filter offensive content and monitor users’ interactions, there is no guarantee that we can successfully keep our users free from predatory behavior, offensive contact or other acts that violate the privacy of our users. A significant number of failures to prevent our users’ exposure to such infiltration would severely harm our reputation and business.

We could be liable for breaches of security of our website and third-party payment systems, which may have a material adverse effect on our reputation and business.

In 2008, 2009, 2010 and the first quarter of 2011, 16.5%, 19.9%, 12.9% and 14.9%, respectively, of our net sales proceeds collected were generated from sales of our virtual currency through third-party payment systems. In such transactions, secure transmission of confidential information, such as users’ debit and credit card numbers and expiration dates, personal information and billing addresses, over public networks, including our official website, is essential for maintaining user confidence. We currently provide password protection for all of our users’ accounts. In addition, we are developing new tools to better ensure the security of our users’ accounts in the future. While we have not experienced any breach of our security to date, we still must prevent future breaches and current security measures may be inadequate. In addition, we expect that an increasing number of our sales will be conducted over the Internet as a result of the expanded user base and the growing use of online payment systems. We also expect that associated online crime will likely increase accordingly. We must therefore be prepared to increase our security measures and efforts so that our users have confidence in the reliability of the online payment systems that we use. We do not have control over the security measures of our third-party payment operators, and their security measures may not be adequate at present or may not be adequate with the expected increased usage of online payment systems. We could be exposed to litigation and possible liability if we fail to safeguard confidential user information, which could harm our reputation and our ability to attract users and may have a material adverse effect on our business.

The successful operation of our business depends on the performance and reliability of the Internet infrastructure and fixed telecommunications networks in China.

Our business depends on the performance and reliability of the Internet infrastructure in China. Almost all access to the Internet is maintained through state-owned telecommunication operators under the administrative control and regulatory supervision of the Ministry of Industry and Information Technology, or the MIIT. In addition, the national networks in China are connected to the Internet through international gateways controlled by the PRC government. These international gateways are the only channels through which a domestic user can connect to the Internet. Although the PRC government has pledged to improve the Internet infrastructure in China as part of its stimulus packaged introduced in the first quarter of 2009, a more sophisticated Internet infrastructure may not be developed in China. We or the users of our virtual worlds may not have access to alternative networks in the event of disruptions, failures or other problems with China’s Internet infrastructure.

Unexpected network interruptions, network security breaches or computer virus attacks could have a material adverse effect on our business, financial condition and results of operations.

Any failure to maintain the satisfactory performance, reliability, security and availability of our network infrastructure may cause significant harm to our reputation and our ability to attract and maintain users. All of the servers operating our virtual worlds, all of the servers handling log-in, billing and data back-up matters for us, and all of our backup servers are hosted and maintained by third-party service providers. Major risks involved in such network infrastructure include any break-downs or system failures resulting in a sustained shutdown of all or a material portion of our servers, including failures that may be attributable to sustained power shutdowns, or efforts to gain unauthorized access to our systems causing loss or corruption of data or malfunctions of software or hardware.

In the past, our server network has experienced unexpected outages for several hours and occasional slower performance in a number of locations in China as a result of failures by third-party service providers. Our network systems are also vulnerable to damage from fire, flood, power loss, telecommunications failures, computer viruses, hacking and similar events. Any network interruption, virus or other inadequacy that causes interruptions in the availability of our virtual worlds or deterioration in the quality of access to our virtual worlds could reduce our users’ satisfaction and ultimately harm our business and results of operations.

We face risks associated with the licensing of our virtual worlds overseas, and if we are unable to effectively manage these risks, they could impair our ability to expand our business internationally.

As of the date of this prospectus, we have granted to Elyn Corporation, a Cayman Islands company we invested in, an exclusive license to operate Mole’s World, Seer and Flower Fairy in Hong Kong, Macau and Taiwan. We finalized the terms of a licensing agreement for a leading Internet company in Southeast Asia to operate one of our virtual worlds in April 2011. We may license our existing and new products in other countries and regions in the future. The offering of our products in the international markets could expose us to a number of risks, including:

Our business depends substantially on the continuing efforts of our management and other key personnel. If we lose their services, we could incur significant costs in finding suitable replacements and our business may be severely disrupted.

Our future success heavily depends upon the continued services of our management and other key personnel. In particular, we rely on the expertise and experience of Mr. Benson Haibing Wang, our chief executive officer, Mr. Paul Keung, our chief financial officer, Mr. Crow Zhen Wei, our chief technology officer, Mr. Roc Yunpeng Cheng, our chief operating officer and Mr. Frank Chenghua Zhu, our vice president. If one or more of our senior management or key personnel were unable or unwilling to continue in their present positions, we might not be able to replace them easily or at all. Our business may be severely disrupted, our financial condition and results of operations may be materially and adversely affected, and we may incur additional expenses to recruit, train and retain key personnel.

If any of our management or key personnel joins a competitor or forms a competing company, we may lose users, distributors, know-how and key professionals and staff members. Each of our executive officers has entered into employment agreements and confidentiality agreements and the majority of them have entered into non-competition agreements with us. However, if any dispute arises between our officers and us, the non-competition provisions contained in their non-competition agreements may not be enforceable, especially in China, where most of these executive officers and key employees reside, on the ground that we have not provided adequate compensation to these executive officers for their non-competition obligations, which is required under the relevant PRC regulations.

We may not be successful in attracting and retaining qualified personnel and our business and results of operations could be negatively impacted.

We will need to hire and retain additional qualified employees to support our existing operations and planned expansion. Our ability to anticipate and effectively respond to changing user needs depends in part on our ability to attract and retain experienced personnel for our online and offline businesses in technology, graphic design, operation and other functions. The effective operation of our information technology system, call center, logistics and other back office functions also depends in part on our professional employees. Since our industry is characterized by high demand and intense competition for talent, we may need to offer higher compensation and other benefits in order to retain key personnel in the future. We cannot assure you that we will be able to attract or retain the qualified key personnel that we will need to achieve our business objectives. In addition, as our business has grown rapidly, our ability to train and integrate new employees into our operations may not meet the increasing demands of our business.

Our principal shareholders have substantial influence over our company and their interests may not be aligned with the interests of our other holders of our ordinary shares and ADSs.

Our founders, Mr. Jason Liqing Zeng, Mr. Benson Haibing Wang, Mr. Crow Zhen Wei and Mr. Roc Yupeng Cheng, who beneficially own our shares through a number of holding entities, and the Qiming Funds together hold 89.2% of our outstanding share capital on an as-converted basis, and held 69.4% of our outstanding share capital upon completion of this offering and the sales of ordinary shares to Saban. Accordingly, our founders and the Qiming Funds have substantial influence over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election and change of directors and other significant corporate actions. This concentration of ownership may discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs. Alternatively, these principal shareholders may cause a merger, consolidation or change of control transaction even if it is opposed by our other shareholders, including those who purchase shares in this offering.

Our operating results fluctuate from period to period, making them difficult to predict and may not be indicative of future performance.

Our operating results from period to period are highly dependent upon, and will fluctuate as a result of a variety of factors, including:

For example, as a result of the seasonality effect discussed above, our revenue decreased in the fourth quarter of 2010 as compared to the third quarter of 2010 and we expect a similar decrease in revenue in the

second quarter of 2011 as compared to the first quarter of 2011. Additionally, because most of our operating expenses are expected to increase in absolute amount in the near future as we continue to expand our business, our net income during any given quarter may be adversely affected by any decrease in revenue due to the seasonality effect. As a result of the aforementioned factors and our US$3.7 million gain recorded for the first quarter of 2011 from disposal of an equity interest in Elyn Corporation in February 2011, we expect that our net income for the second quarter of 2011 will decrease significantly as compared to the first quarter of 2011.

Due to these and other factors, our operating results will vary from period to period, will be difficult to predict for any given period, may be adversely affected from period to period and may not be indicative of our future performance.

If we fail to establish or maintain an effective system of internal controls over financial reporting, we may be unable to accurately report our financial results or prevent fraud, and investor confidence and the market price of our shares may, therefore, be adversely impacted.

We will be subject to reporting obligations under the U.S. securities laws. Our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future. Beginning with our annual report on Form 20-F for the fiscal year ending December 31, 2012, we will be required to prepare a management report on our internal controls over financial reporting containing our management’s assessment of the effectiveness of our internal controls over financial reporting. In addition, depending on our market capitalization, our independent registered public accounting firm may be required to attest to and report on our management’s assessment of the effectiveness of our internal controls over financial reporting. Our management may conclude that our internal controls over our financial reporting are not effective. Moreover, even if our management concludes that our internal controls over financial reporting are effective, our independent registered public accounting firm may still decline to attest to our management’s assessment or may issue a report that is qualified if it is not satisfied with our controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us.

Our company was founded in October 2007, and our first virtual world was commercially launched in September 2008. Prior to this offering, we have been a private company with a short operating history and limited numbers of accounting personnel and other resources with which to address our internal controls and procedures. In connection with the audits of our consolidated combined financial statements for 2008, 2009 and 2010, we and our auditors, an independent registered public accounting firm, identified certain material weakness and significant deficiencies in our internal control over financial reporting as defined in the standards established by the U.S. Public Company Accounting Oversight Board, or PCAOB. The material weakness observed was our lack of sufficient accounting resources and expertise necessary to comply with U.S. GAAP and to prepare and review financial statements and related disclosures under U.S. GAAP for SEC reporting and compliance purposes. The significant deficiencies observed were that we lacked adequate documentation for internal control policies at the entity level and a number of financial reporting and asset management procedures. We also identified a deficiency in the procedures for compiling our operating data when we detected an error in the algorithm of the software program we used to compile operating data, which program is separate from our financial reporting system.

Following the identification of the material weakness and significant deficiencies, we undertook certain remedial steps to address them, including adding accounting and finance personnel with US GAAP experience, hiring a chief financial officer in February 2011, providing access to training programs to accounting personnel, and adopting internal controls and other financial closing and reporting policies. We also plan to implement more rigorous internal control procedures to ensure the accuracy of our operating data. To further our efforts in this regard, we have implemented two separate software programs using two separate software engineers that compile the operating data based on the same source data, and cross-check the results from their calculations in order to timely detect any error in the calculations.

However, the implementation of these measures may not fully address the material weakness and other deficiencies in our internal control over financial reporting, and we cannot yet conclude that they have been fully remedied. We plan to continue to address and remediate this material weakness and significant deficiencies and other deficiencies in our internal controls over financial reporting in time to meet the deadline for compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, and we also plan to engage external consultants to help us with such compliance. If we fail to timely achieve and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal controls over financial reporting. Moreover, effective internal controls over financial reporting are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to achieve and maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the market price of our ordinary shares. Furthermore, we anticipate that we will incur considerable costs and use significant management time and other resources in an effort to comply with Section 404 of the Sarbanes-Oxley Act.

We may be unable to secure additional funding in the future or to obtain such funding on favorable terms.

We believe that our current cash and cash equivalents and the anticipated cash flow from operations will be sufficient to meet our anticipated cash needs for the next 12 months. We may, however, require additional cash resources to finance our continued growth or other future developments, including any investments or acquisitions we may decide to pursue. The amount and timing of such additional financing needs will vary principally depending on the timing of new product launches, investments and/or acquisitions, and the amount of cash flow from our operations. If our resources are insufficient to satisfy our cash requirements, we may seek to issue additional equity or debt securities or obtain a credit facility. The issuance of additional equity securities or securities convertible into our ordinary shares could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. Our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties. Financing may not be available in amounts or on terms acceptable to us, if at all, especially if there is a recession or other events causing volatilities in the capital markets worldwide.

We have a limited insurance coverage which could expose us to significant costs and business disruption.

Other than insurance for some of the vehicles used in our business, we have not purchased any insurance to cover our assets, property and business. If we were to incur substantial losses or liabilities due to fire, explosions, floods, a wide range of other natural disasters or accidents or business interruption, our results of operations could be materially and adversely affected.

If the PRC government determines that the contractual arrangements that establish the structure for operating our business do not comply with applicable PRC laws and regulations, we could be subject to severe penalties.

We are a Cayman Islands company and, as such, we are classified as a foreign enterprise under Chinese laws, and our PRC subsidiary, Shanghai Shengran Information Technology Co., Ltd., or Shanghai Shengran, is a foreign-invested enterprise. Various regulations in China currently restrict or prevent foreign-invested entities from holding certain licenses required to operate online virtual worlds, including Internet content provision, Internet culture operation and Internet publishing licenses. In light of these restrictions, we rely on our VIE, Shanghai Taomee, to hold and maintain the licenses necessary to operate our virtual worlds in China. We do not have any equity interest in Shanghai Taomee but receive its economic benefits through various contractual arrangements and certain corporate governance and shareholder rights arrangements. In addition, we have entered into agreements with Shanghai Taomee and its shareholders which provide us with a substantial ability to control Shanghai Taomee. For a description of these contractual arrangements with Shanghai Taomee, see “Corporate History and Structure—Our Corporate Structure—Contractual Arrangements with Shanghai Taomee and its Shareholders.”

The Circular on Strengthening the Administration of Foreign Investment in and Operation of Value-added Telecommunications Business, or the MII Circular, issued by the MII, in July 2006, reiterated the regulations on foreign investment in telecommunications businesses, which require foreign investors to set up foreign-invested enterprises and obtain a business operating license for Internet content provision to conduct any value-added telecommunications business in China. Under the MII Circular, a domestic company that holds an Internet content provision license is prohibited from leasing, transferring or selling the license to foreign investors in any form, and from providing any assistance, including providing resources, sites or facilities, to foreign investors that conduct value-added telecommunications business illegally in China. Furthermore, the relevant trademarks and domain names that are used in the value-added telecommunications business must be owned by the local Internet content provision license holder. The MII Circular further requires each Internet content provision license holder to have the necessary facilities for its approved business operations and to maintain such facilities in the regions covered by its license. In addition, all value-added telecommunications service providers are required to maintain network and information security in accordance with the standards set forth under relevant PRC regulations. Due to a lack of interpretative materials from the regulator, it is unclear what impact the MII Circular will have on us or the other Chinese Internet companies that have adopted the same or similar corporate and contractual structures as ours.

In the opinion of King & Wood, our PRC counsel, (i) the ownership structure and the business and operation model of Shanghai Shengran and Shanghai Taomee are not in violation of any provisions of applicable PRC laws and regulations, and (ii) each contract under Shanghai Shengran’s contractual arrangements with Shanghai Taomee and its shareholders is valid and legally binding. However, there are uncertainties regarding the interpretation and application of PRC laws and regulations, including the MII Circular. Accordingly, we cannot assure you that the PRC regulatory authorities will ultimately take a view that is consistent with the opinion of our PRC counsel.

If we are found to be in violation of any existing or future PRC laws or regulations, including the MII Circular, or fail to obtain or maintain any of the required permits or approvals, the relevant regulatory authorities would have broad discretion in dealing with such violation, including levying fines, confiscating our income, revoking Shanghai Shengran or Shanghai Taomee’s business or operating licenses, requiring us to restructure the relevant ownership structure or operations, and requiring us to discontinue all or any portion of our business. Any of these actions could cause significant disruption to our business operations and may materially and adversely affect our business, financial condition and results of operations.

If the PRC government determines that our ownership structure does not comply with the restrictions contained in the GAPP Notice, we could be subject to severe penalties.

Our virtual worlds are deemed online games by relevant PRC government authorities and we are subject to relevant PRC regulations on operators of online games. On September 28, 2009, the General Administration of Press and Publication, or the GAPP, together with the National Copyright Administration, and National Office of Combating Pornography and Illegal Publications jointly issued a Notice on Further Strengthening of the Administration of Pre-examination and Approval of Online Game and the Examination and Approval of Imported Online Game, or the GAPP Notice. The GAPP Notice provides, among other things, that foreign investors are not permitted to invest in online game operating businesses in China via wholly-owned, equity joint venture or cooperative joint venture investments, and expressly prohibits foreign investors from gaining control over or participating in domestic online game operators through indirect ways such as establishing other joint venture companies, or contractual or technical arrangements. We are not aware of any online game companies adopting the same or similar contractual arrangements as ours having been penalized or ordered to be terminated since the GAPP Notice first became effective. As advised by our PRC counsel, King & Wood, there is uncertainty with respect to the implementation of the GAPP Notice; however, the GAPP is unlikely to directly affect our control over our PRC subsidiary and VIEs without joint actions with other authorities including the Ministry of Culture, based on the GAPP Notice, since (i) according to the relevant provisions of the Regulation on the Main Functions, Internal Organization and Staffing of the GAPP issued by the General Office of the State

Council on July 11, 2008, or the Regulation on Three Provisions, the GAPP is authorized to approve the publication of online games before their launch on the Internet, while the Ministry of Culture is authorized to administer and regulate the overall online game industry; (ii) a circular on the interpretation of the Regulations on Three Provisions, which was issued by the office of the Central Organization Establishment Commission on September 7, 2009, provides that once an online game is launched on the Internet, it will only be regulated by the Ministry of Culture, and that if an online game is launched on the Internet without prior approval of the GAPP, the Ministry of Culture, instead of the GAPP, is the direct authority to investigate the game; and (iii) the original set of our contractual agreements with our significant VIE took effect in June 2009, which was prior to the effective date of the GAPP Notice. There are, however, uncertainties regarding the interpretation and application of the GAPP Notice. Accordingly, we cannot assure you that the GAPP will not ultimately take a view that is contrary to the opinion of our PRC legal counsel. In the event that we, our PRC subsidiary or VIEs are found to be in violation of the GAPP Notice to operate our online virtual worlds, the GAPP in conjunction with the relevant regulatory authorities would have the power to investigate and deal with such violations, including in the most serious cases where relevant licenses and registrations would be suspended or revoked.

Our contractual arrangements with Shanghai Taomee and its shareholders may not be as effective in providing control over Shanghai Taomee as direct ownership of this company.

We conduct our business in China through Shanghai Taomee. Our contractual arrangements with Shanghai Taomee and its shareholders provide us with effective control over Shanghai Taomee. See “Corporate History and Structure—Our Corporate Structure—Contractual Arrangements with Shanghai Taomee and its Shareholders.” As a result of these contractual arrangements, we are considered to be the primary beneficiary of Shanghai Taomee and accordingly, we consolidate the results of operations, assets and liabilities of Shanghai Taomee in our financial statements.

Although we have been advised by King & Wood, our PRC legal counsel, that each contract under these contractual arrangements is valid and legally binding, these contractual arrangements may not be as effective in providing us with control over Shanghai Taomee as direct ownership of this company. If Shanghai Taomee or its shareholders fail to perform their respective obligations under these contractual arrangements, we may have to incur substantial costs and resources to enforce such arrangements, and rely on legal remedies under PRC law, including seeking specific performance or injunctive relief, and claiming damages, which we cannot assure you will be effective.

These contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements, which may make it difficult to exert effective control over our VIE, and our ability to conduct our business may be negatively affected. See “—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal system could have a material adverse effect on us.”

The shareholders of Shanghai Taomee may have potential conflicts of interest with us, which may materially and adversely affect our business and financial condition.

Shanghai Taomee is jointly owned by Mr. Jason Liqing Zeng, our chairman, Mr. Benson HaibingWang, our co-founder, director and chief executive officer, Mr. Crow Zhen Wei, our co-founder, director and chief technology officer, Mr. Roc Yunpeng Cheng, our co-founder, director and chief operating officer, Mr. Bin Wang and Mr. Yuliang Feng. In addition, except for Mr. Bin Wang and Mr. Yuliang Feng, the above other individuals are also directors or executive officers of Shanghai Taomee. The PRC Company Law provides that a director or member of management owes a fiduciary duty to the company he directs or manages. The abovementioned individuals, except for Mr. Bin Wang and Mr. Yuliang Feng, must therefore act in good faith and in the best

interests of Shanghai Taomee and must not use their respective positions for personal gain. These laws do not require them to consider our best interests when making decisions as a director or member of management of Shanghai Taomee.

Conflicts of interests between these individuals’ role as shareholders or directors of Shanghai Taomee and their duties to our company may arise. We cannot assure you that when conflicts of interest arise, these individuals will act in the best interests of our company or that conflicts of interest will be resolved in our favor. In addition, these individuals may breach or cause Shanghai Taomee to breach or refuse to renew the existing contractual arrangements that allow us to effectively control Shanghai Taomee, and receive economic benefits from it. Currently, we do not have arrangements to address potential conflicts of interest between these individuals and our company and a conflict could result in these individuals as officers of our company violating fiduciary duties to us. If we cannot resolve any conflicts of interest or disputes between us and the shareholders of Shanghai Taomee, we would have to rely on legal proceedings, which could result in disruption of our business, and there would be uncertainty as to the outcome of any such legal proceedings.

Contractual arrangements we have entered into may be subject to scrutiny by the PRC tax authorities, and a finding that we or our affiliated entities owe additional taxes could reduce our net income and the value of your investment.

As required by applicable PRC laws and regulations, arrangements and transactions among related parties need to be periodically filed with local tax authorities and may be subject to audit or challenge by the PRC tax authorities. We could face adverse tax consequences if the PRC tax authorities determine that the contractual arrangements between Shanghai Shengran and Shanghai Taomee do not represent pricing at arm’s length and adjust Shanghai Taomee’s income in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction, for PRC tax purposes, of expense deductions recorded by Shanghai Taomee, which could in turn increase its tax liabilities. In addition, the PRC tax authorities may impose late payment fees and other penalties on our affiliated entities for underpaid taxes. Our net income may be adversely affected if our affiliated entities’ tax liabilities increase or if they are found to be subject to late payment fees or other penalties.

Changes in economic and political policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.

Substantially all of our business operations are conducted in China. Accordingly, our business, results of operations, financial condition and prospects are subject to a significant degree to economic, political and legal developments in China. For example, due to the global financial crisis, the growth of the Chinese economy also slowed down in the second half of 2008 and early 2009. Any prolonged slowdown in the Chinese economy, in particular the information technology industry, could have a negative impact on our business, operating results and financial condition in a number of ways. For example, our users may decrease spending on our products, while we may have difficulty expanding our user base fast enough, or at all, to offset the impact of decreased spending by our existing users.

Although the Chinese economy is no longer a planned economy, the PRC government continues to exercise significant control over China’s economic growth through direct allocation of resources, monetary and tax policies, and a host of other government policies such as those that encourage or restrict investment in certain industries by foreign investors, control the exchange between RMB and foreign currencies, and regulate the growth of the general or specific market. These government involvements have been instrumental in China’s significant growth in the past 30 years. If the PRC government’s current or future policies fail to help the Chinese economy achieve further growth or otherwise negatively affect our business, our growth rate or strategy, our results of operations could be adversely affected as a result.

Uncertainties in PRC government policies and regulations regarding virtual worlds and online games and children’s Internet use in China may adversely affect our business

In April 2007, the GAPP, the MII, the Ministry of Education, the Ministry of Public Security, and other relevant government authorities jointly issued a circular concerning the mandatory implementation of an addiction prevention program in virtual worlds and online games, which aims to protect the physical and psychological health of minors. This circular requires all virtual worlds to incorporate an addiction prevention program and an identity verification system, both of which limit the amount of time that a minor or other user may continuously spend participating in a virtual world or playing an online game. Failure to do so may subject us to certain penalties, such as suspension of Internet publishing operation and relevant Internet-access services or revocation of relevant licenses.

On June 3, 2010, the Ministry of Culture, or the MOC, adopted the Provisional Administration Measures of Online Games, or the Online Games Administration Measures, which became effective as of August 1, 2010. The MOC also issued a notice regarding the implementation of the Online Games Administration Measures. We are required to establish the identity verification systems within three months of the effectiveness of the Online Games Administration Measures for online games and virtual worlds which started operation after August 1, 2010, and within six months for those which started operation prior to August 1, 2010. Failing to do so may subject us to an order from relevant authorities to rectify and a fine up to RMB20,000 (US$3,054).

However, since the users of our virtual worlds are principally minors, the implementation of an identity verification system has practical difficulties, mainly because minors do not have PRC identity cards. We understand that the purpose of identity verification system required under the abovementioned circular issued in 2007 is to facilitate addiction prevention, hence, we have implemented addiction prevention programs for all users of our virtual worlds. We have established the identity verification system in all of our virtual worlds (including the two virtual worlds launched after August 1, 2010) and are currently using it as one of the ways for registration. We plan to use the identity verification system as the only option for registration once required by relevant authorities.

In addition, a notice jointly issued by several central governmental agencies in February 2007 increased the punishment for Internet cafés admitting minors. As Internet cafés provide means for children to access the Internet especially in smaller cities, this restriction may adversely affect our plan for growth in these cities. Further strengthening of these regulations, or enactment by the PRC government of any additional laws to further tighten its administration over the Internet, online games, and, in particular, the Internet use and access to online games and virtual worlds by children, may result in less time spent by users or fewer users, which may materially and adversely affect our business results and prospects for future growth.

The laws and regulations governing virtual worlds and online games in China are developing and are subject to future changes. If we or the third-party publishers we work with fail to obtain or maintain all applicable permits and approvals, our business and operations would be materially and adversely affected.

The online game industry in China is heavily regulated by the PRC government. Various regulatory authorities of the PRC central government, such as the State Council, the MIIT, the GAPP, the Ministry of Culture and the Ministry of Public Security, have the authority to issue and implement regulations governing various aspects of the online game industries.

We are required to obtain applicable permits or approvals from different regulatory authorities in order to operate our virtual worlds. An Internet content provider, or ICP, such as Shanghai Taomee, must obtain an ICP license in order to engage in any commercial ICP operations in China. Online game operators must also obtain a license from the Ministry of Culture and an Internet publishing license from the GAPP in order to distribute games through the Internet. We hold the Internet culture operation license issued by the Ministry of Culture and the Internet publishing license issued by GAPP. Prior to obtaining the Internet publishing license from GAPP, we

worked with third party publishers to publish Mole’s World, Seer, Flower Fairy, Magic Haqi and Gong Fu Pai. The term of our agreements with that publisher in connection with these five virtual worlds will expire on December 2, 2014, January 3, 2015, February 7, 2015, August 11, 2015 and April 10, 2016, respectively. The current PRC rules are not clear as to whether this practice is permissible, or whether any penalties will be imposed on this practice. We have made verbal inquiries with the officials at the GAPP and have been informed that the GAPP is aware of this practice and does not object to such practice, through which a virtual world operator publishes its virtual worlds via a third-party publisher, so long as the Internet publication of these virtual worlds has been approved by the GAPP. The process for GAPP approval is lengthy. We have obtained approvals for the Internet publications of Mole’s World, Seer, Magic Haqi, Flower Fairy, and Gong Fu Pai from the GAPP. If this practice is later challenged by the GAPP, or if we cannot obtain the GAPP approval for our virtual worlds to be launched in future or fail to maintain any of our permits or approvals, we may be subject to various penalties, including fines and the discontinuation or restriction of our operations. Any such disruption in our business operations would materially and adversely affect our business, financial condition and results of operations.

As virtual worlds and online game industry is at an early stage of development in China, new laws and regulations may be adopted from time to time to require additional licenses and permits other than those we currently have. As a result, uncertainties exist regarding the interpretation and implementation of current and future PRC laws and regulations applicable to virtual worlds. We cannot assure you that we will be able to timely obtain required licenses or any other new license required in the future, or at all. We cannot assure you that we will not be found in violation of any current or future PRC laws and regulations.

Regulation and censorship of information disseminated over the Internet in China may adversely affect our business, and we may be liable for information displayed on, retrieved from, or linked to our Internet websites.

The PRC government has adopted certain regulations governing Internet access and the distribution of news and other information over the Internet. Under these regulations, Internet content providers and Internet publishers are prohibited from posting or displaying over the Internet content that, among other things, violates PRC laws and regulations, impairs the national dignity of China, or is obscene, superstitious, fraudulent or defamatory. Failure to comply with these requirements could result in the revocation of ICP and other required licenses and the closure of the concerned websites. The website operator may also be held liable for such prohibited information displayed on, retrieved from or linked to such website.

In addition, the MIIT has published regulations that subject website operators to potential liability for content included on their websites and the actions of users and others using their websites, including liability for violations of PRC laws prohibiting the dissemination of content deemed to be socially destabilizing. The Ministry of Public Security has the authority to order any local Internet service provider, or ISP, to block any Internet website maintained outside China at its sole discretion. Periodically, the Ministry of Public Security has stopped the dissemination over the Internet of information which it believes to be socially destabilizing. The State Secrecy Bureau, which is directly responsible for the protection of State secrets of the PRC government, is authorized to block any website it deems to be leaking state secrets or failing to meet the relevant regulations relating to the protection of state secrets in the dissemination of online information.

As these regulations are subject to interpretation by the relevant authorities, it may not be possible for us to determine in all cases the type of content that could result in liability for us as a website operator. In addition, we may not be able to control or restrict the content of other Internet content providers linked to or accessible through our websites, or content generated or placed on our websites by our users, despite our attempt to monitor such content. To the extent that regulatory authorities find any portion of our content objectionable, they may require us to limit or eliminate the dissemination of such information or otherwise curtail the nature of such content on our websites, which may reduce our user traffic and have a material adverse effect on our financial condition and results of operations. In addition, we may be subject to significant penalties for violations of those

regulations arising from information displayed on, retrieved from or linked to our websites, including a suspension or shutdown of our operations.

There are currently no laws or regulations in the PRC governing property rights of virtual assets and therefore it is not clear what liabilities, if any, we may have relating to the loss of virtual assets by our users.

Users of our virtual worlds acquire and accumulate some virtual assets, such as performance-enhancing items, clothing, accessories and other in-game items. Such virtual assets can be highly valued by users. In practice, virtual assets can be lost for various reasons, such as data loss caused by delay of network service by a network crash, or by hacking activities. There are currently no PRC laws and regulations governing property rights of virtual assets. As a result, it is unclear who is the legal owner of virtual assets and whether the ownership of virtual assets is protected by law. In addition, it is unclear under PRC law whether an operator of virtual worlds such as us would have any liability (whether in contract, tort or otherwise) for loss of such virtual assets by users. Based on several judgments regarding the liabilities of online game operators for loss of virtual assets by users, the courts have generally required the online game operators to provide well-developed security systems to protect such virtual assets owned by users. In the event of a loss of virtual assets, we may be sued by users and may be held liable for damages.

Restrictions on virtual currency may adversely affect our game operations revenues.

Our virtual world operations revenues are collected through the sale of our prepaid cards. The Notice on the Reinforcement of the Administration of Online Games issued by the Ministry of Culture and other governmental authorities on February 15, 2007, directs the People’s Bank of China to strengthen the administration of virtual currency in online games to avoid any adverse impact on the PRC economy and financial system. This notice also applies to virtual worlds we operate. This notice provides that the total amount of virtual currency issued by online game operators and the amount purchased by individual users should be strictly limited, with a strict and clear division between virtual transactions and real transactions carried out by way of electronic commerce. This notice also provides that virtual currency should only be used to purchase in-game items. On June 4, 2009, Ministry of Culture and Ministry of Commerce jointly issued Notice on the Reinforcement of the Administration of Virtual Currency in Online Games, which defines what virtual currency is and requires that entities obtain the approval from the Ministry of Culture before issuing virtual currency and engaging in transactions using virtual currency in connection with online games. We have obtained the approval from the Ministry of Culture for the issuing of our virtual currency. These restrictions on virtual currency may result in lower sales of our prepaid cards, and could have an adverse effect on our revenues from online business.

Our business benefits from certain government tax incentives. Expiration, reduction or discontinuation of, or changes to, these incentives will increase our tax burden and reduce our net income.

Shanghai Taomee, as a “software enterprise,” enjoys a full exemption from enterprise income tax, or EIT, in 2009 and 2010 and a 50% reduction in the EIT rate from 2011 to 2013. The reduced applicable EIT rate of Shanghai Taomee would be 12.5% from 2011 to 2013. Shanghai Taomee’s tax holiday period was approved by relevant tax authorities in May 2010. Shanghai Shengran received certification as a “software enterprise” in September 2010, and is entitled to enjoy full exemption from EIT for two years starting from its first profitable year, and 50% reduction in EIT rate in the three subsequent years. The relevant tax authorities informed Shanghai Shengran in April 2011 that the full EIT exemption would apply retroactively in 2009 and 2010, and 50% reduction in EIT rate will apply from 2011 to 2013. If Shanghai Taomee and Shanghai Shengran fail to maintain their respective qualification as a “software enterprise,” the effective EIT rate will increase, which could adversely affect our results of operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Taxation.”

Various local governments in China have provided discretionary preferential tax treatments to us. However, these local governments may decide to reduce or eliminate these preferential tax treatments at any time.

Furthermore, these local implementations of tax laws may be found to violate national laws or regulations and we may be subject to retroactive imposition of higher taxes as a result. Any expiration, reduction or discontinuation of, or changes to, these tax incentives will increase our tax burden and reduce our net income and thus have a material adverse effect on our operating results.

We principally rely on dividends and other distributions on equity paid by our PRC subsidiary to fund any cash and financing requirements we may have, and any limitation on the ability of our PRC subsidiary to make payments to us, or the tax implications of making payments to us, could have a material adverse effect on our ability to conduct our business.

We are a holding company, and we rely principally on dividends and other distributions on equity from our subsidiary in China for our cash requirements, including the funds necessary to service any debt we may incur. Current PRC regulations permit our PRC subsidiary to pay dividends to us only out of its accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. In addition, our subsidiary in China is required to set aside at least 10% of its after-tax profits each year, if any, to fund a statutory reserve until such reserve reaches 50% of its registered capital. These reserves are not distributable as cash dividends. The registered capital of Shanghai Shengran is US$2.5 million. As of the date of this prospectus, Shanghai Shengran has made allocations to its statutory reserve fund in compliance with the applicable PRC laws and regulations. Furthermore, if our subsidiary in China incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other payments to us. Most of our assets are held by, and substantially all of our earnings and cash flows are attributable to, our PRC subsidiary. If earnings from our PRC subsidiary were to decline, our earnings and cash flow would be materially and adversely affected. Our cash flows are principally derived from dividends paid to us by our PRC subsidiary. As a result, our ability to distribute dividends largely depends on earnings from our PRC subsidiary and its ability to pay dividends out of its earnings. Our PRC subsidiary does not have a history of paying dividends. We cannot assure you that our PRC subsidiary will generate sufficient earnings and cash flows in the near future to pay dividends or otherwise distribute sufficient funds to enable us to meet our obligations, pay interest and expenses or declare dividends.

In addition, under the PRC Enterprise Income Tax Law and the Implementing Rules, both of which became effective on January 1, 2008, dividends generated from the business of our PRC subsidiary after January 1, 2008 and payable to us may be subject to a 10% withholding tax if the PRC tax authorities determine that we are a non-resident enterprise, unless there is an applicable tax treaty with China that provides for a different withholding arrangement and we are deemed to be entitled to such favorable treatment.

We may be classified as a “resident enterprise” for PRC enterprise income tax purposes, which could result in our global income becoming subject to 25% PRC enterprise income tax.

The PRC Enterprise Income Tax Law provides that enterprises established outside China whose “effective management” are located in China are considered “resident enterprises” and will generally be subject to the uniform 25% EIT rate as to their global income. Under the implementation regulations, “effective management” is defined as substantial and overall management and control over such aspects as the production and business, personnel, accounts and properties of an enterprise.

In April 2009, the State Administration of Taxation released a circular that sets out the standards and procedures for recognizing the location of the “effective management” of an enterprise registered outside of the PRC and funded by Chinese enterprises as controlling investors, or a Chinese Funded Enterprise. Under the circular, a Chinese Funded Enterprise is considered a resident enterprise if all of the following applies: (i) a Chinese Funded Enterprise’s major management department and personnel who are responsible for carrying out daily operations are located in the PRC; (ii) the department or the personnel who have the right to decide or approve the Chinese Funded Enterprise’s financial and human resource matters are located in the PRC; (iii) the major assets, account book, company seal and meeting minutes of the Chinese Funded Enterprise are located or stored in the PRC; and (iv) the directors or management personnel holding no less than 50% voting rights of the

Chinese Funded Enterprise habitually reside in the PRC. The circular explicitly provides that the above standards apply to the enterprises which are registered outside the PRC and funded by Chinese enterprises as controlling investors, and therefore such standards may be cited for reference only and may not be directly adopted when considering whether our “effective management” is in the PRC or not. Accordingly, it is still uncertain whether we may be considered a resident enterprise under the PRC EIT Law. If we are considered a resident enterprise and earn income other than dividends from our PRC subsidiary, we will be subject to a 25% PRC income tax on our global income and such 25% PRC EIT on our global income could significantly increase our tax burden and materially and adversely affect our cash flow and profitability.

If we are classified as a “resident enterprise” for PRC enterprise income tax purposes, you may be subject to PRC withholding tax on dividends from us and to PRC income tax on gain realized on the transfer of our ADSs or ordinary shares.

Under the PRC Enterprise Income Tax Law and related implementation regulations, PRC EIT withholding tax at the rate of 10% is applicable to dividends payable to investors that are “non-resident enterprises,” which do not have an establishment or place of business in the PRC, or which have such establishment or place of business if the relevant income is not effectively connected with the establishment or place of business, to the extent such dividends have their sources within the PRC. In addition, any gain realized on the transfer of ADSs or shares by such investors is subject to 10% PRC income tax if such gain is regarded as income derived from sources within the PRC unless a treaty otherwise provides. If we are considered a PRC “resident enterprise,” it is unclear whether dividends we pay with respect to our ordinary shares or ADSs, or the gain you may realize from the transfer of our ordinary shares or ADSs, would be treated as income derived from sources within the PRC and be subject to PRC tax. If we are required under the PRC EIT Law to withhold PRC income tax on dividends payable to our non-PRC investors that are “non-resident enterprises,” or if you are required to pay PRC income tax on the transfer of our ordinary shares or ADSs, the value of your investment in our ordinary shares or ADSs may be materially and adversely affected.

Uncertainties with respect to the PRC legal system could have a material adverse effect on us.

We conduct our business primarily through our subsidiary and affiliated entities in China. Our operations in China are governed by PRC laws and regulations. The PRC legal system is based on statutes. Prior court decisions may be cited for reference but have limited precedential value.

Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until some time after the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from using the proceeds of this offering to make loans or additional capital contributions to our PRC operating subsidiary, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

In utilizing the proceeds of this offering in the manner described in “Use of Proceeds,” as an offshore holding company of our PRC operating subsidiary, we may make loans to our PRC subsidiary, or we may make additional capital contributions to our PRC subsidiary. Loans by us to our subsidiary in China, which is a foreign-invested enterprise, to finance its activities cannot exceed statutory limits and must be registered with the

State Administration of Foreign Exchange, or SAFE, or its local counterpart. Capital contributions must be approved by the PRC Ministry of Commerce or its local counterpart. We may not be able to obtain these government approvals on a timely basis, if at all, with respect to future capital contributions by us to our PRC subsidiary. If we fail to receive such approvals, our ability to use the proceeds of this offering and to capitalize our PRC operations may be negatively affected, which could adversely affect our liquidity and our ability to fund and expand our business.

Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.

Substantially all of our cash inflows and outflows are denominated in Renminbi. We may convert a portion of our revenues into other currencies to meet our foreign currency obligations such as payment of dividends declared in respect of our ordinary shares. Under China’s existing foreign exchange regulations, our PRC subsidiary is able to make payments of current accounts, like dividends to its offshore holding companies, in foreign currencies, without prior approval from SAFE, by complying with certain procedural requirements. However, we cannot assure you that the PRC authorities will not take further measures in the future to restrict access to foreign currencies for current account transactions. We may also have different views with the PRC authorities with respect to certain foreign exchange transactions. These and other uncertainties with respect to currency exchange controls may have a material adverse impact on our operations and financial condition.

Governmental control of currency conversion may affect the value of your investment.

The PRC government imposes controls on the convertibility of the RMB into foreign currencies and, in certain cases, the remittance of currency out of China. We receive substantially all of our revenues in RMB. Under our current corporate structure, our income is primarily derived from dividend payments from our PRC subsidiary. Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiary to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy its foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related transactions, can be made in foreign currencies without prior approval from SAFE by complying with certain procedural requirements. However, approval from appropriate government authorities is required where RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs.

We may be subject to penalties, including restriction on our ability to inject capital into our PRC subsidiary and our PRC subsidiary’s ability to distribute profits to us, if our PRC resident shareholders or beneficial owners fail to comply with relevant PRC foreign exchange rules.

SAFE issued a public notice in October 2005 requiring PRC residents to register with the local SAFE branch before establishing or controlling any company outside of China for the purpose of capital financing with assets or equities of PRC companies, referred to in the notice as an “offshore special purpose vehicle.” PRC residents that are shareholders and/or beneficial owners of offshore special purpose companies established before November 1, 2005 were required to register with the local SAFE branch before March 31, 2006. In addition, any PRC resident that is a shareholder of an offshore special purpose vehicle is required to amend its SAFE registration with respect to that offshore special purpose company in connection with any increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China or other material changes in share capital. In May 2007, SAFE issued relevant guidance to its local branches with respect to the operational process for SAFE registration, which standardized more specific and stringent supervision on the registration relating to the SAFE notice.

All our individual shareholders who are subject to Circular 75 have completed registration with SAFE with regard to the establishment of our company or their shareholding in our company as required under Circular 75, and they have also filed application for change of registration to reflect our company’s investment activities and later share subdivision. We are committed to compliance with Circular 75 and have taken steps to ensure that our shareholders and beneficial owners who are subject to Circular 75 also comply with the relevant rules. However, we cannot provide any assurance that all of our shareholders and beneficial owners who are PRC residents will comply with our request to make, obtain or update any applicable registrations or comply with other requirements required by the SAFE notice or other related rules. In case of any non-compliance on any of our PRC resident shareholders or beneficial owners, our PRC subsidiary and such shareholders and beneficial owners may be subject to fines and other legal sanctions, including restriction on our ability to contribute additional capital into our PRC subsidiary and our PRC subsidiary’s ability to distribute dividends to our offshore holding companies, which will adversely affect our business.

All employee participants in our share incentive plans who are PRC citizens may be required to register with SAFE. We may also face regulatory uncertainties that could restrict our ability to adopt additional option plans for our directors and employees under PRC law.

In December 2006, the People’s Bank of China promulgated the Administrative Measures for Individual Foreign Exchange, which set forth the respective requirements for foreign exchange transactions by PRC individuals under either current account or the capital account. In January 2007, SAFE issued the Implementation Rules of the Administrative Measures for Individual Foreign Exchange, which, among other things, specified approval requirements for certain capital account transactions such as a PRC citizen’s participation in the employee stock ownership plans or stock option plans of an overseas publicly-listed company. On March 28, 2007, SAFE promulgated the Processing Guidance on Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Ownership Plans or Stock Option Plans of Overseas-Listed Companies, or the Stock Option Rule. Under the Stock Option Rule, PRC citizens who are granted stock options by an overseas publicly-listed company are required, through a qualified PRC domestic agent or PRC subsidiary of such overseas publicly-listed company, to register with SAFE and complete certain other procedures.

We and our PRC citizen employees participating in our stock incentive plan will be subject to the Stock Option Rule after this offering. Failure to comply with the Stock Option Rule and other relevant rules will subject us or our PRC citizen employees participating in our stock incentive plan to fines and other legal or administrative sanctions and impose restrictions on our execution of option plans, including the grant of options under such plans to our employees, which could adversely affect our business operations.

Fluctuation in the value of the RMB may have a material adverse effect on the value of your investment.

The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the new policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy resulted in an over 20% appreciation of the RMB against the U.S. dollar over the following three years. For almost two years after reaching a high against the U.S. dollar in July 2008, however, the Renminbi traded within a narrow band against the U.S. dollar, remaining within 1% of its July 2008 high. As a consequence, the Renminbi fluctuated sharply since July 2008 against other freely traded currencies, in tandem with the U.S. dollar. In June 2010, the PRC government announced that it would increase RMB exchange rate flexibility. However, it remains unclear how this flexibility might be implemented. There remains significant international pressure on the PRC government to adopt a more flexible currency policy, which could result in greater fluctuation of the RMB against the U.S. dollar. Substantially all of our revenues and costs are denominated in RMB, and a significant portion of our financial assets are also denominated in RMB. We principally rely on dividends and other distributions paid to us by our subsidiary in China. Any significant revaluation of the RMB may materially and adversely affect our cash flows, revenues, earnings and financial

position, and the value of, and any dividends payable on, our ADSs in U.S. dollars. Any fluctuations of the exchange rate between the RMB and the U.S. dollar could also result in foreign currency translation losses for financial reporting purposes.

The approval of the China Securities Regulatory Commission, or the CSRC, may be required in connection with this offering under a PRC regulation. The regulation also establishes more complex procedures for acquisitions conducted by foreign investors that could make it more difficult for us to grow through acquisitions.

On August 8, 2006, six PRC regulatory agencies, including the Ministry of Commerce, the State Assets Supervision and Administration Commission, or SASAC, the State Administration for Taxation, the State Administration for Industry and Commerce, the CSRC, and SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the New M&A Rule, which became effective on September 8, 2006. The regulations require offshore special purpose vehicles that are controlled by PRC companies or residents and that have been formed for the purpose of seeking a public listing on an overseas stock exchange through acquisitions of PRC domestic companies or assets to obtain CSRC approval prior to publicly listing their securities on an overseas stock exchange. On September 21, 2006, the CSRC published a notice on its website specifying the documents and materials that special purpose vehicles are required to submit when seeking CSRC approval for their listings outside of China. The interpretation and application of the above regulations remain unclear, and this offering may ultimately require approval from the CSRC, and if it does, it is uncertain how long it will take us to obtain the approval. If CSRC approval is required for this offering, our failure to obtain or delay in obtaining the CSRC approval for this offering would subject us to sanctions imposed by the CSRC and other PRC regulatory agencies, which could include fines and penalties on our operations in China, restrictions or limitations on our ability to pay dividends outside of China, and other forms of sanctions that may materially and adversely affect our business, results of operations and financial condition.

Our PRC counsel, King & Wood, has advised us that, based on their understanding of the current PRC laws, regulations and rules and the procedures announced on September 21, 2006, we will not be required to submit an application to the CSRC for the approval of the listing and trading of our ADSs on the New York Stock Exchange, because we do not constitute a special purpose vehicle, as defined by the New M&A Rules, which is required to obtain approval from the CSRC for overseas listing, and no public record is found indicating that any of the issuers having similar onshore corporate structures and already listed on an off-shore stock exchange has been required by the CSRC to procure the approval of the CSRC prior to its listing.

The new regulations also established additional procedures and requirements that are expected to make merger and acquisition activities in China by foreign investors more time-consuming and complex, including requirements in some instances that the Ministry of Commerce be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise, or that the approval from the Ministry of Commerce be obtained in circumstances where overseas companies established or controlled by PRC enterprises or residents acquire affiliated domestic companies. We may grow our business in part by acquiring other companies operating in our industry. Complying with the requirements of the new regulations to complete such transactions could be time-consuming, and any required approval processes, including approval from Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

We face risks of health epidemics and other disasters, which could severely disrupt our business operations.

Our business could be materially and adversely affected by the outbreak of H1N1, or swine influenza, avian influenza, severe acute respiratory syndrome, or SARS, or another epidemic. In 2009 and early 2010, there were outbreaks of swine influenza in certain regions of the world, including China. Any adverse public health developments in China could require the temporary closure of our offices. Such closures could severely disrupt our business operations and adversely affect our results of operations.

Our operations are vulnerable to interruption and damage from man-made or natural disasters, including wars, acts of terrorism, earthquakes, fire, floods, environmental accidents, power loss, communications failures and similar events, all of which may disrupt our business. If any significant man-made or natural disaster were to occur in the future, our ability to operate our business could be seriously impaired.

The enforcement of labor contract law and increase in labor costs in the PRC may adversely affect our business and our profitability.

China adopted a labor contract law and its implementation rules effective on January 1, 2008 and September 18, 2008, respectively. The labor contract law and its implementation rules impose more stringent requirements on employers with regard to, among others, minimum wages, severance payment upon permitted termination of the employment by an employer and non-fixed term employment contracts, time limits for probation period as well as the duration and the times that an employee can be placed on a fixed term employment contract. Due to the limited period of effectiveness of the labor contract law and its implementation rules and the lack of clarity with respect to their implementation and potential penalties and fines, it is uncertain how they will impact our current employment policies and practices. Our employment policies and practices may violate the labor contract law or its implementation rules and we may be subject to related penalties, fines or legal fees. Compliance with the labor contract law and its implementation rules may increase our operating expenses, in particular our personnel expenses, as the continued success of our business depends significantly on our ability to attract and retain qualified personnel. In the event that we decide to terminate some of our employees or otherwise change our employment or labor practices, the labor contract law and its implementation rules may also limit our ability to effect those changes in a manner that we believe to be cost-effective or desirable, which could adversely affect our business and results of operations.

There has been no public market for our ordinary shares or ADSs prior to this offering, and an active trading for our ADSs may not develop after this offering so you may not be able to resell your ADSs at or above the price you paid, or at all.

Prior to this offering, there has been no public market for our ordinary shares or ADSs. We have received approval to list our ADSs on the New York Stock Exchange. Our ordinary shares will not be listed on any exchange or quoted for trading on any over-the-counter trading system. If an active trading market for our ADSs does not develop after this offering, the market price and liquidity of our ADSs would be materially and adversely affected.

The initial public offering price for our ADSs will be determined by negotiations between us and the underwriters and may bear no relationship to the market price for our ADSs after the offering. An active trading market for our ADSs may not develop and the market price of our ADSs may decline below the initial public offering price. You may lose parts or all of your investment in our ADSs.

The market price for our ADSs may be volatile, which could result in substantial losses to you.

The market price for our ADSs may be volatile and subject to wide fluctuations in response to factors such as actual or anticipated fluctuations in our quarterly results of operations, changes in financial estimates by securities research analysts, changes in the economic performance or market valuations of other companies operate in our industry, announcements by us or our competitors of material acquisitions, strategic partnerships, joint ventures or capital commitments, fluctuations of exchange rates between RMB and the U.S. dollar, intellectual property litigation, release of lock-up or other transfer restrictions on our outstanding shares or ADSs, and economic or political conditions in China. In addition, the performance, and fluctuation in market prices, of other companies with business operations located mainly in China that have listed their securities in the United States may affect the volatility in the price of and trading volumes of our ADSs. Volatility in global capital

markets, as was experienced during the global financial crisis, could also have an adverse effect on the market price of our ADSs. Furthermore, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our ADSs.

Since the initial public offering price is substantially higher than our net tangible book value per share, you will incur immediate and substantial dilution.

As of March 31, 2011, our existing investors paid an average of approximately US$0.0080 per share for our ordinary shares on an as converted basis, assuming our Series A preferred shares being converted into ordinary shares immediately upon the completion of this offering. If you purchase our ADSs in this offering, you will pay more for your ADSs than the amount paid by our existing shareholders for their ordinary shares on a per ADS basis. As a result, you will experience immediate and substantial dilution of approximately US$6.60 per ADS (assuming no exercise by the underwriters of their option to purchase additional ADSs), representing the difference between our net tangible book value per ADS as of March 31, 2011, after giving effect to the conversion of our Series A preferred shares and this offering at the initial public offering price. In addition, you may experience further dilution to the extent that our ordinary shares are issued upon the exercise of share options or other share-based awards. See “Dilution” for a more complete description of how the value of your investment in our ADSs will be diluted upon completion of this offering.

Substantial future sales or the perception of sales of our ADSs or ordinary shares in the public market could cause the price of our ADSs to decline.

Sales of our ADSs or ordinary shares in the public market after this offering, or the perception that these sales could occur, could cause the market price of our ADSs to decline. All ADSs sold in this offering will be freely transferable without restriction or additional registration under the Securities Act of 1933, as amended, or the Securities Act. The remaining ordinary shares outstanding after this offering will be available for sale, upon the expiration of the applicable lock-up period beginning from the date of this prospectus, subject to volume and other restrictions as applicable under Rule 144 and Rule 701 under the Securities Act. See “Shares Eligible for Future Sale” and “Underwriting” for a detailed description of the lock-up restrictions. Any or all of these shares may be released prior to expiration of the lock-up period at the discretion of the lead underwriters for this offering. To the extent shares are released before the expiration of the lock-up period and these shares are sold into the market, the market price of our ADSs could decline.

In addition, as disclosed under “Description of Share Capital—Registration Rights,” certain holders of our ordinary and preferred shares have the right to cause us to register the sale of an aggregate of 147,222,222 shares under the Securities Act and subject to a 180-day lock-up period in connection with this offering. Registration of these shares under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the related registration statement. Sales of these registered shares in the public market could cause the price of our ADSs to decline.

You may not have the same voting rights as the holders of our ordinary shares and must act through the depositary to exercise your rights.

As an ADS holder, you may only exercise voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Under the deposit agreement, you must vote by giving voting instructions to the depositary. Upon receipt of your voting instructions, the depositary will vote the underlying ordinary shares in accordance with these instructions. Otherwise, you will not be able to exercise your right to vote unless you withdraw the ordinary shares underlying your ADSs.

Pursuant to our third amended and restated memorandum and articles of association, we may convene a shareholders’ meeting upon ten days’ notice. When a shareholder’s meeting is convened, you may not receive sufficient advance notice to withdraw the ordinary shares underlying your ADSs to allow you to vote with respect to any specific matter. If we give timely notice, the depositary will notify you of the upcoming vote and arrange to deliver our voting materials to you. We cannot assure you that you will receive the voting materials in time to instruct the depositary to vote the ordinary shares underlying your ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for the manner of carrying out voting instructions. This means that you may not be able to exercise your right to vote and there may be nothing you can do if the ordinary shares underlying your ADSs are not voted as you requested.

You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are registered under the Securities Act, or the distribution of them to ADS holders is exempted from registration under the Securities Act with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not be able to rely on an exemption from registration under the Securities Act to distribute such rights and securities. Accordingly, holders of our ADSs may be unable to participate in our rights offerings and may experience dilution in their holdings as a result.

Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deem it advisable to do so because of any requirement of law or of any government or governmental body.

You may face difficulties in protecting your interests, and your ability to protect your rights through the U.S. federal courts may be limited because we are organized under Cayman Islands law, conduct substantially all of our operations in China and the majority of our directors and officers reside outside the United States.

We are organized in the Cayman Islands and substantially all of our assets are located outside of the United States. We conduct substantially all of our current operations in China through our subsidiary and affiliated entities in China. The majority of our officers and directors reside outside the United States and a substantial portion of the assets of those persons are located outside of the United States. As a result, it may be difficult for you to bring an action against us or against these individuals in the United States in the event that you believe that your rights have been infringed under the securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state, and it is uncertain whether such Cayman Islands or PRC courts would be competent to hear original actions brought in the Cayman Islands or the PRC against us or such persons predicated upon the securities laws of the United States or any state. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

Our corporate affairs are governed by our memorandum and articles of association, as amended from time to time, and by the Companies Law (2010 Revision) and the common law of the Cayman Islands. The rights of

shareholders to take legal action against our directors and us, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in some jurisdictions in the United States. In particular, because the Cayman Islands law has no legislation specifically dedicated to the rights of investors in securities, and thus no statutorily defined private causes of action to investors in securities such as those found under the Securities Act or the Securities Exchange Act of 1934 in the United States, it provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States.

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than would shareholders of a corporation organized in a jurisdiction in the United States.

Our management will have considerable discretion as to the use of the net proceeds to be received by us from this offering and you may not agree with our management on these uses.

Our management will have considerable discretion in the application of the net proceeds received by us. You will not have the opportunity, as part of your investment decision, to assess whether proceeds are being used appropriately. You must rely on the judgment of our management regarding the application of the net proceeds of this offering. The net proceeds may be used for general corporate purposes that do not improve our efforts to maintain profitability or increase our share price. The net proceeds from this offering may be placed in investments that do not produce income or lose value.

Our articles of association contain anti-takeover provisions that could discourage a third party from acquiring us, which could limit our shareholders’ opportunity to sell their shares, including ordinary shares represented by our ADSs, at a premium.

We have adopted our third amended and restated articles of association to be effective upon the completion of this offering that contain provisions to limit the ability of others to acquire control of our company or cause us to engage in change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. For example, our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our ordinary shares, in the form of ADS or otherwise. Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of our ADSs may fall and the voting and other rights of the holders of our ordinary shares and ADSs may be materially and adversely affected.

We may be classified as a passive foreign investment company for U.S. federal income tax purposes, which could result in adverse U.S. federal income tax consequences to U.S. Holders of our ADSs or ordinary shares.

Based on the current and anticipated valuation of our assets and composition of our income and assets, we do not expect to be a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for our taxable year ending December 31, 2011 or the foreseeable future. However, the application of the PFIC rules is

subject to uncertainty in several respects, including how the contractual arrangements with our affiliated entity, Shanghai Taomee, will be treated for purposes of the PFIC rules. In addition, we must make a separate determination after the close of each taxable year as to whether we were a PFIC for that year. Accordingly, we cannot assure you that we will not be a PFIC for our 2011 taxable year or any future taxable year. A non-U.S. corporation will be a PFIC for any taxable year if either (i) at least 75% of its gross income for such year is passive income or (ii) at least 50% of the value of its assets (based on an average of the quarterly values of the assets) during such year is attributable to assets that produce passive income or are held for the production of passive income. Because the value of our assets for purposes of the PFIC test may be determined, in part, by reference to the market price of our ADSs or ordinary shares, a significant decrease in the market price of the ADSs or ordinary shares may cause us to become a PFIC. In addition, changes in the composition of our income or assets may cause us to become a PFIC. If we are a PFIC for any taxable year during which a U.S. Holder (as defined in “Taxation—United States Federal Income Taxation”) holds an ADS or ordinary share, certain adverse U.S. federal income tax consequences could apply to such U.S. Holder. See “Taxation—United States Federal Income Taxation—Passive Foreign Investment Company.”

As a public company, we will incur a significantly higher level of legal, accounting and other expenses than we do as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and the New York Stock Exchange, have required changes in the corporate governance practices of public companies.

When we become a public company, we will establish additional board committees and will adopt and implement additional policies regarding internal controls over financial reporting and disclosure controls and procedures. In particular, compliance with Section 404 of the Sarbanes-Oxley Act, which requires public companies to include a report of management on the effectiveness of their internal control over financial reporting, will increase our costs. In addition, we will incur costs associated with public company reporting requirements, such as the requirements to file an annual report and other reports with the SEC. We expect these rules and regulations to increase our legal and financial compliance costs, but we cannot predict or estimate the additional costs or the timing of initially additional costs we may incur.

This prospectus contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to us. These statements involve known and unknown risks, uncertainties and other factors, including those listed under “Risk Factors,” which may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements.

In some cases, you can identify these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “potential,” “continue,” “is/are likely to” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include, among other things, statements relating to:

This prospectus also contains data related to the children’s online entertainment industry in China, including projections that are based on a number of assumptions. These market data, including data from iResearch, Entgroup, and Frost & Sullivan, include projections that are based on a number of assumptions. The children’s entertainment and media market and children’s product market in China may not grow at the rates suggested by the market data, or at all. The failure of the markets to grow at the projected rates may have a material adverse effect on our business and the market price of our ADSs. In addition, the rapidly changing nature of the children’s online entertainment industry in China subjects any projections or estimates relating to the growth prospects or future condition of our market to significant uncertainties. If any one or more of the assumptions underlying the market data turns out to be incorrect, our actual results may differ from the projections based on these assumptions.

You should read thoroughly this prospectus and the documents that we refer to in this prospectus with the understanding that our actual results in the future may be materially different from or worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements. Other sections of this prospectus include additional factors which could adversely affect our business and financial performance. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

You should not rely upon forward-looking statements as predictions of future events. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

We estimate that we will receive net proceeds from this offering of approximately US$57.5 million after deducting the underwriting discounts and commissions and the estimated offering expenses payable by us.

The primary purposes of this offering are to create a public market for our shares for the benefit of all shareholders, retain talented employees by providing them with equity incentives and obtain additional capital. We intend to use the net proceeds we will receive from this offering as follows:

As of the date of this prospectus, we cannot specify with certainty the particular uses for the net proceeds we will receive upon the completion of this offering. The foregoing represents our current intentions to use and allocate the net proceeds of this offering based upon our present plans and business conditions. Our management, however, will have significant flexibility and discretion to apply the net proceeds of this offering. If an unforeseen event occurs or business conditions change, we may use the proceeds of this offering differently than as described in this prospectus.

In utilizing the net proceeds of this offering, as an offshore holding company, we are permitted, under PRC laws and regulations, to provide funding to our PRC subsidiary only through loans or capital contributions and to our VIE only through loans. Subject to satisfaction of applicable government registration and approval requirements, we may extend inter-company loans to our subsidiary and VIE in China or make additional capital contributions to our subsidiary or VIEs in China to fund their capital expenditures or working capital. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all. See “Risk Factors—Risks Related to Doing Business in China—PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from using the proceeds of this offering to make loans or additional capital contributions to our PRC operating subsidiary, which could materially and adversely affect our liquidity and our ability to fund and expand our business.”

Pending use of the net proceeds, we intend to hold our net proceeds in demand deposits or invest them in interest-bearing government securities.

Our board of directors has complete discretion over whether to pay dividends on our ordinary shares. If our board of directors decides to pay dividends on our ordinary shares, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant.

On May 6, 2009, we issued 125,000,000 shares of Series A convertible redeemable preferred shares for aggregate cash proceeds of US$4,948,718, net of direct and incremental equity issuance costs of US$51,282 to new investors. As the Series A preferred shares were negotiated with independent third-party investors, the cash proceeds received represented the fair value of the issued Series A preferred shares. The accretion to the redemption value was calculated over the period from the issuance date to the earliest redemption date using the effective interest method and reflected as a reduction to net income to arrive at net income attributable to the ordinary shareholders in the accompanying consolidated combined statements of operations and amounted to US$210,092, US$468,580 and US$119,516 in 2009, 2010 and the first quarter of 2011, respectively. These amount were considered deemed dividends for the years ended December 31, 2009, and 2010 and the three months ended March 31, 2011.

In November 2010, we declared a cash dividend of US$10.0 million to be paid out of our current cash reserves to our shareholders who were record holders of ours as of October 31, 2010, of which we paid US$1.05 million in December 2010, and an additional US$2.55 million in March 2011, and plan to pay the rest in the second half of 2011. The ordinary shareholders will receive approximately US$0.0174 per share and each Series A preferred shareholder will participate in the dividend distribution on an as-converted basis.

We intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business. If we pay any dividends, the depositary will pay our ADS holders the dividends it receives on our ordinary shares, after deducting its fees and expenses as provided in the deposit agreement. See “Description of American Depositary Shares.” Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.

We are a holding company incorporated in the Cayman Islands. We rely principally on dividends from our subsidiary in China for our cash requirements, including any payment of dividends to our shareholders. Current PRC regulations permit our PRC subsidiary to pay dividends to us only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. In addition, each of our subsidiary and VIEs in China is required to set aside a certain amount of its after-tax profits each year, if any, to fund certain statutory reserves. These reserves are not distributable as cash dividends. Furthermore, if our subsidiary or VIEs in China incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us.

You should read this table together with our consolidated combined financial statements and the related notes included elsewhere in this prospectus and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per ordinary share is substantially in excess of the book value per ordinary share attributable to the existing shareholders for our presently outstanding ordinary shares.

As of March 31, 2011, we had net tangible book value of US$22.0 million, or US$0.05 per ordinary share and US$1.0 per ADS. Net tangible book value represents the amount of total consolidated assets, excluding intangible assets and capitalized film costs, minus the amount of total consolidated liabilities and mezzanine equity. Our pro forma net tangible book value as of March 31, 2011 was approximately US$27.7 million, or US$0.05 per ordinary share and US$1.0 per ADS. Pro forma net tangible book value adjusts net tangible book value to give effect to the automatic conversion of all our outstanding Series A preferred shares into 125,000,000 ordinary shares upon the completion of this offering.

Without taking into account any other changes in net tangible book value after March 31, 2011, other than to give effect to (i) the automatic conversion of all of our outstanding Series A preferred shares into 125,000,000 ordinary shares upon the completion of this offering; and (ii) our sale of the 7,187,500 ADSs offered in this offering, at the initial public offering price of US$9.0 per ADS and after deduction of underwriting discounts and commissions and estimated offering expenses payable by us (assuming the over-allotment option is not exercised), our pro forma as adjusted net tangible book value at March 31, 2011 would have been US$85.2 million, or US$0.12 per ordinary share, or US$2.40 per ADS. This represents an immediate increase in pro forma as adjusted net tangible book value of US$0.07 per ordinary share, or US$1.40 per ADS, to existing shareholders and an immediate dilution in pro forma as adjusted net tangible book value of US$0.33 per ordinary share, or US$6.60 per ADS, to purchasers of ADSs in this offering.

The following table summarizes, on a pro forma as adjusted basis described above, as of March 31, 2011, the differences between our existing shareholders, including holders of our Series A preferred shares that will be automatically converted into ordinary shares immediately upon the completion of this offering and the new investors with respect to the number of ordinary shares (in the form of ADSs or shares) purchased from us, the total consideration paid and the average price per ordinary share paid (at the initial public offering price of US$9.0 per ADS) before deducting underwriting discounts and commissions and estimated offering expenses. The total number of ordinary shares does not include ordinary shares underlying the ADSs issuable pursuant to the exercise of the over-allotment option granted to the underwriters.

The discussion and tables above also assume no exercise of any outstanding stock options and the exclusion of the 4,500,000 restricted ordinary shares granted on May 24, 2011 that are not vested as of the date of this offering. As of March 31, 2011, there were 62,465,000 ordinary shares issuable upon exercise of outstanding options at a weighted average exercise price of US$0.15 per share. To the extent that any of these options are exercised, there will be further dilution to new investors.

Our business is primarily conducted in China and substantially all of our revenues are denominated in RMB. This prospectus contains translations of RMB amounts into U.S. dollars at specified rates solely for the convenience of the reader. For all dates and periods through December 31, 2008, exchange rates of RMB into U.S. dollars are based on the noon buying rate in The City of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York. For January 1, 2009 and all later dates and periods, the exchange rate refers to the exchange rate as set forth in the H.10 statistical release of the Federal Reserve Board. Unless otherwise noted, all translations from RMB to U.S. dollars were made at a rate of RMB6.5483 to US$1.00, the exchange rate set forth as of March 31, 2011. No representation is made that the RMB amounts referred to in this prospectus could have been or could be converted into U.S. dollars at any particular rate or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. On June 3, 2011, the exchange rate was RMB6.4796 to US$1.00.

The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this prospectus or will use in the preparation of our periodic reports or any other information to be provided to you.

Source: Federal Reserve Bank of New York and Federal Reserve Statistical Release

We were incorporated in the Cayman Islands in order to enjoy the following benefits:

However, certain disadvantages accompany incorporation in the Cayman Islands. These disadvantages include:

Our constituent documents do not contain provisions requiring that disputes, including those arising under the securities laws of the United States, among us, our officers, directors and shareholders, be arbitrated.

Substantially all of our operations are conducted in China, and substantially all of our assets are located in China. Substantially all of our officers are nationals or residents of jurisdictions other than the United States and a substantial portion of their assets are located outside the United States. As a result, it may be difficult for a shareholder to effect service of process within the United States upon us or these persons, or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States.

We have appointed CT Corporation System, 111 Eighth Avenue, New York, NY 10011, as our agent upon whom process may be served in any action brought against us under the securities laws of the United States.

Maples and Calder, our counsel as to Cayman Islands law, and King & Wood, our counsel as to PRC law, have advised us, respectively, that there is uncertainty as to whether the courts of the Cayman Islands and China, respectively, would:

Maples and Calder has further advised us that a final and conclusive judgment in the federal or state courts of the United States under which a sum of money is payable, other than a sum payable in respect of taxes, or other similar charges, fines, penalties or multiple damages, and which was neither obtained in a manner nor is of a kind enforcement of which is contrary to natural justice or the public policy of the Cayman Islands, will be recognized and enforced in the courts of the Cayman Islands under the common law doctrine of obligation, without any re-examination of the merits of the underlying dispute. However, the Cayman Islands courts are unlikely to enforce a punitive judgment of a United States court predicated upon the liabilities provision of the federal securities laws in the United States without retrial on the merits if such judgment gives rise to obligations to make payments that may be regarded as fines, penalties or similar charges.

King & Wood has further advised us that the recognition and enforcement of foreign judgments are provided for under PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on principles of reciprocity between jurisdictions. China does not have any treaties or other agreements with the United States that provide for the reciprocal recognition and enforcement of foreign judgments. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC law or national sovereignty, security or public interest. As a result, it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.

We commenced operations of our business of children’s online entertainment in October 2007 through Shanghai Taomee, a limited liability company established in China. Shanghai Taomee holds our licenses required for the above business under PRC laws and is in charge of the operation of our websites for our virtual worlds. To enable us to raise capital from international investors, our holding company, Taomee Holdings Limited, was incorporated under the laws of the Cayman Islands in September 2008.

In November 2008, we incorporated Taomee Holdings (HK) Limited, or Taomee HK, our wholly-owned subsidiary in Hong Kong. In June 2009, Taomee HK established its wholly-owned subsidiary, Shanghai Shengran, in China. Taomee HK is our base for overseas investors relationship and investment management as we continue to explore investment and acquisitions opportunities outside of mainland China. For discussions of tax implications related to Taomee HK, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Taxation—Hong Kong.”

PRC laws, rules and regulations currently restrict foreign-invested entities engaging in the operation of Internet-related businesses, including virtual worlds, in China. To comply with PRC laws, rules and regulations, we operate our virtual worlds through our VIE, Shanghai Taomee. In June 2009, through Shanghai Shengran, we entered into certain contractual arrangements with Shanghai Taomee and its shareholders through which we gained effective control over the operations of Shanghai Taomee.

In April 2009, we issued in a private placement an aggregate of 125,000,000 Series A preferred shares for an aggregate purchase price of US$5.0 million to the Qiming Funds.

In December 2009, we entered into a share subscription agreement with Elyn Corporation, a company incorporated under the laws of the Cayman Islands, and its shareholder and certain other parties thereto, to acquire a minority interest in Elyn Corporation, with the consideration of certain operation rights of several of our virtual worlds licensed to Elyn Corporation in the areas of Hong Kong, Macau and Taiwan, which subsequently sub-licensed these rights to Taiwan Taomee Co., Ltd., its wholly-owned subsidiary in Taiwan. Our equity interest in Elyn Corporation was subsequently reduced in February 2011 when we sold a 10.5% equity interest in Elyn to our series A shareholders and a new investor.

In October 2010, Shanghai Taomee invested in a minority stake in Shenzhen Ruigao Information Technology Co., Ltd., or Shenzhen Ruigao, a newly established Chinese company principally engaged in the research and development of hardware and platform for handheld game consoles in China, also see “Related Party Transactions—Transactions with Certain Officers, Shareholders and Affiliates and Key Management Personnel.”

In November 2010, Shanghai Taomee established its wholly-owned subsidiary, Shanghai Taomee Animation Co., Ltd., or Taomee Animation, in China, which primarily engages in the business of animation design and development.

On February 14, 2011, our shareholders approved a 50-for-1 share split of each of our ordinary shares and Series A preferred shares which became effective immediately. At the same time, the par value of the shares was changed from US$0.001 per share to US$0.00002 per share. Unless otherwise noted, all share information and per share data included in the prospectus and accompanying financial statements have been adjusted to reflect this share split and change in par value.

Subject to the completion of this offering of our ADSs, Saban agreed to purchase from each of Joy Union Holdings Limited, a BVI company owned by Mr. Benson Haibing Wang, our chief executive officer, Universys Holdings Ltd., a BVI company owned by Mr. Crow Zhen Wei, our chief technology officer, and Charming China Limited, a BVI company owned by Mr. Roc Yunpeng Cheng, our chief operating officer, an aggregate of such number of ordinary shares equal to US$10.0 million divided by the price per ordinary share, which is the initial public offering price per ADS divided by the number of ordinary shares in each ADS. At the initial public offering price of US$9.0 per ADS, with one ADS representing 20 shares, the aggregate number of ordinary shares sold by these shareholders to Saban would be 22,222,222 shares. As a result of these transactions, Saban is expected to hold 3.1% of our ordinary shares upon the completion of this offering, assuming no exercise of the underwriters’ over-allotment option. The transfer to Saban is being made pursuant to a private purchase exempt from registration with the U.S. Securities and Exchange Commission.

Saban has agreed, subject to certain customary exceptions, not to offer, sell, contract to sell, announce the intention to sell, issue, pledge, lend, grant or purchase any option, right or warrant for the sale of, or otherwise dispose of or transfer, any of our ordinary shares acquired in its investment for a period of 180 days after the date of this prospectus, without the prior written consent of the representatives on behalf of the underwriters.

We additionally granted Saban a non-voting observer seat on our board of directors for a period of eighteen months after the closing of this offering and certain registration rights.

We have entered into contractual arrangements with Shanghai Taomee and its shareholders, through which we exercise effective control over operations of Shanghai Taomee and receive economic benefits generated from it. As a result of these contractual arrangements, under U.S. GAAP, we are considered the primary beneficiary of Shanghai Taomee and thus consolidate its results in our consolidated combined financial statements. However, these contractual arrangements may not be as effective in providing us with control over the VIE as direct ownership of it. In addition, the VIE or its shareholders may breach the contractual arrangements with us. In such cases, we would have to rely on legal remedies under PRC law, which may not always be effective, particularly in light of uncertainties in the PRC legal system. See “Risk Factors—Risks Related to Our Corporate Structure—If the PRC government determines that the contractual arrangements that establish the structure for operating our business do not comply with applicable PRC laws and regulations, we could be subject to severe penalties” and “Risk Factors—Risks Related to Our Corporate Structure—If the PRC government determines that our ownership structure does not comply with the restrictions contained in the GAPP Notice, we could be subject to severe penalties.”

Our relationships with Shanghai Taomee and its shareholders are governed by a series of contractual arrangements. Under PRC laws, each of Shanghai Taomee and Shanghai Shengran is an independent legal person and neither of them is exposed to liabilities incurred by the other party. Other than pursuant to the contractual arrangements between Shanghai Taomee and Shanghai Shengran, Shanghai Taomee is not required to transfer any funds generated from its operations to Shanghai Shengran.

Loan Agreement. Certain shareholders of Shanghai Taomee, namely Messrs. Jason Liqing Zeng, Benson Haibing Wang, Crow Zhen Wei, Roc Yunpeng Cheng and Bin Wang entered into a loan agreement with Shanghai Shengran, under which Shanghai Shengran provided an interest-free loan of RMB2.5 million (US$0.4 million) to these shareholders, solely for their respective contributions to the increased capital of Shanghai Taomee. The loan has a term of ten years, which can be extended if mutually agreed by the parties. Shanghai Shengran has the right to determine the method of loan repayment, including requiring the shareholders to transfer all of their respective equity interest in Shanghai Taomee to Shanghai Shengran and/or its designee.

Option Agreement. Shanghai Taomee’s shareholders have entered into an option agreement with Shanghai Shengran, under which each shareholder of Shanghai Taomee granted Shanghai Shengran an exclusive option to purchase or have its designee purchase his equity interest in Shanghai Taomee at the purchase price equal to the lowest price permitted by the PRC laws, and agreed to assist Shanghai Shengran in obtaining all necessary government approvals as may be then required in connection with the purchase. Shanghai Shengran may exercise such option at any time to the extent permitted by the PRC laws. In addition, Shanghai Taomee and its shareholders agree that without Shanghai Shengran’s prior written consent, they will not engage in certain actions including transferring or otherwise disposing of the equity interest in Shanghai Taomee.

Proxy Agreement. Shanghai Taomee and its shareholders have entered into a proxy agreement with Shanghai Shengran, under which each shareholder of Shanghai Taomee granted an irrevocable power of attorney to Shanghai Shengran that authorizes Shanghai Shengran to vote as the shareholder’s attorney-in-fact on all of the matters of Shanghai Taomee requiring shareholders’ approval, including the appointment of board members and senior management members.

Business Operation Agreement. Shanghai Taomee and its shareholders have entered into a business operation agreement with Shanghai Shengran, under which each of the shareholders agrees that, without the prior written consent of Shanghai Shengran or its designee, Shanghai Taomee will not conduct any transactions which might substantially affect its assets, businesses, personnel, obligations, rights or operations confirmed by Shanghai Shengran. Shanghai Taomee and its shareholders agree to fully comply with the advices in connection with its business operation and financial management provided by Shanghai Shengran from time to time and to elect directors and officers of Shanghai Taomee in consistence with the direction of Shanghai Shengran. In addition, the shareholders agree to unconditionally transfer to Shanghai Shengran, without any consideration, any dividends or other proceeds received from Shanghai Taomee in their capacity as shareholders of Shanghai Taomee.

Commercial Cooperation Agreement. Under the commercial cooperation agreement between Shanghai Taomee and Shanghai Shengran, Shanghai Shengran agrees to place certain game updates and value-added components developed by it, or the objects, on Shanghai Taomee’s platform for operation. Shanghai Shengran will provide routine maintenance, updates, technical support and debugging for the operation of the objects, and Shanghai Taomee will provide platform servers, broadband resources and customer services. Unless Shanghai Shengran directs otherwise and subject to applicable laws, any intellectual property in relation to the objects will belong to Shanghai Shengran and cannot be used by Shanghai Taomee beyond the agreed scope of uses. Shanghai Shengran will enjoy the profits generated from this operation after the deduction of a reasonable portion thereof by Shanghai Taomee. The rate for the deduction will be determined through negotiation by both parties based on the principles of arm’s-length pricing.

Shares Pledge Agreement. Shanghai Taomee and its shareholders have entered into an equity interest pledge agreement with Shanghai Shengran, under which the shareholders of Shanghai Taomee pledged all of their equity interests in Shanghai Taomee to Shanghai Shengran to secure their and Shanghai Taomee’s obligations under certain agreements above and as collateral for all of the amounts payable by Shanghai Taomee to Shanghai Shengran under those agreements. If any event of default as defined under this agreement occurs, Shanghai Shengran, as the pledgee, will be entitled to dispose of the pledged equity interests. In addition, any equity proceeds (including but not limited to any dividend or profit) from Shanghai Taomee will be further pledged in favor of Shanghai Shengran excepted otherwise agreed by Shanghai Shengran in writing.

The following selected consolidated combined statements of operations data for the years ended December 31, 2008, 2009 and 2010 and the selected consolidated combined balance sheet data as of December 31, 2008, 2009 and 2010 have been derived from our audited consolidated combined financial statements, which are included elsewhere in this prospectus. The following selected consolidated combined statement of operations data for the three-month periods ended March 31, 2010 and 2011 and the selected consolidated combined balance sheet data as of March 31, 2011 have been derived from our unaudited consolidated combined financial statements included elsewhere in this prospectus. Our selected consolidated combined balance sheet data as of December 31, 2007 and the selected consolidated combined statement of operations data for the period from October 8, 2007 (inception date) to December 31, 2007 have been derived from our unaudited consolidated combined financial statements that are not included in this prospectus.

You should read the selected consolidated combined financial data in conjunction with those financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. Our consolidated combined financial statements are prepared and presented in accordance with U.S. GAAP. The unaudited condensed consolidated financial statements were prepared on a basis consistent with our audited consolidated financial statements and include, in the opinion of management, all adjustments necessary, which include only normal recurring adjustments, for the fair statement of the financial information contained in those statements. Our historical results are not necessarily indicative of our results expected for future periods.

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our audited consolidated combined financial statements and unaudited consolidated combined financial information included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.

We are one of the leading children’s entertainment and media companies in China. In 2010, we ranked as the largest online entertainment community for children in China, measured by market share and active accounts, according to the iResearch Report. Our success online has translated into growing demand for our content offline in print media, merchandising, television, film and live performances.

Our children’s online entertainment community is the largest such community in China where, as of June 2010, an estimated 89.6 million children in the five to 15 age group used the Internet primarily to frequent virtual worlds and/or other entertainment communities for children, according to the iResearch Report. In the first quarter of 2011, we had approximately 27.3 million active accounts, defined as registered accounts that were accessed at least once during the quarter. Our online entertainment community, www.61.com, hosts four of the top six most visited virtual worlds by children in the five to 15 age group in China, according to the iResearch Report. In our virtual worlds, children adopt avatars and learn through interactive games and group activities set in imaginative landscapes with evolving story lines of exploration and adventure. The “Seer” and “Mole’s World” virtual worlds we developed ranked as the most and second most visited virtual worlds for children in China, respectively, according to the iResearch Report.

We work with publishers to offer a wide range of children’s books and magazines, featuring iconic characters, story lines and images we have developed and popularized, or our franchises. We license our franchises to leading brands in toys and other consumer products for children in China. We have also staged carnivals and live performances with event organizers and developed content for animation film and television, which we expect to release in 2011. We refer to these other businesses as our offline business.

We generate revenues from our online business primarily through the sales of subscriptions and virtual items, which users pay for primarily in the form of virtual currency purchased with prepaid cards. Our prepaid cards are distributed in over 65,000 retail outlets in over 21,000 towns and cities across 31 provinces in China. We generate revenues from our offline business mainly from license fees and royalties based on contracts with book publishers, makers of consumer products and other licensees.

For 2008, 2009, 2010 and the first quarter of 2011, approximately 100%, 97.3%, 93.6% and 95.0%, respectively, of our net revenues were generated from online business, and approximately nil, 2.7%, 6.4% and 5.0%, respectively, of our net revenues were generated from offline business.

We have achieved substantial growth since we launched our first virtual world, Mole’s World, in September 2008. Our net revenues grew from US$0.1 million in 2008 to US$7.1 million in 2009 and US$36.0 million in 2010, and amounted to US$12.4 million in the first quarter of 2011. Our gross profit grew from US$0.01 million in 2008 to US$5.1 million in 2009 and US$30.1 million in 2010, and amounted to US$10.4 million in the first quarter of 2011. We incurred a net loss of US$0.9 million in 2008. Our net income grew from US$1.3 million in 2009 to US$21.6 million in 2010, and amounted to US$9.1 million in the first quarter of 2011. The number of active paying accounts, in our online entertainment community increased from 0.1 million in the three months ended December 31, 2008 to 2.4 million in the three months ended December 31, 2010 and 2.7 million in the

three months ended March 31, 2011, and per paying account average gross revenues from the operation of our virtual communities in China, or ARPU, increased from approximately US$1.2 to US$3.9 and US$4.6 in the same periods.

Our results of operations are affected by the factors described in more details in the “—Descriptions of Certain Statement of Operations Items—Net revenues” as well as the general and specific factors, including:

We generate revenues from two sources: (i) online business through the operation of our virtual worlds and provision of other online services and products, including royalties for licensing our virtual worlds, and (ii) offline business.

Our revenues from online business grew rapidly since we commercially launched our first virtual world, Mole’s World, in September 2008. Our revenues from offline business also grew rapidly since 2009, when we first leveraged our online business to enter into arrangements to license our franchises to makers of consumer products and publishers of children’s books. The following table sets forth a breakdown of our net revenues from the periods indicated.

Our net revenues from online business amounted to US$0.1 million, US$6.9 million, US$33.7 million and US$11.8 million in 2008, 2009, 2010 and the first quarter of 2011, respectively.

Our net revenues from online business are net of discount and rebate granted to our distributors, as well as business taxes and surcharges incurred in connection with our operations. Each of Shanghai Shengran and Shanghai Taomee is subject to PRC business tax at a statutory tax rate of 5% and surcharges totalling approximately 0.5% related to urban construction and education, which we deduct from our gross online business revenues.

We generate revenues from our online business primarily through two revenue streams—time-based and item-based. While users can access our virtual worlds for free, users may choose to pay a RMB10 (US$1.5) fee per virtual world to access premium features and gain privileges within each of our virtual worlds for 30 days. Users who pay the subscription fee enjoy additional capabilities, special privileges, such as having a higher upper limit for the total number of friends that the users can have and access to exclusive online parties. In addition, users pay a fee for each virtual item within our virtual worlds. We generated a significant portion of our net revenues from online business through the time-based revenue stream in 2008, 2009, 2010, and the first quarter of 2011. We anticipate generating more revenues through the item-based revenues stream going forward as we introduce more virtual items. For more details on revenue recognition, see “—Critical Accounting Policies and Estimates—Revenue Recognition.” In 2009, we also generated a small amount of revenues from royalties for licensing our virtual worlds to a licensee in Taiwan. We subsequently accounted for income from the licensing arrangement as share of profit in equity investment after we obtained an equity interest in 2009 in the licensee. See “—Share of Profits/Loss in Equity Investments.” In the future, we may generate online business revenues from licensing our virtual worlds outside of China. We plan to license our virtual worlds to new international markets, including Southeast Asia. Starting from the second half of 2010, we also began to operate third-party online casual games on our platform and generate revenues from such licensing arrangements.

Users can purchase subscriptions and virtual items using our virtual currency, the Mibi, which in turn can be purchased from different distribution channels, such as our prepaid cards, third-party prepaid cards, online payment channels and cellular telecom operators. We sell the prepaid cards to our distributors at a pre-negotiated discount on the face value of the cards and offer a volume rebate to distributors if they meet a pre-set sales requirement. Net proceeds from distributors are initially recorded as advances from customer. Upon activation or charge of the prepaid cards or the Mibi, these advances from customers are transferred to deferred revenues. The proceeds received from sales of the Mibi directly to users through third-party payment channels are recorded as deferred revenues. For more details on our distribution agreements and payment systems, see “Business—Our Business Segments—Online Business—Pricing, payment and distribution.”

Our physical prepaid cards will expire on the expiration date printed thereon, which is generally two years after the date of card production. The proceeds from the expired physical prepaid cards that have never been activated are recognized as other operating income upon expiration of the cards. In 2008 and 2009, we had not recognized any income or revenues in connection with any expired prepaid cards. In 2010 and the first quarter of 2011, we recognized US$41,801 and approximately US$0.1 million, respectively, as other operating income due to expiration of prepaid cards.

The table below lists our portfolio of virtual worlds currently offered and their respective date of commercial launch.

The following table sets forth the number of active accounts, the number of active paying accounts and ARPU for each period indicated.

We believe net revenue from our online business is primarily affected by the following factors:

Our net revenues from offline business amounted to nil, US$0.2 million, US$2.3 million and US$0.6 million in 2008, 2009, 2010 and the first quarter of 2011, respectively.

Our revenues from offline business mostly consisted of publishing royalties, and merchandise licensing fees generated from licensing our content in the PRC. In addition to licensing our franchises, we sometimes procure and sell merchandises that bear images of our franchises, as we did in the first half of 2009, and books featuring our franchises. We take the associated inventory risks in connection with such sales. See “—Cost of Services— Offline business.”

We invest in the production of, or license our franchise to producers of, two animation series with over 100 planned episodes and two feature films, based on our “Mole’s World” and “Seer” franchises, which we expect to launch or release in 2011, from which we expect to generate revenues through sharing net sales proceeds from advertising and box office receipts. We generated a small amount of revenues in the fourth quarter of 2010 from carnivals and other live performance events for children, and plan to generate more revenues from such activities in the future.

Our results of operations will be significantly affected by our ability to grow our offline business by leveraging our brand name and the popularity of our franchise assets and content creation capabilities. We believe net revenue from our offline business is primarily affected by the following factors:

The following table sets forth a breakdown of our cost of services and as a percentage of total cost of services for the periods indicated.

Our cost of services relating to our online business primarily consists of bandwidth leasing and server hosting fees, salaries and benefits of our operations staff, production costs for prepaid cards, depreciation and amortization of servers and other computer equipment and software purchased from third-parties, and other direct costs.

Our bandwidth leasing fees represent the fees we pay to bandwidth vendors, which are typically telecommunications operators such as China Telecom and China Unicom, or independent third parties that purchase bandwidth from major telecommunications operators in China. We also purchase servers from which we incur depreciation expenses and rental expenses for storing our servers. In the foreseeable future, we expect our bandwidth leasing fees and server-related depreciation and rental expenses to continue to increase in absolute amount given the anticipated increase in the volume of our website traffic, and to decrease as a percentage of our revenues as we continue to increase our revenues and achieve better economies of scale as a result of increased sales volume and continued technological improvements that optimize bandwidth and server usage.

Salaries and benefits (including share-based compensation) cost for our online business primarily comprise compensation to operations support staff, including employees responsible for database and user system maintenance, bandwidth and server monitoring and maintenance, prepaid card and billing system maintenance, online security, technical support and customer service. We expect costs associated with salaries and benefits to increase as we continue to expand our operations and hire more operation staff. Our operations staff for online business increased from 13 as of December 31, 2008 to 132 as of December 31, 2010 and decreased slightly to 118 as of March 31, 2011.

Our production costs include the cost of manufacturing and transporting physical prepaid cards to our distributors around China. We expect such production costs to increase in absolute amount as we continue to expand our operations and enter into distribution agreements with city level distributors. However, we do not expect production costs of the prepaid card to comprise a material part of our cost of services going forward.

Cost of services relating to our offline business is primarily comprised of compensation to our operations employees and merchandise cost, which is the cost involved in producing labels used to verify the authenticity of our licensed products and inventory costs associated with occasional book sales by us in 2010. We currently do not expect to incur merchandise cost after the first quarter of 2011 as we do not currently expect to conduct direct book sales after the first quarter of 2011.

We plan to account for the expenses incurred in the co-production of the films and television series as cost of services in future periods.

Our operating expenses consist of product development expenses, sales and marketing expenses and general and administration expenses. The following table sets forth a breakdown of our operating expenses in terms of amount and as a percentage of our total net revenues for the periods indicated. As we continue to expand both our online and offline business, we expect our operating expenses to increase in absolute amount, and we aim to maintain or enhance our operating efficiency when our business further scales up.

Our product development expenses consist primarily of salaries and benefits, including share-based compensation, for personnel engaged in concept generation, community function development and design, story line development, website structure and content development and design, graphic and audio design, quality control and testing of our virtual worlds and other online services. Product development expenses accounted for approximately 251.2%, 20.4%, 12.9% and 16.9% of our total net revenues in 2008, 2009, 2010 and the first quarter of 2011, respectively. Our product development expenses increased in recent years primarily due to our hiring additional writers, engineers, development staff, animation and graphic artists. We expect that our product development expenses will further increase in absolute amount in the future as we continue to devote resources to improve our interactive communities and the overall user experience and to create new virtual worlds, and as we incur higher share-based compensation expenses. However, we expect our product development expenses to stay relatively stable as a percentage of our total net revenues and we expect our revenue growth will keep pace with the increase in our product development expenses.

Our sales and marketing expenses primarily consist of advertising and promotional expenses, salaries and benefits, including share-based compensation, and other overhead expenses incurred by our sales and marketing personnel. Sales and marketing expenses accounted for approximately 146.4%, 12.6%, 4.4% and 8.3% of our total net revenues in 2008, 2009, 2010 and the first quarter of 2011, respectively. Our sales and marketing expenses increased in the absolute amount in recent years, primarily due to the growth of our sales and marketing team as well as an expansion of our marketing efforts. We expect that our sales and marketing expenses will

increase in absolute amount as we further promote our virtual worlds in future periods on search engines, web portals and casual game websites and devote efforts to further expanding our user base. Historically, as we have benefited from word of mouth to promote our virtual worlds. Over the long term, we do not expect sales and marketing expenses to constitute a major component of our operating expenses.

Our general and administration expenses primarily consist of salaries and benefits, including share-based compensation, for our general and administration, finance and human resources personnel, office rentals, depreciation and amortization expenses relating to property and equipment used in general and administrative functions, professional service fees and other expenses incurred in connection with general corporate purposes. General and administration expenses accounted for approximately 325.6%, 16.4%, 15.9% and 13.3% of our total net revenues in 2008, 2009, 2010 and the first quarter of 2011, respectively. We expect our general and administration expenses to increase in absolute amount as we incur additional expenses in connection with the expansion of our business and our operations as a publicly traded company, which include hiring more staff for our general and administrative team, expenses related to improving and maintaining our internal control over financial reporting and complying with our reporting obligations, and as we incur higher share-based compensation expenses. However, we expect our general and administration expenses to stay relatively stable or decrease as a percentage of our total net revenues in the future as we expect our revenue growth will outpace the increase in our general and administration expenses.

Our other operating income consists of PRC government subsidies granted to our operating subsidiary and significant VIE in China and income recognized as a result of expiration of prepaid cards. Other operating income amounted to US$0.3 million in 2010 and US$0.2 million in the first quarter of 2011. We did not receive government subsidies or recognize any income from expired prepaid cards in 2008 or 2009. We expect to continue to receive certain government subsidies in 2011. However, the amount we receive may vary depending on government policy, our business operations and other factors. In 2011, we expect to recognize a small amount of other operating income due to the expiration of prepaid cards.

In December 2009, we obtained a minority interest in Elyn Corporation and its wholly owned subsidiary Taiwan Taomee Co., Ltd. in exchange for, as consideration, a three-year exclusive right to operate certain of our virtual worlds in Taiwan, Hong Kong and Macau. As we have the ability to exercise significant influence over Elyn Corporation, we account for this investment using the equity method of accounting. Our share of profits from our equity investment in Elyn Corporation in 2009, 2010 and the first quarter of 2011 amounted to approximately US$0.05 million, US$0.5 million and US$0.4 million, respectively. On February 25, 2011, we entered into an agreement to effectively sell a 10.5% equity interest in Elyn Corporation that had been indirectly held by a nominal shareholder on our behalf.

In October 2010, pursuant to an equity investment agreement, we entered into with Shenzhen Decent Investment Limited and two individuals unrelated to us to form Shenzhen Ruigao in the PRC for the purpose of developing console games. We obtained a minority interest in Shenzhen Ruigao for total cash consideration of US$1.0 million with the first installment paid in October 2010 and the remaining consideration was paid in February and March of 2011. As we can appoint one of a total of three directors on the board and have the ability to exercise significant influence over Shenzhen Ruigao, we account for this investment using the equity method of accounting. Our share of loss in equity investment in Shenzhen Ruigao was US$0.05 million in 2010 and US$0.08 million in the first quarter of 2011.

We are incorporated in the Cayman Islands. Under the current law of the Cayman Islands, we are not subject to income or capital gains tax. In addition, payment of dividends by us to our shareholders is not subject to withholding tax in the Cayman Islands.

Our subsidiary in Hong Kong is subject to a profit tax at the rate of 16.5% on assessable profit determined under relevant Hong Kong tax regulations.

According to the Mainland and Hong Kong Special Administrative Region Arrangement on the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, or the Tax Agreement, dividends paid by a foreign-invested enterprise in mainland China to its corporate shareholder in Hong Kong will be subject to withholding tax at a maximum rate of 5.0%, provided however that such Hong Kong company directly owns at least 25.0% of the equity interest in the mainland foreign-invested enterprise. However, under the New EIT Law and its implementation rules, as well as Circular No. 601 issued by SAT in October 2009, or Circular 601, dividends from our PRC subsidiary paid to us through our Hong Kong subsidiary may be subject to withholding tax at a rate of 10.0% if our Hong Kong subsidiary is not considered to be the “beneficial owner” of the dividends distributed by a resident enterprise of the PRC.

Taomee HK, a company incorporated in Hong Kong in November 2008, currently holds all the equity interest in Shanghai Shengran. To the extent that Taomee HK is considered a “non-resident enterprise” of the PRC under the Tax Agreement, dividends paid by Shanghai Shengran may be subject to a maximum withholding tax rate of 10.0%. For 2008, 2009 and 2010, Taomee HK had a loss and therefore would not be subject to a 25% EIT under PRC tax laws in 2008, 2009 and 2010 had Taomee HK been deemed a “resident enterprise” by the PRC tax authorities. Dividends paid by Taomee HK to its shareholder will not be subject to any Hong Kong withholding tax.

Prior to January 1, 2008, companies established in China were generally subject to state and local EIT at statutory rates of 30% and 3% respectively. On March 16, 2007, the National People’s Congress of China enacted a new enterprise income tax law, i.e. the PRC Enterprise Income Tax Law, which took effect beginning January 1, 2008. On December 6, 2007, the State Council also adopted the Implementing Rules for the Enterprise Income Tax Law, or the Implementing Rules, which also took effect beginning January 1, 2008. Under the PRC Enterprise Income Tax Law, foreign invested enterprises, or FIEs, and Chinese domestic companies are subject to EIT at a uniform rate of 25%. On February 22, 2008, the Ministry of Finance and the State Administration of Taxation, or the SAT, promulgated the Notice on Several Preferential Policies in Respect of Enterprise Income Tax, or Notice No. 1 2008, reiterating the policy that a software enterprise newly established within China may, upon determination, be exempted from income taxes for its first two profit-making years and shall be subject to the income tax at half the standard rate for the next three years. On April 24, 2009, the Ministry of Finance and SAT promulgated the Notice on Several Issues Relevant to the Implementation of the Preferential Policies on Enterprise Income Tax, which states that, software enterprises established prior to the end of 2007 may, upon certification, enjoy the preferential policies on the EIT reductions and exemptions within specified periods as provided in the Notice No. 1 2008. Our VIE, Shanghai Taomee, which was established in 2007 and qualified as a “software enterprise” in 2009, enjoys a full exemption from EIT in 2009 and 2010 and a reduced EIT rate of 12.5% from 2011 to 2013. Shanghai Taomee’s tax holiday period was approved by relevant tax authorities in May 2010. In addition, our wholly-owned subsidiary, Shanghai Shengran, which was established in 2009 and

qualified as a “software enterprise” in 2010, is entitled to enjoy full exemption from EIT for two years starting from its first profitable year, and 50% reduction in EIT rate in the three subsequent years. The relevant tax authorities informed Shanghai Shengran in April 2011 that the full EIT exemption would apply retroactively in 2009 and 2010, and 50% reduction in EIT rate will apply from 2011 to 2013. Continued qualification as a “software enterprise” is however subject to an annual assessment by the relevant government authorities in China. See “Risk Factors—Risks Related to Doing Business in China—We may be classified as a “resident enterprise” for PRC enterprise income tax purposes, which could result in our global income becoming subject to 25% PRC enterprise income tax.”

Under the PRC Enterprise Income Tax Law and the Implementing Rules, dividends generated from the business of our PRC subsidiary after January 1, 2008 and payable to us may be subject to a withholding tax rate of 10% if we are considered a non-resident enterprise incorporated outside of the PRC unless there is an applicable tax treaty with China that provides for a different withholding arrangement and we are deemed to be entitled to such favorable treatment. Distributions of earnings generated before January 1, 2008 are exempt from PRC withholding tax.

The PRC Enterprise Income Tax Law provides that enterprises established outside China whose “effective management” is located in China are considered “resident enterprises” and will generally be subject to the uniform 25% EIT rate as to their global income. Under the implementation regulations, “effective management” is defined as substantial and overall management and control over such aspects as the production and business, personnel, accounts and properties of an enterprise. The risk that we may be deemed to be a PRC resident enterprise under the PRC Enterprise Income Tax Law and be subject to the PRC enterprise income tax at the rate of 25% on our worldwide income is disclosed in “Risk Factors—Risks Related to Doing Business in China—We may be classified as a “resident enterprise” for PRC enterprise income tax purposes, which could result in our global income becoming subject to 25% PRC enterprise income tax.”

In May 2009, we adopted our 2009 Employee Stock Option Plan, or the 2009 Plan. We reserved 45,000,000 shares for grants under the 2009 Plan. As of the date of this prospectus, options to purchase 42,940,000 ordinary shares were outstanding and 2,060,000 ordinary shares were available for future grants under the 2009 Plan. We did not grant any options prior to 2009.

In June 2010, we adopted our 2010 Share Incentive Plan, or the 2010 Plan. We reserved 55,000,000 shares for grants under the 2010 Plan. As of the date of this prospectus, options to purchase 38,840,000 ordinary shares were outstanding, 4,500,000 restricted shares were outstanding and 16,160,000 ordinary shares were available for future grants under the 2010 Plan.

On June 24, 2009, we granted options to purchase a total of 10,500,000 ordinary shares at the price of US$0.0400 per share to certain of our employees under the 2009 Plan. These options are subject to vesting over four years, starting from June 24, 2009, and were valued at the estimated fair value on the date of the award.

On June 7, 2010, we granted options to purchase a total of 35,175,000 ordinary shares at the price of US$0.0700 per share to certain of our directors, executive officers and employees under the 2009 Plan. These options are subject to vesting over four years, starting from June 7, 2010, and were valued at the estimated fair market value on the date of the award.

On January 4, 2011, we granted options to our employees and a third-party consultant to purchase 16,665,000 and 2,500,000 of ordinary shares of the Company, respectively, at an exercise price of US$0.3600 per share. These options vest over a four-year requisite service period, with 25% of the options to vest on each anniversary after the grant date. The fair value of the stock options as of the grant date was US$3,605,856 in the aggregate, or US$0.1881 per share.

On May 24, 2011, we granted options to purchase a total of 20,175,000 ordinary shares at the initial public offering price and a total of 4,500,000 restricted shares to our independent director appointees, executive officers and employees under the 2010 Plan. The options granted to the independent director appointees are subject to vesting over three years, and the rest are subject to vesting over four years, starting from May 24, 2011.

We characterized the share grants as compensation for the relevant employees’ services to us and recorded share-based compensation expenses. Our share-based compensation expenses amounted to nil, approximately US$0.07 million, US$0.2 million and US$0.3 million in 2008, 2009, 2010 and the first quarter of 2011, respectively. We measure share-based compensation expenses based on the grant date fair value of the awards. The fair value of the award, net of forfeitures, is recognized as compensation expense over the period during which the recipient is required to provide services in exchange for the award, which is generally the vesting period. We adjust the estimated forfeiture rate over the requisite service period to the extent that expected forfeitures differ from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of share-based compensation costs to be recognized in future periods.

As of December 31, 2010, we had US$1,011,976 in unrecognized compensation expenses related to non-vested share-based compensation awards, which we expect to recognize over a weighted average period of 3.3 years. As of March 31, 2011, we had US$4,152,157 in unrecognized compensation expenses related to non-vested share-based compensation awards, which we expect to recognize over a weighted average period of 3.2 years.

We are required to estimate the grant-date fair value of the share options and other share-based awards that we grant to our employees. The grant date fair value of the share options granted in June 2009, June 2010, and January 2011 was estimated using the Black-Scholes-Merton option-pricing model. We estimated the expected term based on option terms related to vesting schedule and expected option expiration date. The volatility rate estimation is developed based on the volatility of the comparable companies within the expected term commensurate with the expected time period modified to reflect ways in which currently available information indicates that the future of the subject company is reasonably expected. The risk-free interest rate is selected based on the yield of Chinese International Government Bond, which is denominated in U.S. dollars, with duration closest to the expected term.

As a private company, we determine the fair value of our ordinary shares as of the grant date of the share-based awards by making complex and highly subjective judgments and assumptions about our projected financial and operating results. We are also required to make other assumptions such as our weighted average cost of capital, general market and macroeconomic conditions, nature and prospects of the children’s entertainment and media industry, nature and stage of development of our company, comparable companies, and our business risks. These assumptions are inherently uncertain. Changes in these assumptions could significantly affect the valuation results and the amount of share-based compensation expenses we recognize in our consolidated combined financial statements.

The fair value of our Company’s ordinary shares underlying the share options granted in June 2009, June 2010, and January 2011 was estimated by determining the equity value of our Company and then allocating the equity value into the various classes of shares and options using the option-pricing method, which is one of the generally accepted valuation methodologies. Firstly, the total equity value was developed by using the discounted cash flow approach and the guideline companies approach, which incorporates certain assumptions including the market performance of comparable listed companies, as well as the our forecasted financial results and growth trends. We checked the results obtained under the discounted cash flow approach against the results obtained from the guideline companies approach and found no material discrepancies. Then, equity value is allocated using the option pricing method under three scenarios, namely liquidation scenario, redemption scenario and initial public offering, or IPO, scenario (based on the terms of the preferred shares, share options and management’s expectation on an IPO event) to determine the fair value of our ordinary shares. Under the option-

pricing method, each class of equity is modeled as a call option with a distinct claim on the enterprise value of our company. The main inputs to this model include equity value of our company, exercise price, expected volatility, expected term, expected dividend yield and risk free interest rate.

In the discounted cash flow analyses, we used a weighted average cost of capital, or WACC, of 22% for the June 2009 grant, 22% for the June 2010 grant, and 18% for the January 2011 grant, respectively, as the discount rates to derive the business enterprise value of our company. The WACC was calculated using the capital asset pricing model based on the required return on equity investors expect to earn and the post-tax cost of debt of our company. The WACCs were determined based on a consideration of the factors including risk-free rate, comparative industry risk, equity risk premium, company size and non systematic risk factors. The decrease in WACCs from June 24, 2009 and June 7, 2010 to January 4, 2011 was due to the factors discussed below in the explanations for the increase in the fair value of our ordinary shares between grant dates. The decrease was also due to a longer track record for forecasting. According to the guideline prescribed by the AICPA Audit and Accounting Practice Aid, “Valuation of Privately Held Company Equity Securities Issued as Compensation,” or the Practice Aid, when an enterprise has established a solid financial history, the reliability of forecasted results is generally higher than those made at an earlier stage, and therefore the perceived risks of investing in the enterprise are generally lower than in an earlier stage. Therefore, the estimated WACC, which reflects the perceived risks of and a market participant’s expected rate of return for investing in our securities, also declined gradually from June 2009 to January 2011 to the time of this offering as our company progressed through the earlier stages of development and towards this offering.

In arriving at the equity value for our company, we applied a discount for lack of marketability, or DLOM, of 33.0% for the June 24, 2009 grant and 21.0% for the June 7, 2010 grant and 7.0% for the January 4, 2011 grant, respectively, to reflect the fact that, at the time of the grants, we were a closely-held company and there was no public market for our ordinary shares. We used the put option method to estimate the DLOM, taking into consideration factors like the timing of liquidity event such as an IPO and estimated volatility of our ordinary shares. The decrease in the DLOM is primarily because the Company is approaching the expected IPO, as the closer the valuation date is from the expected IPO, the lower the put option value is, and thus the lower the implied DLOM. For the determination of the fair value of the options granted on June 24, 2009, June 7, 2010 and January 4, 2011 and the fair value of the underlying ordinary shares of our company, we also considered retrospective valuations conducted by an independent appraiser.

Other general assumptions used in deriving the fair value of the ordinary shares transferred and our total equity value include the following: (i) there will be no material changes in the existing political, legal, fiscal and economic conditions in China; (ii) there will be no material changes in tax law in China and the tax rates applicable to our subsidiary and VIEs; (iii) exchange rates and interest rates will not differ materially from currently prevailing rates, (iv) the availability of finance will not be a constraint on the future growth of the Company, (v) the Company will retain and have competent management, key personnel and technical staff to support its ongoing operation, and (vi) there will be no material deviation in industry trends and market conditions from economic forecasts.

In May 2009, we repurchased 5,000,000 ordinary shares from a shareholder for total cash proceeds of US$160,000. We cancelled the repurchased shares immediately after such transfer. This repurchase resulted in a compensation charge of US$61,560, which was the difference between the cash consideration paid and the US$0.0214 per share fair value of the ordinary shares on the repurchase date.

The table below sets forth certain information concerning the options and restricted shares awarded to our employees on the dates indicated:

The increase in the fair value of our ordinary shares from US$0.0214 per share on June 24, 2009 to US$0.0700 per share on June 7, 2010 was primarily attributable to the following developments of our company during the period:

The increase in the fair value of our ordinary shares from US$0.0700 per share on June 7, 2010 to US$0.3600 per share on January 4, 2011 was primarily attributable to the following factors. As it is difficult to attribute with precision the portion of the fair value increase to a particular factor, the following represents our good-faith estimates based on various relevant factors, including our assessment of our business developments and projections of our growth prospects:

The two new virtual worlds launched in the second half of 2010 attracted 8.7 million registered accounts that created avatars in a relatively short period of time. Their combined active accounts reached 9.8 million during the fourth quarter of 2010. These new virtual worlds were targeted at specific users. From these new launches, we gained insights into the preferences of specific user segments, and we demonstrated our ability to expand our user base with new targeted products. Since their respective launch, we were also able to generate healthy amounts of revenues from subscriptions given the life cycle of the virtual worlds and the target users. We anticipated greater ARPU and revenue contributions from these virtual worlds as we expected sales of virtual items to increase since their introduction in November 2010 and February 2011, respectively.

Meanwhile, our total ARPU continued to increase faster than forecasted in the third and fourth quarter of 2010. The performance of the newly launched virtual worlds in the second half of 2010

and the increase in ARPU provided us with added confidence in our core product development capabilities and demonstrated our ability to maintain high levels of user engagement over time. As a result, we decided in the second half of 2010 to further expand our product development capabilities. We added 79 product development staff from June 2010 to December 31, 2010, an increase of 43% from the previous total development staff. We also set a strategic goal of launching more virtual worlds per year, compared to the previous projection of three new virtual worlds over the ensuing four years.

We revised our financial projections accordingly, based on the revised number of virtual worlds to be launched and the average revenue contributions from existing virtual worlds in the second half of 2010 (excluding the performance of the most and least profitable virtual worlds). We believe that the resulting increase in revenue projections contributed approximately 40% to 45% of the increase in the fair value of our ordinary shares during this period;

In July 2010, as a result of the popularity of the Seer franchise, we were approached for the first time by a production company with a proven track record of successfully launching children’s films to invest in a film based on the Seer franchise. The film opportunity represented an initial step in the implementation of our expansion strategy into the broader children’s media and entertainment industry. We decided to co-invest in the film in September 2010. We also began the in-house development of an animation TV series based on the Seer franchise, initially with 52 episodes. We estimated that the incremental revenues from our film and animations would contribute 2% to 3% to the increase in the fair value of our ordinary shares. In addition, we believed that the film and animation programs, when released, would generate greater demand for our products and contribute to online and offline revenue growth from our franchises, and Seer franchise in particular.

The combined effect from the foregoing factors prompted us to revise our financial projections to reflect a slower rate of natural attrition in the user base of the Seer franchise and to reflect higher ARPU in the remaining years of the estimated useful life for the Seer virtual world. We believe the revision accounted for approximately 12% to 18% of the increase in the fair value of our ordinary shares during this period; and

We compared our valuations derived from the discount cash flow method to the result derived from the guideline company method. In arriving at a similar conclusion under the guideline company method, we considered the same factors in our earnings forecast and also considered the favorable market conditions in the second half of 2010. The share price performance of China-based publicly-traded companies significantly improved in the second half of 2010. The NASDAQ China Index generally increased in 2010 and reached 195.23 on December 31, 2010, compared to 165.71 on June 1, 2010.

Though we experienced a decrease in active paying accounts and revenues in the fourth quarter of 2010, we believe that such decrease does not materially affect our earnings forecast because of the following factors:

With regards to the share options and restricted shares that we awarded on May 24, 2011, we used the mid-point of the price range indicated on the cover of the preliminary prospectus dated May 24, 2011 as the estimated fair value of our ordinary shares. As the exercise price of the share options is the initial public offering price per ordinary share set forth on this final prospectus, the grant date was not established until the IPO effective date. The compensation cost of the options will be remeasured based on the initial public offering price. We are in the process of determining the compensation cost to be recognized for the share options over the three-year or four-year vesting period. We will recognize total compensation expenses of approximately US$2,250,000 for the restricted share awards ratably over the four-year vesting period following the grant date.

The increase in the fair value of our ordinary shares from US$0.3600 per share on January 4, 2011 to US$0.4500, the initial public offering price, was primarily attributable to the following factors. The percentage range assigned to each individual factor represents our good-faith estimate based on various relevant factors, including our assessment of our business and projections of our growth prospects.

As a result of these developments, we slightly increased our overall ARPU growth projections and revenue projections from Mole’s Hero and other Mole’s World franchises for our online business and offline businesses, which we believe contributed approximately 30% to 35% of the increase in the fair value of our ordinary shares during this period.

We have considered the guidance prescribed by the AICPA Practice Aid “Valuation of Privately-Held-Company Equity Securities Issued as Compensation,” or the Practice Aid, in determining the fair value of our ordinary shares as of various dates before this offering. The Practice Aid states, among other things, that the value of a private enterprise during the period culminating in its successful IPO may increase significantly. We therefore believe the ultimate price of this offering is generally not likely to be a reasonable estimate of the fair value of our ordinary shares as of various dates before this offering. However, as explained below, we believe certain factors contributed to the changes in the fair value of our ordinary shares as of various dates before this offering.

We prepare our financial statements in conformity with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and the disclosure of our contingent assets and liabilities. We continually evaluate these judgments, estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates.

An accounting policy is considered critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time such estimate is made, and if different accounting estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could material impact our consolidated combined financial statements. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements. The following descriptions of critical accounting policies, judgments and estimates should be read in conjunction with our consolidated combined financial statements and other disclosures included in this prospectus.

When reviewing our financial statements, you should consider (i) our selection of critical accounting policies, (ii) the judgment and other uncertainties affecting the application of such policies, and (iii) the sensitivity of reported results to changes in conditions and assumptions.

We earn revenues primarily through developing and operating proprietary online virtual worlds. We provide such services to children via an online entertainment platform pursuant to a time-based revenue model and an item-based revenue model. Since our inception, we have not licensed or otherwise marketed any of our proprietary software to third parties except in one instance which was immaterial.

Time-based model—Users pay RMB10 (US$1.5) for a 30-day subscription per virtual world to access premium features in each of our virtual worlds. We recognize revenue generated from subscription fees ratably over the users’ subscription period.

Item-based model—Users purchase our in-game virtual items under this model. Revenues are recognized over the estimated lives of the virtual items purchased or as the virtual items are consumed. For the virtual items that are immediately consumed, we recognize revenue upon consumption. For the virtual items with no predetermined expiration or permanent items, we recognize revenue ratably over the estimated average lives of these items, which range from one year to one and a half years. The amount of the unamortized permanent items and unconsumed items are recognized as deferred revenue. We estimate the average lives of our permanent items based on an assessment of our historical data and user behavior patterns, including the average period that users typically stay in our virtual worlds, the age group of our target users, and the number of active paying users in our virtual worlds, and the promotional events we launched, with reference to industry research data. We assess the estimated lives of our permanent items periodically. If there are indications of any significant changes to their estimated lives, the revised estimates will be applied prospectively in the period of change. Prior to June 30, 2010, we did not have sufficient historical data from our virtual worlds to estimate the useful life of the permanent items, and used the industry research data and peer company information in developing the estimate of the average life of permanent items, which was determined to be one year for all our virtual worlds. Effective July 1, 2010, we changed the accounting estimate of the useful life of our permanent items in Mole’s World from one year to 18 months based on an analysis of the life of the virtual world and user behavior patterns using historical user data since the launch of Mole’s World in September 2008. The effect of the change in accounting

estimate on net income and earnings per share for the year ended December 31, 2010 was immaterial. Due to the lack of sufficient historical data for our other virtual worlds, we have not changed the estimate for the useful life of permanent items in other virtual worlds. We will continue to monitor the user behavior patterns of each of our virtual worlds and will utilize such information to update the estimates of the useful lives of permanent items.

We record revenues net of sales discounts and rebates to our distributors. The cost of providing free virtual items as a result of promotional activities was immaterial.

Users pay subscription fees and purchase virtual items using our virtual currency, which can be purchased via various distribution channels, such as our prepaid cards, third-party prepaid cards, online payment channels, and via short messages, or SMS, through cellular telecom operators. Under both the time-based and the item-based revenue models, proceeds we receive directly from end users for sales of the Mibi are recorded as deferred revenues, while proceeds we receive from sales of the Mibi to parties in the distribution channel and from sales of prepaid cards are initially recorded as advances from customers. As we do not have control over and generally do not know the ultimate selling price of the prepaid cards or the Mibi sold by the distributors, we record net proceeds from the distributors as advances from customers. Upon activation of prepaid cards or purchase of the Mibi, advances from customers are immediately transferred to deferred revenues.

Prepaid cards expire on the expiration date printed thereon, which is generally two years after the date of card production. Proceeds from expired prepaid cards that have never been activated are recognized as other income upon expiration of the cards. We recognized nil, nil, US$41,801 and approximately US$0.1 million in other operating income in connection with expired prepaid cards for the years ended December 31, 2008, 2009 and 2010 and the first quarter of 2011, respectively.

Revenues from our offline business mainly include licensing income and royalty fees for licensing our franchises to merchandisers and book publishers, and revenue from book trading, which involves selling books based on our franchises. Most of the revenues generated under merchandise licensing income and royalty fees are recognized at the end of each month and calculated at the contractual royalty rate times the sales of the licensed merchandise product for the month. The sales of the licensed product are derived from the monthly sales reports provided by the licensee.

In certain of our merchandise licensing arrangements, we receive a guaranteed base fee and additional royalty fees that are contingent on sales volume. Proceeds from nonrefundable advances and minimum guaranteed royalties in excess of royalties earned are generally recognized as revenues at the end of the contract term. In a small number of our merchandise licensing arrangements, we receive a fixed royalty fee from the licensee over the contract period. We recognize this type of royalty revenue ratably over the contract period.

Share-based payment transactions with employees, such as share options, are measured based on the grant-date fair value of the equity awards. We recognize share-based compensation costs net of an estimated forfeiture rate using a straight line method over the requisite service period of the award, which is generally the same as the vesting period. We adjust the estimated forfeiture rate over the requisite service period to the extent that expected forfeitures differ from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of share-based compensation costs to be recognized in future periods.

term based on option terms related to vesting schedule and expected option expiration date. The volatility rate estimation is developed based on the volatility of the comparable companies within the expected term commensurate with the expected time period modified to reflect ways in which currently available information indicates that the future of the subject company is reasonably expected. The risk-free interest rate is selected based on the yield of Chinese International Government Bond, which is denominated in U.S. dollars, with duration closest to the expected term.

We are in the process of estimating the fair value of the share options awarded on May 24, 2011. As the exercise price of the share options is the initial public offering price per share set forth on this final prospectus, the grant date was not established until the IPO effective date. The compensation cost of the options will be remeasured based on the initial public offering price. The fair value of the restricted shares awarded on May 24, 2011 is estimated at the mid-point of the price range indicated on the cover of the preliminary prospectus dated May 24, 2011, which is US$2,250,000 in the aggregate, or US$0.50 per ordinary share.

The fair value of our Company’s ordinary shares underlying the share options granted in June 2009, June 2010, and January 2011 was estimated by determining the equity value of our Company and then allocating the equity value into the various classes of shares and options using the option-pricing method, which is one of the generally accepted valuation methodologies. Firstly, the total equity value was developed by using the discounted cash flow approach and the guideline companies approach, which incorporates certain assumptions including the market performance of comparable listed companies, as well as the our forecasted financial results and growth trends. We checked the results obtained under the discounted cash flow approach against the results obtained from the guideline companies approach and found no material discrepancies. Then, equity value is allocated using the option pricing method under three scenarios, namely liquidation scenario, redemption scenario and IPO scenario (based on the terms of the preferred shares, share options and management’s expectation on an IPO event) to determine the fair value of our ordinary shares. Under the option-pricing method, each class of equity is modeled as a call option with a distinct claim on the enterprise value of our company. The main inputs to this model include equity value of our company, exercise price, expected volatility, expected term, expected dividend yield and risk-free interest rate.

In the discounted cash flow analyses, we used a weighted average cost of capital of 22% for the June 2009 grant, 22% for the June 2010 grant, and 18% for the January 2011 grant, respectively, as the discount rates to derive the business enterprise value of our company. The weighted average cost of capital was calculated using the capital asset pricing model based on the required return on equity investors expect to earn and the post-tax cost of debt of our company. The decrease in the weighted average cost of capital is primarily because we used a lower small size risk premium in the January 2011 valuation to reflect the growth of our company.

In arriving at the equity value of our company, we applied a discount for lack of marketability, or DLOM, of 33.0% for the June 2009 grant, 21.0% for the June 2010 grant and 7.0% for the January 2011 grant, respectively, to reflect the fact that, at the time of the grants, we were a closely-held company and there was no public market for our ordinary shares. We used the put option method to estimate the DLOM, taking into consideration factors like the timing of liquidity event such as an IPO and estimated volatility of our ordinary shares. The decrease in the DLOM is primarily because we are approaching the expected IPO, as the closer the valuation date is from the expected IPO, the lower the put option value is, and thus the lower the implied DLOM. For the determination of

the fair value of the options granted on each of the above grant dates and the fair value of the underlying ordinary shares of our company, we also considered retrospective valuations conducted by an independent appraiser.

Other general assumptions used in deriving the fair value of the ordinary shares transferred and our total equity value include the following: (i) there will be no material changes in the existing political, legal, fiscal and economic conditions in China; (ii) there will be no material changes in tax law in China and the tax rates applicable to our subsidiary and VIE; (iii) exchange rates and interest rates will not differ materially from currently prevailing rates, (iv) the availability of finance will not be a constraint on the future growth of the Company, (v) the Company will retain and have competent management, key personnel and technical staff to support its ongoing operation, and (vi) there will be no material deviation in industry trends and market conditions from economic forecasts.

We provide for current income taxes in accordance with the laws of the relevant tax authorities. We recognize deferred income taxes when temporary differences exist between the tax bases of assets and liabilities and their reported amounts in the consolidated combined financial statements. Net operating loss carry forwards and credits are applied using enacted statutory tax rates applicable to future years. We reduce deferred tax assets by a valuation allowance when, in the opinion of our management, it is more-likely-than-not that a portion of or all of our deferred tax assets will not be realized. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on their characteristics.

We consider positive and negative evidence when determining whether some portion or all of our deferred tax assets will not be realized. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carry-forward periods, our historical results of operations, and our tax planning strategies. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based upon the level of our historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, we believe it is more-likely-than-not that we will realize all the benefits of the deductible differences as of December 31, 2009 and 2010. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carry forward periods are reduced. Such reduction of deferred tax asset could increase our income tax expense and adversely affect our results of operations in the period in which an allowance is recorded.

We recognize the impact of uncertain income tax positions at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant tax authority. For a tax position that meets the more-likely-than-not recognition threshold, we initially and subsequently measure the tax benefit as the largest amount that we judge to have a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority. Our liability associated with unrecognized tax benefits is adjusted periodically due to changing circumstances, such as the progress of tax audits, case law developments and new or emerging legislation. Such adjustments are recognized entirely in the period in which they are identified. Our effective tax rate includes the net impact of changes in the liability for unrecognized tax benefits and subsequent adjustments as considered appropriate by our management. We classify interest and/or penalties related to uncertain tax positions in income tax expense.

PRC laws and regulations currently prohibit or restrict foreign ownership of Internet-related business. In order to comply with these foreign ownership restrictions, we operate our online entertainment community through Shanghai Taomee. We have entered into a series of contractual arrangements with Shanghai Taomee and its equity owners. As a result of these contractual arrangements, we have the ability to effectively control Shanghai Taomee, and we are considered the primary beneficiary of Shanghai Taomee. Accordingly, Shanghai

Taomee is a VIE of our company under U.S. GAAP and we consolidate the results in our consolidated financial statements. Any changes in PRC laws and regulations that affect our ability to control Shanghai Taomee might preclude us from consolidating Shanghai Taomee in the future.

Prior to this offering, we have been a private company with a short operating history and limited numbers of accounting personnel and other resources with which to address our internal controls and procedures. In connection with the audit of our consolidated combined financial statements for 2008 and 2009, we and our auditors, an independent registered public accounting firm, identified certain material weakness and significant deficiencies in our internal control over financial reporting as defined in the standards established by the U.S. Public Company Accounting Oversight Board, or PCAOB. The material weakness observed was our lack of sufficient accounting resources and expertise necessary to comply with U.S. GAAP and to prepare and review financial statements and related disclosures under U.S. GAAP for the SEC reporting and compliance purposes. The significant deficiencies observed were that we lacked adequate documentation for internal control policies at the entity level and a number of financial reporting and asset management procedures.

Following the identification of the material weakness and significant deficiencies, we undertook certain remedial steps to address them, including adding accounting and finance staff with U.S. GAAP experience providing access to training programs to accounting personnel, and adopting internal control and other financial closing and reporting policies. Specifically, in April and May 2010, we hired a senior finance director and a financial reporting manager to lead our U.S. GAAP financial closing and reporting team. Our senior finance director is a certified public accountant in the United States. Before joining Taomee, he served as the controller for one and a half years in a China-based private company preparing for an initial public offering in the U.S. Prior to that, he had four years of experience at the Shanghai office of a Big Four accounting firm primarily working on U.S. GAAP engagements, including the initial public offerings of several China-based foreign private issuers. He majored in accounting and received his master’s degree in commerce from University of Sydney, Australia. Before joining Taomee, our financial reporting manager worked on IFRS and PRC GAAP audit engagements at the Shanghai office of a Big Four accounting firm for two and half years and then as a financial analyst and reporting manager at a China-based foreign private issuer for one and a half years, applying U.S. GAAP.

We also hired our chief financial officer in February 2011 with extensive experience in finance.

In addition, we streamlined our monthly and quarterly financial closing and reporting procedures and formalized reviewing and monitoring control activities including the implementation of a financial closing checklist as part of the period-end closing process. We also designed and implemented controls to ensure that significant non-routine transactions, accounting estimates, and other adjustments were properly reviewed, analyzed and monitored by sufficient and appropriate accounting staff on a timely basis. We plan to further enhance management reviews of account reconciliations, non-routine and complex transactions and significant agreements to ensure accuracy of U.S. GAAP financial reporting. We also plan to engage external consultants to help us comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. However, the implementation of these measures may not fully address the material weakness and significant deficiencies in our internal control over financial reporting, and we cannot yet conclude that they have been fully remedied. See “Risk Factors—Risks Related to Our Business—If we fail to establish or maintain an effective system of internal controls over financial reporting, we may be unable to accurately report our financial results or prevent fraud, and investor confidence and the market price of our shares may, therefore, be adversely impacted.”

The following table sets forth a summary of our consolidated combined results of operations for the periods indicated both in absolute amount and as a percentage of our total net revenues.


Oppenheimer & Co.		Pacific Crest Securities		Stifel Nicolaus Weisel		CICC


	Ordinary Shares Purchased					Total Consideration					Average Price Per Ordinary Share		Average Price Per ADS
	Number		Percent			Amount		Percent			Average Price Per Ordinary Share		Average Price Per ADS
Existing shareholders		575,000,000		80	%	US$	5,872,585		8.3	%	US$	0.01	US$	0.20
New investors		143,750,000		20	%	US$	64,687,500		91.7	%	US$	0.45	US$	9.00

Total		718,750,000		100	%	US$	70,560,085		100.0	%	US$	0.10	US$	2.00


Period	Noon Buying Rate
Period	Period End		Average⁽¹⁾		Low		High
	(RMB per US$1.00)
2006		7.8041		7.9579		8.0702		7.8041
2007		7.2946		7.5806		7.8127		7.2946
2008		6.8225		6.9193		7.2946		6.7800
2009		6.8259		6.8295		6.8470		6.8176
2010		6.6000		6.7603		6.8330		6.6000
2010
November		6.6670		6.6538		6.6892		6.6330
December		6.6000		6.6497		6.6745		6.6000
2011
January		6.6017		6.5964		6.6364		6.5809
February		6.5713		6.5761		6.5965		6.5520
March		6.5483		6.5645		6.5743		6.5483
April		6.4900		6.5267		6.5477		6.4900
May		6.4786		6.4957		6.5073		6.4786
June (through June 3, 2011)		6.4796		6.4800		6.4824		6.4780


	For the Three Months Periods Ended
	2008		2009								2010								2011
	December 31		March 31		June 30		September 30		December 31		March 31		June 30		September 30		December 31		March 31
Active Accounts (in thousands)⁽¹⁾		5,938		13,716		15,172		20,367		26,609		30,344		33,989		36,213		25,967		27,329
Active Paying Accounts (in thousands)⁽²⁾		108		437		1,104		1,186		1,761		2,961		3,274		3,062		2,415		2,741
ARPU (in US$)⁽³⁾		1.2		1.3		1.3		1.7		1.9		2.3		3.0		3.3		3.9		4.6


	For the Years Ended December 31,												For the Three Months Ended March 31,
	2008				2009				2010				2010				2011
	US$		%		US$		%		US$		%		US$		%		US$		%
													(unaudited)				(unaudited)
	(in thousands, except percentages)
Cost of services:
Online business		115		100.0		1,913		95.5		5,166		88.3		995		95.5		1,668		85.3
Offline business		—		—		90		4.5		685		11.7		47		4.5		287		14.7

Total cost of services		115		100.0		2,003		100.0		5,851		100.0		1,042		100.0		1,955		100.0


	Page
Prospectus Summary		1
Risk Factors		11
Special Note Regarding Forward-Looking Statements		39
Use of Proceeds		40
Dividend Policy		41
Capitalization		42
Dilution		43
Exchange Rate Information		45
Enforceability of Civil Liabilities		46
Corporate History and Structure		48
Selected Consolidated Financial Data		52
Management’s Discussion and Analysis of Financial Condition and Results of Operations		55
Our Industry		91
Business		94
Regulation		110
Management		120
Principal Shareholders		128
Related Party Transactions		131
Description of Share Capital		134
Description of American Depositary Shares		143
Shares Eligible for Future Sale		154
Taxation		156
Underwriting		162
Expenses Related to this Offering		169
Legal Matters		170
Experts		170
Where You Can Find Additional Information		171
Index to Consolidated Combined Financial Statements		F-1


	As of March 31, 2011
	Actual		Pro Forma		Pro Forma as Adjusted
	(US$ in thousands)
Series A convertible redeemable preferred shares, US$0.00002 par value, 125,000,000 shares authorized, issued and outstanding		5,747		—		—

Equity:
Ordinary shares (US$0.00002 par value, 875,000,000 shares authorized, 450,000,000 shares issued and outstanding, and 575,000,000 shares issued and outstanding on a pro forma basis)		9		12		15
Additional paid-in capital		1,432		7,176		64,679
Accumulated other comprehensive income		959		959		959
Retained earnings		20,268		20,268		20,268

Total equity		22,668		28,415		85,921

Total capitalization		28,415		28,415		85,921


	Per Ordinary Share		Per ADS
Initial public offering price	US$	0.45	US$	9.00
Net tangible book value as of March 31, 2011	US$	0.05	US$	1.00
Pro forma net tangible book value as of March 31, 2011	US$	0.05	US$	1.00
Increase in pro forma as adjusted net tangible book value attributable to this offering	US$	0.07	US$	1.40
Pro forma as adjusted net tangible book value after the offering	US$	0.12	US$	2.40
Amount of dilution in pro forma as adjusted net tangible book value to new investors in the offering	US$	0.33	US$	6.60


		Direct ownership

		Contractual arrangements: See “—Contractual Arrangements with Shanghai Taomee and its Shareholders.”


	For Period from October 8, 2007 (inception date) to December 31, 2007		For Years Ended December 31,						For Three Months Ended March 31,
			2008		2009		2010		2010		2011
									(unaudited)		(unaudited)
	(US$ in thousands)
Consolidated Combined Statement of Operations Data:
Share-based compensation expenses:
Cost of services		—		—		1.0		14.8		0.7		50.0
Product development expenses		—		—		10.1		80.9		1.7		114.2
Sales and marketing expenses		—		—		0.2		69.1		0.1		13.8
General and administrative expenses		—		—		61.9		5.6		1.9		95.6

Total		—		—		73.2		170.4		4.4		273.6


	As of December 31,										As of March 31,
	2007			2008			2009		2010		2011
											(unaudited)
	(US$ in thousands)
Consolidated Combined Balance Sheet Data:
Cash and cash equivalents		664			348			10,835		43,087		54,101
Accounts receivable, net		—			135			800		438		253
Total current assets		946			642			12,338		47,684		60,054
Total assets		984			900			13,461		53,032		66,512
Total current liabilities		15			764			7,063		34,297		38,097
Advances from customers		—			47			3,497		8,684		11,097
Deferred revenue		—			46			1,904		10,783		13,638
Mezzanine equity:
Series A convertible redeemable preferred shares		—			—			5,159		5,628		5,747
Ordinary shares		10			10			9		9		9
Additional paid-in capital		993			993			988		1,158		1,432
(Accumulated deficit) retained earnings		(67	)		(955	)		153		11,258		959

Total equity		969			136			1,239		13,107		22,668

Total liabilities, mezzanine equity and equity		984			900			13,461		53,032		66,512


	Date of Commercial Launch⁽¹⁾
Mole’s World		September 2008
Seer		September 2009
Flower Fairy		June 2010
Gong Fu Pai		September 2010
Magic Haqi		October 2010


Grant Date/Award Date	Options		Restricted Shares		Exercise Price/ Purchase Price (US$)		Fair Value of Ordinary Shares (US$)			Initial Public Offering Price		Intrinsic Value⁽¹⁾ (US$ in millions)		Type of Valuation
June 24, 2009		10,500,000		—		0.0400		0.0214			0.4500		4.3		Retrospective
June 7, 2010		35,175,000		—		0.0700		0.0700			0.4500		13.3		Retrospective
January 4, 2011		19,165,000		—		0.3600		0.3600			0.4500		1.7		Retrospective
May 24, 2011		20,175,000		—		0.4500		0.5000	⁽²⁾		0.4500		—		—
				4,500,000		nil		0.5000	⁽²⁾				—		—


Credit Suisse		Deutsche Bank Securities