1006-00007 · Client 1006 · Diligence

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PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT

MEMORANDUM

TO: Harrison Wexford, Esq., Partner, Calderwood & Harkness LLP Sandra K. Nair, CFO, Crestline Packaging Solutions LLC

FROM: Ryan Kowalski, Associate, Calderwood & Harkness LLP

DATE: October 20, 2022

RE: ProShield Industrial Coatings Product Line Acquisition — Earnout Structure Analysis and Purchase Price Allocation Considerations

MATTER NO.: 1006-00007

CC: Beatrice Holloway, Esq. (Calderwood & Harkness LLP); Derek Amato, Esq. (General Counsel, Crestline Packaging Solutions LLC); Megan Chu, Esq. (Calderwood & Harkness LLP)

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I. EXECUTIVE SUMMARY

This memorandum analyzes the proposed volume-based earnout structure in connection with Crestline Packaging Solutions LLC's ("Crestline," "CPS," or "Buyer") proposed acquisition of substantially all assets comprising the ProShield Industrial Coatings product line (the "ProShield Product Line" or "ProShield") from Voss Chemical Industries, Inc. ("Voss," "VCI," or "Seller"). The purpose of this memorandum is to evaluate the proposed earnout mechanics, assess risks to Buyer, and provide specific recommendations for provisions to be included in the Asset Purchase Agreement (the "APA") that protect Buyer's interests throughout the earnout measurement period and beyond.

Transaction Overview. Crestline proposes to acquire substantially all assets constituting the ProShield Product Line pursuant to an asset purchase transaction for aggregate base consideration of $18,000,000, structured as follows: (i) $14,500,000 in upfront cash payable at Closing via wire transfer; (ii) $2,000,000 deposited into an indemnification escrow account with Pinnacle Trust Company at Closing; and (iii) a target earnout payment of $1,500,000 contingent upon the achievement of specified volume targets during a 24-month post-Closing measurement period. In addition to the target earnout, the earnout structure provides for up to an additional $2,000,000 in upside earnout payments if the product line exceeds target volume, resulting in a maximum earnout payment of $3,500,000 and maximum total consideration of $20,000,000.

Valuation Context. The earnout component is designed to bridge a valuation gap between Buyer's and Seller's expectations regarding the future performance of the ProShield Product Line. Based on ProShield's fiscal year 2021 EBITDA of $4,100,000, the base purchase price of $18,000,000 implies a multiple of approximately 4.39× FY2021 EBITDA, while the maximum total consideration of $20,000,000 at full earnout implies a multiple of approximately 4.88×. At the earnout threshold (where no earnout would be payable), total consideration of $16,500,000 implies a multiple of approximately 4.02×. This range of 4.02× to 4.88× is consistent with observed transaction multiples in comparable specialty chemical product line acquisitions.

Parties and Key Stakeholders. Crestline is a Delaware limited liability company headquartered at 4100 Rockside Road, Suite 300, Independence, OH 44131, and is a portfolio company of Kestrel Capital Partners Fund III, LP (the "Sponsor" or "Ashgrove Equity Partners"). Voss is a New York corporation headquartered at 790 Niagara Falls Boulevard, Tonawanda, NY 14150, wholly owned by Frederick G. Voss (62%) and Elena M. Voss (38%) (collectively, the "Seller Principals"). Seller is represented by Langford, Crewe & Cascade Insurance Brokers, with Patricia Okonkwo serving as lead partner, based at 120 Delaware Avenue, Suite 900, Buffalo, NY 14202.

Scope of Memorandum. In addition to the detailed analysis of the proposed earnout structure, this memorandum addresses the following related matters: (i) the interaction between the earnout and the proposed indemnification framework, including escrow mechanics and representations and warranties insurance; (ii) purchase price allocation considerations for federal and state income tax purposes under Section 1060 of the Internal Revenue Code; (iii) specific APA drafting recommendations to protect Buyer's operational flexibility during the earnout measurement period; (iv) dispute resolution mechanisms for earnout-related disagreements; and (v) a risk assessment identifying open items and anticipated areas of negotiation with Seller's counsel.

II. PROPOSED PURCHASE PRICE STRUCTURE

A. Components of Consideration

The aggregate purchase price for the ProShield Product Line is structured in three principal components, as set forth below. The base purchase price of $18,000,000 assumes achievement of the target earnout, while the maximum total consideration of $20,000,000 assumes achievement of the full stretch earnout.

1. Upfront Cash at Closing: $14,500,000. At the Closing, Buyer will pay to Seller (or as Seller may direct) the sum of Fourteen Million Five Hundred Thousand Dollars ($14,500,000) in immediately available funds by wire transfer to an account designated by Seller in writing at least two (2) business days prior to the Closing Date. This upfront cash component represents approximately 80.6% of the base purchase price and approximately 72.5% of the maximum total consideration. The upfront cash payment is not subject to any contingencies other than the satisfaction or waiver of conditions precedent to Closing as set forth in the APA.

2. Indemnification Escrow Holdback: $2,000,000. At the Closing, Buyer will deposit Two Million Dollars ($2,000,000) (the "Escrow Amount") with Pinnacle Trust Company, as escrow agent (the "Escrow Agent"), pursuant to the terms of an Escrow Agreement to be entered into among Buyer, Seller, and Escrow Agent at Closing. The Escrow Agent contact is Rachel Underwood, Trust Officer, located at 40 Wall Street, 16th Floor, New York, NY 10005. The Escrow Amount will serve as a source of recovery for Buyer's indemnification claims arising under Article [●] of the APA. Subject to any pending or resolved indemnification claims, the Escrow Amount (or the remaining balance thereof) will be released to Seller twelve (12) months following the Closing Date. The Escrow Amount represents approximately 11.1% of the base purchase price and provides meaningful collateral security for Buyer during the initial post-Closing period when integration risks and potential representation breaches are most likely to be discovered.

3. Earnout — Target Payment: $1,500,000. The target earnout payment of One Million Five Hundred Thousand Dollars ($1,500,000) is contingent upon the achievement of a target volume of 3,000,000 gallons of ProShield-branded coatings shipped during the 24-month Earnout Period (as defined below). The earnout structure also provides for additional upside payments of up to Two Million Dollars ($2,000,000) above the target earnout if volume exceeds the target level, resulting in a maximum earnout payment of Three Million Five Hundred Thousand Dollars ($3,500,000). The detailed mechanics of the earnout, including threshold, target, and stretch tiers, interpolation formulas, and payment timing, are discussed in Section III of this memorandum.

Total Maximum Consideration. The maximum aggregate consideration payable by Buyer in connection with the acquisition of the ProShield Product Line is Twenty Million Dollars ($20,000,000), calculated as follows:

For reconciliation purposes, the base purchase price of $18,000,000 comprises the upfront cash ($14,500,000), the escrow amount ($2,000,000), and the target earnout ($1,500,000). The incremental $2,000,000 between the base purchase price and the maximum total consideration represents the additional upside earnout available between the target and stretch volume levels. All components of consideration, including the earnout, are subject to the working capital adjustment mechanism described in Section II.B below.

B. Working Capital Adjustment

The APA will include a customary post-Closing working capital adjustment mechanism designed to ensure that Buyer receives an appropriate level of net working capital at Closing consistent with the normal operating requirements of the ProShield Product Line.

Estimated Net Working Capital. Based on Seller's preliminary financial information and Buyer's due diligence analysis, the estimated net working capital ("NWC") of the ProShield Product Line at Closing is approximately $1,850,000. This estimate is based on current asset and current liability balances as of September 30, 2022, adjusted for expected changes through the anticipated Closing Date. Net working capital is defined as current assets (including accounts receivable, inventory, prepaid expenses, and other current assets included in the acquired assets) less current liabilities (including accounts payable, accrued expenses, and other current liabilities constituting assumed liabilities), in each case determined in accordance with GAAP applied consistently with Seller's historical accounting practices.

Target NWC. The target net working capital (the "Target NWC") has been established at $1,800,000, which reflects an approximation of the normalized working capital required to operate the ProShield Product Line in the ordinary course of business. The Target NWC was derived from an analysis of trailing twelve-month average net working capital levels, adjusted for seasonal fluctuations and non-recurring items.

Adjustment Mechanism. The working capital adjustment will operate on a dollar-for-dollar basis without any collar, deadband, or threshold. If the actual Closing NWC exceeds the Target NWC, Buyer will pay the excess to Seller. If the actual Closing NWC is less than the Target NWC, Seller will pay the shortfall to Buyer. This dollar-for-dollar mechanism ensures that both parties bear the full economic impact of any deviation from the Target NWC, without the ambiguity or windfall potential introduced by collar mechanisms.

True-Up Timeline. The working capital true-up will be completed within ninety (90) days following the Closing Date, based on a final Closing balance sheet prepared by Buyer in accordance with GAAP and the accounting principles specified in the APA. Assuming the Closing occurs on January 20, 2023 (the current target Closing Date is January 16, 2023, but allowing for potential short delays), the working capital true-up deadline would fall on approximately April 20, 2023. Buyer will deliver the final Closing balance sheet and a statement of Closing NWC to Seller within sixty (60) days following Closing, and Seller will have a thirty (30) day objection period following receipt thereof. If Seller raises no objection within such period, the Closing NWC as set forth in Buyer's statement will be deemed final and binding.

Dispute Resolution. In the event Seller objects to Buyer's determination of Closing NWC, the parties will negotiate in good faith to resolve the dispute within fifteen (15) days. If the parties are unable to resolve the dispute within such period, the disputed items will be submitted to the independent accountant for final and binding resolution, as described in Section V.A below.

Recommendation. We recommend that the APA provide that Buyer prepares the Closing balance sheet, that Seller has a clearly defined objection period limited to specific line items, and that unresolved disputes are submitted to the independent accountant for final determination. This approach gives Buyer initial control over the preparation of the Closing balance sheet while affording Seller appropriate review rights. The APA should also include detailed accounting methodologies and illustrative calculations as exhibits to minimize disputes over accounting principles.

C. Financing Sources

The acquisition of the ProShield Product Line will be financed through a combination of equity contributions from the Sponsor and incremental debt under Crestline's existing senior secured credit facility.

Equity Contribution. Kestrel Capital Partners Fund III, LP will contribute $6,000,000 in equity capital to Crestline via a capital call to the limited partners of Fund III. This equity contribution represents approximately 33.3% of the base purchase price and will be funded in immediately available funds on or prior to the Closing Date. Julian H. Prescott, Managing Partner of Cobalt Ridge Partners Management III, LLC (the general partner of Fund III), has confirmed Fund III's commitment to fund the capital call, subject to completion of the Fund's investment committee approval process.

Incremental Term Loan. Crestline will draw $12,500,000 in incremental term loan borrowings (the "Incremental Term Loan C") under its existing senior secured credit facility with Great Lakes Commerce Bank, N.A. ("GLCB") pursuant to an amendment to the Credit Agreement dated March 15, 2021, by and among Crestline, GLCB (as administrative agent and a lender), and the other lenders party thereto (as amended to date, the "Credit Agreement"). The Incremental Term Loan C will require a Third Amendment to the Credit Agreement (the "Third Amendment"), which will need to be negotiated and executed prior to Closing. Douglas Fenn, Senior Vice President and Relationship Manager at GLCB, has indicated preliminary support for the incremental borrowing, subject to completion of GLCB's internal credit approval process and satisfactory review of the acquisition terms and the ProShield Product Line's financial performance. We anticipate that GLCB will require customary lender diligence, including review of the APA, financial projections for the combined business, and environmental due diligence reports.

Total Financing. The aggregate financing commitment of $18,500,000 ($6,000,000 equity plus $12,500,000 debt) exceeds the base purchase price of $18,000,000 by $500,000. This excess is intended to cover estimated transaction expenses (including legal fees, accounting and tax advisory fees, R&W insurance premium, environmental assessment costs, and other customary closing costs) and to provide a working capital reserve for the combined business post-Closing.

Note on Lender Consent. GLCB lender consent is a condition precedent to Closing. The Third Amendment will need to address, among other things, the incremental borrowing capacity, any adjustments to financial covenants, the addition of acquired assets to the collateral package, and compliance with the existing Credit Agreement's restrictions on acquisitions. We recommend that Megan Chu coordinate with GLCB's outside counsel to commence Third Amendment negotiations promptly following circulation of the draft APA.

III. EARNOUT MECHANICS — DETAILED ANALYSIS

A. Measurement Metric: Volume-Based (Gallons Shipped)

The proposed earnout is based on total gallons of ProShield-branded coatings shipped by Crestline (or its affiliates) during the 24-month Earnout Period. The Earnout Period commences on January 17, 2023, the day immediately following the target Closing Date, and ends on January 16, 2025, resulting in a full 24-month measurement window.

Rationale for Volume-Based Metric. After careful consideration of the available alternatives, we recommend a volume-based earnout metric (measured in gallons shipped) rather than a revenue-based or EBITDA-based metric. This recommendation is grounded in several interrelated considerations:

First, a volume-based metric minimizes the scope for disputes related to pricing decisions, product mix, and cost allocation that frequently plague revenue- or EBITDA-based earnouts. Revenue-based earnouts invite challenges to Buyer's pricing strategy, discount practices, and customer contract terms, while EBITDA-based earnouts create an even broader surface area for disputes encompassing cost allocation methodologies, overhead charges, shared services fees, and capital expenditure characterization. Volume metrics avoid these issues entirely, as the measurement is independent of the prices at which products are sold or the costs incurred in producing and delivering them.

Second, gallons shipped is a more objectively measurable quantity than either revenue or EBITDA. Volume can be verified by reference to concrete, contemporaneously created documentation including shipping records, bills of lading, delivery confirmations, and entries in Buyer's enterprise resource planning (ERP) and inventory management systems. This objectivity reduces the opportunity for subjective judgment calls and post-hoc accounting adjustments that are characteristic of financial metric earnouts.

Third, a volume-based metric reduces Seller's ability to challenge Buyer's pricing strategy or cost management decisions during the Earnout Period. Under a revenue or EBITDA earnout, Seller could argue that Buyer depressed revenue by offering excessive discounts or increased costs by allocating disproportionate overhead, thereby reducing the earnout payment. A volume metric insulates Buyer from such challenges and preserves Buyer's complete autonomy over pricing and cost management.

Fourth, the volume-based approach aligns incentives in a constructive manner. Seller benefits from Buyer's investment in growing the product line's distribution footprint, expanding customer relationships, and increasing market penetration — all of which drive higher shipment volumes. Simultaneously, Buyer retains full flexibility over pricing, margin management, product formulation, and operational integration decisions without creating earnout-related exposure.

Historical Volume Analysis. An analysis of ProShield's historical shipping volumes supports the proposed earnout thresholds and targets:

The annualized gallons shipped have grown from 1,320,000 in FY2020 to an estimated 1,560,000 in FY2022, representing compound annual growth of approximately 8.7%. At the FY2022 estimated annual run rate of 1,560,000 gallons, a 24-month run rate would yield approximately 3,120,000 gallons. This figure exceeds the earnout target of 3,000,000 gallons (by approximately 4%) but falls below the stretch target of 3,800,000 gallons (by approximately 17.9%), suggesting that the target is achievable based on current trajectory while the stretch requires meaningful volume growth during the Earnout Period.

B. Earnout Tiers and Interpolation

The proposed earnout structure consists of three tiers — Threshold, Target, and Stretch — with linear interpolation between tiers. The structure is designed to provide downside protection to Buyer while offering Seller meaningful upside participation if the ProShield Product Line outperforms expectations.

Threshold: 2,400,000 Gallons — $0 Earnout. No earnout payment is due if total gallons shipped during the Earnout Period are less than or equal to 2,400,000 gallons. This threshold represents approximately 77% of the projected 24-month run rate at FY2022 levels (3,120,000 gallons), meaning that a decline of approximately 23% from projected levels would be required before any earnout payment is triggered. This provides Buyer with substantial downside protection and ensures that no earnout is payable unless the product line performs at a level reasonably consistent with its recent historical trajectory.

Target: 3,000,000 Gallons — $1,500,000 Earnout. If total gallons shipped during the Earnout Period equal or exceed 3,000,000 gallons, the earnout payment equals $1,500,000. Between the Threshold and the Target, the earnout payment is determined by linear interpolation at a rate of $2.50 per gallon above the Threshold, calculated as follows:

$1,500,000 ÷ (3,000,000 − 2,400,000) = $1,500,000 ÷ 600,000 = $2.50 per gallon

Illustrative Calculation: If 2,700,000 gallons are shipped during the Earnout Period (300,000 gallons above the Threshold), the earnout payment would be calculated as 300,000 × $2.50 = $750,000.

Stretch (Maximum): 3,800,000 Gallons — $3,500,000 Earnout. If total gallons shipped during the Earnout Period equal or exceed 3,800,000 gallons, the maximum earnout payment of $3,500,000 is payable. Between the Target and the Stretch, the earnout payment is determined by linear interpolation at a rate of $2.50 per gallon above the Target, calculated as follows:

($3,500,000 − $1,500,000) ÷ (3,800,000 − 3,000,000) = $2,000,000 ÷ 800,000 = $2.50 per gallon

Illustrative Calculation: If 3,400,000 gallons are shipped during the Earnout Period (400,000 gallons above the Target), the earnout payment would be calculated as $1,500,000 + (400,000 × $2.50) = $1,500,000 + $1,000,000 = $2,500,000.

Cap: $3,500,000. The earnout payment is capped at $3,500,000. No additional earnout is payable for gallons shipped in excess of the Stretch level of 3,800,000 gallons. This cap limits Buyer's total acquisition cost to $20,000,000 regardless of how significantly the ProShield Product Line outperforms during the Earnout Period.

Uniform Interpolation Rate. A notable feature of the proposed structure is the uniform interpolation rate of $2.50 per gallon across both the Threshold-to-Target tier and the Target-to-Stretch tier. This uniformity simplifies the earnout calculation, reduces ambiguity, and avoids the complexity of different per-gallon rates in different bands. It also creates a straightforward linear relationship between gallons shipped and earnout payments throughout the entire range, which should minimize disputes and facilitate transparent communication with Seller regarding interim volume performance.

C. Earnout Payment Timing

The earnout payment will be due within sixty (60) days after the end of the Earnout Period. Assuming the Earnout Period ends on January 16, 2025, the earnout payment would be due no later than March 17, 2025. The payment process involves the following sequential steps:

Step 1: Earnout Statement. Within forty-five (45) days after the end of the Earnout Period (i.e., by approximately March 2, 2025), Buyer will prepare and deliver to Seller a written statement (the "Earnout Statement") setting forth (i) the total gallons of ProShield-branded coatings shipped during the Earnout Period, (ii) the calculation of the earnout payment based on the earnout formula, and (iii) reasonable supporting documentation, including summary shipping data.

Step 2: Seller Objection Period. Seller will have fifteen (15) days following receipt of the Earnout Statement to review the statement and deliver a written objection to Buyer specifying in reasonable detail the items or amounts to which Seller objects and the basis for such objection. If Seller does not deliver a written objection within such 15-day period, the Earnout Statement will be deemed accepted by Seller and will become final and binding.

Step 3: Payment. If Seller does not object (or the parties resolve any objection), Buyer will pay the earnout amount to Seller within the remainder of the 60-day period following the end of the Earnout Period. If Seller timely objects and the parties are unable to resolve the dispute during the 15-day objection period, the dispute resolution mechanism described in Section V will apply, and payment of any undisputed portion will be made within the 60-day window, with the disputed portion held pending resolution.

D. Earnout Sensitivity Analysis

The following table illustrates the earnout payment, total consideration (inclusive of upfront cash and escrow), and implied EV/EBITDA multiple at various volume levels during the 24-month Earnout Period:

Note: Total Consideration equals Upfront Cash ($14,500,000) plus Escrow ($2,000,000) plus Earnout Payment. Implied multiple based on FY2021 EBITDA of $4,100,000.

Analysis of Implied Multiples. At the Threshold (where no earnout is payable), total consideration of $16,500,000 implies a multiple of 4.02× FY2021 EBITDA, which represents the floor of Buyer's acquisition cost. At the Target level, total consideration of $18,000,000 implies a multiple of 4.39×, which is consistent with the parties' baseline valuation expectations. At the Stretch level (full earnout), total consideration of $20,000,000 implies a multiple of 4.88×, which represents the ceiling.

The resulting multiple range of 4.02× to 4.88× is reasonable relative to comparable specialty chemical product line transactions, which have generally traded in the 3.5× to 6.0× EBITDA range depending on scale, growth profile, customer concentration, and proprietary technology. The earnout structure effectively shifts a portion of the valuation risk from Buyer to Seller, requiring Seller to participate in the product line's performance during the Earnout Period to receive the full consideration contemplated by both parties.

IV. BUYER PROTECTIONS — OPERATIONAL COVENANTS DURING THE EARNOUT PERIOD

A. Buyer's Discretion to Operate the Business

The single most critical provision in the earnout section of the APA — from Buyer's perspective — is an unambiguous statement that Buyer retains sole and absolute discretion over the operation of the ProShield Product Line during the Earnout Period. This provision is essential to protect Crestline's ability to integrate the ProShield Product Line into its existing approximately $112 million revenue packaging coatings business without being constrained by earnout-related limitations or obligations.

The APA should expressly state that Buyer will have sole and absolute discretion with respect to all aspects of the operation of the ProShield Product Line during the Earnout Period, including without limitation:

(a) Pricing of ProShield products, including list prices, volume discounts, promotional pricing, and contract pricing;

(b) Manufacturing processes, production scheduling, production volumes, and choice of manufacturing facility or facilities;

(c) Marketing and sales strategy, including allocation of marketing resources, advertising expenditure, trade show participation, and sales force deployment;

(d) Customer relationships and contract terms, including decisions to accept, reject, modify, or terminate customer contracts;

(e) Headcount and personnel decisions, including hiring, termination, compensation, reassignment, and organizational restructuring of transferred employees;

(f) Capital expenditure levels, including decisions regarding equipment purchases, facility improvements, and technology investments;

(g) Product formulation changes, including modification, reformulation, or discontinuation of any of the 47 proprietary coating formulations being acquired;

(h) Integration of the ProShield Product Line with Crestline's existing packaging coatings business, including consolidation of product lines, cross-selling initiatives, shared services arrangements, and operational synergies; and

(i) All other operational, strategic, and financial decisions relating to the ProShield Product Line.

This enumeration should be drafted as illustrative rather than exhaustive to avoid any negative inference that Buyer's discretion is limited to the specifically enumerated categories.

B. Good Faith / Commercially Reasonable Efforts Standard

A significant area of tension in earnout negotiations is the interplay between Buyer's desire for operational discretion and Seller's expectation that Buyer will make good-faith efforts to achieve the earnout targets. Sellers frequently seek affirmative covenants obligating Buyer to operate the acquired business in a manner designed to maximize the earnout payment, while buyers resist any constraint on their operational flexibility.

Recommended Approach. We recommend that the APA include a limited covenant that Buyer will operate the ProShield Product Line in good faith and in the ordinary course of business consistent with Seller's past practices, but that this covenant be accompanied by express carve-outs making clear that Buyer has no affirmative obligation to take any specific action to achieve earnout targets. Specifically, the APA should state that notwithstanding any other provision of the Agreement, Buyer shall have no obligation to:

(a) Prioritize the ProShield Product Line over Buyer's other business lines or product lines, or allocate any minimum level of resources to the ProShield Product Line;

(b) Maintain any minimum level of marketing expenditure, capital investment, research and development spending, or headcount attributable to the ProShield Product Line;

(c) Refrain from introducing, developing, or marketing products that compete with or are substitutes for ProShield products;

(d) Continue manufacturing or warehousing operations at the Tonawanda facility located at 790 Niagara Falls Boulevard, Tonawanda, NY 14150 (noting that Buyer is currently negotiating a new direct lease with Niagara Industrial Realty LLC for a 42,000 square foot facility at $14.50 per square foot per year, but should not be contractually bound to maintain operations at that or any other specific location);

(e) Avoid any organizational restructuring, product line consolidation, or changes to the ProShield Product Line's distribution channels; or

(f) Take any other action (or refrain from taking any action) for the purpose of maximizing the earnout payment or gallons shipped during the Earnout Period.

Bad-Faith Carve-Out. As a limited and appropriate concession to Seller, the APA should include a carve-out providing that Buyer shall not take any action with the primary purpose and intention of reducing gallons shipped during the Earnout Period solely to avoid or reduce earnout payments. This "bad-faith floor" prevents Buyer from engaging in deliberate manipulation of volume figures — for example, by artificially delaying shipments until after the Earnout Period ends or by diverting customer orders to non-ProShield products without commercial justification — while preserving Buyer's discretion to make all bona fide business decisions even if such decisions have the incidental effect of reducing volume.

Recommended Standard. The "no affirmative duty with a bad-faith floor" standard is the most buyer-favorable construct commonly accepted in negotiated M&A earnout transactions. It has been validated by Delaware courts and is well-understood by practitioners on both sides of the table. We believe this standard appropriately balances Buyer's need for integration flexibility with Seller's reasonable expectation that Buyer will not act in bad faith to deprive Seller of the benefit of the earnout.

C. Anti-Manipulation Provisions

We anticipate that Seller's counsel at Langford, Crewe & Cascade Insurance Brokers will seek additional protections against Buyer deliberately suppressing volume to avoid earnout payments. Such requests may take the form of affirmative operational covenants, minimum volume commitments, or "commercially reasonable efforts" standards.

Recommended Concession. As noted above, we recommend that Buyer concede a narrow bad-faith covenant, but resist any broader obligations. The bad-faith covenant should be drafted narrowly to require that the challenged action have the "primary purpose and intention" of reducing earnout payments — a demanding standard that places the burden on Seller to demonstrate that Buyer's actions were motivated primarily by a desire to avoid earnout liability rather than by legitimate business considerations.

Positions to Resist. We recommend that Buyer resist the following anticipated Seller requests:

(a) "Commercially reasonable efforts" to achieve earnout targets. This standard is excessively vague and creates significant litigation risk. What constitutes "commercially reasonable efforts" to ship 3,000,000 gallons of industrial coatings over a 24-month period is inherently subjective and would invite second-guessing of virtually every operational decision Buyer makes during the Earnout Period.

(b) Seller consent or consultation rights over operational decisions. Any provision requiring Buyer to consult with, notify, or obtain consent from Seller (or the Seller Principals) before making operational decisions during the Earnout Period would be unacceptable. Such provisions effectively give Seller a veto over Buyer's business decisions and are inconsistent with the fundamental premise of an asset sale in which Buyer acquires full ownership and control of the acquired assets.

(c) Minimum volume commitments or production floors. Any obligation to maintain minimum production or shipment volumes would constrain Buyer's operational flexibility and shift market risk from Seller (where it properly resides after closing) back to Buyer.

(d) Maintain-the-business covenants. Buyer should resist any covenant requiring Buyer to operate the ProShield Product Line as a standalone business, maintain its separate identity, or refrain from integrating it with Crestline's existing operations.

D. Accounting and Record-Keeping

The APA should include provisions requiring Buyer to maintain adequate books and records to support the calculation of gallons shipped during the Earnout Period, while appropriately limiting the scope of Seller's access to Buyer's records.

Record-Keeping Obligations. Buyer will maintain books and records sufficient to calculate the total gallons of ProShield-branded coatings shipped during the Earnout Period, including shipping records, bills of lading, delivery confirmations, and entries in Buyer's ERP and inventory management systems. These records will serve as the primary documentation supporting the Earnout Statement. Buyer will maintain such records for a period of at least twelve (12) months following the end of the Earnout Period (i.e., until at least January 16, 2026) to allow for audit and dispute resolution.

Seller Audit Rights. Seller will have limited audit rights to review records relevant to the calculation of gallons shipped, exercisable only during the 15-day objection period following Seller's receipt of the Earnout Statement. Any such review will be conducted at Seller's expense, at Buyer's offices during normal business hours, and subject to confidentiality obligations. Seller's audit rights should be limited to records directly relevant to the calculation of gallons shipped and should not extend to Buyer's broader financial records, pricing information, customer contracts, or other commercially sensitive information unrelated to the volume calculation.

E. Assignment and Acceleration

Acceleration. The earnout obligation should not accelerate upon a subsequent sale, merger, or other change of control of Crestline or the ProShield Product Line during the Earnout Period. We recommend that the APA expressly state that no change of control, asset sale, or other disposition by Buyer will trigger an acceleration of the earnout obligation or entitle Seller to any payment in excess of the earnout amount that would otherwise be due based on actual gallons shipped through the end of the Earnout Period. This is essential to preserve Kestrel Capital Partners Fund III, LP's flexibility as equity sponsor to pursue exit strategies — including a sale of Crestline or the ProShield Product Line — without being locked in by earnout-related obligations or facing windfall payments to Seller.

Alternative Mechanism. As an alternative to acceleration, if Buyer sells or otherwise disposes of substantially all of the ProShield Product Line assets during the Earnout Period, Buyer should have the option to either (a) assign the earnout obligations to the acquiror, with Buyer remaining secondarily liable for payment of the earnout in the event the acquiror defaults, or (b) make a good-faith estimate of the projected total gallons that would be shipped during the remainder of the Earnout Period (based on trailing actual performance and available forecasts) and pay the corresponding earnout amount to Seller at the time of the secondary sale, with such payment being final and not subject to subsequent true-up. This mechanism gives Buyer (and the Sponsor) flexibility to exit while providing Seller with reasonable assurance that the earnout obligation will be honored.

We anticipate that Seller will seek a full acceleration clause providing for immediate payment of the maximum earnout upon a change of control. We should be prepared to negotiate this point firmly, as acceleration provisions can result in significant windfall payments to Seller that are not supported by actual product line performance.

V. EARNOUT DISPUTE RESOLUTION

A. Independent Accountant Mechanism

The APA should include a structured dispute resolution mechanism for disagreements regarding the Earnout Statement. We recommend the following framework:

Initial Negotiation. If Seller delivers a timely written objection to the Earnout Statement, the parties will negotiate in good faith for a period of fifteen (15) days following delivery of Seller's objection to resolve the disputed items. During this negotiation period, the parties' respective finance teams (specifically, Sandra K. Nair for Buyer and such person as Seller may designate) will meet at least once to discuss and attempt to reconcile the disputed items.

Submission to Independent Accountant. If the parties are unable to resolve the dispute within the 15-day negotiation period, the disputed items (and only the disputed items) will be submitted for resolution to an independent accountant. The proposed default independent accountant is Halcyon Chartered Accountants LLP, with Martin Szabo, CPA, serving as engagement partner. Halcyon's offices are located at 1301 East 9th Street, Suite 2400, Cleveland, OH 44114.

Independence Concern. We note that Halcyon Chartered Accountants LLP is currently serving as Buyer's accounting advisor and is performing financial and tax due diligence on the ProShield Product Line in connection with the transaction. Seller may object to Halcyon's designation as the independent accountant on the grounds that Halcyon lacks independence due to its existing relationship with Buyer. This is a reasonable objection that we should be prepared to address.

Recommended Approach. We recommend that the APA provide for Halcyon as the default independent accountant, with a fallback mechanism in the event either party objects to Halcyon within a specified period (e.g., ten (10) business days after the APA is executed). If either party timely objects, the parties will attempt to mutually agree on a substitute independent accountant within ten (10) business days. If the parties are unable to agree, each party will designate one nationally recognized accounting firm (other than the parties' respective auditors and advisors), and the two designated firms will jointly select a third firm to serve as the independent accountant. This tiered selection process provides Buyer with the benefit of its preferred advisor while offering a fair fallback mechanism.

Standard of Review. The independent accountant's determination will be final and binding on both parties, absent manifest error. The independent accountant will act as an expert and not as an arbitrator, and the independent accountant's determination will not be subject to appeal or judicial review except in the case of fraud or manifest error. The independent accountant's determination must fall within the range bounded by Buyer's calculation and Seller's objection — the accountant may not determine a value outside this range.

Cost Allocation. The fees and expenses of the independent accountant will be borne by the parties in inverse proportion to their success. Specifically, the costs will be allocated to the party whose position (as set forth in Buyer's Earnout Statement or Seller's objection, as applicable) is further from the independent accountant's determination, with the allocation calculated on a pro rata basis based on relative proximity to the accountant's final determination. This cost allocation mechanism incentivizes both parties to take reasonable positions and discourages frivolous objections.

B. Scope of Independent Accountant Review

The scope of the independent accountant's review should be strictly limited to the mathematical calculation of gallons shipped during the Earnout Period and the application of the earnout formula to the verified gallons figure. The independent accountant should resolve disputes regarding (i) whether specific shipments qualify as shipments of "ProShield-branded coatings" under the APA definition, (ii) whether specific shipments should be excluded as samples, returns, promotional shipments, or intra-company transfers, and (iii) the arithmetic accuracy of the earnout calculation.

Bifurcation of Disputes. Critically, the independent accountant should not be empowered to resolve disputes regarding Buyer's compliance with operational covenants, good-faith obligations, or the bad-faith carve-out discussed in Section IV.B above. Such disputes involve legal questions regarding contractual interpretation and the subjective intent of Buyer's business decisions, which are appropriately resolved through the APA's general dispute resolution provisions (whether litigation or arbitration). This bifurcation protects Buyer from having an accountant — rather than a court or arbitrator — make quasi-legal determinations about the propriety of Buyer's operational conduct during the Earnout Period.

The APA should expressly state that the independent accountant will have no authority to (i) interpret any provision of the APA other than the earnout calculation provisions, (ii) determine whether Buyer has complied with its covenants regarding the operation of the ProShield Product Line, (iii) make findings of fact regarding Buyer's intent or motivations, or (iv) award damages or any form of relief other than a determination of the gallons shipped and the resulting earnout payment amount.

VI. INTERACTION WITH INDEMNIFICATION FRAMEWORK

A. Indemnification Cap and Basket

The APA's indemnification provisions will include customary cap and basket limitations on Seller's indemnification obligations:

Indemnification Cap. The aggregate liability of Seller for indemnification claims arising from breaches of Seller's non-fundamental representations and warranties will be capped at 25% of the Purchase Price, calculated as 25% × $18,000,000 = $4,500,000. This cap represents a reasonable balance between Buyer's need for meaningful indemnification protection and Seller's desire to limit post-closing exposure.

Indemnification Basket. The APA will include a tipping basket (also known as a first-dollar basket) with a threshold of 1% of the Purchase Price, calculated as 1% × $18,000,000 = $180,000. Under the tipping basket structure, Seller has no indemnification liability unless and until the aggregate amount of Buyer's Losses exceeds $180,000, at which point Seller becomes liable for the full amount of all Losses from the first dollar — not merely the excess over the basket threshold. This structure provides Seller with protection against nuisance claims and de minimis losses while ensuring that once the threshold is crossed, Buyer recovers the full amount of its losses.

Fundamental Representations. Breaches of Fundamental Representations — defined to include Seller's representations regarding organization, authority, title to acquired assets, brokers, and taxes — will not be subject to the cap. Seller's liability for breaches of Fundamental Representations will extend up to the full amount of the purchase price received by Seller, reflecting the heightened importance of these representations and the expectation that breaches of Fundamental Representations are more likely to involve knowing or intentional misconduct.

B. Purchase Price Definition for Indemnification Purposes

A key drafting question is whether "Purchase Price" for purposes of the indemnification cap and basket includes the earnout consideration.

Recommendation. We recommend that "Purchase Price" for purposes of calculating the indemnification cap and basket be defined as the base purchase price of $18,000,000, which includes the upfront cash ($14,500,000), the escrow amount ($2,000,000), and the target earnout ($1,500,000), but excludes the additional $2,000,000 of upside earnout above the target level.

Rationale. The indemnification cap and basket should be based on a fixed amount that is known and determinable at the time of signing, rather than on a contingent amount that will not be finally determined until after the conclusion of the Earnout Period. Using a fixed base purchase price of $18,000,000 provides certainty to both parties regarding the scope of the indemnification regime and allows the indemnification provisions to operate independently of the earnout outcome. Additionally, if the total earnout paid exceeds the target level (i.e., Seller receives total consideration in excess of $18,000,000), the indemnification cap does not increase, which is favorable to Buyer. Conversely, if the earnout is less than the target (or zero), the cap remains at $4,500,000, which provides Buyer with a consistent level of indemnification protection regardless of the earnout outcome.

C. Escrow as Source of Indemnification Recovery

Escrow Mechanics. The $2,000,000 indemnification escrow will be held by Pinnacle Trust Company (reference number PT-2023-00418) pursuant to an Escrow Agreement entered into at Closing. The Escrow Amount will be invested in accordance with the investment instructions set forth in the Escrow Agreement (anticipated to provide for investment in money market funds or short-term U.S. Treasury obligations). Interest earned on the Escrow Amount will be allocated to Seller for tax purposes and will be released to Seller together with the principal balance.

Release Schedule. The Escrow Amount (or the remaining balance thereof, net of any amounts disbursed to satisfy resolved claims and any amounts retained to secure pending claims) will be released to Seller on the date that is twelve (12) months following the Closing Date (the "Escrow Release Date"). Assuming a Closing Date of January 20, 2023, the Escrow Release Date would be approximately January 20, 2024. At the time of release, the Escrow Agent will disburse to Seller the balance of the Escrow Amount less (i) any amounts previously disbursed to Buyer in satisfaction of resolved indemnification claims and (ii) any amounts retained to secure pending indemnification claims that have been the subject of timely written notices of claim delivered by Buyer prior to the Escrow Release Date.

Relationship to Direct Claims. The APA should expressly provide that the indemnification escrow serves as Buyer's primary, but not exclusive, source of recovery for indemnification claims. Buyer should not be required to exhaust the escrow before pursuing direct indemnification claims against Seller. This is particularly important given the timing mismatch between the escrow release (12 months post-Closing) and the survival period for Fundamental Representations (36 months post-Closing). During the period between the Escrow Release Date and the expiration of the Fundamental Representation survival period, Buyer must be able to pursue indemnification claims directly against Seller without the protection of the escrow collateral.

Survival Periods. The following survival periods apply:

The alignment of the general representation survival period with the Escrow Release Date is intentional — it ensures that Buyer has escrow security throughout the period during which general representation claims may be asserted. However, claims under Fundamental Representations (and potentially tax representations) may be asserted after the escrow has been released, requiring Buyer to rely on direct claims against Seller and/or the R&W insurance policy described below.

D. R&W Insurance Interaction

Policy Overview. Buyer has arranged a buyer-side representations and warranties insurance policy from Coventry Mutual Insurance Co. The key terms of the policy are as follows:

Function of R&W Insurance. The R&W policy provides Buyer with an additional layer of recovery beyond the $4,500,000 indemnification cap for breaches of Seller's representations and warranties. The $9,000,000 policy limit, combined with the $4,500,000 indemnification cap, provides Buyer with aggregate recovery capacity of up to $13,500,000 for representation and warranty breaches (subject to the retention and policy exclusions). The R&W policy also reduces friction in the negotiation of the indemnification provisions, as Seller may be more willing to accept a lower cap knowing that Buyer has recourse to the insurance policy for losses exceeding the cap.

Retention Structure. The $450,000 retention is split equally between Seller and Buyer. The Seller portion ($225,000) is effectively an indemnification obligation that must be exhausted before the R&W policy responds — Seller's first $225,000 of indemnification liability is effectively a deductible under the policy. The Buyer portion ($225,000) represents Buyer's self-insured retention.

Earnout-Related Losses. A critical open item is whether the R&W policy covers earnout-related losses — specifically, losses arising from Seller's breach of representations and warranties that cause a reduction in volume during the Earnout Period. For example, if Seller's representation regarding the absence of undisclosed material liabilities is breached, and the resulting undisclosed liability (such as an environmental remediation obligation or a product liability claim) disrupts manufacturing operations and reduces volume during the Earnout Period, Buyer may suffer two categories of loss: (i) direct losses from the breach (e.g., remediation costs) and (ii) indirect losses in the form of reduced earnout volume and the corresponding inability to recover the earned portion of the earnout from Seller (since Buyer is the payor). The R&W policy should cover both categories of loss to the extent they arise from breaches of covered representations.

Recommendation. We recommend coordinating with Coventry Mutual Insurance Co. (through Underwriter Gail Emerson) to confirm that the R&W policy does not exclude earnout-related diminution in value from the definition of covered losses. Specifically, Buyer should request written confirmation that (i) losses resulting from volume reductions during the Earnout Period caused by breaches of Seller's representations are covered losses under the policy, and (ii) the policy does not contain an exclusion for consequential damages, lost profits, or diminution in value that would operate to exclude earnout-related losses. If the standard policy form contains such exclusions, we should negotiate endorsements or carve-outs to ensure coverage.

E. Setoff Rights

Recommendation. The APA should include a right of setoff entitling Buyer to withhold from earnout payments amounts equal to unsatisfied indemnification claims. This right is particularly important given the timing gap between the Escrow Release Date (January 20, 2024) and the earnout payment date (March 17, 2025). During this approximately 14-month gap, Buyer will have no collateral security for post-escrow indemnification claims. The right to set off against earnout payments provides Buyer with a practical mechanism for recovering indemnification losses that arise (or remain unresolved) after the escrow has been released.

Scope of Setoff Right. We anticipate that Seller will resist broad setoff rights, arguing that the right to withhold earnout payments based on unresolved indemnification claims gives Buyer an unfair ability to manufacture claims to reduce or eliminate the earnout. To address this concern, we recommend the following compromise:

Buyer may set off against earnout payments only for indemnification claims that (i) have been reduced to a final, non-appealable judgment by a court of competent jurisdiction, or (ii) are the subject of a pending, good-faith written notice of claim delivered by Buyer to Seller prior to the earnout payment date, supported by a reasonable estimate of the claimed losses and a description of the factual and legal basis for the claim.

For claims in category (ii), Buyer may withhold from the earnout payment an amount equal to Buyer's good-faith estimate of the pending claim. Any amounts withheld for pending claims will be placed in a separate interest-bearing escrow account (or retained by Buyer, depending on the negotiated terms) and will be released to Seller promptly upon resolution of the pending claim to the extent the claim is resolved in Seller's favor.

This approach balances Buyer's need for security against unresolved indemnification claims with Seller's legitimate interest in receiving earned consideration in a timely manner. It prevents Buyer from using frivolous claims to withhold earnout payments while preserving Buyer's right to protect itself against genuine losses.

VII. PURCHASE PRICE ALLOCATION

A. Tax Allocation Overview

Because the transaction is structured as an asset purchase, the parties must agree on the allocation of the purchase price among the acquired assets for federal and state income tax purposes. Section 1060 of the Internal Revenue Code and the Treasury Regulations promulgated thereunder (specifically Treas. Reg. § 1.1060-1(a)) require that in an "applicable asset acquisition" (defined as any transfer of a trade or business in which the transferee's basis in the acquired assets is determined wholly by reference to the consideration paid), the consideration must be allocated among the acquired assets using the residual method prescribed by Section 338(b)(5) and Treas. Reg. § 1.338-6.

Both parties are required to file IRS Form 8594 (Asset Acquisition Statement Under Section 1060) with their respective federal income tax returns for the taxable year in which the acquisition occurs. The parties are obligated to allocate the purchase price consistently on their respective Form 8594 filings, and any inconsistent reporting may trigger IRS scrutiny and adverse tax consequences.

Tax Advisors. Buyer's tax advisor for purposes of the purchase price allocation is Halcyon Chartered Accountants LLP, with Martin Szabo, CPA, serving as engagement partner. Seller's tax advisor is Ridgeway & Associates, P.C., with Denise Ridgeway, CPA, serving as lead advisor, located at 95 Franklin Street, Suite 400, Buffalo, NY 14202. Both firms should be involved in the negotiation and preparation of the agreed allocation schedule.

B. Proposed Allocation Among Asset Classes

Under the residual method, the purchase price is allocated among seven classes of assets in order of priority (Class I through Class VII), with the residual (unallocated) amount assigned to goodwill and going concern value (Class VII). The preliminary allocation framework set forth below is subject to final negotiation with Seller and third-party valuation:

Class I — Cash and Cash Equivalents: $0. Cash and cash equivalents are excluded from the acquired assets under the APA. No allocation is required.

Class II — Certificates of Deposit, Government Securities, and Similar Items: $0. No Class II assets are included in the acquired assets. No allocation is required.

Class III — Accounts Receivable, Mortgages, and Credit Card Receivables: $0. Pre-Closing accounts receivable are excluded from the acquired assets. All receivables generated prior to the Closing Date will be retained by Seller. No allocation is required.

Class IV — Inventory: Approximately $2,100,000. The acquired assets include all inventory of the ProShield Product Line, consisting of raw materials (approximately $750,000), work-in-process (approximately $400,000), and finished goods (approximately $950,000). The estimated Closing inventory of approximately $2,100,000 is based on Seller's most recent inventory counts and cost records, adjusted for expected production and shipment activity through the anticipated Closing Date. The final inventory valuation will be determined as part of the Closing working capital adjustment process.

Class V — Equipment and Other Tangible Assets: Approximately $3,200,000. The acquired assets include all tangible personal property used in the operation of the ProShield Product Line, including:

• Three (3) high-speed dispersion mills;

• Two (2) automated filling lines;

• Fourteen (14) stainless steel mixing tanks, each with a capacity of 5,000 gallons;

• Laboratory and quality control equipment, including spectrophotometers, viscometers, pH meters, gloss meters, and related analytical instruments;

• Packaging and labeling equipment;

• Miscellaneous tools, fixtures, and spare parts.

The estimated fair market value of $3,200,000 is based on Seller's fixed asset schedule book values, adjusted for estimated fair market value based on Buyer's preliminary assessment. A formal equipment appraisal may be required to support the final allocation.

Class VI — Section 197 Intangibles Other Than Goodwill and Going Concern Value: To Be Determined. The acquired assets include significant Section 197 intangible assets, including:

• The ProShield trademark (U.S. Registration No. 2,876,411), including all associated trade dress, logos, and brand elements;

• Forty-seven (47) proprietary coating formulations and related trade secrets;

• Customer-specific formulation libraries developed by Seller over the course of its operations;

• Twenty-three (23) active customer supply agreements and associated customer relationships;

• Covenants not to compete from Frederick G. Voss and Elena M. Voss (discussed further in Section VII.E below); and

• Other intangible assets, including technical documentation, training materials, and regulatory approvals.

The allocation to Class VI intangibles will require a third-party valuation to establish the fair market value of the individual intangible assets. This valuation should be performed by Halcyon Chartered Accountants LLP (or a valuation specialist engaged by Halcyon) and should employ standard valuation methodologies including the relief-from-royalty method (for trademarks), the multi-period excess earnings method (for customer relationships), and the cost approach (for formulations and trade secrets).

Class VII — Goodwill and Going Concern Value: Residual. The balance of the purchase price after allocations to Classes I through VI will be assigned to goodwill and going concern value. Goodwill represents the premium paid by Buyer over the aggregate fair market value of the identifiable tangible and intangible assets, reflecting the going concern value of the ProShield Product Line, its assembled workforce, its market position, and other value-creating factors not separately identifiable.

C. Buyer's Allocation Priorities

Crestline's tax planning objective is to maximize the allocation of purchase price to asset categories with shorter depreciable or amortizable lives, thereby accelerating the tax deductions available to Buyer and reducing the present value of Buyer's after-tax acquisition cost.

Equipment (Class V): 5- or 7-Year MACRS Recovery Period. Equipment and other tangible personal property are depreciable under the Modified Accelerated Cost Recovery System (MACRS) over 5-year or 7-year recovery periods, depending on the asset category. Equipment depreciation provides relatively rapid tax deductions compared to the 15-year amortization period applicable to Section 197 intangibles and goodwill. Accordingly, maximizing the allocation to equipment (to the extent supportable by fair market value) is tax-favorable for Buyer.

Inventory (Class IV): Deductible as Cost of Goods Sold. The cost of acquired inventory is recovered as a deduction when the inventory is sold to customers, which typically occurs within months of the acquisition. This provides the fastest tax recovery of any asset class and makes inventory allocation highly tax-efficient for Buyer.

Section 197 Intangibles and Goodwill (Classes VI and VII): 15-Year Amortization. Both Section 197 intangibles and goodwill are amortizable over a 15-year period on a straight-line basis. While 15-year amortization is less favorable than the shorter recovery periods available for equipment and inventory, it is nevertheless preferable to a non-deductible allocation (e.g., land). Imp

PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
MEMORANDUM
TO: Harrison Wexford, Esq., Partner, Calderwood & Harkness LLP Sandra K. Nair, CFO, Crestline Packaging Solutions LLC
FROM: Ryan Kowalski, Associate, Calderwood & Harkness LLP
DATE: October 20, 2022
RE: ProShield Industrial Coatings Product Line Acquisition — Earnout Structure Analysis and Purchase Price Allocation Considerations
MATTER NO.: 1006-00007
CC: Beatrice Holloway, Esq. (Calderwood & Harkness LLP); Derek Amato, Esq. (General Counsel, Crestline Packaging Solutions LLC); Megan Chu, Esq. (Calderwood & Harkness LLP)
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I. EXECUTIVE SUMMARY
This memorandum analyzes the proposed volume-based earnout structure in connection with Crestline Packaging Solutions LLC's ("Crestline," "CPS," or "Buyer") proposed acquisition of substantially all assets comprising the ProShield Industrial Coatings product line (the "ProShield Product Line" or "ProShield") from Voss Chemical Industries, Inc. ("Voss," "VCI," or "Seller"). The purpose of this memorandum is to evaluate the proposed earnout mechanics, assess risks to Buyer, and provide specific recommendations for provisions to be included in the Asset Purchase Agreement (the "APA") that protect Buyer's interests throughout the earnout measurement period and beyond.
Transaction Overview. Crestline proposes to acquire substantially all assets constituting the ProShield Product Line pursuant to an asset purchase transaction for aggregate base consideration of $18,000,000, structured as follows: (i) $14,500,000 in upfront cash payable at Closing via wire transfer; (ii) $2,000,000 deposited into an indemnification escrow account with Pinnacle Trust Company at Closing; and (iii) a target earnout payment of $1,500,000 contingent upon the achievement of specified volume targets during a 24-month post-Closing measurement period. In addition to the target earnout, the earnout structure provides for up to an additional $2,000,000 in upside earnout payments if the product line exceeds target volume, resulting in a maximum earnout payment of $3,500,000 and maximum total consideration of $20,000,000.
Valuation Context. The earnout component is designed to bridge a valuation gap between Buyer's and Seller's expectations regarding the future performance of the ProShield Product Line. Based on ProShield's fiscal year 2021 EBITDA of $4,100,000, the base purchase price of $18,000,000 implies a multiple of approximately 4.39× FY2021 EBITDA, while the maximum total consideration of $20,000,000 at full earnout implies a multiple of approximately 4.88×. At the earnout threshold (where no earnout would be payable), total consideration of $16,500,000 implies a multiple of approximately 4.02×. This range of 4.02× to 4.88× is consistent with observed transaction multiples in comparable specialty chemical product line acquisitions.
Parties and Key Stakeholders. Crestline is a Delaware limited liability company headquartered at 4100 Rockside Road, Suite 300, Independence, OH 44131, and is a portfolio company of Kestrel Capital Partners Fund III, LP (the "Sponsor" or "Ashgrove Equity Partners"). Voss is a New York corporation headquartered at 790 Niagara Falls Boulevard, Tonawanda, NY 14150, wholly owned by Frederick G. Voss (62%) and Elena M. Voss (38%) (collectively, the "Seller Principals"). Seller is represented by Langford, Crewe & Cascade Insurance Brokers, with Patricia Okonkwo serving as lead partner, based at 120 Delaware Avenue, Suite 900, Buffalo, NY 14202.
Scope of Memorandum. In addition to the detailed analysis of the proposed earnout structure, this memorandum addresses the following related matters: (i) the interaction between the earnout and the proposed indemnification framework, including escrow mechanics and representations and warranties insurance; (ii) purchase price allocation considerations for federal and state income tax purposes under Section 1060 of the Internal Revenue Code; (iii) specific APA drafting recommendations to protect Buyer's operational flexibility during the earnout measurement period; (iv) dispute resolution mechanisms for earnout-related disagreements; and (v) a risk assessment identifying open items and anticipated areas of negotiation with Seller's counsel.
II. PROPOSED PURCHASE PRICE STRUCTURE
A. Components of Consideration
The aggregate purchase price for the ProShield Product Line is structured in three principal components, as set forth below. The base purchase price of $18,000,000 assumes achievement of the target earnout, while the maximum total consideration of $20,000,000 assumes achievement of the full stretch earnout.
1. Upfront Cash at Closing: $14,500,000. At the Closing, Buyer will pay to Seller (or as Seller may direct) the sum of Fourteen Million Five Hundred Thousand Dollars ($14,500,000) in immediately available funds by wire transfer to an account designated by Seller in writing at least two (2) business days prior to the Closing Date. This upfront cash component represents approximately 80.6% of the base purchase price and approximately 72.5% of the maximum total consideration. The upfront cash payment is not subject to any contingencies other than the satisfaction or waiver of conditions precedent to Closing as set forth in the APA.
2. Indemnification Escrow Holdback: $2,000,000. At the Closing, Buyer will deposit Two Million Dollars ($2,000,000) (the "Escrow Amount") with Pinnacle Trust Company, as escrow agent (the "Escrow Agent"), pursuant to the terms of an Escrow Agreement to be entered into among Buyer, Seller, and Escrow Agent at Closing. The Escrow Agent contact is Rachel Underwood, Trust Officer, located at 40 Wall Street, 16th Floor, New York, NY 10005. The Escrow Amount will serve as a source of recovery for Buyer's indemnification claims arising under Article [●] of the APA. Subject to any pending or resolved indemnification claims, the Escrow Amount (or the remaining balance thereof) will be released to Seller twelve (12) months following the Closing Date. The Escrow Amount represents approximately 11.1% of the base purchase price and provides meaningful collateral security for Buyer during the initial post-Closing period when integration risks and potential representation breaches are most likely to be discovered.
3. Earnout — Target Payment: $1,500,000. The target earnout payment of One Million Five Hundred Thousand Dollars ($1,500,000) is contingent upon the achievement of a target volume of 3,000,000 gallons of ProShield-branded coatings shipped during the 24-month Earnout Period (as defined below). The earnout structure also provides for additional upside payments of up to Two Million Dollars ($2,000,000) above the target earnout if volume exceeds the target level, resulting in a maximum earnout payment of Three Million Five Hundred Thousand Dollars ($3,500,000). The detailed mechanics of the earnout, including threshold, target, and stretch tiers, interpolation formulas, and payment timing, are discussed in Section III of this memorandum.
Total Maximum Consideration. The maximum aggregate consideration payable by Buyer in connection with the acquisition of the ProShield Product Line is Twenty Million Dollars ($20,000,000), calculated as follows:
For reconciliation purposes, the base purchase price of $18,000,000 comprises the upfront cash ($14,500,000), the escrow amount ($2,000,000), and the target earnout ($1,500,000). The incremental $2,000,000 between the base purchase price and the maximum total consideration represents the additional upside earnout available between the target and stretch volume levels. All components of consideration, including the earnout, are subject to the working capital adjustment mechanism described in Section II.B below.
B. Working Capital Adjustment
The APA will include a customary post-Closing working capital adjustment mechanism designed to ensure that Buyer receives an appropriate level of net working capital at Closing consistent with the normal operating requirements of the ProShield Product Line.
Estimated Net Working Capital. Based on Seller's preliminary financial information and Buyer's due diligence analysis, the estimated net working capital ("NWC") of the ProShield Product Line at Closing is approximately $1,850,000. This estimate is based on current asset and current liability balances as of September 30, 2022, adjusted for expected changes through the anticipated Closing Date. Net working capital is defined as current assets (including accounts receivable, inventory, prepaid expenses, and other current assets included in the acquired assets) less current liabilities (including accounts payable, accrued expenses, and other current liabilities constituting assumed liabilities), in each case determined in accordance with GAAP applied consistently with Seller's historical accounting practices.
Target NWC. The target net working capital (the "Target NWC") has been established at $1,800,000, which reflects an approximation of the normalized working capital required to operate the ProShield Product Line in the ordinary course of business. The Target NWC was derived from an analysis of trailing twelve-month average net working capital levels, adjusted for seasonal fluctuations and non-recurring items.
Adjustment Mechanism. The working capital adjustment will operate on a dollar-for-dollar basis without any collar, deadband, or threshold. If the actual Closing NWC exceeds the Target NWC, Buyer will pay the excess to Seller. If the actual Closing NWC is less than the Target NWC, Seller will pay the shortfall to Buyer. This dollar-for-dollar mechanism ensures that both parties bear the full economic impact of any deviation from the Target NWC, without the ambiguity or windfall potential introduced by collar mechanisms.
True-Up Timeline. The working capital true-up will be completed within ninety (90) days following the Closing Date, based on a final Closing balance sheet prepared by Buyer in accordance with GAAP and the accounting principles specified in the APA. Assuming the Closing occurs on January 20, 2023 (the current target Closing Date is January 16, 2023, but allowing for potential short delays), the working capital true-up deadline would fall on approximately April 20, 2023. Buyer will deliver the final Closing balance sheet and a statement of Closing NWC to Seller within sixty (60) days following Closing, and Seller will have a thirty (30) day objection period following receipt thereof. If Seller raises no objection within such period, the Closing NWC as set forth in Buyer's statement will be deemed final and binding.
Dispute Resolution. In the event Seller objects to Buyer's determination of Closing NWC, the parties will negotiate in good faith to resolve the dispute within fifteen (15) days. If the parties are unable to resolve the dispute within such period, the disputed items will be submitted to the independent accountant for final and binding resolution, as described in Section V.A below.
Recommendation. We recommend that the APA provide that Buyer prepares the Closing balance sheet, that Seller has a clearly defined objection period limited to specific line items, and that unresolved disputes are submitted to the independent accountant for final determination. This approach gives Buyer initial control over the preparation of the Closing balance sheet while affording Seller appropriate review rights. The APA should also include detailed accounting methodologies and illustrative calculations as exhibits to minimize disputes over accounting principles.
C. Financing Sources
The acquisition of the ProShield Product Line will be financed through a combination of equity contributions from the Sponsor and incremental debt under Crestline's existing senior secured credit facility.
Equity Contribution. Kestrel Capital Partners Fund III, LP will contribute $6,000,000 in equity capital to Crestline via a capital call to the limited partners of Fund III. This equity contribution represents approximately 33.3% of the base purchase price and will be funded in immediately available funds on or prior to the Closing Date. Julian H. Prescott, Managing Partner of Cobalt Ridge Partners Management III, LLC (the general partner of Fund III), has confirmed Fund III's commitment to fund the capital call, subject to completion of the Fund's investment committee approval process.
Incremental Term Loan. Crestline will draw $12,500,000 in incremental term loan borrowings (the "Incremental Term Loan C") under its existing senior secured credit facility with Great Lakes Commerce Bank, N.A. ("GLCB") pursuant to an amendment to the Credit Agreement dated March 15, 2021, by and among Crestline, GLCB (as administrative agent and a lender), and the other lenders party thereto (as amended to date, the "Credit Agreement"). The Incremental Term Loan C will require a Third Amendment to the Credit Agreement (the "Third Amendment"), which will need to be negotiated and executed prior to Closing. Douglas Fenn, Senior Vice President and Relationship Manager at GLCB, has indicated preliminary support for the incremental borrowing, subject to completion of GLCB's internal credit approval process and satisfactory review of the acquisition terms and the ProShield Product Line's financial performance. We anticipate that GLCB will require customary lender diligence, including review of the APA, financial projections for the combined business, and environmental due diligence reports.
Total Financing. The aggregate financing commitment of $18,500,000 ($6,000,000 equity plus $12,500,000 debt) exceeds the base purchase price of $18,000,000 by $500,000. This excess is intended to cover estimated transaction expenses (including legal fees, accounting and tax advisory fees, R&W insurance premium, environmental assessment costs, and other customary closing costs) and to provide a working capital reserve for the combined business post-Closing.
Note on Lender Consent. GLCB lender consent is a condition precedent to Closing. The Third Amendment will need to address, among other things, the incremental borrowing capacity, any adjustments to financial covenants, the addition of acquired assets to the collateral package, and compliance with the existing Credit Agreement's restrictions on acquisitions. We recommend that Megan Chu coordinate with GLCB's outside counsel to commence Third Amendment negotiations promptly following circulation of the draft APA.
III. EARNOUT MECHANICS — DETAILED ANALYSIS
A. Measurement Metric: Volume-Based (Gallons Shipped)
The proposed earnout is based on total gallons of ProShield-branded coatings shipped by Crestline (or its affiliates) during the 24-month Earnout Period. The Earnout Period commences on January 17, 2023, the day immediately following the target Closing Date, and ends on January 16, 2025, resulting in a full 24-month measurement window.
Rationale for Volume-Based Metric. After careful consideration of the available alternatives, we recommend a volume-based earnout metric (measured in gallons shipped) rather than a revenue-based or EBITDA-based metric. This recommendation is grounded in several interrelated considerations:
First, a volume-based metric minimizes the scope for disputes related to pricing decisions, product mix, and cost allocation that frequently plague revenue- or EBITDA-based earnouts. Revenue-based earnouts invite challenges to Buyer's pricing strategy, discount practices, and customer contract terms, while EBITDA-based earnouts create an even broader surface area for disputes encompassing cost allocation methodologies, overhead charges, shared services fees, and capital expenditure characterization. Volume metrics avoid these issues entirely, as the measurement is independent of the prices at which products are sold or the costs incurred in producing and delivering them.
Second, gallons shipped is a more objectively measurable quantity than either revenue or EBITDA. Volume can be verified by reference to concrete, contemporaneously created documentation including shipping records, bills of lading, delivery confirmations, and entries in Buyer's enterprise resource planning (ERP) and inventory management systems. This objectivity reduces the opportunity for subjective judgment calls and post-hoc accounting adjustments that are characteristic of financial metric earnouts.
Third, a volume-based metric reduces Seller's ability to challenge Buyer's pricing strategy or cost management decisions during the Earnout Period. Under a revenue or EBITDA earnout, Seller could argue that Buyer depressed revenue by offering excessive discounts or increased costs by allocating disproportionate overhead, thereby reducing the earnout payment. A volume metric insulates Buyer from such challenges and preserves Buyer's complete autonomy over pricing and cost management.
Fourth, the volume-based approach aligns incentives in a constructive manner. Seller benefits from Buyer's investment in growing the product line's distribution footprint, expanding customer relationships, and increasing market penetration — all of which drive higher shipment volumes. Simultaneously, Buyer retains full flexibility over pricing, margin management, product formulation, and operational integration decisions without creating earnout-related exposure.
Historical Volume Analysis. An analysis of ProShield's historical shipping volumes supports the proposed earnout thresholds and targets:
The annualized gallons shipped have grown from 1,320,000 in FY2020 to an estimated 1,560,000 in FY2022, representing compound annual growth of approximately 8.7%. At the FY2022 estimated annual run rate of 1,560,000 gallons, a 24-month run rate would yield approximately 3,120,000 gallons. This figure exceeds the earnout target of 3,000,000 gallons (by approximately 4%) but falls below the stretch target of 3,800,000 gallons (by approximately 17.9%), suggesting that the target is achievable based on current trajectory while the stretch requires meaningful volume growth during the Earnout Period.
B. Earnout Tiers and Interpolation
The proposed earnout structure consists of three tiers — Threshold, Target, and Stretch — with linear interpolation between tiers. The structure is designed to provide downside protection to Buyer while offering Seller meaningful upside participation if the ProShield Product Line outperforms expectations.
Threshold: 2,400,000 Gallons — $0 Earnout. No earnout payment is due if total gallons shipped during the Earnout Period are less than or equal to 2,400,000 gallons. This threshold represents approximately 77% of the projected 24-month run rate at FY2022 levels (3,120,000 gallons), meaning that a decline of approximately 23% from projected levels would be required before any earnout payment is triggered. This provides Buyer with substantial downside protection and ensures that no earnout is payable unless the product line performs at a level reasonably consistent with its recent historical trajectory.
Target: 3,000,000 Gallons — $1,500,000 Earnout. If total gallons shipped during the Earnout Period equal or exceed 3,000,000 gallons, the earnout payment equals $1,500,000. Between the Threshold and the Target, the earnout payment is determined by linear interpolation at a rate of $2.50 per gallon above the Threshold, calculated as follows:
$1,500,000 ÷ (3,000,000 − 2,400,000) = $1,500,000 ÷ 600,000 = $2.50 per gallon
Illustrative Calculation: If 2,700,000 gallons are shipped during the Earnout Period (300,000 gallons above the Threshold), the earnout payment would be calculated as 300,000 × $2.50 = $750,000.
Stretch (Maximum): 3,800,000 Gallons — $3,500,000 Earnout. If total gallons shipped during the Earnout Period equal or exceed 3,800,000 gallons, the maximum earnout payment of $3,500,000 is payable. Between the Target and the Stretch, the earnout payment is determined by linear interpolation at a rate of $2.50 per gallon above the Target, calculated as follows:
($3,500,000 − $1,500,000) ÷ (3,800,000 − 3,000,000) = $2,000,000 ÷ 800,000 = $2.50 per gallon
Illustrative Calculation: If 3,400,000 gallons are shipped during the Earnout Period (400,000 gallons above the Target), the earnout payment would be calculated as $1,500,000 + (400,000 × $2.50) = $1,500,000 + $1,000,000 = $2,500,000.
Cap: $3,500,000. The earnout payment is capped at $3,500,000. No additional earnout is payable for gallons shipped in excess of the Stretch level of 3,800,000 gallons. This cap limits Buyer's total acquisition cost to $20,000,000 regardless of how significantly the ProShield Product Line outperforms during the Earnout Period.
Uniform Interpolation Rate. A notable feature of the proposed structure is the uniform interpolation rate of $2.50 per gallon across both the Threshold-to-Target tier and the Target-to-Stretch tier. This uniformity simplifies the earnout calculation, reduces ambiguity, and avoids the complexity of different per-gallon rates in different bands. It also creates a straightforward linear relationship between gallons shipped and earnout payments throughout the entire range, which should minimize disputes and facilitate transparent communication with Seller regarding interim volume performance.
C. Earnout Payment Timing
The earnout payment will be due within sixty (60) days after the end of the Earnout Period. Assuming the Earnout Period ends on January 16, 2025, the earnout payment would be due no later than March 17, 2025. The payment process involves the following sequential steps:
Step 1: Earnout Statement. Within forty-five (45) days after the end of the Earnout Period (i.e., by approximately March 2, 2025), Buyer will prepare and deliver to Seller a written statement (the "Earnout Statement") setting forth (i) the total gallons of ProShield-branded coatings shipped during the Earnout Period, (ii) the calculation of the earnout payment based on the earnout formula, and (iii) reasonable supporting documentation, including summary shipping data.
Step 2: Seller Objection Period. Seller will have fifteen (15) days following receipt of the Earnout Statement to review the statement and deliver a written objection to Buyer specifying in reasonable detail the items or amounts to which Seller objects and the basis for such objection. If Seller does not deliver a written objection within such 15-day period, the Earnout Statement will be deemed accepted by Seller and will become final and binding.
Step 3: Payment. If Seller does not object (or the parties resolve any objection), Buyer will pay the earnout amount to Seller within the remainder of the 60-day period following the end of the Earnout Period. If Seller timely objects and the parties are unable to resolve the dispute during the 15-day objection period, the dispute resolution mechanism described in Section V will apply, and payment of any undisputed portion will be made within the 60-day window, with the disputed portion held pending resolution.
D. Earnout Sensitivity Analysis
The following table illustrates the earnout payment, total consideration (inclusive of upfront cash and escrow), and implied EV/EBITDA multiple at various volume levels during the 24-month Earnout Period:
Note: Total Consideration equals Upfront Cash ($14,500,000) plus Escrow ($2,000,000) plus Earnout Payment. Implied multiple based on FY2021 EBITDA of $4,100,000.
Analysis of Implied Multiples. At the Threshold (where no earnout is payable), total consideration of $16,500,000 implies a multiple of 4.02× FY2021 EBITDA, which represents the floor of Buyer's acquisition cost. At the Target level, total consideration of $18,000,000 implies a multiple of 4.39×, which is consistent with the parties' baseline valuation expectations. At the Stretch level (full earnout), total consideration of $20,000,000 implies a multiple of 4.88×, which represents the ceiling.
The resulting multiple range of 4.02× to 4.88× is reasonable relative to comparable specialty chemical product line transactions, which have generally traded in the 3.5× to 6.0× EBITDA range depending on scale, growth profile, customer concentration, and proprietary technology. The earnout structure effectively shifts a portion of the valuation risk from Buyer to Seller, requiring Seller to participate in the product line's performance during the Earnout Period to receive the full consideration contemplated by both parties.
IV. BUYER PROTECTIONS — OPERATIONAL COVENANTS DURING THE EARNOUT PERIOD
A. Buyer's Discretion to Operate the Business
The single most critical provision in the earnout section of the APA — from Buyer's perspective — is an unambiguous statement that Buyer retains sole and absolute discretion over the operation of the ProShield Product Line during the Earnout Period. This provision is essential to protect Crestline's ability to integrate the ProShield Product Line into its existing approximately $112 million revenue packaging coatings business without being constrained by earnout-related limitations or obligations.
The APA should expressly state that Buyer will have sole and absolute discretion with respect to all aspects of the operation of the ProShield Product Line during the Earnout Period, including without limitation:
(a) Pricing of ProShield products, including list prices, volume discounts, promotional pricing, and contract pricing;
(b) Manufacturing processes, production scheduling, production volumes, and choice of manufacturing facility or facilities;
(c) Marketing and sales strategy, including allocation of marketing resources, advertising expenditure, trade show participation, and sales force deployment;
(d) Customer relationships and contract terms, including decisions to accept, reject, modify, or terminate customer contracts;
(e) Headcount and personnel decisions, including hiring, termination, compensation, reassignment, and organizational restructuring of transferred employees;
(f) Capital expenditure levels, including decisions regarding equipment purchases, facility improvements, and technology investments;
(g) Product formulation changes, including modification, reformulation, or discontinuation of any of the 47 proprietary coating formulations being acquired;
(h) Integration of the ProShield Product Line with Crestline's existing packaging coatings business, including consolidation of product lines, cross-selling initiatives, shared services arrangements, and operational synergies; and
(i) All other operational, strategic, and financial decisions relating to the ProShield Product Line.
This enumeration should be drafted as illustrative rather than exhaustive to avoid any negative inference that Buyer's discretion is limited to the specifically enumerated categories.
B. Good Faith / Commercially Reasonable Efforts Standard
A significant area of tension in earnout negotiations is the interplay between Buyer's desire for operational discretion and Seller's expectation that Buyer will make good-faith efforts to achieve the earnout targets. Sellers frequently seek affirmative covenants obligating Buyer to operate the acquired business in a manner designed to maximize the earnout payment, while buyers resist any constraint on their operational flexibility.
Recommended Approach. We recommend that the APA include a limited covenant that Buyer will operate the ProShield Product Line in good faith and in the ordinary course of business consistent with Seller's past practices, but that this covenant be accompanied by express carve-outs making clear that Buyer has no affirmative obligation to take any specific action to achieve earnout targets. Specifically, the APA should state that notwithstanding any other provision of the Agreement, Buyer shall have no obligation to:
(a) Prioritize the ProShield Product Line over Buyer's other business lines or product lines, or allocate any minimum level of resources to the ProShield Product Line;
(b) Maintain any minimum level of marketing expenditure, capital investment, research and development spending, or headcount attributable to the ProShield Product Line;
(c) Refrain from introducing, developing, or marketing products that compete with or are substitutes for ProShield products;
(d) Continue manufacturing or warehousing operations at the Tonawanda facility located at 790 Niagara Falls Boulevard, Tonawanda, NY 14150 (noting that Buyer is currently negotiating a new direct lease with Niagara Industrial Realty LLC for a 42,000 square foot facility at $14.50 per square foot per year, but should not be contractually bound to maintain operations at that or any other specific location);
(e) Avoid any organizational restructuring, product line consolidation, or changes to the ProShield Product Line's distribution channels; or
(f) Take any other action (or refrain from taking any action) for the purpose of maximizing the earnout payment or gallons shipped during the Earnout Period.
Bad-Faith Carve-Out. As a limited and appropriate concession to Seller, the APA should include a carve-out providing that Buyer shall not take any action with the primary purpose and intention of reducing gallons shipped during the Earnout Period solely to avoid or reduce earnout payments. This "bad-faith floor" prevents Buyer from engaging in deliberate manipulation of volume figures — for example, by artificially delaying shipments until after the Earnout Period ends or by diverting customer orders to non-ProShield products without commercial justification — while preserving Buyer's discretion to make all bona fide business decisions even if such decisions have the incidental effect of reducing volume.
Recommended Standard. The "no affirmative duty with a bad-faith floor" standard is the most buyer-favorable construct commonly accepted in negotiated M&A earnout transactions. It has been validated by Delaware courts and is well-understood by practitioners on both sides of the table. We believe this standard appropriately balances Buyer's need for integration flexibility with Seller's reasonable expectation that Buyer will not act in bad faith to deprive Seller of the benefit of the earnout.
C. Anti-Manipulation Provisions
We anticipate that Seller's counsel at Langford, Crewe & Cascade Insurance Brokers will seek additional protections against Buyer deliberately suppressing volume to avoid earnout payments. Such requests may take the form of affirmative operational covenants, minimum volume commitments, or "commercially reasonable efforts" standards.
Recommended Concession. As noted above, we recommend that Buyer concede a narrow bad-faith covenant, but resist any broader obligations. The bad-faith covenant should be drafted narrowly to require that the challenged action have the "primary purpose and intention" of reducing earnout payments — a demanding standard that places the burden on Seller to demonstrate that Buyer's actions were motivated primarily by a desire to avoid earnout liability rather than by legitimate business considerations.
Positions to Resist. We recommend that Buyer resist the following anticipated Seller requests:
(a) "Commercially reasonable efforts" to achieve earnout targets. This standard is excessively vague and creates significant litigation risk. What constitutes "commercially reasonable efforts" to ship 3,000,000 gallons of industrial coatings over a 24-month period is inherently subjective and would invite second-guessing of virtually every operational decision Buyer makes during the Earnout Period.
(b) Seller consent or consultation rights over operational decisions. Any provision requiring Buyer to consult with, notify, or obtain consent from Seller (or the Seller Principals) before making operational decisions during the Earnout Period would be unacceptable. Such provisions effectively give Seller a veto over Buyer's business decisions and are inconsistent with the fundamental premise of an asset sale in which Buyer acquires full ownership and control of the acquired assets.
(c) Minimum volume commitments or production floors. Any obligation to maintain minimum production or shipment volumes would constrain Buyer's operational flexibility and shift market risk from Seller (where it properly resides after closing) back to Buyer.
(d) Maintain-the-business covenants. Buyer should resist any covenant requiring Buyer to operate the ProShield Product Line as a standalone business, maintain its separate identity, or refrain from integrating it with Crestline's existing operations.
D. Accounting and Record-Keeping
The APA should include provisions requiring Buyer to maintain adequate books and records to support the calculation of gallons shipped during the Earnout Period, while appropriately limiting the scope of Seller's access to Buyer's records.
Record-Keeping Obligations. Buyer will maintain books and records sufficient to calculate the total gallons of ProShield-branded coatings shipped during the Earnout Period, including shipping records, bills of lading, delivery confirmations, and entries in Buyer's ERP and inventory management systems. These records will serve as the primary documentation supporting the Earnout Statement. Buyer will maintain such records for a period of at least twelve (12) months following the end of the Earnout Period (i.e., until at least January 16, 2026) to allow for audit and dispute resolution.
Seller Audit Rights. Seller will have limited audit rights to review records relevant to the calculation of gallons shipped, exercisable only during the 15-day objection period following Seller's receipt of the Earnout Statement. Any such review will be conducted at Seller's expense, at Buyer's offices during normal business hours, and subject to confidentiality obligations. Seller's audit rights should be limited to records directly relevant to the calculation of gallons shipped and should not extend to Buyer's broader financial records, pricing information, customer contracts, or other commercially sensitive information unrelated to the volume calculation.
E. Assignment and Acceleration
Acceleration. The earnout obligation should not accelerate upon a subsequent sale, merger, or other change of control of Crestline or the ProShield Product Line during the Earnout Period. We recommend that the APA expressly state that no change of control, asset sale, or other disposition by Buyer will trigger an acceleration of the earnout obligation or entitle Seller to any payment in excess of the earnout amount that would otherwise be due based on actual gallons shipped through the end of the Earnout Period. This is essential to preserve Kestrel Capital Partners Fund III, LP's flexibility as equity sponsor to pursue exit strategies — including a sale of Crestline or the ProShield Product Line — without being locked in by earnout-related obligations or facing windfall payments to Seller.
Alternative Mechanism. As an alternative to acceleration, if Buyer sells or otherwise disposes of substantially all of the ProShield Product Line assets during the Earnout Period, Buyer should have the option to either (a) assign the earnout obligations to the acquiror, with Buyer remaining secondarily liable for payment of the earnout in the event the acquiror defaults, or (b) make a good-faith estimate of the projected total gallons that would be shipped during the remainder of the Earnout Period (based on trailing actual performance and available forecasts) and pay the corresponding earnout amount to Seller at the time of the secondary sale, with such payment being final and not subject to subsequent true-up. This mechanism gives Buyer (and the Sponsor) flexibility to exit while providing Seller with reasonable assurance that the earnout obligation will be honored.
We anticipate that Seller will seek a full acceleration clause providing for immediate payment of the maximum earnout upon a change of control. We should be prepared to negotiate this point firmly, as acceleration provisions can result in significant windfall payments to Seller that are not supported by actual product line performance.
V. EARNOUT DISPUTE RESOLUTION
A. Independent Accountant Mechanism
The APA should include a structured dispute resolution mechanism for disagreements regarding the Earnout Statement. We recommend the following framework:
Initial Negotiation. If Seller delivers a timely written objection to the Earnout Statement, the parties will negotiate in good faith for a period of fifteen (15) days following delivery of Seller's objection to resolve the disputed items. During this negotiation period, the parties' respective finance teams (specifically, Sandra K. Nair for Buyer and such person as Seller may designate) will meet at least once to discuss and attempt to reconcile the disputed items.
Submission to Independent Accountant. If the parties are unable to resolve the dispute within the 15-day negotiation period, the disputed items (and only the disputed items) will be submitted for resolution to an independent accountant. The proposed default independent accountant is Halcyon Chartered Accountants LLP, with Martin Szabo, CPA, serving as engagement partner. Halcyon's offices are located at 1301 East 9th Street, Suite 2400, Cleveland, OH 44114.
Independence Concern. We note that Halcyon Chartered Accountants LLP is currently serving as Buyer's accounting advisor and is performing financial and tax due diligence on the ProShield Product Line in connection with the transaction. Seller may object to Halcyon's designation as the independent accountant on the grounds that Halcyon lacks independence due to its existing relationship with Buyer. This is a reasonable objection that we should be prepared to address.
Recommended Approach. We recommend that the APA provide for Halcyon as the default independent accountant, with a fallback mechanism in the event either party objects to Halcyon within a specified period (e.g., ten (10) business days after the APA is executed). If either party timely objects, the parties will attempt to mutually agree on a substitute independent accountant within ten (10) business days. If the parties are unable to agree, each party will designate one nationally recognized accounting firm (other than the parties' respective auditors and advisors), and the two designated firms will jointly select a third firm to serve as the independent accountant. This tiered selection process provides Buyer with the benefit of its preferred advisor while offering a fair fallback mechanism.
Standard of Review. The independent accountant's determination will be final and binding on both parties, absent manifest error. The independent accountant will act as an expert and not as an arbitrator, and the independent accountant's determination will not be subject to appeal or judicial review except in the case of fraud or manifest error. The independent accountant's determination must fall within the range bounded by Buyer's calculation and Seller's objection — the accountant may not determine a value outside this range.
Cost Allocation. The fees and expenses of the independent accountant will be borne by the parties in inverse proportion to their success. Specifically, the costs will be allocated to the party whose position (as set forth in Buyer's Earnout Statement or Seller's objection, as applicable) is further from the independent accountant's determination, with the allocation calculated on a pro rata basis based on relative proximity to the accountant's final determination. This cost allocation mechanism incentivizes both parties to take reasonable positions and discourages frivolous objections.
B. Scope of Independent Accountant Review
The scope of the independent accountant's review should be strictly limited to the mathematical calculation of gallons shipped during the Earnout Period and the application of the earnout formula to the verified gallons figure. The independent accountant should resolve disputes regarding (i) whether specific shipments qualify as shipments of "ProShield-branded coatings" under the APA definition, (ii) whether specific shipments should be excluded as samples, returns, promotional shipments, or intra-company transfers, and (iii) the arithmetic accuracy of the earnout calculation.
Bifurcation of Disputes. Critically, the independent accountant should not be empowered to resolve disputes regarding Buyer's compliance with operational covenants, good-faith obligations, or the bad-faith carve-out discussed in Section IV.B above. Such disputes involve legal questions regarding contractual interpretation and the subjective intent of Buyer's business decisions, which are appropriately resolved through the APA's general dispute resolution provisions (whether litigation or arbitration). This bifurcation protects Buyer from having an accountant — rather than a court or arbitrator — make quasi-legal determinations about the propriety of Buyer's operational conduct during the Earnout Period.
The APA should expressly state that the independent accountant will have no authority to (i) interpret any provision of the APA other than the earnout calculation provisions, (ii) determine whether Buyer has complied with its covenants regarding the operation of the ProShield Product Line, (iii) make findings of fact regarding Buyer's intent or motivations, or (iv) award damages or any form of relief other than a determination of the gallons shipped and the resulting earnout payment amount.
VI. INTERACTION WITH INDEMNIFICATION FRAMEWORK
A. Indemnification Cap and Basket
The APA's indemnification provisions will include customary cap and basket limitations on Seller's indemnification obligations:
Indemnification Cap. The aggregate liability of Seller for indemnification claims arising from breaches of Seller's non-fundamental representations and warranties will be capped at 25% of the Purchase Price, calculated as 25% × $18,000,000 = $4,500,000. This cap represents a reasonable balance between Buyer's need for meaningful indemnification protection and Seller's desire to limit post-closing exposure.
Indemnification Basket. The APA will include a tipping basket (also known as a first-dollar basket) with a threshold of 1% of the Purchase Price, calculated as 1% × $18,000,000 = $180,000. Under the tipping basket structure, Seller has no indemnification liability unless and until the aggregate amount of Buyer's Losses exceeds $180,000, at which point Seller becomes liable for the full amount of all Losses from the first dollar — not merely the excess over the basket threshold. This structure provides Seller with protection against nuisance claims and de minimis losses while ensuring that once the threshold is crossed, Buyer recovers the full amount of its losses.
Fundamental Representations. Breaches of Fundamental Representations — defined to include Seller's representations regarding organization, authority, title to acquired assets, brokers, and taxes — will not be subject to the cap. Seller's liability for breaches of Fundamental Representations will extend up to the full amount of the purchase price received by Seller, reflecting the heightened importance of these representations and the expectation that breaches of Fundamental Representations are more likely to involve knowing or intentional misconduct.
B. Purchase Price Definition for Indemnification Purposes
A key drafting question is whether "Purchase Price" for purposes of the indemnification cap and basket includes the earnout consideration.
Recommendation. We recommend that "Purchase Price" for purposes of calculating the indemnification cap and basket be defined as the base purchase price of $18,000,000, which includes the upfront cash ($14,500,000), the escrow amount ($2,000,000), and the target earnout ($1,500,000), but excludes the additional $2,000,000 of upside earnout above the target level.
Rationale. The indemnification cap and basket should be based on a fixed amount that is known and determinable at the time of signing, rather than on a contingent amount that will not be finally determined until after the conclusion of the Earnout Period. Using a fixed base purchase price of $18,000,000 provides certainty to both parties regarding the scope of the indemnification regime and allows the indemnification provisions to operate independently of the earnout outcome. Additionally, if the total earnout paid exceeds the target level (i.e., Seller receives total consideration in excess of $18,000,000), the indemnification cap does not increase, which is favorable to Buyer. Conversely, if the earnout is less than the target (or zero), the cap remains at $4,500,000, which provides Buyer with a consistent level of indemnification protection regardless of the earnout outcome.
C. Escrow as Source of Indemnification Recovery
Escrow Mechanics. The $2,000,000 indemnification escrow will be held by Pinnacle Trust Company (reference number PT-2023-00418) pursuant to an Escrow Agreement entered into at Closing. The Escrow Amount will be invested in accordance with the investment instructions set forth in the Escrow Agreement (anticipated to provide for investment in money market funds or short-term U.S. Treasury obligations). Interest earned on the Escrow Amount will be allocated to Seller for tax purposes and will be released to Seller together with the principal balance.
Release Schedule. The Escrow Amount (or the remaining balance thereof, net of any amounts disbursed to satisfy resolved claims and any amounts retained to secure pending claims) will be released to Seller on the date that is twelve (12) months following the Closing Date (the "Escrow Release Date"). Assuming a Closing Date of January 20, 2023, the Escrow Release Date would be approximately January 20, 2024. At the time of release, the Escrow Agent will disburse to Seller the balance of the Escrow Amount less (i) any amounts previously disbursed to Buyer in satisfaction of resolved indemnification claims and (ii) any amounts retained to secure pending indemnification claims that have been the subject of timely written notices of claim delivered by Buyer prior to the Escrow Release Date.
Relationship to Direct Claims. The APA should expressly provide that the indemnification escrow serves as Buyer's primary, but not exclusive, source of recovery for indemnification claims. Buyer should not be required to exhaust the escrow before pursuing direct indemnification claims against Seller. This is particularly important given the timing mismatch between the escrow release (12 months post-Closing) and the survival period for Fundamental Representations (36 months post-Closing). During the period between the Escrow Release Date and the expiration of the Fundamental Representation survival period, Buyer must be able to pursue indemnification claims directly against Seller without the protection of the escrow collateral.
Survival Periods. The following survival periods apply:
The alignment of the general representation survival period with the Escrow Release Date is intentional — it ensures that Buyer has escrow security throughout the period during which general representation claims may be asserted. However, claims under Fundamental Representations (and potentially tax representations) may be asserted after the escrow has been released, requiring Buyer to rely on direct claims against Seller and/or the R&W insurance policy described below.
D. R&W Insurance Interaction
Policy Overview. Buyer has arranged a buyer-side representations and warranties insurance policy from Coventry Mutual Insurance Co. The key terms of the policy are as follows:
Function of R&W Insurance. The R&W policy provides Buyer with an additional layer of recovery beyond the $4,500,000 indemnification cap for breaches of Seller's representations and warranties. The $9,000,000 policy limit, combined with the $4,500,000 indemnification cap, provides Buyer with aggregate recovery capacity of up to $13,500,000 for representation and warranty breaches (subject to the retention and policy exclusions). The R&W policy also reduces friction in the negotiation of the indemnification provisions, as Seller may be more willing to accept a lower cap knowing that Buyer has recourse to the insurance policy for losses exceeding the cap.
Retention Structure. The $450,000 retention is split equally between Seller and Buyer. The Seller portion ($225,000) is effectively an indemnification obligation that must be exhausted before the R&W policy responds — Seller's first $225,000 of indemnification liability is effectively a deductible under the policy. The Buyer portion ($225,000) represents Buyer's self-insured retention.
Earnout-Related Losses. A critical open item is whether the R&W policy covers earnout-related losses — specifically, losses arising from Seller's breach of representations and warranties that cause a reduction in volume during the Earnout Period. For example, if Seller's representation regarding the absence of undisclosed material liabilities is breached, and the resulting undisclosed liability (such as an environmental remediation obligation or a product liability claim) disrupts manufacturing operations and reduces volume during the Earnout Period, Buyer may suffer two categories of loss: (i) direct losses from the breach (e.g., remediation costs) and (ii) indirect losses in the form of reduced earnout volume and the corresponding inability to recover the earned portion of the earnout from Seller (since Buyer is the payor). The R&W policy should cover both categories of loss to the extent they arise from breaches of covered representations.
Recommendation. We recommend coordinating with Coventry Mutual Insurance Co. (through Underwriter Gail Emerson) to confirm that the R&W policy does not exclude earnout-related diminution in value from the definition of covered losses. Specifically, Buyer should request written confirmation that (i) losses resulting from volume reductions during the Earnout Period caused by breaches of Seller's representations are covered losses under the policy, and (ii) the policy does not contain an exclusion for consequential damages, lost profits, or diminution in value that would operate to exclude earnout-related losses. If the standard policy form contains such exclusions, we should negotiate endorsements or carve-outs to ensure coverage.
E. Setoff Rights
Recommendation. The APA should include a right of setoff entitling Buyer to withhold from earnout payments amounts equal to unsatisfied indemnification claims. This right is particularly important given the timing gap between the Escrow Release Date (January 20, 2024) and the earnout payment date (March 17, 2025). During this approximately 14-month gap, Buyer will have no collateral security for post-escrow indemnification claims. The right to set off against earnout payments provides Buyer with a practical mechanism for recovering indemnification losses that arise (or remain unresolved) after the escrow has been released.
Scope of Setoff Right. We anticipate that Seller will resist broad setoff rights, arguing that the right to withhold earnout payments based on unresolved indemnification claims gives Buyer an unfair ability to manufacture claims to reduce or eliminate the earnout. To address this concern, we recommend the following compromise:
Buyer may set off against earnout payments only for indemnification claims that (i) have been reduced to a final, non-appealable judgment by a court of competent jurisdiction, or (ii) are the subject of a pending, good-faith written notice of claim delivered by Buyer to Seller prior to the earnout payment date, supported by a reasonable estimate of the claimed losses and a description of the factual and legal basis for the claim.
For claims in category (ii), Buyer may withhold from the earnout payment an amount equal to Buyer's good-faith estimate of the pending claim. Any amounts withheld for pending claims will be placed in a separate interest-bearing escrow account (or retained by Buyer, depending on the negotiated terms) and will be released to Seller promptly upon resolution of the pending claim to the extent the claim is resolved in Seller's favor.
This approach balances Buyer's need for security against unresolved indemnification claims with Seller's legitimate interest in receiving earned consideration in a timely manner. It prevents Buyer from using frivolous claims to withhold earnout payments while preserving Buyer's right to protect itself against genuine losses.
VII. PURCHASE PRICE ALLOCATION
A. Tax Allocation Overview
Because the transaction is structured as an asset purchase, the parties must agree on the allocation of the purchase price among the acquired assets for federal and state income tax purposes. Section 1060 of the Internal Revenue Code and the Treasury Regulations promulgated thereunder (specifically Treas. Reg. § 1.1060-1(a)) require that in an "applicable asset acquisition" (defined as any transfer of a trade or business in which the transferee's basis in the acquired assets is determined wholly by reference to the consideration paid), the consideration must be allocated among the acquired assets using the residual method prescribed by Section 338(b)(5) and Treas. Reg. § 1.338-6.
Both parties are required to file IRS Form 8594 (Asset Acquisition Statement Under Section 1060) with their respective federal income tax returns for the taxable year in which the acquisition occurs. The parties are obligated to allocate the purchase price consistently on their respective Form 8594 filings, and any inconsistent reporting may trigger IRS scrutiny and adverse tax consequences.
Tax Advisors. Buyer's tax advisor for purposes of the purchase price allocation is Halcyon Chartered Accountants LLP, with Martin Szabo, CPA, serving as engagement partner. Seller's tax advisor is Ridgeway & Associates, P.C., with Denise Ridgeway, CPA, serving as lead advisor, located at 95 Franklin Street, Suite 400, Buffalo, NY 14202. Both firms should be involved in the negotiation and preparation of the agreed allocation schedule.
B. Proposed Allocation Among Asset Classes
Under the residual method, the purchase price is allocated among seven classes of assets in order of priority (Class I through Class VII), with the residual (unallocated) amount assigned to goodwill and going concern value (Class VII). The preliminary allocation framework set forth below is subject to final negotiation with Seller and third-party valuation:
Class I — Cash and Cash Equivalents: $0. Cash and cash equivalents are excluded from the acquired assets under the APA. No allocation is required.
Class II — Certificates of Deposit, Government Securities, and Similar Items: $0. No Class II assets are included in the acquired assets. No allocation is required.
Class III — Accounts Receivable, Mortgages, and Credit Card Receivables: $0. Pre-Closing accounts receivable are excluded from the acquired assets. All receivables generated prior to the Closing Date will be retained by Seller. No allocation is required.
Class IV — Inventory: Approximately $2,100,000. The acquired assets include all inventory of the ProShield Product Line, consisting of raw materials (approximately $750,000), work-in-process (approximately $400,000), and finished goods (approximately $950,000). The estimated Closing inventory of approximately $2,100,000 is based on Seller's most recent inventory counts and cost records, adjusted for expected production and shipment activity through the anticipated Closing Date. The final inventory valuation will be determined as part of the Closing working capital adjustment process.
Class V — Equipment and Other Tangible Assets: Approximately $3,200,000. The acquired assets include all tangible personal property used in the operation of the ProShield Product Line, including:
• Three (3) high-speed dispersion mills;
• Two (2) automated filling lines;
• Fourteen (14) stainless steel mixing tanks, each with a capacity of 5,000 gallons;
• Laboratory and quality control equipment, including spectrophotometers, viscometers, pH meters, gloss meters, and related analytical instruments;
• Packaging and labeling equipment;
• Miscellaneous tools, fixtures, and spare parts.
The estimated fair market value of $3,200,000 is based on Seller's fixed asset schedule book values, adjusted for estimated fair market value based on Buyer's preliminary assessment. A formal equipment appraisal may be required to support the final allocation.
Class VI — Section 197 Intangibles Other Than Goodwill and Going Concern Value: To Be Determined. The acquired assets include significant Section 197 intangible assets, including:
• The ProShield trademark (U.S. Registration No. 2,876,411), including all associated trade dress, logos, and brand elements;
• Forty-seven (47) proprietary coating formulations and related trade secrets;
• Customer-specific formulation libraries developed by Seller over the course of its operations;
• Twenty-three (23) active customer supply agreements and associated customer relationships;
• Covenants not to compete from Frederick G. Voss and Elena M. Voss (discussed further in Section VII.E below); and
• Other intangible assets, including technical documentation, training materials, and regulatory approvals.
The allocation to Class VI intangibles will require a third-party valuation to establish the fair market value of the individual intangible assets. This valuation should be performed by Halcyon Chartered Accountants LLP (or a valuation specialist engaged by Halcyon) and should employ standard valuation methodologies including the relief-from-royalty method (for trademarks), the multi-period excess earnings method (for customer relationships), and the cost approach (for formulations and trade secrets).
Class VII — Goodwill and Going Concern Value: Residual. The balance of the purchase price after allocations to Classes I through VI will be assigned to goodwill and going concern value. Goodwill represents the premium paid by Buyer over the aggregate fair market value of the identifiable tangible and intangible assets, reflecting the going concern value of the ProShield Product Line, its assembled workforce, its market position, and other value-creating factors not separately identifiable.
C. Buyer's Allocation Priorities
Crestline's tax planning objective is to maximize the allocation of purchase price to asset categories with shorter depreciable or amortizable lives, thereby accelerating the tax deductions available to Buyer and reducing the present value of Buyer's after-tax acquisition cost.
Equipment (Class V): 5- or 7-Year MACRS Recovery Period. Equipment and other tangible personal property are depreciable under the Modified Accelerated Cost Recovery System (MACRS) over 5-year or 7-year recovery periods, depending on the asset category. Equipment depreciation provides relatively rapid tax deductions compared to the 15-year amortization period applicable to Section 197 intangibles and goodwill. Accordingly, maximizing the allocation to equipment (to the extent supportable by fair market value) is tax-favorable for Buyer.
Inventory (Class IV): Deductible as Cost of Goods Sold. The cost of acquired inventory is recovered as a deduction when the inventory is sold to customers, which typically occurs within months of the acquisition. This provides the fastest tax recovery of any asset class and makes inventory allocation highly tax-efficient for Buyer.
Section 197 Intangibles and Goodwill (Classes VI and VII): 15-Year Amortization. Both Section 197 intangibles and goodwill are amortizable over a 15-year period on a straight-line basis. While 15-year amortization is less favorable than the shorter recovery periods available for equipment and inventory, it is nevertheless preferable to a non-deductible allocation (e.g., land). Imp

PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT

MEMORANDUM

MATTER NO.: 1006-00007

I. EXECUTIVE SUMMARY

II. PROPOSED PURCHASE PRICE STRUCTURE

V. EARNOUT DISPUTE RESOLUTION

VI. INTERACTION WITH INDEMNIFICATION FRAMEWORK

VII. PURCHASE PRICE ALLOCATION

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