1009-00001 · Skybridge Fintech Ltd · Analysis & Strategy

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MEMORANDUM

PRIVILEGED & CONFIDENTIAL ATTORNEY-CLIENT COMMUNICATION

November 22, 2023

FROM: Calderwood & Harkness LLP 600 Lexington Avenue New York, NY 10022

TO: Arjun Mehta, Chief Executive Officer & Co-Founder David Lindstrom, Chief Financial Officer Priya Ramanathan, General Counsel

Skybridge Fintech Ltd. 1400 Market Street, Suite 2200 Wilmington, DE 19801

RE: Federal and Delaware Tax Considerations for Proposed $60,000,000 Convertible Promissory Note Bridge Financing

MATTER NO.: 1009-00001

PREPARED BY: Leonard Ashford, Of Counsel, Emerging Companies & Venture Capital Nina Reyes, Senior Associate, Emerging Companies & Venture Capital

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I. Executive Summary

You have asked us to analyze the federal income tax and Delaware tax implications arising from Skybridge Fintech Ltd.'s (the "Company") proposed issuance of $60,000,000 in aggregate principal amount of convertible promissory notes (the "Notes" or "Convertible Notes") to a syndicate of institutional investors led by Ridgeline Ventures Fund IV, L.P. (the "Lead Investor" and, together with the other investors described herein, the "Purchasers"). This memorandum is prepared in connection with the proposed bridge financing transaction (the "Bridge Financing" or the "Transaction") as described in the term sheet dated November 20, 2023 (the "Term Sheet") circulated to us by the Company's General Counsel.

This memorandum addresses the following key areas of federal and Delaware tax analysis:

1. Debt versus Equity Classification. Whether the Notes should be properly classified as debt instruments, rather than equity, for federal income tax purposes — a threshold determination that governs the applicability of the interest deduction rules, original issue discount provisions, and the tax treatment of conversion and repayment events.

2. Original Issue discount (OID). Whether the stated interest payable on the Notes constitutes "qualified stated interest" under the applicable Treasury Regulations or, alternatively, is required to be treated as OID, with the attendant accrual and reporting consequences for both the Company and the Purchasers.

3. Treatment of Stated Interest. The federal income tax characterization and timing of the 6.00% per annum simple interest (600 basis points) accruing on the Notes, computed on a 365-day year basis, including the deductibility of such interest by the Company.

4. Tax Consequences of Conversion. The federal income tax treatment of the automatic conversion of the Notes into equity securities of the Company upon the occurrence of a Qualified Financing, as well as the optional conversion at maturity, including the treatment of accrued but unpaid interest that converts into equity.

5. Tax Treatment at Maturity. The federal income tax consequences to both the Company and the Purchasers if the Notes are not converted and are instead repaid in cash at maturity.

6. Change of Control Payment. The federal income tax implications of the change of control provision, which entitles holders to the greater of a 2.0x multiple of outstanding principal plus accrued interest or the amount payable upon conversion at the Valuation Cap.

7. Delaware Tax Considerations. The impact of the Transaction on the Company's Delaware franchise tax obligations, including the potential effects of conversion on the franchise tax calculation, as well as related Delaware unclaimed property and state income tax considerations.

In addition, this memorandum addresses the applicability of Section 409A of the Internal Revenue Code, information reporting and withholding obligations, the tax implications of the most favored nation provision, and the impact of the Bridge Financing on the Company's existing capital structure.

Please note that this memorandum is intended as a preliminary analysis based upon the Term Sheet and the deal structure as described to us as of the date hereof. Our final analysis should be revisited upon the execution of definitive transaction documents, including the Note Purchase Agreement and the form of Convertible Promissory Note. This memorandum is prepared solely for the benefit of the Company and its officers and directors named above, and does not constitute tax advice to the Purchasers or any other third party. The Purchasers should consult their own tax advisors regarding the tax consequences of the Transaction.

II. Background and Transaction Summary

A. The Company

Skybridge Fintech Ltd. (the "Company") is a Delaware C-corporation (EIN: 83-2147605; Delaware File Number: 6384291) incorporated in 2017. The Company operates a cloud-based payments orchestration and embedded lending platform, providing integrated financial technology infrastructure to enterprise and mid-market clients across multiple industry verticals. The Company's principal executive offices are located at 1400 Market Street, Suite 2200, Wilmington, Delaware 19801.

B. Proposed Transaction

The Company proposes to issue convertible promissory notes in an aggregate principal amount of $60,000,000 to the Purchaser syndicate. The material economic terms of the Notes, as set forth in the Term Sheet, are summarized below.

Interest Rate. The Notes bear interest at a rate of 6.00% per annum (600 basis points), computed as simple interest on a 365-day year basis. Based on the full aggregate principal amount of $60,000,000, annual interest accrual would total $3,600,000. Interest accrues from the date of issuance and is payable upon conversion or at maturity, as described below.

Maturity Date. The Notes mature twenty-four (24) months from the date of closing. Assuming a closing date of January 15, 2024, the anticipated maturity date would be January 15, 2026.

Conversion Mechanics — Automatic Conversion. Upon the occurrence of a Qualified Financing — defined as a Series D preferred stock financing raising at least $80,000,000 in new equity capital — all outstanding principal and accrued but unpaid interest on the Notes automatically convert into equity securities of the Company at the Conversion Price. The Conversion Price is defined as the lower of:

(a) 80% of the price per share paid by investors in the Series D preferred stock financing (reflecting a 20% conversion discount); or

(b) the price per share implied by a $750,000,000 pre-money valuation cap on a fully diluted basis (the "Valuation Cap"), which, based on approximately 48,500,000 fully diluted shares outstanding immediately prior to the Bridge Financing, implies a conversion price of approximately $15.46 per share (the "Cap-Implied Conversion Price").

Optional Conversion at Maturity. If no Qualified Financing occurs prior to the Maturity Date, each holder of Notes has the election to either (i) convert the outstanding principal and accrued interest on its Notes into equity of the Company at the Cap-Implied Conversion Price, or (ii) demand repayment in cash of the outstanding principal plus all accrued and unpaid interest.

Change of Control Provision. Upon the occurrence of a Change of Control (as defined in the Term Sheet) prior to conversion, each holder of Notes is entitled to receive the greater of:

(i) 2.0x the outstanding principal amount plus all accrued and unpaid interest on such holder's Notes (resulting in a maximum aggregate Change of Control payment of $120,000,000 at issuance, assuming the 2.0x amount exceeds the cap-conversion value); or

(ii) the amount that would be payable to such holder upon conversion of the Notes at the Cap-Implied Conversion Price.

Most Favored Nation (MFN) Provision. The Notes include a most favored nation provision providing that if the Company issues any subsequent convertible note or Simple Agreement for Future Equity ("SAFE") on terms that are more favorable to the purchaser thereof than the terms of the Notes, the holders of the Notes shall have the right to amend the terms of their Notes to incorporate such more favorable terms.

Subordination. The Notes are subordinated in right of payment to the Company's existing $15,000,000 venture debt facility with Kelvantis Lending Corp. (the "Kelvantis Facility"), issued pursuant to that certain Loan and Security Agreement, dated August 15, 2022, by and between the Company and Kelvantis Lending Corp.

C. Purchaser Syndicate

The Notes will be purchased by the following institutional investors:

All Purchasers are United States institutional investment funds organized as Delaware limited partnerships or limited liability companies. Ridgeline Ventures Fund IV, L.P. and Beacon Hill Capital Partners, LLC are existing investors in the Company, having participated in prior preferred stock rounds. Northstar Innovation Fund II, L.P. is a new investor. Halcyon Growth Equity, L.P. is an existing investor that participated in the Company's Series B financing. All transactions between the Company and the Purchasers are conducted at arm's length.

D. Company Financial Snapshot

The Company's current financial position, as reported to us by the Company's Chief Financial Officer, is summarized below:

The Company's most recent independent 409A valuation, prepared by Atlas Valuation Services, Inc. and dated September 15, 2023, established the fair market value of the Company's common stock at $8.42 per share. This valuation is relevant to several aspects of the tax analysis set forth below, including the Section 409A analysis in Section X.

III. Debt vs. Equity Classification

A. General Principles

A threshold question in analyzing the federal income tax consequences of the Notes is whether they should be treated as debt or equity for federal income tax purposes. This classification is critical because it determines whether the Company is entitled to deduct interest payments, whether holders must accrue original issue discount, and whether the conversion of the Notes into equity is treated as a recapitalization or as a taxable exchange.

The Internal Revenue Code does not provide a bright-line test for distinguishing debt from equity. Instead, the determination is made based on a multi-factor analysis that weighs the economic substance of the instrument against its legal form. Courts have developed numerous factors to be considered, though no single factor is dispositive. Among the most commonly cited factors, drawn from cases such as Mixon v. United States, 464 F.2d 394 (5th Cir. 1972), and the factors articulated in Notice 94-47, 1994-1 C.B. 357, are the following:

• Whether there is an unconditional obligation to pay a sum certain on a fixed date;

• Whether holders possess the right to enforce payment of principal and interest;

• Whether the instrument bears a stated interest rate that reflects market conditions;

• Whether the instrument has a fixed maturity date;

• The degree of subordination of the instrument to other obligations of the issuer;

• The debt-to-equity ratio of the issuer before and after the issuance;

• The intent of the parties to create a debtor-creditor relationship;

• Whether the instrument is convertible into equity of the issuer;

• Whether the instrument participates in the profits of the issuer;

• Whether the holders are existing equity holders (proportionality of holdings); and

• Whether the issuer has the ability to obtain financing from independent creditors on comparable terms.

The IRS has historically scrutinized convertible instruments issued by closely held and private companies with particular care, given the potential for instruments denominated as "debt" to function economically as equity capital contributions. Nevertheless, the case law and administrative guidance recognize that convertible notes can constitute bona fide debt for federal income tax purposes, provided the economic substance of the instrument supports that classification.

B. Application to the Skybridge Convertible Notes

Applying the multi-factor analysis to the Notes, we identify the following factors supporting and potentially undermining debt treatment.

Factors Supporting Debt Treatment. Several significant factors support the classification of the Notes as debt for federal income tax purposes:

• Stated Interest Rate. The Notes bear a stated interest rate of 6.00% per annum, which represents a commercially reasonable rate for subordinated convertible bridge notes issued by a venture-backed technology company with Skybridge's financial profile. The rate is fixed, applies uniformly to all Purchasers, and does not fluctuate based on the Company's financial performance.

• Fixed Maturity Date. The Notes have a fixed maturity date of twenty-four months from closing (January 15, 2026, assuming a January 15, 2024 closing). At maturity, holders have the right to demand repayment of principal plus accrued interest in cash. The existence of a fixed maturity date and a mandatory repayment obligation is one of the strongest indicia of debt treatment.

• Mandatory Repayment Obligation. Absent conversion (whether automatic upon a Qualified Financing or elective at maturity), the Company is unconditionally obligated to repay the outstanding principal and accrued interest in cash on the Maturity Date. This repayment obligation exists regardless of the Company's financial condition, profitability, or available cash.

• Written Promissory Notes. The obligations will be evidenced by written promissory notes executed by the Company in favor of each Purchaser, reflecting the intent of the parties to create a debtor-creditor relationship.

• Arm's-Length Terms. The Notes are issued to institutional investors in an arm's-length transaction, with terms that reflect market conditions for convertible bridge financings in the venture capital industry.

Factors That Could Weigh Toward Equity Treatment. Certain features of the Notes could, in isolation, be viewed as equity-like characteristics:

• Conversion Feature. The Notes are convertible into equity of the Company, either automatically upon a Qualified Financing or at the election of the holders at maturity. The conversion feature, together with the 20% conversion discount and the $750,000,000 valuation cap, gives the Notes an equity-linked character that could be argued to diminish their debt-like qualities.

• Subordination. The Notes are subordinated in right of payment to the Kelvantis Facility. Subordination is a factor that courts and the IRS have identified as weighing against debt treatment, though subordination to senior secured indebtedness is a common and commercially expected feature of convertible bridge notes.

• Equity-Linked Economics. The conversion discount and valuation cap effectively provide the Purchasers with an equity upside that is not characteristic of a traditional fixed-income obligation. If the Company's value increases significantly, the Purchasers will benefit through a lower conversion price, which resembles an equity return rather than a fixed return on debt capital.

Assessment. On balance, we believe there is a strong basis for treating the Notes as debt for federal income tax purposes during the period prior to conversion. The Notes possess the core indicia of indebtedness: a stated interest rate, a fixed maturity date, an unconditional repayment obligation at maturity, and the form of written promissory notes evidencing the debtor-creditor relationship. The conversion feature, while an equity-linked characteristic, is contingent upon a future event (the Qualified Financing) that may or may not occur. Until conversion, the Notes function as debt obligations of the Company with respect to which the Company owes a fixed sum certain on a date certain.

We further note that all four Purchasers are third-party institutional investment funds transacting at arm's length. While certain Purchasers (Ridgeline, Beacon Hill, and Halcyon) are existing equity investors in the Company, their participation in the Bridge Financing is through new and separate investment vehicles, and the terms of the Notes do not suggest a proportionality of holdings that would undermine debt treatment. The mix of existing and new investors can sometimes be a factor in the debt-equity analysis, but here the arm's-length nature of the transaction and the commercially reasonable terms of the Notes militate in favor of debt classification.

C. Risk Factors and Limitations

Notwithstanding the foregoing analysis, we identify the following risk factors and limitations:

Debt-to-Equity Ratio. Upon issuance of the Notes, the Company's total outstanding indebtedness will be approximately $75,000,000 ($15,000,000 under the Kelvantis Facility plus $60,000,000 in Convertible Notes). When compared to the Company's historical equity capitalization — which includes total paid-in capital from Series A, B, and C preferred stock financings resulting in a Series C post-money valuation of $620,000,000 — the debt-to-equity ratio does not appear to be excessively leveraged. However, the Company's current 409A common stock valuation of $8.42 per share implies a significantly lower equity value for common stockholders, and the Company's ongoing operating losses (monthly burn of ~$4.8 million) could, in theory, raise questions about the Company's ability to service the debt absent additional equity financing. The IRS could point to these factors as evidence that the Notes are more akin to equity contributions than bona fide debt.

Mitigating Factors. Several considerations mitigate this risk. First, the Notes are designed to convert automatically upon a near-term Qualified Financing, which the Company expects to complete in Q3–Q4 2024 — well before the Maturity Date. The short 24-month tenor of the Notes limits the period during which debt classification could be challenged. Second, the Purchasers are bona fide third-party institutional investors with no obligation to invest additional equity in the Company, and their investment decision was made on arm's-length terms. Third, the Company has sufficient post-bridge cash (approximately $78.5 million, providing approximately 16.4 months of runway) to service the interest obligation during the expected life of the Notes.

We believe the risk of a successful IRS challenge to the debt classification of the Notes is low, but it cannot be eliminated entirely. If the Company's financial condition deteriorates materially, or if the anticipated Qualified Financing is significantly delayed, the risk profile may change.

IV. Original Issue discount (OID) Analysis

A. General Framework — IRC Sections 1272, 1273, and 1274

Under Section 1273(a) of the Internal Revenue Code, original issue discount is defined as the excess, if any, of a debt instrument's "stated redemption price at maturity" over its "issue price." The stated redemption price at maturity includes all payments required to be made under the instrument other than payments of "qualified stated interest" (as defined below). The issue price of a debt instrument issued for cash is generally equal to the amount of cash paid for the instrument. See IRC § 1273(b)(2).

In the case of the Notes, the issue price of each Note is equal to the principal amount paid by the respective Purchaser. Accordingly, the aggregate issue price of the Notes is $60,000,000.

The stated redemption price at maturity of each Note includes the principal amount plus any amounts payable at maturity that do not constitute qualified stated interest. As discussed in greater detail below, the characterization of the 6.00% stated interest is central to the OID analysis.

If OID exists, it must be accrued into income by the holder on a constant-yield basis over the life of the instrument under Section 1272(a), regardless of the holder's overall method of accounting. Even a cash-method holder must include OID in income as it accrues, irrespective of whether cash payments are received. For the Company, OID that accrues is treated as interest expense, deductible under Section 163 subject to the limitations discussed in Section V below.

B. Treatment of Stated Interest

The Notes bear interest at a rate of 6.00% per annum, computed as simple interest on a 365-day year basis. Annual interest accrual on the full $60,000,000 principal amount is $3,600,000. Over the full 24-month term, total stated interest would be approximately $7,200,000.

The critical question for OID purposes is whether the stated interest on the Notes constitutes "qualified stated interest" ("QSI") under Treasury Regulation § 1.1273-1(c). QSI is defined as stated interest that is unconditionally payable in cash or in property (other than debt instruments of the issuer) at fixed periodic intervals of one year or less during the entire term of the debt instrument, at a single fixed rate. Treas. Reg. § 1.1273-1(c)(1)(i).

The significance of this determination is as follows: if the stated interest qualifies as QSI, it is excluded from the stated redemption price at maturity, and no OID arises (assuming the Notes are issued at par). If, however, the stated interest does not qualify as QSI, it is included in the stated redemption price at maturity, resulting in OID equal to the total amount of such non-qualified interest.

Analysis of QSI Requirements. Under the proposed structure described in the Term Sheet, interest on the Notes accrues at 6.00% per annum but is not payable in cash on a periodic basis. Rather, interest accrues and is payable only upon the earliest of (i) conversion of the Notes (at which point accrued interest converts into equity), (ii) repayment at maturity, or (iii) a Change of Control. Interest is not unconditionally payable in cash at least annually.

This structure fails to satisfy the QSI requirements of Treasury Regulation § 1.1273-1(c)(1)(i) for two reasons. First, the interest is not payable at fixed periodic intervals of one year or less; it accrues and is payable only upon conversion, maturity, or a Change of Control. Second, and perhaps more significantly, interest that is payable upon conversion is satisfied through the issuance of equity securities of the Company rather than cash. Interest payable in property other than cash may still qualify as QSI, but the issuance of stock of the issuer in satisfaction of an interest obligation does not constitute payment of interest in "property (other than debt instruments of the issuer)" for QSI purposes, because the conversion mechanism operates as an exchange rather than a cash payment.

Conclusion. Because the 6.00% stated interest on the Notes is not unconditionally payable in cash at fixed periodic intervals of one year or less, it likely does not qualify as QSI under Treasury Regulation § 1.1273-1(c). Instead, the stated interest would be included in the stated redemption price at maturity and treated as OID for federal income tax purposes.

Alternative Analysis. We note that if the definitive note documents are structured such that the Company has an affirmative, unconditional right (not merely the option) to pay interest in cash at least annually — for example, through a mandatory annual interest payment provision — there may be a basis for treating the interest as QSI, thereby eliminating OID. We recommend that this structural alternative be discussed with the Company and the Purchasers in connection with the negotiation of definitive documents, as the elimination of OID would simplify the tax reporting obligations for both the Company and the holders. However, we understand that the current intent is for interest to accrue and be payable only upon conversion or maturity, which precludes QSI treatment.

C. OID Accrual Requirements

If, as we expect, the stated interest is treated as OID, the following accrual and recognition rules apply:

Holders. Each Purchaser (holder) must accrue OID into income over the life of its Note using the constant-yield method prescribed by Section 1272(a). Under this method, OID for each accrual period is calculated by multiplying the holder's adjusted issue price at the beginning of the period by the yield to maturity of the instrument, and subtracting any QSI allocable to the period (zero, in this case). This accrual is required regardless of the holder's overall method of accounting; even cash-method holders must include OID in gross income as it accrues. The holder's tax basis in the Note increases by the amount of OID included in income.

Company. For the Company, the OID accrued on the Notes is treated as interest expense, deductible under Section 163 (subject to the limitations discussed in Section V below). The Company recognizes the deduction as the OID accrues, consistent with its accrual method of accounting.

Illustrative Calculation. For purposes of illustration, assuming a 24-month term, an aggregate principal amount of $60,000,000, and total stated interest of $7,200,000 (computed as simple interest at 6.00% per annum), the total OID over the full term would be approximately $7,200,000 on a simple basis. Under the constant-yield methodology, which assumes semi-annual compounding, the actual OID accrual pattern would result in somewhat higher total OID due to the compounding effect. We note that annual interest on the full principal amount is $3,600,000, and the precise accrual schedule would be determined based on the closing date and the specific terms of the definitive note documents.

We recommend that the Company's tax advisors at Pinnacle Audit Group LLP prepare a detailed OID accrual schedule upon closing, reflecting the actual closing date, yield to maturity, and accrual periods.

D. Conversion Feature and Contingent Payment Debt Instrument (CPDI) Rules

An additional question arises as to whether the conversion feature (including the 20% discount and the $750,000,000 valuation cap) or the Change of Control payment provision could cause the Notes to be classified as contingent payment debt instruments ("CPDIs") under Treasury Regulation §§ 1.1275-4.

General Rule. Under Treasury Regulation § 1.1275-4(a), a debt instrument that provides for one or more contingent payments is a CPDI, and is subject to the specialized CPDI accrual and allocation rules, unless an exception applies. CPDI treatment would significantly complicate the tax reporting for both the Company and the holders, as it would require the application of a "projected payment schedule" and the recognition of gain or loss upon the resolution of contingencies.

Conversion Feature Exception. Treasury Regulation § 1.1275-4(a)(4) provides a critical exception: a debt instrument is not treated as a CPDI solely because it is convertible into stock of the issuer or provides for a payment or series of payments that are adjusted based on the issuer's stock. This exception is directly applicable to the Notes, which are convertible into equity securities of the Company. Accordingly, the conversion feature — including the 20% discount and the valuation cap mechanism — should not cause the Notes to be treated as CPDIs.

Change of Control Provision. The Change of Control provision, which entitles holders to the greater of (i) 2.0x outstanding principal plus accrued interest or (ii) the amount payable upon conversion at the Valuation Cap, warrants separate analysis. The 2.0x multiple payment is a fixed amount determinable at issuance and is not contingent on the Company's stock price or equity value. However, the "greater of" formulation introduces a contingent element: the actual payment depends on a comparison between the 2.0x amount and the cap-conversion value, the latter of which is tied to the Company's equity value at the time of a Change of Control.

We believe the Change of Control provision is analogous to acceleration clauses, put rights, and early termination provisions commonly found in convertible notes and other debt instruments. Under Treasury Regulation § 1.1275-4(a)(4) and the related interpretive guidance, such provisions are generally not treated as contingent payments that would cause the instrument to be classified as a CPDI. The Change of Control provision is more properly viewed as a redemption feature that provides for an alternative payment upon a defined acceleration event, rather than a contingent payment in the relevant sense.

Assessment. We believe the Notes should not be treated as CPDIs. The conversion feature is squarely within the exception of Treasury Regulation § 1.1275-4(a)(4), and the Change of Control provision, while containing a contingent element, is analogous to provisions that have generally been held not to trigger CPDI treatment. However, we note that the analysis is inherently fact-specific, and the IRS has not issued definitive guidance addressing the precise structure of the Change of Control provision in the Notes.

Recommendation. We recommend that the Company monitor developments in IRS guidance relating to the CPDI rules as applied to convertible instruments with change of control provisions. If the risk of CPDI treatment is deemed material by the Company or the Purchasers, consideration should be given to obtaining a formal tax opinion addressing this specific issue.

V. Tax Treatment of Interest — Company Deductions

A. Interest Expense Deduction Under Section 163

Under Section 163(a) of the Internal Revenue Code, the Company is generally entitled to deduct "all interest paid or accrued within the taxable year on indebtedness." To the extent the Notes are properly classified as debt (as analyzed in Section III above), the interest accruing on the Notes — whether characterized as stated interest or OID — constitutes deductible interest expense for the Company.

Timing of Deduction. The Company is an accrual-basis taxpayer. Accordingly, the Company's deduction for interest expense (or OID) arises as the interest or OID accrues, rather than when it is paid. Under the OID rules, the Company's deduction is computed on a constant-yield basis, consistent with the accrual methodology applicable to the holders. The Company's annual interest deduction attributable to the Notes is expected to be approximately $3,600,000 per year (based on the 6.00% stated rate and $60,000,000 principal), subject to the precise OID accrual schedule determined at closing.

B. Section 163(j) Business Interest Limitation

The deductibility of interest expense is subject to the business interest expense limitation imposed by Section 163(j) of the Internal Revenue Code, as amended by the Tax Cuts and Jobs Act of 2017 and further modified by subsequent legislation.

General Rule. Under Section 163(j)(1), the deduction for "business interest" for any taxable year is limited to the sum of:

(i) the taxpayer's business interest income for the taxable year;

(ii) 30% of the taxpayer's adjusted taxable income ("ATI") for the taxable year; and

(iii) the taxpayer's floor plan financing interest for the taxable year (not applicable here).

Application to Skybridge. The Company's total annual interest expense across all outstanding indebtedness is estimated as follows:

Given the Company's pre-profitability status — with a monthly cash burn rate of approximately $4,800,000, implying annual operating losses in excess of $57,000,000 — the Company's ATI is likely to be negative or very limited. Beginning with taxable years after 2021, ATI is calculated without adding back depreciation, amortization, and depletion, which further reduces ATI for capital-intensive or loss-making companies. Consequently, the 30% of ATI component of the Section 163(j) limitation may be zero or near-zero for the Company in the near term, potentially constraining the deductibility of some or all of the Company's business interest expense.

Carryforward. Any business interest expense that is disallowed under Section 163(j) in a given taxable year is carried forward to succeeding taxable years indefinitely under Section 163(j)(2). The disallowed interest is treated as business interest paid or accrued in the succeeding taxable year, subject again to the Section 163(j) limitation in that year. While this preserves the ultimate deductibility of the interest expense, it defers the timing of the deduction, which may affect the Company's tax planning and financial projections.

Small Business Exemption. Section 163(j)(3) provides an exemption for taxpayers with average annual gross receipts of $29,000,000 or less (as adjusted for inflation) for the three prior taxable years. Given the Company's ARR of approximately $78,000,000, it is likely that the Company's average annual gross receipts exceed this threshold, rendering the small business exemption unavailable. We recommend that the Company's tax advisors confirm this calculation based on the Company's actual gross receipts for the 2020, 2021, and 2022 taxable years.

C. Related-Party Interest Considerations

Sections 267(a)(2) and 267(b) of the Internal Revenue Code impose a matching rule that defers the deduction for interest owed to a "related person" until the period in which the corresponding amount is includible in the gross income of the related person. Similarly, Section 163(e)(3) imposes limitations on the deductibility of OID on debt held by related persons.

Application. The Purchasers are third-party institutional investment funds. None of the Purchasers is a "related person" to the Company within the meaning of Section 267(b), which defines related persons to include, among others, individuals and entities that are related by family, ownership, or common control. Specifically:

• Ridgeline Ventures Fund IV, L.P. and Beacon Hill Capital Partners, LLC are existing preferred stock investors, but their equity ownership in the Company does not, based on the information available to us, exceed the 50% threshold required for related-party status under Section 267(b)(2) (more than 50% ownership by value).

• Halcyon Growth Equity, L.P. is an existing Series B investor, but again its ownership stake does not approach the 50% threshold.

• Northstar Innovation Fund II, L.P. is a new investor with no prior equity stake in the Company.

Accordingly, the related-party interest deferral rules of Section 267 and the related-party OID limitations of Section 163(e)(3) should not apply to the Notes. We recommend that the Company confirm the current ownership percentages of each Purchaser (including through affiliated funds) to ensure that no Purchaser, together with its affiliates, holds a sufficient equity stake to trigger related-party treatment.

VI. Tax Consequences of Conversion

A. Automatic Conversion Upon Qualified Financing

Upon the occurrence of a Qualified Financing — defined as a Series D preferred stock financing in which the Company raises at least $80,000,000 in new equity capital — all outstanding principal and accrued but unpaid interest on the Notes automatically convert into equity securities of the Company at the Conversion Price (the lower of 80% of the Series D price per share or the Cap-Implied Conversion Price of approximately $15.46 per share).

General Rule — Tax-Free Recapitalization. Under Section 368(a)(1)(E) of the Internal Revenue Code, an exchange of securities (including convertible debt instruments) for stock in the same corporation qualifies as a "recapitalization," which is a form of tax-free reorganization. Additionally, Section 1036 provides non-recognition treatment for certain exchanges of stock and securities of the same corporation. Under either authority, the conversion of a convertible debt instrument into stock of the issuing corporation is generally treated as a tax-free exchange, with no gain or loss recognized by either the holder or the issuer, subject to certain exceptions.

The automatic conversion of the Notes into Series D preferred stock (or a separate series of preferred stock issued in connection with the conversion) upon a Qualified Financing should qualify as a tax-free recapitalization under Section 368(a)(1)(E), provided the conversion is effectuated as an exchange of the Notes (which constitute "securities" of the Company) for stock of the Company. The conversion is an integral part of the terms of the Notes and is not a separate taxable transaction.

Treatment of Accrued Interest Upon Conversion. A critical exception to the non-recognition treatment applies to the portion of the equity received that is attributable to accrued but unpaid interest on the Notes. Under well-established federal income tax principles, when a debt instrument is converted into stock and the conversion satisfies an accrued interest obligation, the holder is treated as having received a payment of interest equal to the fair market value of the stock received in satisfaction of the accrued interest claim. This amount is taxable to the holder as ordinary income in the year of conversion.

Correspondingly, the Company is treated as having paid the accrued interest at the time of conversion. The fair market value of the stock issued in satisfaction of the accrued interest obligation is deductible by the Company as interest expense (subject to the Section 163(j) limitations discussed in Section V.B above).

For example, if a holder with $30,000,000 in principal has accrued $1,800,000 in interest at the time of conversion (reflecting one year of accrual at 6.00%), the holder would recognize $1,800,000 in ordinary interest income, and the Company would deduct a corresponding $1,800,000 in interest expense (subject to Section 163(j)).

Conversion discount and Bargain Element. The conversion price mechanism — under which the Notes convert at a 20% discount to the Series D price or at the Cap-Implied Conversion Price, whichever is lower — effectively provides the holders with additional shares relative to what they would receive at the full Series D price. This "bargain" element raises the question of whether the difference between the conversion price and the fair market value of the equity received has independent tax significance.

In the context of a tax-free recapitalization, the bargain element inherent in a conversion discount does not give rise to separately taxable income, because the entire conversion (other than the interest component) is treated as a non-recognition exchange. The holder simply receives a basis and holding period in the converted equity that carries over from the surrendered notes, as described below. The conversion discount is a feature of the original terms of the Notes, negotiated at arm's length, and is reflected in the number of shares received rather than in the recognition of additional income.

B. Holder Tax Treatment Upon Conversion

Basis. To the extent the conversion is treated as a tax-free recapitalization under Section 368(a)(1)(E), each holder's aggregate tax basis in the equity securities received upon conversion is equal to the holder's adjusted basis in the surrendered Note immediately prior to conversion. The holder's adjusted basis in the Note includes (i) the original purchase price (i.e., the principal amount paid) and (ii) any OID that has been accrued into income by the holder during the holding period, reduced by (iii) any payments received on the Note (none, prior to conversion, other than the deemed interest payment described above).

For example, if a holder purchased a Note for $30,000,000, accrued $2,700,000 in OID over 18 months (assuming conversion occurs approximately 18 months after issuance), and is treated as receiving $2,700,000 in interest income upon conversion, the holder's basis in the equity received would be approximately $30,000,000 (original basis of $30,000,000, plus $2,700,000 in OID accrued, minus $2,700,000 allocated to the interest component of the conversion). The precise calculation would depend on the timing of conversion and the OID accrual schedule.

Holding Period. Under Section 1223(1), the holding period of equity securities received in a tax-free recapitalization includes (i.e., "tacks" to) the holding period of the surrendered securities (the Notes). This is significant because it determines whether gain on a subsequent sale of the equity is eligible for long-term capital gain treatment. If a holder holds the Note for more than one year prior to conversion, the holding period of the equity received upon conversion would include the pre-conversion holding period of the Note.

No Gain Recognition in the Absence of Boot. In a tax-free recapitalization, gain is recognized by the holder only to the extent that "boot" (i.e., money or other property other than stock or securities) is received. In the automatic conversion upon a Qualified Financing, the holders receive equity securities of the Company in exchange for the Notes; no cash or other property is received. Accordingly, no gain should be recognized by the holders upon conversion (other than the ordinary income attributable to accrued interest, as discussed above), even if the fair market value of the equity received exceeds the holder's adjusted basis in the Note.

C. Company Tax Treatment Upon Conversion

Non-Recognition Under Section 1032. Section 1032(a) of the Internal Revenue Code provides that a corporation does not recognize gain or loss on the receipt of money or other property in exchange for its own stock. Accordingly, the Company does not recognize gain or loss upon the issuance of Series D preferred stock (or any other class of its stock) in exchange for the convertible Notes upon conversion.

Remaining Unamortized OID. To the extent that any OID attributable to the Notes has not been fully amortized as of the date of conversion, the Company's remaining OID deduction would generally be allowed in the taxable year in which the conversion occurs. This accelerated deduction reflects the termination of the debt obligation and the recognition of the full economic cost of the borrowing.

Cancellation of Indebtedness (COD) Income — Section 108(e)(8). Under Section 108(e)(8), if a debtor corporation transfers its own stock in satisfaction of indebtedness, the corporation is treated as having satisfied the indebtedness with an amount of money equal to the fair market value of the stock transferred. If the principal amount of the indebtedness exceeds the fair market value of the stock issued, the excess is treated as cancellation of indebtedness income ("COD income") to the debtor corporation, which must be included in gross income unless an exclusion applies (e.g., the insolvency or bankruptcy exclusions of Section 108(a)).

In the context of the Notes, COD income would arise only if the fair market value of the equity issued upon conversion is less than the adjusted issue price of the Notes at the time of conversion. Given the $750,000,000 valuation cap and the expectation that the Series D valuation will meet or exceed this level, it is unlikely that COD income will arise upon conversion. However, if the Company's valuation declines materially between the issuance of the Notes and the date of conversion — such that the fair market value of the equity issued is less than the adjusted issue price of the Notes — COD income could result. We recommend that the Company monitor its valuation trajectory and consult with its tax advisors regarding COD income risk as the Qualified Financing approaches.

VII. Tax Treatment at Maturity (If No Qualified Financing Occurs)

A. Repayment in Cash

If no Qualified Financing occurs prior to the Maturity Date (January 15, 2026), each holder has the right to demand repayment in cash of the outstanding principal amount plus all accrued and unpaid interest on its Note.

Principal Repayment. The repayment of the principal amount of a debt instrument at maturity does not give rise to gain or loss for either the Company or the holder, provided the instrument is repaid at its adjusted issue price. Because the Notes are expected to be issued at par (i.e., the issue price equals the principal amount), repayment of the principal at par should not result in any gain or loss recognition.

Payment of Accrued Interest. Any accrued and unpaid interest paid in cash at maturity is treated as ordinary income to the holder and is deductible by the Company as interest expense under Section 163, subject to the Section 163(j) limitations discussed in Section V.B above. If the interest has been accrued by the holders as OID during the term of the Notes (as expected, based on the analysis in Section IV.B), the cash payment at maturity would not result in additional income inclusion to the holders, because the OID has already been included in income on an accrual basis. Instead, the cash payment would reduce the holder's adjusted basis in the Note.

No Additional OID. If the Notes are issued at par and repaid at par (with interest treated as OID), and no other payments are made other than the principal and accrued interest, there should be no additional OID recognition at maturity beyond the amounts already accrued during the term of the Notes.

B. Optional Conversion at Valuation Cap

If, at maturity, holders elect to convert their Notes into equity of the Company at the Cap-Implied Conversion Price of approximately $15.46 per share (rather than demanding cash repayment), the tax analysis follows the same framework as the automatic conversion upon a Qualified Financing discussed in Section VI above.

The principal distinction is that the conversion price is fixed at the Cap-Implied Conversion Price rather than being determined by reference to the price paid by investors in a Qualified Financing. The tax-free recapitalization analysis, the treatment of accrued interest as ordinary income, the basis and holding period rules, and the Company's non-recognition under Section 1032 all apply in the same manner as described in Section VI.

The Company should ensure that the definitive note documents clearly specify the mechanics of optional conversion at maturity, including the number and class of shares to be issued, to support the recapitalization characterization for federal income tax purposes.

VIII. Tax Consequences of Change of Control

A. Change of Control Payment Analysis

The Notes provide that upon the occurrence of a Change of Control prior to conversion, each holder is entitled to receive the greater of:

(i) 2.0x the outstanding principal amount plus all accrued and unpaid interest on such holder's Notes; or

(ii) the amount that would be payable to such holder upon conversion of the Notes at the Cap-Implied Conversion Price.

At issuance, the maximum aggregate Change of Control payment under clause (i) would be $120,000,000 (2.0 × $60,000,000 principal), assuming the 2.0x amount exceeds the cap-conversion value. The actual Change of Control payment for each holder would depend on the accrued interest at the time of the Change of Control and the relative values of the 2.0x payment and the cap-conversion payment.

Holder Tax Treatment — If 2.0x Payment Applies. If the Change of Control payment under clause (i) (2.0x principal plus accrued interest) exceeds the cap-conversion value, the holder would receive a cash payment in excess of its adjusted basis in the Note. The tax consequences are as follows:

• The portion of the payment attributable to accrued but unpaid interest is treated as ordinary income to the holder, consistent with the general rules governing interest payments.

• The excess of the payment over the holder's adjusted basis in the Note (after accounting for accrued OID and the interest component) is treated as gain on the retirement of the debt instrument. If the Note is a capital asset in the holder's hands (as is generally the case for institutional investment funds), this gain would be characterized as capital gain — either short-term or long-term depending on whether the holder's holding period exceeds one year at the time of the Change of Control.

• For example, if a holder purchased a Note for $30,000,000, accrued $1,800,000 in OID over one year, and received a Change of Control payment of $63,600,000 (2.0 × ($30,000,000 + $1,800,000)), the holder would recognize $1,800,000 in ordinary interest income (or no additional income if the OID has already been accrued) and $30,000,000 in capital gain ($63,600,000 total payment minus $1,800,000 interest component minus $31,800,000 adjusted basis).

Holder Tax Treatment — If Cap-Conversion Payment Applies. If the cap-conversion value exceeds the 2.0x payment, the holder effectively converts the Note into equity at the Cap-Implied Conversion Price. The tax treatment in this scenario follows the recapitalization analysis described in Section VI above, with the additional consideration that the conversion occurs in the context of an acquisition, which may affect the form and character of the consideration received. If the acquirer pays cash or non-stock consideration for the converted equity, the holder may recognize gain on the acquisition in the same manner as other Company stockholders.

Company Tax Treatment. For the Company, the Change of Control payment under clause (i) is treated as a payment in retirement of the debt obligation. The excess of the Change of Control payment over the adjusted issue price of the Notes at the time of retirement is generally treated as a "repurchase premium." Under Treasury Regulation § 1.163-4(c) and § 1.1275-1(f), a repurchase premium is treated as additional interest expense, deductible by the Company in the year of retirement, subject to the Section 163(j) limitations. In the example above, the $30,000,000 repurchase premium (aggregate, if the 2.0x payment applies to all Notes) would be deductible as additional interest expense.

The Company should be aware that the deductibility of the repurchase premium in the year of a Change of Control could be affected by the overall tax structure of the acquisition, including the application of Section 381 (carryover of tax attributes in corporate acquisitions), Section 382 (limitation on net operating loss carryovers), and the terms of any merger agreement or plan of reorganization.

B. Integration with Acquisition Tax Structure

The Change of Control payment structure should not be analyzed in isolation. If a Change of Control becomes imminent, the Company and the Purchasers should coordinate with acquisition counsel to determine how the Change of Control payment interacts with the overall acquisition structure. Key considerations include:

• Whether the Change of Control payment is characterized as an additional component of the aggregate acquisition consideration, a separate contractual obligation of the Company, or a pre-closing debt retirement;

• Whether the Change of Control triggers a deemed conversion (with the holders receiving equity that is subsequently acquired) or a direct cash payment from the Company (or from the acquirer on behalf of the Company);

• The impact of the payment on the allocation of purchase price among the Company's assets under Section 1060 (applicable asset acquisition) or on the basis of the acquired stock under Section 338 (if a Section 338 election is made); and

• The treatment of the payment for purposes of any tax indemnification or tax escrow provisions in the definitive acquisition agreement.

We recommend that the Company engage acquisition tax counsel early in any Change of Control process to ensure that the convertible note provisions are addressed in the transaction structure and definitive agreements.

IX. Most Favored Nation (MFN) Provision — Tax Implications

The Notes include a most favored nation provision that provides the holders with the right to amend the terms of their Notes to incorporate any more favorable terms offered by the Company in a subsequent convertible note or SAFE issuance. This provision could be triggered if, for example, the Company issues a subsequent convertible note with a lower valuation cap, a higher conversion discount, a lower interest rate, or other more favorable economic terms.

Significant Modification Analysis. If the MFN provision is triggered and the terms of the Notes are amended, the amendment could constitute a "significant modification" of the Notes under Treasury Regulation § 1.1001-3. Under this regulation, a significant modification of a debt instrument is treated as an exchange of the original instrument for a new instrument for federal income tax purposes. This deemed exchange can have the following consequences:

• Gain or Loss Recognition. The holder would recognize gain or loss on the deemed exchange, measured as the difference between the fair market value of the "new" instrument (the Note as modified) and the holder's adjusted basis in the "old" instrument (the Note before modification).

• Reset of OID. The deemed exchange would reset the OID calculation for the modified instrument. The issue price of the "new" instrument would be its fair market value at the time of the deemed exchange, and any difference between the new issue price and the new stated redemption price at maturity would constitute OID on the modified instrument.

• New Holding Period. The holding period of the "new" instrument would commence on the date of the deemed exchange, which could affect the character of any gain or loss recognized on a subsequent disposition or conversion of the modified instrument.

Thresholds for Significant Modification. Treasury Regulation § 1.1001-3(e) identifies several specific types of modifications that are per se significant, including changes in the yield of a debt instrument by more than the greater of 25 basis points or 5% of the annual yield of the unmodified instrument, changes in the timing of payments, and changes in the obligor. A change in the valuation cap or conversion discount may not fall squarely within any of these specific categories, but could be analyzed as a change in the yield of the instrument (since a lower valuation cap or higher discount increases the economic value of the conversion feature and effectively reduces the implied yield on the debt component).

The analysis is inherently fact-specific and depends on the nature and magnitude of the modification. A modest adjustment (e.g., a slight reduction in the valuation cap that does not materially affect the economic terms) may not rise to the level of a significant modification, while a substantial change (e.g., a reduction in the valuation cap from $750,000,000 to $500,000,000) could clearly constitute a significant modification.

Recommendation. If a subsequent convertible note or SAFE issuance is contemplated on terms that would trigger the MFN provision, we recommend that the Company perform a detailed Treas. Reg. § 1.1001-3 significant modification analysis before execution of the subsequent issuance. This analysis should quantify the economic impact of the proposed modification on the yield and other terms of the existing Notes and assess whether the modification crosses the applicable thresholds. If a significant modification would result, the Company and the holders should consider the tax consequences of the deemed exchange and evaluate whether alternative structures could avoid triggering a significant modification.

X. Section 409A Considerations

Section 409A of the Internal Revenue Code imposes significant restrictions on "nonqualified deferred compensation" arrangements, including requirements as to the timing of deferral elections, the timing and form of distributions, and the prohibition of acceleration of benefits. Failure to comply with Section 409A can result in immediate income inclusion, a 20% additional tax, and interest penalties.

Exclusion for Bona Fide Debt Instruments. The regulations under Section 409A provide that bona fide debt instruments are not treated as deferred compensation subject to Section 409A. Specifically, a payment pursuant to the terms of a debt instrument — including a payment of principal, stated interest, or OID — is not deferred compensation if the instrument is a bona fide indebtedness of the issuer. The convertible Notes should qualify for this exclusion because they represent an unconditional obligation of the Company to pay a sum certain (principal plus accrued interest) on a date certain (the Maturity Date) or upon the occurrence of specified events (Qualified Financing, Change of Control).

Conversion Feature, discount, and Valuation Cap. The conversion feature, conversion discount, and valuation cap do not, by themselves, cause the Notes to be treated as deferred compensation, provided the Notes are not "in the money" equity appreciation instruments. Section 409A is primarily concerned with equity-based instruments (such as stock options and stock appreciation rights) that have exercise prices below the fair market value of the underlying stock at the time of grant. The Notes are not stock options or equity appreciation rights; they are debt instruments with a contingent conversion feature.

Comparison to 409A Valuation. The Company's most recent independent 409A valuation, dated September 15, 2023 and prepared by Atlas Valuation Services, Inc. (contact: Martin Khoury), established the fair market value of the Company's common stock at $8.42 per share. The Cap-Implied Conversion Price of the Notes is approximately $15.46 per share, which is approximately 84% above the current 409A fair market value. This substantial premium supports the position that the Notes are not "in the money" equity instruments and do not function as deferred compensation subject to Section 409A.

Conclusion. Based on the foregoing analysis, Section 409A should not apply to the convertible Notes. The Notes are bona fide debt instruments with terms that are not designed to defer compensation, and the conversion price is substantially above the current fair market value of the Company's common stock.

Caveat. This determination should be revisited if the Company's 409A valuation increases materially prior to conversion. If, for example, the Company's 409A fair market value per common share increases above the Cap-Implied Conversion Price of $15.46 prior to a Qualified Financing, the Notes could be viewed as "in the money" at that time, which could, in theory, raise Section 409A concerns. While we believe the exclusion for bona fide debt instruments would continue to apply in that scenario, the analysis would require reconsideration in light of the facts and circumstances at that time. We recommend that the Company notify us of any material change in its 409A valuation so that we may update this analysis accordingly.

XI. Delaware Tax Considerations

A. Delaware Franchise Tax

Skybridge Fintech Ltd. is a Delaware C-corporation and is subject to the annual Delaware franchise tax. The Delaware franchise tax is not an income tax but rather a tax imposed on the privilege of incorporation in Delaware, calculated based on the corporation's authorized and outstanding capital stock and total gross assets.

Methods of Calculation. Delaware law provides two methods for calculating the franchise tax: the Authorized Shares Method and the Assumed Par Value Capital Method. Most corporations with large authorized share counts and significant asset bases, including venture-backed technology companies, elect the Assumed Par Value Capital Method, which generally results in a lower tax liability. Under the Assumed Par Value Capital Method, the franchise tax is calculated based on a formula that takes into account the corporation's total gross assets (as reported on its federal income tax return) and the total number of issued shares, resulting in an "assumed par value" per share. The tax is then computed based on the number of authorized shares and the assumed par value.

Impact of the Convertible Note Issuance. The issuance of the convertible Notes does not, by itself, increase the number of issued and outstanding shares of the Company's stock. Accordingly, the issuance of the Notes should not directly affect the Company's franchise tax calculation under either method. The proceeds from the sale of the Notes would, however, increase the Company's total gross assets (cash), which is a factor in the Assumed Par Val

MEMORANDUM
PRIVILEGED & CONFIDENTIAL ATTORNEY-CLIENT COMMUNICATION
November 22, 2023
FROM: Calderwood & Harkness LLP 600 Lexington Avenue New York, NY 10022
TO: Arjun Mehta, Chief Executive Officer & Co-Founder David Lindstrom, Chief Financial Officer Priya Ramanathan, General Counsel
Skybridge Fintech Ltd. 1400 Market Street, Suite 2200 Wilmington, DE 19801
RE: Federal and Delaware Tax Considerations for Proposed $60,000,000 Convertible Promissory Note Bridge Financing
MATTER NO.: 1009-00001
PREPARED BY: Leonard Ashford, Of Counsel, Emerging Companies & Venture Capital Nina Reyes, Senior Associate, Emerging Companies & Venture Capital
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I. Executive Summary
You have asked us to analyze the federal income tax and Delaware tax implications arising from Skybridge Fintech Ltd.'s (the "Company") proposed issuance of $60,000,000 in aggregate principal amount of convertible promissory notes (the "Notes" or "Convertible Notes") to a syndicate of institutional investors led by Ridgeline Ventures Fund IV, L.P. (the "Lead Investor" and, together with the other investors described herein, the "Purchasers"). This memorandum is prepared in connection with the proposed bridge financing transaction (the "Bridge Financing" or the "Transaction") as described in the term sheet dated November 20, 2023 (the "Term Sheet") circulated to us by the Company's General Counsel.
This memorandum addresses the following key areas of federal and Delaware tax analysis:
1. Debt versus Equity Classification. Whether the Notes should be properly classified as debt instruments, rather than equity, for federal income tax purposes — a threshold determination that governs the applicability of the interest deduction rules, original issue discount provisions, and the tax treatment of conversion and repayment events.
2. Original Issue discount (OID). Whether the stated interest payable on the Notes constitutes "qualified stated interest" under the applicable Treasury Regulations or, alternatively, is required to be treated as OID, with the attendant accrual and reporting consequences for both the Company and the Purchasers.
3. Treatment of Stated Interest. The federal income tax characterization and timing of the 6.00% per annum simple interest (600 basis points) accruing on the Notes, computed on a 365-day year basis, including the deductibility of such interest by the Company.
4. Tax Consequences of Conversion. The federal income tax treatment of the automatic conversion of the Notes into equity securities of the Company upon the occurrence of a Qualified Financing, as well as the optional conversion at maturity, including the treatment of accrued but unpaid interest that converts into equity.
5. Tax Treatment at Maturity. The federal income tax consequences to both the Company and the Purchasers if the Notes are not converted and are instead repaid in cash at maturity.
6. Change of Control Payment. The federal income tax implications of the change of control provision, which entitles holders to the greater of a 2.0x multiple of outstanding principal plus accrued interest or the amount payable upon conversion at the Valuation Cap.
7. Delaware Tax Considerations. The impact of the Transaction on the Company's Delaware franchise tax obligations, including the potential effects of conversion on the franchise tax calculation, as well as related Delaware unclaimed property and state income tax considerations.
In addition, this memorandum addresses the applicability of Section 409A of the Internal Revenue Code, information reporting and withholding obligations, the tax implications of the most favored nation provision, and the impact of the Bridge Financing on the Company's existing capital structure.
Please note that this memorandum is intended as a preliminary analysis based upon the Term Sheet and the deal structure as described to us as of the date hereof. Our final analysis should be revisited upon the execution of definitive transaction documents, including the Note Purchase Agreement and the form of Convertible Promissory Note. This memorandum is prepared solely for the benefit of the Company and its officers and directors named above, and does not constitute tax advice to the Purchasers or any other third party. The Purchasers should consult their own tax advisors regarding the tax consequences of the Transaction.
II. Background and Transaction Summary
A. The Company
Skybridge Fintech Ltd. (the "Company") is a Delaware C-corporation (EIN: 83-2147605; Delaware File Number: 6384291) incorporated in 2017. The Company operates a cloud-based payments orchestration and embedded lending platform, providing integrated financial technology infrastructure to enterprise and mid-market clients across multiple industry verticals. The Company's principal executive offices are located at 1400 Market Street, Suite 2200, Wilmington, Delaware 19801.
B. Proposed Transaction
The Company proposes to issue convertible promissory notes in an aggregate principal amount of $60,000,000 to the Purchaser syndicate. The material economic terms of the Notes, as set forth in the Term Sheet, are summarized below.
Interest Rate. The Notes bear interest at a rate of 6.00% per annum (600 basis points), computed as simple interest on a 365-day year basis. Based on the full aggregate principal amount of $60,000,000, annual interest accrual would total $3,600,000. Interest accrues from the date of issuance and is payable upon conversion or at maturity, as described below.
Maturity Date. The Notes mature twenty-four (24) months from the date of closing. Assuming a closing date of January 15, 2024, the anticipated maturity date would be January 15, 2026.
Conversion Mechanics — Automatic Conversion. Upon the occurrence of a Qualified Financing — defined as a Series D preferred stock financing raising at least $80,000,000 in new equity capital — all outstanding principal and accrued but unpaid interest on the Notes automatically convert into equity securities of the Company at the Conversion Price. The Conversion Price is defined as the lower of:
(a) 80% of the price per share paid by investors in the Series D preferred stock financing (reflecting a 20% conversion discount); or
(b) the price per share implied by a $750,000,000 pre-money valuation cap on a fully diluted basis (the "Valuation Cap"), which, based on approximately 48,500,000 fully diluted shares outstanding immediately prior to the Bridge Financing, implies a conversion price of approximately $15.46 per share (the "Cap-Implied Conversion Price").
Optional Conversion at Maturity. If no Qualified Financing occurs prior to the Maturity Date, each holder of Notes has the election to either (i) convert the outstanding principal and accrued interest on its Notes into equity of the Company at the Cap-Implied Conversion Price, or (ii) demand repayment in cash of the outstanding principal plus all accrued and unpaid interest.
Change of Control Provision. Upon the occurrence of a Change of Control (as defined in the Term Sheet) prior to conversion, each holder of Notes is entitled to receive the greater of:
(i) 2.0x the outstanding principal amount plus all accrued and unpaid interest on such holder's Notes (resulting in a maximum aggregate Change of Control payment of $120,000,000 at issuance, assuming the 2.0x amount exceeds the cap-conversion value); or
(ii) the amount that would be payable to such holder upon conversion of the Notes at the Cap-Implied Conversion Price.
Most Favored Nation (MFN) Provision. The Notes include a most favored nation provision providing that if the Company issues any subsequent convertible note or Simple Agreement for Future Equity ("SAFE") on terms that are more favorable to the purchaser thereof than the terms of the Notes, the holders of the Notes shall have the right to amend the terms of their Notes to incorporate such more favorable terms.
Subordination. The Notes are subordinated in right of payment to the Company's existing $15,000,000 venture debt facility with Kelvantis Lending Corp. (the "Kelvantis Facility"), issued pursuant to that certain Loan and Security Agreement, dated August 15, 2022, by and between the Company and Kelvantis Lending Corp.
C. Purchaser Syndicate
The Notes will be purchased by the following institutional investors:
All Purchasers are United States institutional investment funds organized as Delaware limited partnerships or limited liability companies. Ridgeline Ventures Fund IV, L.P. and Beacon Hill Capital Partners, LLC are existing investors in the Company, having participated in prior preferred stock rounds. Northstar Innovation Fund II, L.P. is a new investor. Halcyon Growth Equity, L.P. is an existing investor that participated in the Company's Series B financing. All transactions between the Company and the Purchasers are conducted at arm's length.
D. Company Financial Snapshot
The Company's current financial position, as reported to us by the Company's Chief Financial Officer, is summarized below:
The Company's most recent independent 409A valuation, prepared by Atlas Valuation Services, Inc. and dated September 15, 2023, established the fair market value of the Company's common stock at $8.42 per share. This valuation is relevant to several aspects of the tax analysis set forth below, including the Section 409A analysis in Section X.
III. Debt vs. Equity Classification
A. General Principles
A threshold question in analyzing the federal income tax consequences of the Notes is whether they should be treated as debt or equity for federal income tax purposes. This classification is critical because it determines whether the Company is entitled to deduct interest payments, whether holders must accrue original issue discount, and whether the conversion of the Notes into equity is treated as a recapitalization or as a taxable exchange.
The Internal Revenue Code does not provide a bright-line test for distinguishing debt from equity. Instead, the determination is made based on a multi-factor analysis that weighs the economic substance of the instrument against its legal form. Courts have developed numerous factors to be considered, though no single factor is dispositive. Among the most commonly cited factors, drawn from cases such as Mixon v. United States, 464 F.2d 394 (5th Cir. 1972), and the factors articulated in Notice 94-47, 1994-1 C.B. 357, are the following:
• Whether there is an unconditional obligation to pay a sum certain on a fixed date;
• Whether holders possess the right to enforce payment of principal and interest;
• Whether the instrument bears a stated interest rate that reflects market conditions;
• Whether the instrument has a fixed maturity date;
• The degree of subordination of the instrument to other obligations of the issuer;
• The debt-to-equity ratio of the issuer before and after the issuance;
• The intent of the parties to create a debtor-creditor relationship;
• Whether the instrument is convertible into equity of the issuer;
• Whether the instrument participates in the profits of the issuer;
• Whether the holders are existing equity holders (proportionality of holdings); and
• Whether the issuer has the ability to obtain financing from independent creditors on comparable terms.
The IRS has historically scrutinized convertible instruments issued by closely held and private companies with particular care, given the potential for instruments denominated as "debt" to function economically as equity capital contributions. Nevertheless, the case law and administrative guidance recognize that convertible notes can constitute bona fide debt for federal income tax purposes, provided the economic substance of the instrument supports that classification.
B. Application to the Skybridge Convertible Notes
Applying the multi-factor analysis to the Notes, we identify the following factors supporting and potentially undermining debt treatment.
Factors Supporting Debt Treatment. Several significant factors support the classification of the Notes as debt for federal income tax purposes:
• Stated Interest Rate. The Notes bear a stated interest rate of 6.00% per annum, which represents a commercially reasonable rate for subordinated convertible bridge notes issued by a venture-backed technology company with Skybridge's financial profile. The rate is fixed, applies uniformly to all Purchasers, and does not fluctuate based on the Company's financial performance.
• Fixed Maturity Date. The Notes have a fixed maturity date of twenty-four months from closing (January 15, 2026, assuming a January 15, 2024 closing). At maturity, holders have the right to demand repayment of principal plus accrued interest in cash. The existence of a fixed maturity date and a mandatory repayment obligation is one of the strongest indicia of debt treatment.
• Mandatory Repayment Obligation. Absent conversion (whether automatic upon a Qualified Financing or elective at maturity), the Company is unconditionally obligated to repay the outstanding principal and accrued interest in cash on the Maturity Date. This repayment obligation exists regardless of the Company's financial condition, profitability, or available cash.
• Written Promissory Notes. The obligations will be evidenced by written promissory notes executed by the Company in favor of each Purchaser, reflecting the intent of the parties to create a debtor-creditor relationship.
• Arm's-Length Terms. The Notes are issued to institutional investors in an arm's-length transaction, with terms that reflect market conditions for convertible bridge financings in the venture capital industry.
Factors That Could Weigh Toward Equity Treatment. Certain features of the Notes could, in isolation, be viewed as equity-like characteristics:
• Conversion Feature. The Notes are convertible into equity of the Company, either automatically upon a Qualified Financing or at the election of the holders at maturity. The conversion feature, together with the 20% conversion discount and the $750,000,000 valuation cap, gives the Notes an equity-linked character that could be argued to diminish their debt-like qualities.
• Subordination. The Notes are subordinated in right of payment to the Kelvantis Facility. Subordination is a factor that courts and the IRS have identified as weighing against debt treatment, though subordination to senior secured indebtedness is a common and commercially expected feature of convertible bridge notes.
• Equity-Linked Economics. The conversion discount and valuation cap effectively provide the Purchasers with an equity upside that is not characteristic of a traditional fixed-income obligation. If the Company's value increases significantly, the Purchasers will benefit through a lower conversion price, which resembles an equity return rather than a fixed return on debt capital.
Assessment. On balance, we believe there is a strong basis for treating the Notes as debt for federal income tax purposes during the period prior to conversion. The Notes possess the core indicia of indebtedness: a stated interest rate, a fixed maturity date, an unconditional repayment obligation at maturity, and the form of written promissory notes evidencing the debtor-creditor relationship. The conversion feature, while an equity-linked characteristic, is contingent upon a future event (the Qualified Financing) that may or may not occur. Until conversion, the Notes function as debt obligations of the Company with respect to which the Company owes a fixed sum certain on a date certain.
We further note that all four Purchasers are third-party institutional investment funds transacting at arm's length. While certain Purchasers (Ridgeline, Beacon Hill, and Halcyon) are existing equity investors in the Company, their participation in the Bridge Financing is through new and separate investment vehicles, and the terms of the Notes do not suggest a proportionality of holdings that would undermine debt treatment. The mix of existing and new investors can sometimes be a factor in the debt-equity analysis, but here the arm's-length nature of the transaction and the commercially reasonable terms of the Notes militate in favor of debt classification.
C. Risk Factors and Limitations
Notwithstanding the foregoing analysis, we identify the following risk factors and limitations:
Debt-to-Equity Ratio. Upon issuance of the Notes, the Company's total outstanding indebtedness will be approximately $75,000,000 ($15,000,000 under the Kelvantis Facility plus $60,000,000 in Convertible Notes). When compared to the Company's historical equity capitalization — which includes total paid-in capital from Series A, B, and C preferred stock financings resulting in a Series C post-money valuation of $620,000,000 — the debt-to-equity ratio does not appear to be excessively leveraged. However, the Company's current 409A common stock valuation of $8.42 per share implies a significantly lower equity value for common stockholders, and the Company's ongoing operating losses (monthly burn of ~$4.8 million) could, in theory, raise questions about the Company's ability to service the debt absent additional equity financing. The IRS could point to these factors as evidence that the Notes are more akin to equity contributions than bona fide debt.
Mitigating Factors. Several considerations mitigate this risk. First, the Notes are designed to convert automatically upon a near-term Qualified Financing, which the Company expects to complete in Q3–Q4 2024 — well before the Maturity Date. The short 24-month tenor of the Notes limits the period during which debt classification could be challenged. Second, the Purchasers are bona fide third-party institutional investors with no obligation to invest additional equity in the Company, and their investment decision was made on arm's-length terms. Third, the Company has sufficient post-bridge cash (approximately $78.5 million, providing approximately 16.4 months of runway) to service the interest obligation during the expected life of the Notes.
We believe the risk of a successful IRS challenge to the debt classification of the Notes is low, but it cannot be eliminated entirely. If the Company's financial condition deteriorates materially, or if the anticipated Qualified Financing is significantly delayed, the risk profile may change.
IV. Original Issue discount (OID) Analysis
A. General Framework — IRC Sections 1272, 1273, and 1274
Under Section 1273(a) of the Internal Revenue Code, original issue discount is defined as the excess, if any, of a debt instrument's "stated redemption price at maturity" over its "issue price." The stated redemption price at maturity includes all payments required to be made under the instrument other than payments of "qualified stated interest" (as defined below). The issue price of a debt instrument issued for cash is generally equal to the amount of cash paid for the instrument. See IRC § 1273(b)(2).
In the case of the Notes, the issue price of each Note is equal to the principal amount paid by the respective Purchaser. Accordingly, the aggregate issue price of the Notes is $60,000,000.
The stated redemption price at maturity of each Note includes the principal amount plus any amounts payable at maturity that do not constitute qualified stated interest. As discussed in greater detail below, the characterization of the 6.00% stated interest is central to the OID analysis.
If OID exists, it must be accrued into income by the holder on a constant-yield basis over the life of the instrument under Section 1272(a), regardless of the holder's overall method of accounting. Even a cash-method holder must include OID in income as it accrues, irrespective of whether cash payments are received. For the Company, OID that accrues is treated as interest expense, deductible under Section 163 subject to the limitations discussed in Section V below.
B. Treatment of Stated Interest
The Notes bear interest at a rate of 6.00% per annum, computed as simple interest on a 365-day year basis. Annual interest accrual on the full $60,000,000 principal amount is $3,600,000. Over the full 24-month term, total stated interest would be approximately $7,200,000.
The critical question for OID purposes is whether the stated interest on the Notes constitutes "qualified stated interest" ("QSI") under Treasury Regulation § 1.1273-1(c). QSI is defined as stated interest that is unconditionally payable in cash or in property (other than debt instruments of the issuer) at fixed periodic intervals of one year or less during the entire term of the debt instrument, at a single fixed rate. Treas. Reg. § 1.1273-1(c)(1)(i).
The significance of this determination is as follows: if the stated interest qualifies as QSI, it is excluded from the stated redemption price at maturity, and no OID arises (assuming the Notes are issued at par). If, however, the stated interest does not qualify as QSI, it is included in the stated redemption price at maturity, resulting in OID equal to the total amount of such non-qualified interest.
Analysis of QSI Requirements. Under the proposed structure described in the Term Sheet, interest on the Notes accrues at 6.00% per annum but is not payable in cash on a periodic basis. Rather, interest accrues and is payable only upon the earliest of (i) conversion of the Notes (at which point accrued interest converts into equity), (ii) repayment at maturity, or (iii) a Change of Control. Interest is not unconditionally payable in cash at least annually.
This structure fails to satisfy the QSI requirements of Treasury Regulation § 1.1273-1(c)(1)(i) for two reasons. First, the interest is not payable at fixed periodic intervals of one year or less; it accrues and is payable only upon conversion, maturity, or a Change of Control. Second, and perhaps more significantly, interest that is payable upon conversion is satisfied through the issuance of equity securities of the Company rather than cash. Interest payable in property other than cash may still qualify as QSI, but the issuance of stock of the issuer in satisfaction of an interest obligation does not constitute payment of interest in "property (other than debt instruments of the issuer)" for QSI purposes, because the conversion mechanism operates as an exchange rather than a cash payment.
Conclusion. Because the 6.00% stated interest on the Notes is not unconditionally payable in cash at fixed periodic intervals of one year or less, it likely does not qualify as QSI under Treasury Regulation § 1.1273-1(c). Instead, the stated interest would be included in the stated redemption price at maturity and treated as OID for federal income tax purposes.
Alternative Analysis. We note that if the definitive note documents are structured such that the Company has an affirmative, unconditional right (not merely the option) to pay interest in cash at least annually — for example, through a mandatory annual interest payment provision — there may be a basis for treating the interest as QSI, thereby eliminating OID. We recommend that this structural alternative be discussed with the Company and the Purchasers in connection with the negotiation of definitive documents, as the elimination of OID would simplify the tax reporting obligations for both the Company and the holders. However, we understand that the current intent is for interest to accrue and be payable only upon conversion or maturity, which precludes QSI treatment.
C. OID Accrual Requirements
If, as we expect, the stated interest is treated as OID, the following accrual and recognition rules apply:
Holders. Each Purchaser (holder) must accrue OID into income over the life of its Note using the constant-yield method prescribed by Section 1272(a). Under this method, OID for each accrual period is calculated by multiplying the holder's adjusted issue price at the beginning of the period by the yield to maturity of the instrument, and subtracting any QSI allocable to the period (zero, in this case). This accrual is required regardless of the holder's overall method of accounting; even cash-method holders must include OID in gross income as it accrues. The holder's tax basis in the Note increases by the amount of OID included in income.
Company. For the Company, the OID accrued on the Notes is treated as interest expense, deductible under Section 163 (subject to the limitations discussed in Section V below). The Company recognizes the deduction as the OID accrues, consistent with its accrual method of accounting.
Illustrative Calculation. For purposes of illustration, assuming a 24-month term, an aggregate principal amount of $60,000,000, and total stated interest of $7,200,000 (computed as simple interest at 6.00% per annum), the total OID over the full term would be approximately $7,200,000 on a simple basis. Under the constant-yield methodology, which assumes semi-annual compounding, the actual OID accrual pattern would result in somewhat higher total OID due to the compounding effect. We note that annual interest on the full principal amount is $3,600,000, and the precise accrual schedule would be determined based on the closing date and the specific terms of the definitive note documents.
We recommend that the Company's tax advisors at Pinnacle Audit Group LLP prepare a detailed OID accrual schedule upon closing, reflecting the actual closing date, yield to maturity, and accrual periods.
D. Conversion Feature and Contingent Payment Debt Instrument (CPDI) Rules
An additional question arises as to whether the conversion feature (including the 20% discount and the $750,000,000 valuation cap) or the Change of Control payment provision could cause the Notes to be classified as contingent payment debt instruments ("CPDIs") under Treasury Regulation §§ 1.1275-4.
General Rule. Under Treasury Regulation § 1.1275-4(a), a debt instrument that provides for one or more contingent payments is a CPDI, and is subject to the specialized CPDI accrual and allocation rules, unless an exception applies. CPDI treatment would significantly complicate the tax reporting for both the Company and the holders, as it would require the application of a "projected payment schedule" and the recognition of gain or loss upon the resolution of contingencies.
Conversion Feature Exception. Treasury Regulation § 1.1275-4(a)(4) provides a critical exception: a debt instrument is not treated as a CPDI solely because it is convertible into stock of the issuer or provides for a payment or series of payments that are adjusted based on the issuer's stock. This exception is directly applicable to the Notes, which are convertible into equity securities of the Company. Accordingly, the conversion feature — including the 20% discount and the valuation cap mechanism — should not cause the Notes to be treated as CPDIs.
Change of Control Provision. The Change of Control provision, which entitles holders to the greater of (i) 2.0x outstanding principal plus accrued interest or (ii) the amount payable upon conversion at the Valuation Cap, warrants separate analysis. The 2.0x multiple payment is a fixed amount determinable at issuance and is not contingent on the Company's stock price or equity value. However, the "greater of" formulation introduces a contingent element: the actual payment depends on a comparison between the 2.0x amount and the cap-conversion value, the latter of which is tied to the Company's equity value at the time of a Change of Control.
We believe the Change of Control provision is analogous to acceleration clauses, put rights, and early termination provisions commonly found in convertible notes and other debt instruments. Under Treasury Regulation § 1.1275-4(a)(4) and the related interpretive guidance, such provisions are generally not treated as contingent payments that would cause the instrument to be classified as a CPDI. The Change of Control provision is more properly viewed as a redemption feature that provides for an alternative payment upon a defined acceleration event, rather than a contingent payment in the relevant sense.
Assessment. We believe the Notes should not be treated as CPDIs. The conversion feature is squarely within the exception of Treasury Regulation § 1.1275-4(a)(4), and the Change of Control provision, while containing a contingent element, is analogous to provisions that have generally been held not to trigger CPDI treatment. However, we note that the analysis is inherently fact-specific, and the IRS has not issued definitive guidance addressing the precise structure of the Change of Control provision in the Notes.
Recommendation. We recommend that the Company monitor developments in IRS guidance relating to the CPDI rules as applied to convertible instruments with change of control provisions. If the risk of CPDI treatment is deemed material by the Company or the Purchasers, consideration should be given to obtaining a formal tax opinion addressing this specific issue.
V. Tax Treatment of Interest — Company Deductions
A. Interest Expense Deduction Under Section 163
Under Section 163(a) of the Internal Revenue Code, the Company is generally entitled to deduct "all interest paid or accrued within the taxable year on indebtedness." To the extent the Notes are properly classified as debt (as analyzed in Section III above), the interest accruing on the Notes — whether characterized as stated interest or OID — constitutes deductible interest expense for the Company.
Timing of Deduction. The Company is an accrual-basis taxpayer. Accordingly, the Company's deduction for interest expense (or OID) arises as the interest or OID accrues, rather than when it is paid. Under the OID rules, the Company's deduction is computed on a constant-yield basis, consistent with the accrual methodology applicable to the holders. The Company's annual interest deduction attributable to the Notes is expected to be approximately $3,600,000 per year (based on the 6.00% stated rate and $60,000,000 principal), subject to the precise OID accrual schedule determined at closing.
B. Section 163(j) Business Interest Limitation
The deductibility of interest expense is subject to the business interest expense limitation imposed by Section 163(j) of the Internal Revenue Code, as amended by the Tax Cuts and Jobs Act of 2017 and further modified by subsequent legislation.
General Rule. Under Section 163(j)(1), the deduction for "business interest" for any taxable year is limited to the sum of:
(i) the taxpayer's business interest income for the taxable year;
(ii) 30% of the taxpayer's adjusted taxable income ("ATI") for the taxable year; and
(iii) the taxpayer's floor plan financing interest for the taxable year (not applicable here).
Application to Skybridge. The Company's total annual interest expense across all outstanding indebtedness is estimated as follows:
Given the Company's pre-profitability status — with a monthly cash burn rate of approximately $4,800,000, implying annual operating losses in excess of $57,000,000 — the Company's ATI is likely to be negative or very limited. Beginning with taxable years after 2021, ATI is calculated without adding back depreciation, amortization, and depletion, which further reduces ATI for capital-intensive or loss-making companies. Consequently, the 30% of ATI component of the Section 163(j) limitation may be zero or near-zero for the Company in the near term, potentially constraining the deductibility of some or all of the Company's business interest expense.
Carryforward. Any business interest expense that is disallowed under Section 163(j) in a given taxable year is carried forward to succeeding taxable years indefinitely under Section 163(j)(2). The disallowed interest is treated as business interest paid or accrued in the succeeding taxable year, subject again to the Section 163(j) limitation in that year. While this preserves the ultimate deductibility of the interest expense, it defers the timing of the deduction, which may affect the Company's tax planning and financial projections.
Small Business Exemption. Section 163(j)(3) provides an exemption for taxpayers with average annual gross receipts of $29,000,000 or less (as adjusted for inflation) for the three prior taxable years. Given the Company's ARR of approximately $78,000,000, it is likely that the Company's average annual gross receipts exceed this threshold, rendering the small business exemption unavailable. We recommend that the Company's tax advisors confirm this calculation based on the Company's actual gross receipts for the 2020, 2021, and 2022 taxable years.
C. Related-Party Interest Considerations
Sections 267(a)(2) and 267(b) of the Internal Revenue Code impose a matching rule that defers the deduction for interest owed to a "related person" until the period in which the corresponding amount is includible in the gross income of the related person. Similarly, Section 163(e)(3) imposes limitations on the deductibility of OID on debt held by related persons.
Application. The Purchasers are third-party institutional investment funds. None of the Purchasers is a "related person" to the Company within the meaning of Section 267(b), which defines related persons to include, among others, individuals and entities that are related by family, ownership, or common control. Specifically:
• Ridgeline Ventures Fund IV, L.P. and Beacon Hill Capital Partners, LLC are existing preferred stock investors, but their equity ownership in the Company does not, based on the information available to us, exceed the 50% threshold required for related-party status under Section 267(b)(2) (more than 50% ownership by value).
• Halcyon Growth Equity, L.P. is an existing Series B investor, but again its ownership stake does not approach the 50% threshold.
• Northstar Innovation Fund II, L.P. is a new investor with no prior equity stake in the Company.
Accordingly, the related-party interest deferral rules of Section 267 and the related-party OID limitations of Section 163(e)(3) should not apply to the Notes. We recommend that the Company confirm the current ownership percentages of each Purchaser (including through affiliated funds) to ensure that no Purchaser, together with its affiliates, holds a sufficient equity stake to trigger related-party treatment.
VI. Tax Consequences of Conversion
A. Automatic Conversion Upon Qualified Financing
Upon the occurrence of a Qualified Financing — defined as a Series D preferred stock financing in which the Company raises at least $80,000,000 in new equity capital — all outstanding principal and accrued but unpaid interest on the Notes automatically convert into equity securities of the Company at the Conversion Price (the lower of 80% of the Series D price per share or the Cap-Implied Conversion Price of approximately $15.46 per share).
General Rule — Tax-Free Recapitalization. Under Section 368(a)(1)(E) of the Internal Revenue Code, an exchange of securities (including convertible debt instruments) for stock in the same corporation qualifies as a "recapitalization," which is a form of tax-free reorganization. Additionally, Section 1036 provides non-recognition treatment for certain exchanges of stock and securities of the same corporation. Under either authority, the conversion of a convertible debt instrument into stock of the issuing corporation is generally treated as a tax-free exchange, with no gain or loss recognized by either the holder or the issuer, subject to certain exceptions.
The automatic conversion of the Notes into Series D preferred stock (or a separate series of preferred stock issued in connection with the conversion) upon a Qualified Financing should qualify as a tax-free recapitalization under Section 368(a)(1)(E), provided the conversion is effectuated as an exchange of the Notes (which constitute "securities" of the Company) for stock of the Company. The conversion is an integral part of the terms of the Notes and is not a separate taxable transaction.
Treatment of Accrued Interest Upon Conversion. A critical exception to the non-recognition treatment applies to the portion of the equity received that is attributable to accrued but unpaid interest on the Notes. Under well-established federal income tax principles, when a debt instrument is converted into stock and the conversion satisfies an accrued interest obligation, the holder is treated as having received a payment of interest equal to the fair market value of the stock received in satisfaction of the accrued interest claim. This amount is taxable to the holder as ordinary income in the year of conversion.
Correspondingly, the Company is treated as having paid the accrued interest at the time of conversion. The fair market value of the stock issued in satisfaction of the accrued interest obligation is deductible by the Company as interest expense (subject to the Section 163(j) limitations discussed in Section V.B above).
For example, if a holder with $30,000,000 in principal has accrued $1,800,000 in interest at the time of conversion (reflecting one year of accrual at 6.00%), the holder would recognize $1,800,000 in ordinary interest income, and the Company would deduct a corresponding $1,800,000 in interest expense (subject to Section 163(j)).
Conversion discount and Bargain Element. The conversion price mechanism — under which the Notes convert at a 20% discount to the Series D price or at the Cap-Implied Conversion Price, whichever is lower — effectively provides the holders with additional shares relative to what they would receive at the full Series D price. This "bargain" element raises the question of whether the difference between the conversion price and the fair market value of the equity received has independent tax significance.
In the context of a tax-free recapitalization, the bargain element inherent in a conversion discount does not give rise to separately taxable income, because the entire conversion (other than the interest component) is treated as a non-recognition exchange. The holder simply receives a basis and holding period in the converted equity that carries over from the surrendered notes, as described below. The conversion discount is a feature of the original terms of the Notes, negotiated at arm's length, and is reflected in the number of shares received rather than in the recognition of additional income.
B. Holder Tax Treatment Upon Conversion
Basis. To the extent the conversion is treated as a tax-free recapitalization under Section 368(a)(1)(E), each holder's aggregate tax basis in the equity securities received upon conversion is equal to the holder's adjusted basis in the surrendered Note immediately prior to conversion. The holder's adjusted basis in the Note includes (i) the original purchase price (i.e., the principal amount paid) and (ii) any OID that has been accrued into income by the holder during the holding period, reduced by (iii) any payments received on the Note (none, prior to conversion, other than the deemed interest payment described above).
For example, if a holder purchased a Note for $30,000,000, accrued $2,700,000 in OID over 18 months (assuming conversion occurs approximately 18 months after issuance), and is treated as receiving $2,700,000 in interest income upon conversion, the holder's basis in the equity received would be approximately $30,000,000 (original basis of $30,000,000, plus $2,700,000 in OID accrued, minus $2,700,000 allocated to the interest component of the conversion). The precise calculation would depend on the timing of conversion and the OID accrual schedule.
Holding Period. Under Section 1223(1), the holding period of equity securities received in a tax-free recapitalization includes (i.e., "tacks" to) the holding period of the surrendered securities (the Notes). This is significant because it determines whether gain on a subsequent sale of the equity is eligible for long-term capital gain treatment. If a holder holds the Note for more than one year prior to conversion, the holding period of the equity received upon conversion would include the pre-conversion holding period of the Note.
No Gain Recognition in the Absence of Boot. In a tax-free recapitalization, gain is recognized by the holder only to the extent that "boot" (i.e., money or other property other than stock or securities) is received. In the automatic conversion upon a Qualified Financing, the holders receive equity securities of the Company in exchange for the Notes; no cash or other property is received. Accordingly, no gain should be recognized by the holders upon conversion (other than the ordinary income attributable to accrued interest, as discussed above), even if the fair market value of the equity received exceeds the holder's adjusted basis in the Note.
C. Company Tax Treatment Upon Conversion
Non-Recognition Under Section 1032. Section 1032(a) of the Internal Revenue Code provides that a corporation does not recognize gain or loss on the receipt of money or other property in exchange for its own stock. Accordingly, the Company does not recognize gain or loss upon the issuance of Series D preferred stock (or any other class of its stock) in exchange for the convertible Notes upon conversion.
Remaining Unamortized OID. To the extent that any OID attributable to the Notes has not been fully amortized as of the date of conversion, the Company's remaining OID deduction would generally be allowed in the taxable year in which the conversion occurs. This accelerated deduction reflects the termination of the debt obligation and the recognition of the full economic cost of the borrowing.
Cancellation of Indebtedness (COD) Income — Section 108(e)(8). Under Section 108(e)(8), if a debtor corporation transfers its own stock in satisfaction of indebtedness, the corporation is treated as having satisfied the indebtedness with an amount of money equal to the fair market value of the stock transferred. If the principal amount of the indebtedness exceeds the fair market value of the stock issued, the excess is treated as cancellation of indebtedness income ("COD income") to the debtor corporation, which must be included in gross income unless an exclusion applies (e.g., the insolvency or bankruptcy exclusions of Section 108(a)).
In the context of the Notes, COD income would arise only if the fair market value of the equity issued upon conversion is less than the adjusted issue price of the Notes at the time of conversion. Given the $750,000,000 valuation cap and the expectation that the Series D valuation will meet or exceed this level, it is unlikely that COD income will arise upon conversion. However, if the Company's valuation declines materially between the issuance of the Notes and the date of conversion — such that the fair market value of the equity issued is less than the adjusted issue price of the Notes — COD income could result. We recommend that the Company monitor its valuation trajectory and consult with its tax advisors regarding COD income risk as the Qualified Financing approaches.
VII. Tax Treatment at Maturity (If No Qualified Financing Occurs)
A. Repayment in Cash
If no Qualified Financing occurs prior to the Maturity Date (January 15, 2026), each holder has the right to demand repayment in cash of the outstanding principal amount plus all accrued and unpaid interest on its Note.
Principal Repayment. The repayment of the principal amount of a debt instrument at maturity does not give rise to gain or loss for either the Company or the holder, provided the instrument is repaid at its adjusted issue price. Because the Notes are expected to be issued at par (i.e., the issue price equals the principal amount), repayment of the principal at par should not result in any gain or loss recognition.
Payment of Accrued Interest. Any accrued and unpaid interest paid in cash at maturity is treated as ordinary income to the holder and is deductible by the Company as interest expense under Section 163, subject to the Section 163(j) limitations discussed in Section V.B above. If the interest has been accrued by the holders as OID during the term of the Notes (as expected, based on the analysis in Section IV.B), the cash payment at maturity would not result in additional income inclusion to the holders, because the OID has already been included in income on an accrual basis. Instead, the cash payment would reduce the holder's adjusted basis in the Note.
No Additional OID. If the Notes are issued at par and repaid at par (with interest treated as OID), and no other payments are made other than the principal and accrued interest, there should be no additional OID recognition at maturity beyond the amounts already accrued during the term of the Notes.
B. Optional Conversion at Valuation Cap
If, at maturity, holders elect to convert their Notes into equity of the Company at the Cap-Implied Conversion Price of approximately $15.46 per share (rather than demanding cash repayment), the tax analysis follows the same framework as the automatic conversion upon a Qualified Financing discussed in Section VI above.
The principal distinction is that the conversion price is fixed at the Cap-Implied Conversion Price rather than being determined by reference to the price paid by investors in a Qualified Financing. The tax-free recapitalization analysis, the treatment of accrued interest as ordinary income, the basis and holding period rules, and the Company's non-recognition under Section 1032 all apply in the same manner as described in Section VI.
The Company should ensure that the definitive note documents clearly specify the mechanics of optional conversion at maturity, including the number and class of shares to be issued, to support the recapitalization characterization for federal income tax purposes.
VIII. Tax Consequences of Change of Control
A. Change of Control Payment Analysis
The Notes provide that upon the occurrence of a Change of Control prior to conversion, each holder is entitled to receive the greater of:
(i) 2.0x the outstanding principal amount plus all accrued and unpaid interest on such holder's Notes; or
(ii) the amount that would be payable to such holder upon conversion of the Notes at the Cap-Implied Conversion Price.
At issuance, the maximum aggregate Change of Control payment under clause (i) would be $120,000,000 (2.0 × $60,000,000 principal), assuming the 2.0x amount exceeds the cap-conversion value. The actual Change of Control payment for each holder would depend on the accrued interest at the time of the Change of Control and the relative values of the 2.0x payment and the cap-conversion payment.
Holder Tax Treatment — If 2.0x Payment Applies. If the Change of Control payment under clause (i) (2.0x principal plus accrued interest) exceeds the cap-conversion value, the holder would receive a cash payment in excess of its adjusted basis in the Note. The tax consequences are as follows:
• The portion of the payment attributable to accrued but unpaid interest is treated as ordinary income to the holder, consistent with the general rules governing interest payments.
• The excess of the payment over the holder's adjusted basis in the Note (after accounting for accrued OID and the interest component) is treated as gain on the retirement of the debt instrument. If the Note is a capital asset in the holder's hands (as is generally the case for institutional investment funds), this gain would be characterized as capital gain — either short-term or long-term depending on whether the holder's holding period exceeds one year at the time of the Change of Control.
• For example, if a holder purchased a Note for $30,000,000, accrued $1,800,000 in OID over one year, and received a Change of Control payment of $63,600,000 (2.0 × ($30,000,000 + $1,800,000)), the holder would recognize $1,800,000 in ordinary interest income (or no additional income if the OID has already been accrued) and $30,000,000 in capital gain ($63,600,000 total payment minus $1,800,000 interest component minus $31,800,000 adjusted basis).
Holder Tax Treatment — If Cap-Conversion Payment Applies. If the cap-conversion value exceeds the 2.0x payment, the holder effectively converts the Note into equity at the Cap-Implied Conversion Price. The tax treatment in this scenario follows the recapitalization analysis described in Section VI above, with the additional consideration that the conversion occurs in the context of an acquisition, which may affect the form and character of the consideration received. If the acquirer pays cash or non-stock consideration for the converted equity, the holder may recognize gain on the acquisition in the same manner as other Company stockholders.
Company Tax Treatment. For the Company, the Change of Control payment under clause (i) is treated as a payment in retirement of the debt obligation. The excess of the Change of Control payment over the adjusted issue price of the Notes at the time of retirement is generally treated as a "repurchase premium." Under Treasury Regulation § 1.163-4(c) and § 1.1275-1(f), a repurchase premium is treated as additional interest expense, deductible by the Company in the year of retirement, subject to the Section 163(j) limitations. In the example above, the $30,000,000 repurchase premium (aggregate, if the 2.0x payment applies to all Notes) would be deductible as additional interest expense.
The Company should be aware that the deductibility of the repurchase premium in the year of a Change of Control could be affected by the overall tax structure of the acquisition, including the application of Section 381 (carryover of tax attributes in corporate acquisitions), Section 382 (limitation on net operating loss carryovers), and the terms of any merger agreement or plan of reorganization.
B. Integration with Acquisition Tax Structure
The Change of Control payment structure should not be analyzed in isolation. If a Change of Control becomes imminent, the Company and the Purchasers should coordinate with acquisition counsel to determine how the Change of Control payment interacts with the overall acquisition structure. Key considerations include:
• Whether the Change of Control payment is characterized as an additional component of the aggregate acquisition consideration, a separate contractual obligation of the Company, or a pre-closing debt retirement;
• Whether the Change of Control triggers a deemed conversion (with the holders receiving equity that is subsequently acquired) or a direct cash payment from the Company (or from the acquirer on behalf of the Company);
• The impact of the payment on the allocation of purchase price among the Company's assets under Section 1060 (applicable asset acquisition) or on the basis of the acquired stock under Section 338 (if a Section 338 election is made); and
• The treatment of the payment for purposes of any tax indemnification or tax escrow provisions in the definitive acquisition agreement.
We recommend that the Company engage acquisition tax counsel early in any Change of Control process to ensure that the convertible note provisions are addressed in the transaction structure and definitive agreements.
IX. Most Favored Nation (MFN) Provision — Tax Implications
The Notes include a most favored nation provision that provides the holders with the right to amend the terms of their Notes to incorporate any more favorable terms offered by the Company in a subsequent convertible note or SAFE issuance. This provision could be triggered if, for example, the Company issues a subsequent convertible note with a lower valuation cap, a higher conversion discount, a lower interest rate, or other more favorable economic terms.
Significant Modification Analysis. If the MFN provision is triggered and the terms of the Notes are amended, the amendment could constitute a "significant modification" of the Notes under Treasury Regulation § 1.1001-3. Under this regulation, a significant modification of a debt instrument is treated as an exchange of the original instrument for a new instrument for federal income tax purposes. This deemed exchange can have the following consequences:
• Gain or Loss Recognition. The holder would recognize gain or loss on the deemed exchange, measured as the difference between the fair market value of the "new" instrument (the Note as modified) and the holder's adjusted basis in the "old" instrument (the Note before modification).
• Reset of OID. The deemed exchange would reset the OID calculation for the modified instrument. The issue price of the "new" instrument would be its fair market value at the time of the deemed exchange, and any difference between the new issue price and the new stated redemption price at maturity would constitute OID on the modified instrument.
• New Holding Period. The holding period of the "new" instrument would commence on the date of the deemed exchange, which could affect the character of any gain or loss recognized on a subsequent disposition or conversion of the modified instrument.
Thresholds for Significant Modification. Treasury Regulation § 1.1001-3(e) identifies several specific types of modifications that are per se significant, including changes in the yield of a debt instrument by more than the greater of 25 basis points or 5% of the annual yield of the unmodified instrument, changes in the timing of payments, and changes in the obligor. A change in the valuation cap or conversion discount may not fall squarely within any of these specific categories, but could be analyzed as a change in the yield of the instrument (since a lower valuation cap or higher discount increases the economic value of the conversion feature and effectively reduces the implied yield on the debt component).
The analysis is inherently fact-specific and depends on the nature and magnitude of the modification. A modest adjustment (e.g., a slight reduction in the valuation cap that does not materially affect the economic terms) may not rise to the level of a significant modification, while a substantial change (e.g., a reduction in the valuation cap from $750,000,000 to $500,000,000) could clearly constitute a significant modification.
Recommendation. If a subsequent convertible note or SAFE issuance is contemplated on terms that would trigger the MFN provision, we recommend that the Company perform a detailed Treas. Reg. § 1.1001-3 significant modification analysis before execution of the subsequent issuance. This analysis should quantify the economic impact of the proposed modification on the yield and other terms of the existing Notes and assess whether the modification crosses the applicable thresholds. If a significant modification would result, the Company and the holders should consider the tax consequences of the deemed exchange and evaluate whether alternative structures could avoid triggering a significant modification.
X. Section 409A Considerations
Section 409A of the Internal Revenue Code imposes significant restrictions on "nonqualified deferred compensation" arrangements, including requirements as to the timing of deferral elections, the timing and form of distributions, and the prohibition of acceleration of benefits. Failure to comply with Section 409A can result in immediate income inclusion, a 20% additional tax, and interest penalties.
Exclusion for Bona Fide Debt Instruments. The regulations under Section 409A provide that bona fide debt instruments are not treated as deferred compensation subject to Section 409A. Specifically, a payment pursuant to the terms of a debt instrument — including a payment of principal, stated interest, or OID — is not deferred compensation if the instrument is a bona fide indebtedness of the issuer. The convertible Notes should qualify for this exclusion because they represent an unconditional obligation of the Company to pay a sum certain (principal plus accrued interest) on a date certain (the Maturity Date) or upon the occurrence of specified events (Qualified Financing, Change of Control).
Conversion Feature, discount, and Valuation Cap. The conversion feature, conversion discount, and valuation cap do not, by themselves, cause the Notes to be treated as deferred compensation, provided the Notes are not "in the money" equity appreciation instruments. Section 409A is primarily concerned with equity-based instruments (such as stock options and stock appreciation rights) that have exercise prices below the fair market value of the underlying stock at the time of grant. The Notes are not stock options or equity appreciation rights; they are debt instruments with a contingent conversion feature.
Comparison to 409A Valuation. The Company's most recent independent 409A valuation, dated September 15, 2023 and prepared by Atlas Valuation Services, Inc. (contact: Martin Khoury), established the fair market value of the Company's common stock at $8.42 per share. The Cap-Implied Conversion Price of the Notes is approximately $15.46 per share, which is approximately 84% above the current 409A fair market value. This substantial premium supports the position that the Notes are not "in the money" equity instruments and do not function as deferred compensation subject to Section 409A.
Conclusion. Based on the foregoing analysis, Section 409A should not apply to the convertible Notes. The Notes are bona fide debt instruments with terms that are not designed to defer compensation, and the conversion price is substantially above the current fair market value of the Company's common stock.
Caveat. This determination should be revisited if the Company's 409A valuation increases materially prior to conversion. If, for example, the Company's 409A fair market value per common share increases above the Cap-Implied Conversion Price of $15.46 prior to a Qualified Financing, the Notes could be viewed as "in the money" at that time, which could, in theory, raise Section 409A concerns. While we believe the exclusion for bona fide debt instruments would continue to apply in that scenario, the analysis would require reconsideration in light of the facts and circumstances at that time. We recommend that the Company notify us of any material change in its 409A valuation so that we may update this analysis accordingly.
XI. Delaware Tax Considerations
A. Delaware Franchise Tax
Skybridge Fintech Ltd. is a Delaware C-corporation and is subject to the annual Delaware franchise tax. The Delaware franchise tax is not an income tax but rather a tax imposed on the privilege of incorporation in Delaware, calculated based on the corporation's authorized and outstanding capital stock and total gross assets.
Methods of Calculation. Delaware law provides two methods for calculating the franchise tax: the Authorized Shares Method and the Assumed Par Value Capital Method. Most corporations with large authorized share counts and significant asset bases, including venture-backed technology companies, elect the Assumed Par Value Capital Method, which generally results in a lower tax liability. Under the Assumed Par Value Capital Method, the franchise tax is calculated based on a formula that takes into account the corporation's total gross assets (as reported on its federal income tax return) and the total number of issued shares, resulting in an "assumed par value" per share. The tax is then computed based on the number of authorized shares and the assumed par value.
Impact of the Convertible Note Issuance. The issuance of the convertible Notes does not, by itself, increase the number of issued and outstanding shares of the Company's stock. Accordingly, the issuance of the Notes should not directly affect the Company's franchise tax calculation under either method. The proceeds from the sale of the Notes would, however, increase the Company's total gross assets (cash), which is a factor in the Assumed Par Val

MEMORANDUM

PRIVILEGED & CONFIDENTIAL ATTORNEY-CLIENT COMMUNICATION

MATTER NO.: 1009-00001

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