1010-00002 · Client 1010 · Equity Compensation Plans

tax-memo-equity-compensation.docx DOCUMENT Capital Markets

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PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGE ATTORNEY WORK PRODUCT

CALDERWOOD & HARKNESS LLP 125 Broad Street New York, NY 10004

MEMORANDUM

TO: Rachel Moynihan, General Counsel & Corporate Secretary, Arbor Health Technologies Inc.

CC: Theodore Langston, Responsible Partner, Capital Markets, Calderwood & Harkness LLP David Halderman, Chief Financial Officer, Arbor Health Technologies Inc.

FROM: Sylvia Hartwell, Specialist Partner, Tax, Calderwood & Harkness LLP

DATE: February 1, 2024

RE: Equity Compensation Tax Matters in Connection with Initial Public Offering of Arbor Health Technologies Inc.

Matter No.: 1010-00002

I. Executive Summary and Purpose

This memorandum analyzes the principal federal income tax issues arising from the equity compensation arrangements of Arbor Health Technologies Inc. ("AHT" or the "Company") in connection with the Company's initial public offering (the "IPO") of shares of its common stock, par value $0.001 per share, on the New York Stock Exchange (the "NYSE") under the ticker symbol "ARHT." Based on current projections shared with this firm, the IPO is expected to price at $20.00 per share on or about February 8, 2024, with closing anticipated on or about February 13, 2024. The base offering consists of 20,000,000 shares of common stock, with an overallotment option of an additional 3,000,000 shares granted to the underwriters led by Whitfield Barrow & Co.

This memorandum addresses five principal areas of analysis:

(1) Section 409A Compliance. Compliance of outstanding stock options under the 2014 Stock Incentive Plan (the "2014 Plan") with the requirements of Section 409A of the Internal Revenue Code of 1986, as amended (the "Code"), including a review of the Company's historical 409A valuation practices and the impact of the IPO on ongoing compliance.

(2) Section 83(b) Elections. The status and tax implications of Section 83(b) elections filed by fourteen (14) current employees who received restricted stock grants under the 2014 Plan in 2021 and 2022, including the consequences of the IPO and subsequent dispositions of such shares.

(3) ISO vs. NQSO Classification and Treatment. The classification and differing tax treatment of incentive stock options ("ISOs") and non-qualified stock options ("NQSOs") granted under the 2014 Plan and the new 2024 Equity Incentive Plan (the "2024 Plan"), including analysis of the $100,000 annual vesting limitation, alternative minimum tax ("AMT") exposure, and disqualifying disposition risks.

(4) Section 423 ESPP Qualification. The qualification of the 2024 Employee Stock Purchase Plan (the "2024 ESPP") under Section 423 of the Code, including a review of plan design, eligibility requirements, and the tax consequences to participants.

(5) Section 162(m) Deduction Limitations. The application of the $1,000,000 annual deduction limitation under Section 162(m) of the Code to compensation paid to "covered employees" of the Company following the IPO, including an assessment of the transition relief available to newly public companies and its applicability to awards under both the 2014 Plan and the 2024 Plan.

Key Conclusion. Based on our review of the applicable plan documents, form grant agreements, board minutes, stockholder consents, and the Company's historical 409A valuation reports, AHT's equity compensation arrangements are generally compliant with the applicable provisions of the Code and the Treasury Regulations promulgated thereunder. We have identified certain areas where further analysis, documentation, or procedural enhancements are warranted, and we set forth specific recommendations in each section of this memorandum and in the consolidated summary of recommendations in Section IX below. None of these observations, in our judgment, rise to the level of a material compliance deficiency that would require remediation prior to the IPO or that would need to be disclosed as a risk factor in the Company's Registration Statement on Form S-1, as amended (the "Registration Statement").

Company Background. Arbor Health Technologies Inc. is a Delaware corporation headquartered at 275 Kendall Avenue, Suite 1400, Cambridge, Massachusetts 02142. The Company was founded in 2014 by Dr. Nathaniel Rourke and Margaret "Meg" Tsujimoto. AHT operates a cloud-based clinical decision support and population health management platform serving over 1,200 hospital systems and physician groups across 42 states. For the fiscal year ended December 31, 2023, the Company reported total revenue of approximately $612.4 million, representing year-over-year growth of approximately 28% compared to fiscal year 2022 revenue of $478.4 million. As of December 31, 2023, the Company employed approximately 3,400 individuals.

The balance of this memorandum is organized as follows: Section II provides additional background on the Company and its equity compensation plans; Section III addresses Section 409A compliance; Section IV addresses Section 83(b) elections; Section V addresses ISO and NQSO classification; Section VI addresses the Section 423 qualification of the ESPP; Section VII addresses Section 162(m) limitations; Section VIII addresses withholding and reporting obligations; Section IX provides a consolidated summary of recommendations; and Section X sets forth the limitations and qualifications applicable to this memorandum. Appendices A through D, referenced throughout, contain supporting tables and schedules.

II. Background

A. Company Overview

Arbor Health Technologies Inc. is a Delaware C-corporation, Employer Identification Number 47-3891205. The Company was incorporated in the State of Delaware on March 14, 2014, and has been taxed as a C-corporation since inception. AHT operates in the healthcare technology sector, providing a Software-as-a-Service ("SaaS") platform for clinical decision support, population health management, and care coordination to hospital systems, integrated delivery networks, and physician groups. The Company's platform is currently deployed across more than 1,200 healthcare organizations in 42 states, processing clinical data for approximately 85 million patient encounters annually.

The Company's pre-IPO capitalization consists of 120,000,000 shares of common stock authorized under its Amended and Restated Certificate of Incorporation, of which 80,000,000 shares are issued and outstanding as of the date of this memorandum. The common stock has a par value of $0.001 per share. AHT has a single class of common stock outstanding, with no dual-class or supervoting structure in place. Prior to the IPO, the Company's equity capitalization also includes the shares reserved under the equity compensation plans described in Section II.B below.

Following the completion of the IPO (assuming full exercise of the overallotment option), AHT will have approximately 103,000,000 shares of common stock outstanding, consisting of the 80,000,000 pre-IPO shares plus the 20,000,000 shares offered in the base offering and the 3,000,000 overallotment shares. At the anticipated IPO price of $20.00 per share, the Company's post-IPO market capitalization will be approximately $2,060,000,000.

The Company has been funded through four rounds of institutional equity financing, including its Series A (2015), Series B led by Brindoval Trelvon Partners Fund IV, L.P. ("Brindoval Summit") (2017), Series C led by Ridgeline Growth Equity Fund III, L.P. ("Ridgeline") (2019), and Series D led by Brindoval Summit (2020). All preferred stock will convert into common stock upon closing of the IPO pursuant to the terms of the Company's Amended and Restated Certificate of Incorporation.

B. Summary of Equity Compensation Plans

1. 2014 Stock Incentive Plan

The 2014 Stock Incentive Plan was adopted by the Board of Directors and approved by the stockholders of AHT in connection with the Company's founding in 2014. The 2014 Plan authorizes the grant of incentive stock options (within the meaning of Section 422 of the Code), non-qualified stock options, and restricted stock awards to employees, directors, and consultants of the Company and its subsidiaries.

A total of 12,000,000 shares of common stock were authorized for issuance under the 2014 Plan. As of the date of this memorandum, 11,200,000 shares have been subject to stock option grants under the 2014 Plan, of which 8,400,000 options have vested and 2,800,000 options remain unvested. The weighted average exercise price of all outstanding options under the 2014 Plan is $3.25 per share, reflecting grants made over the period from 2014 through 2023 at exercise prices set at the then-current fair market value determined in accordance with the Company's independent 409A valuations (as discussed further in Section III.B below).

The 2014 Plan authorized the grant of both ISOs and NQSOs. The classification of each individual grant is specified in the applicable stock option agreement. The plan also authorized the grant of restricted stock awards, and restricted stock grants were made to fourteen (14) employees in 2021 and 2022 (as discussed further in Section IV below).

The 2014 Plan will be frozen to new grants effective as of the IPO, although outstanding awards will continue to be governed by the terms of the 2014 Plan and the applicable grant agreements. No new grants will be made under the 2014 Plan following the effectiveness of the 2024 Equity Incentive Plan.

2. 2024 Equity Incentive Plan

The 2024 Equity Incentive Plan was adopted by the Board of Directors on January 15, 2024, and will become effective upon the closing of the IPO. The 2024 Plan was approved by the Company's stockholders by written consent on January 22, 2024, as described in the Registration Statement. The 2024 Plan is intended to serve as the Company's primary equity compensation vehicle following the IPO.

A total of 10,300,000 shares of common stock have been reserved for issuance under the 2024 Plan, representing approximately 10% of the Company's anticipated post-IPO shares outstanding of 103,000,000. The 2024 Plan includes an annual "evergreen" provision pursuant to which the share reserve will automatically increase on the first day of each fiscal year by an amount equal to 3% of the total number of shares of common stock outstanding on the last day of the immediately preceding fiscal year, or such lesser number of shares as determined by the Board of Directors or the Compensation Committee. This evergreen provision is subject to an aggregate maximum of 30,900,000 additional shares over the ten-year term of the 2024 Plan.

The 2024 Plan authorizes the following types of awards: (i) incentive stock options (ISOs) within the meaning of Section 422 of the Code; (ii) non-qualified stock options (NQSOs); (iii) restricted stock awards; (iv) restricted stock units ("RSUs"); (v) stock appreciation rights ("SARs"); and (vi) performance-based awards, including performance stock units ("PSUs") and performance-vested options. The 2024 Plan will be administered by the Compensation Committee of the Board of Directors, which is expected to be composed entirely of independent directors following the IPO.

3. 2024 Employee Stock Purchase Plan

The 2024 Employee Stock Purchase Plan was adopted by the Board of Directors on January 15, 2024, and will become effective upon the closing of the IPO. The ESPP was approved by the Company's stockholders by written consent on January 22, 2024. The 2024 ESPP is intended to qualify as an "employee stock purchase plan" within the meaning of Section 423 of the Code.

A total of 2,060,000 shares of common stock have been reserved for issuance under the 2024 ESPP, representing approximately 2% of the Company's anticipated post-IPO shares outstanding of 103,000,000. The 2024 ESPP provides for a purchase price equal to 85% of the lesser of the fair market value of a share of common stock on (x) the first day of the applicable offering period (the "offering date") or (y) the last day of the applicable offering period (the "purchase date"), resulting in a maximum discount of 15% from fair market value. This "look-back" feature, combined with the 15% discount, provides the maximum benefit permitted under Section 423 of the Code.

The 2024 ESPP will operate on a semi-annual offering period basis. Eligible employees may authorize payroll deductions of up to 15% of their eligible compensation during each offering period, subject to the $25,000 annual purchase limitation prescribed by Section 423(b)(8) of the Code. The first offering period is expected to commence on or about May 1, 2024, with the first purchase date on or about October 31, 2024.

C. Key Executives and Equity Holdings (Pre-IPO)

The following table sets forth the equity holdings of the Company's five named executive officers as of the date of this memorandum, prior to the IPO:

The shares listed above include shares acquired through founder stock purchases, restricted stock grants, and option exercises, as applicable. Post-IPO ownership percentages are calculated assuming 103,000,000 shares outstanding (including the base offering and full exercise of the overallotment option) and do not give effect to any future equity grants under the 2024 Plan or shares issuable under the 2024 ESPP. These executives may also hold outstanding stock options under the 2014 Plan that are not reflected in the share counts above; a complete schedule of option holdings for each named executive officer is set forth in Appendix A.

III. Section 409A Compliance — Outstanding Options Under the 2014 Stock Incentive Plan

A. Applicable Legal Framework

Section 409A of the Code, enacted as part of the American Jobs Creation Act of 2004, imposes comprehensive requirements on arrangements that constitute "nonqualified deferred compensation." Failure to comply with Section 409A results in severe consequences for the service provider (i.e., the option holder): all deferred compensation under the noncompliant arrangement becomes immediately includable in income to the extent not subject to a substantial risk of forfeiture, and the service provider is subject to an additional tax equal to 20% of the amount includable in income, plus an interest penalty on the underpayment of tax attributable to the deferral period. These penalties apply at the individual level and are in addition to the regular income tax otherwise applicable to the compensation. See Code § 409A(a)(1)(B).

Stock options may be exempt from the requirements of Section 409A under Treasury Regulation § 1.409A-1(b)(5)(i), provided that the following conditions are satisfied:

(i) Exercise Price at or Above Fair Market Value. The exercise price of the option must not be less than the fair market value of the underlying stock on the date of grant. For stock that is not readily tradable on an established securities market (as was the case for AHT common stock prior to the IPO), fair market value must be determined by the reasonable application of a reasonable valuation method. Treasury Regulation § 1.409A-1(b)(5)(iv)(B) sets forth the criteria for a "reasonable valuation method," including factors such as the value of tangible and intangible assets, the present value of anticipated future cash flows, the market value of comparable entities, recent arm's-length transactions involving the company's securities, and other relevant factors. The regulations provide a safe harbor for valuations performed by a qualified independent appraiser, as well as for certain formula valuations and valuations in connection with specific transactions. See Treas. Reg. § 1.409A-1(b)(5)(iv)(B)(2).

(ii) Service Recipient Stock. The option must cover stock of the "service recipient" (or a corporation in a chain of corporations connected through 50% ownership with the service recipient). Treasury Regulation § 1.409A-1(b)(5)(iii) defines "service recipient stock" as common stock of the eligible issuer that, as of the date of grant, does not have any preference as to dividends or distributions in complete liquidation and that is not subject to mandatory repurchase at a price set by or determined under a formula that does not reflect fair market value. Stock that is readily tradable on an established securities market generally satisfies this requirement.

(iii) No Deferral Features. The stock option must not include any feature for the deferral of compensation other than the deferral of recognition of income until the later of exercise or disposition of the option. Features that would cause an option to fail this requirement include, among others, a right to receive stock or cash upon the lapse of a substantial risk of forfeiture without the payment of an exercise price, or a feature extending the right to exercise beyond the later of the 15th day of the third month following the end of the service provider's or service recipient's taxable year in which the option ceases to be subject to a substantial risk of forfeiture. See Treas. Reg. § 1.409A-1(b)(5)(i)(A) and (B).

If a stock option fails to satisfy any of these requirements, the option constitutes nonqualified deferred compensation subject to the full panoply of Section 409A requirements, including the rules governing the timing of deferral elections, the permissible distribution events, the prohibition on the acceleration of payments, and the documentary compliance requirements. Given the severity of the penalties for noncompliance, proper analysis of the 409A exemption for stock options is a critical element of the IPO readiness process.

B. Review of AHT's 409A Valuation History

In connection with our engagement, we have reviewed the Company's independent 409A valuation reports for each calendar year from 2014 through 2023. These valuation reports were prepared on behalf of the Company by qualified independent appraisers. We note that AHT has engaged Hargrove Prindaux Advisory Group LLC ("Hargrove Ellis") in a dual capacity, both as a compensation consultant advising the Board of Directors and the Compensation Committee on executive compensation matters and, through a separate engagement, as the firm preparing certain of the Company's 409A valuation reports. We recommend that the Company confirm whether the 409A valuation reports were prepared by Hargrove Ellis or by a separate independent valuation firm, and, if the same firm performed both functions, that the Company evaluate whether the dual engagement raises any concerns under the IRS guidance regarding independence of the appraiser. For purposes of this memorandum, we have treated the valuation reports provided to us as having been prepared by a qualified independent appraiser within the meaning of Treasury Regulation § 1.409A-1(b)(5)(iv)(B)(2)(ii).

The following summarizes the key milestones in the Company's valuation history, as reflected in the 409A valuation reports reviewed:

2014–2016 (Early Stage). During this period, AHT was in its early stages of development, having recently been founded and still in the process of building its initial platform and securing its first customers. The 409A valuations during this period reflected per-share fair market values in the range of $0.50 to $2.00 per share, consistent with the Company's pre-revenue and early-revenue status. Valuations during this period employed a combination of the income approach (Discounted cash flow analysis), the market approach (analysis of comparable publicly traded companies and recent transactions), and, to a limited extent, the asset approach. Discounts for lack of marketability ("DLOM") were applied to the concluded equity values to reflect the illiquidity of the Company's common stock.

2017 (Series B Financing). The Company's 409A valuation increased materially following the closing of its Series B preferred stock financing led by Brindoval Trelvon Partners Fund IV in the second quarter of 2017. The valuation methodology during this period gave significant weight to the recent arm's-length transaction represented by the Series B financing, consistent with the guidance in Treasury Regulation § 1.409A-1(b)(5)(iv)(B)(2). The per-share fair market value of the common stock increased to reflect the implied equity value of the Series B transaction, adjusted for the relative rights and preferences of the preferred stock using an option pricing method ("OPM") backsolve or probability-weighted expected return method ("PWERM"), as appropriate.

2019 (Series C Financing). The closing of the Series C preferred stock financing led by Ridgeline Growth Equity Fund III in the third quarter of 2019 resulted in a further step-up in the 409A fair market value of the Company's common stock. By this time, the Company had achieved meaningful revenue scale and was demonstrating strong unit economics, which was reflected in the valuation analysis.

2020 (Series D Financing). The Series D preferred stock financing, again led by Brindoval Trelvon Partners Fund IV, closed in the first quarter of 2020, resulting in another material increase in the per-share fair market value of the common stock. The Series D valuation reflected the Company's continued revenue growth and expanding market presence, as well as a narrowing DLOM as the Company moved closer to a potential liquidity event.

2021–2023 (Rapid Growth and Pre-IPO Period). During this period, the Company experienced rapid revenue growth, with fiscal year 2022 revenue of $478.4 million and fiscal year 2023 revenue of $612.4 million, representing year-over-year growth of approximately 28%. The 409A valuations during this period reflected the Company's increasing scale, profitability trajectory, and the growing probability of a near-term IPO. The DLOM decreased significantly during this period as the IPO became more imminent. The per-share fair market values during this period were materially higher than in earlier years, reflecting the Company's transformed financial profile.

The weighted average exercise price of all outstanding options under the 2014 Plan is $3.25 per share. This weighted average reflects the concentration of option grants in the earlier years of the Company's history, when 409A fair market values were significantly lower than in recent periods. Our review of the Company's grant records, including the schedule of all option grants set forth in Appendix A, indicates that each stock option grant under the 2014 Plan was made with an exercise price equal to or greater than the per-share fair market value of the Company's common stock as determined in the most recently completed 409A valuation report as of the date of grant.

We have not identified any option grants under the 2014 Plan where the exercise price was set below the contemporaneous 409A fair market value. Accordingly, based on our review, all outstanding stock options under the 2014 Plan appear to satisfy the exercise price requirement for the stock option exemption under Treasury Regulation § 1.409A-1(b)(5)(i).

C. Service Recipient Stock Requirement

All options outstanding under the 2014 Plan cover shares of AHT common stock, par value $0.001 per share. As noted above, the Company has a single class of common stock outstanding, with no dual-class or supervoting structure. The common stock does not carry any preference as to dividends or distributions in complete liquidation that would disqualify it as "service recipient stock" under Treasury Regulation § 1.409A-1(b)(5)(iii). The Company's preferred stock, which carried liquidation preferences and other preferential rights, will convert into common stock upon closing of the IPO, eliminating any potential issue regarding the relative rights of the common stock and preferred stock.

Accordingly, the common stock underlying the outstanding options qualifies as "service recipient stock" within the meaning of Treasury Regulation § 1.409A-1(b)(5)(iii), and this element of the stock option exemption is satisfied.

D. No Deferral Features

We have reviewed the form stock option agreements used under the 2014 Plan for each year of the Plan's operation, as well as a sample of individual grant agreements for grants to the five named executive officers. Based on our review, the stock option agreements do not include any features that would constitute a deferral of compensation beyond the exercise of the option. Specifically:

• The options do not include any "reload" or "replacement" feature pursuant to which the exercise of an option automatically triggers the grant of a new option.

• The options do not provide for the deferral of settlement beyond the date of exercise. Upon exercise and payment of the exercise price (whether in cash, by net exercise, or by such other methods as may be permitted under the plan), shares of common stock are delivered to the option holder promptly.

• The options do not include any feature pursuant to which the option holder may elect to receive cash or other property in lieu of shares upon exercise.

• The options do not include any stock-settled SAR features with deferred settlement elections.

• The options provide for termination in accordance with standard terms following a termination of employment (typically 90 days following termination for reasons other than cause, disability, or death, and 12 months following termination due to disability or death), which periods are within the timeframes permitted under the regulations.

Accordingly, the outstanding options under the 2014 Plan satisfy the requirement that the option not include any feature for the deferral of compensation, and this element of the stock option exemption is satisfied.

E. Impact of IPO on 409A Compliance

The completion of the IPO and the listing of the Company's common stock on the NYSE will have several implications for the Company's ongoing 409A compliance, although none of these implications affect the compliance status of the outstanding pre-IPO options.

Pre-IPO Grants. Section 409A compliance for stock options is determined as of the date of grant. The subsequent IPO does not retroactively affect the 409A analysis for existing grants. The fact that the IPO price of $20.00 per share substantially exceeds the exercise prices of the outstanding options does not call into question the validity of the prior 409A valuations, which were determined at the time of grant based on the information then available. The IRS has consistently taken the position that hindsight is not an appropriate basis for challenging a contemporaneous valuation that was determined by the reasonable application of a reasonable valuation method. Accordingly, the outstanding options under the 2014 Plan will continue to be exempt from Section 409A following the IPO.

Post-IPO Grants. Upon completion of the IPO and listing on the NYSE, AHT's common stock will become "readily tradable on an established securities market" within the meaning of Treasury Regulation § 1.409A-1(b)(5)(iv)(A). For stock that is readily tradable, fair market value for purposes of the stock option exemption may be determined based on the last sale price before, or the first sale price after, the date of grant; the closing price on the trading day before or the trading day of the date of grant; the arithmetic mean of the high and low prices on the trading day before or the trading day of the date of grant; or any other reasonable method using actual transactions in such stock as reported by the applicable securities market. We recommend that the Company adopt a uniform policy of using the closing price of the Company's common stock on the NYSE on the date of grant (or, if the grant date is not a trading day, the closing price on the immediately preceding trading day) as the exercise price for all post-IPO option grants under the 2024 Plan. This approach provides simplicity, consistency, and defensibility, and is consistent with prevailing market practice among publicly traded companies.

F. Recommendations

Based on our analysis of Section 409A compliance matters, we recommend that the Company take the following actions:

1. Maintain Historical Valuation Reports. All historical 409A valuation reports from 2014 through 2023, together with the underlying data, assumptions, and methodologies, should be maintained in the Company's permanent tax files. These reports may be relevant in the event of an IRS examination or other inquiry into the pricing of pre-IPO option grants. The statute of limitations for assessment of additional tax under Section 409A does not begin to run until the option is exercised and income is recognized; accordingly, these reports should be retained for at least the period during which any outstanding pre-IPO option could be exercised, plus the applicable statute of limitations period.

2. Confirm No Option Repricing or Modifications. The Company should confirm, through a review of Board and Compensation Committee minutes and corporate records, that no outstanding stock option under the 2014 Plan has been repriced, extended, or otherwise materially modified in a manner that could constitute a new "date of grant" for purposes of the 409A valuation analysis. Under Treasury Regulation § 1.409A-1(b)(5)(v), certain modifications to an outstanding option (such as a reduction in the exercise price or an extension of the option term) are treated as the grant of a new option as of the date of the modification, which would need to be tested for 409A compliance based on the fair market value as of that new date of grant. Our review of the Board minutes provided to us has not revealed any such repricing or modification, but we recommend that the Company independently confirm this point.

3. Implement Public-Company FMV Procedures. The Company should adopt a formal policy, approved by the Compensation Committee, for determining the exercise price of post-IPO option grants under the 2024 Plan. As noted above, we recommend the use of the NYSE closing price on the date of grant (or the immediately preceding trading day if the grant date is not a trading day). The policy should also address the timing of option grants, including restrictions on granting options during blackout periods under the Company's insider trading policy and any required pre-clearance procedures.

4. Document the Transition. The transition from private-company valuation methods (independent appraisal) to public-company market price methods (NYSE closing price) should be properly documented in the Compensation Committee's records to demonstrate continuity of the Company's 409A compliance practices.

IV. Section 83(b) Elections — Restricted Stock Grants

A. Applicable Legal Framework

Section 83(a) of the Code provides the general rule governing the taxation of property transferred in connection with the performance of services. Under Section 83(a), the fair market value of such property (less any amount paid for the property) is includable in the service provider's gross income in the first taxable year in which the property becomes "substantially vested" — that is, the first taxable year in which the property is either transferable or is no longer subject to a "substantial risk of forfeiture." A substantial risk of forfeiture generally exists if the property is conditioned upon the future performance of substantial services, or upon the occurrence of a condition related to a purpose of the transfer, and the possibility of forfeiture is substantial. See Treas. Reg. § 1.83-3(c).

Section 83(b) of the Code permits a service provider who receives property that is subject to a substantial risk of forfeiture to elect to include the fair market value of the property in income at the time of transfer (rather than waiting until the property substantially vests). The amount includable in income is the fair market value of the property at the time of transfer, less any amount paid by the service provider for the property. The election has the effect of "freezing" the amount of ordinary income recognized in connection with the property transfer at the value as of the date of transfer; any subsequent appreciation in the value of the property after the date of transfer will be taxable as capital gain (rather than ordinary income) upon a subsequent disposition.

The Section 83(b) election is subject to strict procedural requirements. The election must be filed with the Internal Revenue Service within thirty (30) days after the date of the transfer of the property. See Code § 83(b)(2); Treas. Reg. § 1.83-2(b). The election must include the information specified in Treasury Regulation § 1.83-2(e), including the name, address, and taxpayer identification number of the service provider; a description of the property; the date of transfer; the taxable year for which the election is made; the nature of the restriction; the fair market value of the property at the time of transfer (determined without regard to any restriction other than one that by its terms will never lapse); the amount paid for the property; and a statement that copies of the election have been furnished to all persons for whom the service provider is required to perform services. A copy of the election must also be filed with the service provider's federal income tax return for the taxable year in which the property was transferred.

Once made, a Section 83(b) election is irrevocable. If the property is subsequently forfeited (e.g., because the service provider terminates employment before the vesting conditions are satisfied), the service provider is not entitled to any deduction for the income previously recognized under the election. See Code § 83(b)(1) (flush language). This represents a significant risk of the 83(b) election: if the restricted stock is forfeited, the employee will have paid tax on phantom income with no ability to recover the tax paid.

From the employer's perspective, the service recipient (AHT) is entitled to a corresponding compensation deduction under Section 83(h) of the Code in the year in which the service provider includes the income in gross income. If a Section 83(b) election is made, the deduction is available in the year of the election (the year of transfer), rather than in the later year when the property vests.

B. Status of 83(b) Elections at AHT

Fourteen (14) current employees of the Company received restricted stock grants under the 2014 Stock Incentive Plan during the calendar years 2021 and 2022. These grants were subject to time-based vesting schedules (typically four-year vesting with a one-year cliff), meaning that the shares were subject to a substantial risk of forfeiture at the time of transfer within the meaning of Section 83(a).

All fourteen (14) employees filed Section 83(b) elections with the Internal Revenue Service within the thirty (30) day period following the date of transfer of their respective restricted stock grants. Calderwood & Harkness has reviewed copies of the 83(b) election forms filed by each of the fourteen employees, together with supporting documentation evidencing timely filing, including certified mail receipts, return receipt cards, or other evidence of delivery to the IRS. Based on our review:

• Each election form contains all of the information required by Treasury Regulation § 1.83-2(e).

• Each election was filed within the thirty (30) day period prescribed by Section 83(b)(2) of the Code.

• Each employee received a copy of the election from the Company for inclusion in the employee's personnel file, and the Company retained copies in its tax records.

• The Company confirmed that it reported the amounts included in income by each employee on the applicable Form W-2 for the year of the election and claimed the corresponding compensation deductions on its federal and state income tax returns for the applicable years.

A complete list of the fourteen employees, together with the grant dates, number of restricted shares, fair market value at the time of grant (as determined by the Company's then-current 409A valuation), the election filing date, and the vesting schedule for each grant, is set forth in Appendix B to this memorandum.

At the time of the elections, the fair market value of the Company's common stock was substantially lower than the current anticipated IPO price of $20.00 per share. The elections therefore had the effect of accelerating the recognition of a relatively modest amount of ordinary income (based on the pre-IPO 409A valuation) in exchange for converting all subsequent appreciation into potential capital gain. Given the magnitude of the appreciation from the grant-date fair market values to the IPO price (and potentially beyond), these elections are expected to produce significant tax savings for the participating employees.

C. Impact of IPO on 83(b) Election Holders

For employees who made valid Section 83(b) elections, the IPO does not trigger any additional ordinary income recognition. The ordinary income associated with the restricted stock grants was fully recognized in the year of the election, and no further income inclusion is required upon vesting, upon the IPO, or upon the Company's listing on the NYSE.

Upon a subsequent disposition of the shares, the gain or loss recognized by the employee will be capital in nature. The character of the capital gain or loss — long-term or short-term — is determined by reference to the holding period measured from the date of the transfer of the restricted stock (not the date on which the shares vest). This is one of the principal advantages of the Section 83(b) election: the holding period begins on the date of transfer, which permits the employee to satisfy the one-year holding period for long-term capital gain treatment earlier than would be possible in the absence of the election.

Since the restricted stock grants at issue were made in 2021 and 2022, the one-year holding period will have been satisfied well before any post-IPO disposition. Accordingly, assuming that the shares are held until the date of disposition, any gain recognized upon sale will qualify for long-term capital gain treatment at preferential federal rates (currently a maximum rate of 20%, plus the 3.8% net investment income tax under Section 1411 of the Code, for a combined maximum federal rate of 23.8%).

We note that the shares held by these fourteen employees are included in the approximately 80,000,000 pre-IPO shares that are subject to the 180-day lock-up agreement entered into with the underwriters in connection with the IPO. The lock-up period is expected to expire on or about August 6, 2024 (180 days following the expected pricing date of February 8, 2024). During the lock-up period, these employees will not be able to sell, transfer, or otherwise dispose of their shares (subject to the limited exceptions set forth in the lock-up agreement, including the tax withholding exception discussed in Section VIII.B below).

It is possible that some of the fourteen employees' restricted stock grants have not yet fully vested as of the date of this memorandum. For any shares that remain unvested, the shares continue to be subject to a substantial risk of forfeiture. If any shares are forfeited (e.g., due to a termination of employment prior to vesting), the employee will not be entitled to any deduction or loss for the ordinary income previously recognized under the Section 83(b) election, and AHT will be required to reverse any corresponding compensation deduction previously claimed on its federal and state income tax returns for the year in which the election was made. The inability to recover the tax paid on forfeited shares is an inherent risk of the Section 83(b) election that should have been explained to each employee at the time the election was made.

D. Recommendations

1. Confirm Continued Employment and Vesting Status. The Company should confirm that all fourteen employees who made Section 83(b) elections remain employed by the Company and that their restricted stock grants are on track for full vesting in accordance with the applicable vesting schedules. If any of these employees have terminated employment or are at risk of termination, the Company should assess the impact on the previously claimed compensation deductions.

2. Maintain Election Files. Copies of all fourteen Section 83(b) election forms, together with proof of timely filing, should be maintained in AHT's permanent tax and human resources files. These records should be readily accessible in the event of an IRS examination or other inquiry.

3. Advise Employees on Capital Gain Implications. The Company should work with its human resources department and, if appropriate, outside counsel, to provide affected employees with information regarding the capital gains implications of holding and disposing of their shares, including the applicable holding period calculations and the interaction of the 83(b) election with the lock-up period. While the Company cannot and should not provide individualized tax advice, general educational materials can help employees understand the tax framework and seek appropriate personal tax counsel.

4. Ensure Proper Reporting. The Company should ensure that all compensation recognized under the Section 83(b) elections was properly reported on Forms W-2 for the applicable years and that corresponding compensation deductions were properly claimed on the Company's tax returns. Going forward, no additional W-2 reporting should be required in connection with the vesting of the restricted stock (since the income was already recognized in the year of the election), but the Company should confirm that its payroll and HR systems are properly configured to reflect this treatment.

V. ISO vs. NQSO Classification and Treatment

A. Applicable Legal Framework

Section 422 of the Code governs incentive stock options. An ISO is a stock option granted to an employee of the corporation (or its parent or subsidiary) with respect to the stock of that corporation, which meets the specific statutory requirements set forth in Section 422(b). ISOs provide favorable tax treatment to the employee: there is no regular income tax recognized at the time of grant or at the time of exercise, and if the employee satisfies the applicable holding period requirements upon a subsequent disposition of the shares, the entire gain is treated as long-term capital gain. This treatment stands in contrast to the treatment of NQSOs, where the spread at exercise (the excess of the fair market value of the stock at the time of exercise over the exercise price) is taxable as ordinary income in the year of exercise.

However, the tax benefits of ISOs are subject to important limitations and considerations:

(i) Alternative Minimum Tax. Although the spread at exercise of an ISO is not included in regular taxable income, it is an adjustment item for purposes of the alternative minimum tax ("AMT") under Section 56(b)(3) of the Code. This means that an employee who exercises an ISO and does not sell the underlying shares in the same taxable year may be subject to AMT on the spread at exercise. The AMT can result in a significant current-year tax liability, even though no regular income tax is due. The AMT exposure is particularly acute when the spread at exercise is large relative to the employee's other income, as is the case here given the substantial difference between the exercise prices of the outstanding options and the anticipated IPO price.

(ii) Holding Period Requirements. To qualify for long-term capital gain treatment on the disposition of ISO shares, the employee must hold the shares for at least two years from the date of grant of the option and at least one year from the date of exercise. See Code § 422(a)(1). A disposition that occurs before satisfaction of both holding periods is a "disqualifying disposition," which is discussed in Section V.D below.

(iii) Statutory Requirements for ISO Status. Section 422(b) of the Code requires that the following conditions be met for a stock option to qualify as an ISO:

(a) The option must be granted under a plan that has been approved by the stockholders of the granting corporation and that specifies the aggregate number of shares that may be issued under the plan and the employees or class of employees eligible to receive options.

(b) The option must be granted within ten (10) years of the date the plan was adopted or approved by stockholders, whichever is earlier.

(c) The exercise price must be at least equal to the fair market value of the underlying stock on the date of grant. For an employee who owns (directly or by attribution under Section 424(d)) more than 10% of the total combined voting power of all classes of stock of the employer corporation (or its parent or subsidiary), the exercise price must be at least 110% of fair market value.

(d) The option must not be exercisable after ten (10) years from the date of grant (five years for a greater-than-10% stockholder).

(e) The option must be granted only to an employee of the corporation (or its parent or subsidiary).

(f) The option must, by its terms, not be transferable other than by will or the laws of descent and distribution, and must be exercisable during the employee's lifetime only by the employee.

(iv) $100,000 Annual Vesting Limit. Under Section 422(d) of the Code, to the extent that the aggregate fair market value of stock (determined as of the date of grant) with respect to which ISOs are exercisable for the first time by any individual during any calendar year (under all plans of the individual's employer and its parent and subsidiary corporations) exceeds $100,000, such options are treated as NQSOs rather than ISOs. This limitation is applied by taking options into account in the order in which they were granted. See Treas. Reg. § 1.422-4.

Non-Qualified Stock Options. NQSOs do not benefit from the favorable tax treatment afforded to ISOs. At the time of exercise of an NQSO, the employee recognizes ordinary income equal to the "spread" — the excess of the fair market value of the stock at the time of exercise over the exercise price. This income is subject to income tax withholding, Social Security tax (up to the applicable wage base), and Medicare tax (including the Additional Medicare Tax under Section 3101(b)(2) for wages in excess of $200,000). The employer is entitled to a corresponding compensation deduction under Section 162 of the Code in the amount of the ordinary income recognized by the employee, subject to the limitations of Section 162(m) (discussed in Section VII below) and the reasonable compensation limitation of Section 162(a)(1). There is no AMT adjustment upon the exercise of an NQSO.

B. Classification of Outstanding Options Under the 2014 Plan

The 2014 Stock Incentive Plan authorized the grant of both ISOs and NQSOs. The classification of each individual grant as an ISO or NQSO is specified in the applicable stock option agreement. Of the 11,200,000 total options granted under the 2014 Plan, a detailed analysis is required to determine the precise split between ISOs and NQSOs for each individual option holder, taking into account (a) the classification specified in the grant agreement and (b) the operation of the $100,000 annual vesting limit under Section 422(d), which may have the effect of reclassifying portions of intended ISO grants as NQSOs (as discussed in Section V.C below).

The weighted average exercise price of all outstanding options under the 2014 Plan is $3.25 per share. At the anticipated IPO price of $20.00 per share, the in-the-money spread per option is $16.75 ($20.00 minus $3.25). The aggregate intrinsic value of all outstanding options is therefore approximately $187,600,000 (11,200,000 options multiplied by $16.75 per share). This substantial intrinsic value has significant tax implications for option holders, as outlined below:

For ISOs. The $16.75 per-share spread at exercise will constitute an AMT adjustment item. For an employee exercising a large block of ISOs, the AMT liability could be substantial. For example, an employee exercising ISOs covering 100,000 shares with an exercise price of $3.25 at a market price of $20.00 would have an AMT adjustment of $1,675,000. Depending on the employee's other income, deductions, and AMT credit carryforwards, this could result in a material AMT liability in the year of exercise. Employees should be counseled to consult with their personal tax advisors regarding AMT planning strategies, including the potential benefits of exercising ISOs in installments over multiple tax years or exercising and selling in the same year (which would result in a disqualifying disposition but would avoid the AMT issue).

For NQSOs. Exercise will generate significant ordinary income and corresponding withholding obligations. An employee exercising NQSOs covering 100,000 shares at the same prices described above would recognize $1,675,000 of ordinary income, subject to federal income tax withholding at the supplemental wage rate (37% for supplemental wages exceeding $1,000,000 in a calendar year), Medicare tax (including the 0.9% Additional Medicare Tax), and applicable state income taxes. AHT would be entitled to a corresponding compensation deduction in the year of exercise, subject to the Section 162(m) limitations discussed in Section VII.

C. $100,000 Annual Vesting Limit for ISOs

As noted above, Section 422(d) of the Code provides that, to the extent that the aggregate fair market value of stock (determined as of the date of grant) with respect to which ISOs are exercisable for the first time by an individual during any calendar year exceeds $100,000, the excess options are treated as NQSOs. This limitation is applied on a grant-by-grant basis, taking options into account in the order in which they were granted.

At a weighted average exercise price of $3.25 per share, which approximates the fair market value at the date of grant for the relevant grants, the $100,000 annual vesting limit permits approximately 30,769 shares (i.e., $100,000 / $3.25) to become first exercisable in any given calendar year and retain ISO treatment. Shares in excess of this amount that become first exercisable in the same year will be treated as NQSOs, regardless of the classification specified in the grant agreement.

For employees who received large option grants, this limitation may have caused a portion of the intended ISO grants to be reclassified as NQSOs under the ordering rules of Treasury Regulation § 1.422-4. This is particularly likely for the named executive officers and other senior employees who may have received grants covering a substantial number of shares. A grant-by-grant analysis is necessary to confirm the ISO/NQSO status of each tranche of each outstanding option, taking into account the vesting schedule, the fair market value at the date of grant, and the ordering rules.

Recommendation. We recommend that the Company prepare a detailed grant-by-grant analysis for each outstanding option under the 2014 Plan, confirming the ISO/NQSO classification of each vesting tranche after application of the $100,000 annual vesting limit. This analysis is particularly important for the five named executive officers (Dr. Rourke, Ms. Tsujimoto, Mr. Halderman, Dr. Subramanian, and Ms. Moynihan), whose option exercises are most likely to generate compensation in excess of the Section 162(m) limitation. The analysis should be prepared as a working paper and maintained in the Company's tax files. A summary of this analysis, once completed, should be included in Appendix A to this memorandum.

D. Disqualifying Dispositions

If an employee who exercised an ISO sells or otherwise disposes of the underlying shares before the satisfaction of both applicable holding period requirements — two years from the date of grant and one year from the date of exercise — the disposition is a "disqualifying disposition" under Section 421(b) of the Code. In the event of a disqualifying disposition:

• The employee recognizes ordinary income in the year of the disposition equal to the lesser of (i) the gain realized on the disposition (i.e., the excess of the amount realized over the exercise price) or (ii) the spread at the time of exercise (i.e., the excess of the fair market value at exercise over the exercise price). Any gain in excess of the ordinary income amount is capital gain.

• AHT is entitled to a corresponding compensation deduction equal to the amount of ordinary income recognized by the employee, subject to Section 162(m) limitations if the employee is a covered employee.

The interaction of the disqualifying disposition rules with the IPO lock-up period deserves careful attention. The 180-day lock-up period is expected to expire on or about August 6, 2024 (180 days following the expected pricing date of February 8, 2024). For employees who exercise ISOs at or around the time of the IPO (e.g., in February 2024), the one-year post-exercise holding period would not be satisfied until at least February 2025. Accordingly, even though the lock-up period will prevent sales until August 2024, a sale between August 2024 and February 2025 would constitute a disqualifying disposition.

The lock-up period provides a partial safeguard against premature dispositions, but it does not fully align with the one-year post-exercise holding period. Employees who exercise ISOs in connection with the IPO and sell their shares promptly after the lock-up expires will trigger disqualifying dispositions.

We also note that, as disclosed in the Registration Statement, pre-existing Rule 10b5-1 trading plans are in place for Dr. Nathaniel Rourke and Margaret Tsujimoto. To the extent that these trading plans contemplate sales of shares acquired through ISO exercises, the timing of such sales should be carefully coordinated to avoid unintended disqualifying dispositions or, alternatively, the potential tax consequences of disqualifying dispositions should be modeled in advance.

Recommendation. We recommend that the Company (i) advise all employees holding ISOs of the disqualifying disposition rules and the interaction with the lock-up period; (ii) coordinate with Dr. Rourke and Ms. Tsujimoto (and their personal tax advisors) regarding the treatment of shares that may be sold pursuant to their respective 10b5-1 trading plans; and (iii) implement a system to track disqualifying dispositions for purposes of the Company's entitlement to compensation deductions and for W-2 reporting purposes.

E. Options Under the 2024 Equity Incentive Plan

The 2024 Equity Incentive Plan, which will become effective upon the closing of the IPO, authorizes the grant of both ISOs and NQSOs, as well as RSUs, SARs, and performance-based awards. A total of 10,300,000 shares are initially reserved under the 2024 Plan, with the annual evergreen provision of 3% of outstanding shares described in Section II.B.2 above. The standard form stock option agreement under the 2024 Plan provides for a four-year vesting schedule with a one-year cliff (i.e., 25% of the shares subject to the option vest on the first anniversary of the grant date, and the remaining 75% vest in equal monthly installments over the following thirty-six months).

For post-IPO option grants, the exercise price for ISOs must be set at or above the fair market value of the Company's common stock on the date of grant. As recommended in Section III.E above, fair market value should be determined by reference to the closing price on the NYSE on the date of grant (or the immediately preceding trading day if the grant date is not a trading day). For any employee who is a greater-than-10% stockholder (determined under the attribution rules of Section 424(d) of the Code), the exercise price must be at least 110% of fair market value, and the option term must not exceed five years.

Recommendation. The Company should implement the following procedures with respect to post-IPO option grants under the 2024 Plan:

• Establish a formal grant date policy approved by the Compensation Committee, specifying how and when option grants will be approved, the determination of exercise price, and the process for documenting grants in real time.

• Ensure that the Company's equity plan administration system (including any third-party equity management platform) is properly configured to distinguish between ISO and NQSO grants, apply the $100,000 annual vesting limit automatically, and track disqualifying dispositions.

• Prepare and distribute employee education materials explaining the differences between ISOs and NQSOs, the AMT implications of ISO exercises, the holding period requirements for ISOs, and the consequences of disqualifying dispositions.

VI. Section 423 Qualification — 2024 Employee Stock Purchase Plan

A. Applicable Legal Framework

Section 423 of the Code provides favorable tax treatment for employee stock purchase plans that satisfy the statutory requirements. An "employee stock purchase plan" within the meaning of Section 423 is a plan under which shares of stock of the employer corporation are offered to employees, provided that the plan meets the requirements of Section 423(b). The principal tax benefit of a qualifying ESPP is that no income is recognized by the participating employee at the time of enrollment in the plan or at the time shares are purchased under the plan. Instead, income is recognized only upon the disposition of the shares acquired through the plan, and the character of that income depends on whether the disposition is a "qualifying disposition" or a "disqualifying disposition."

Section 423(b) of the Code sets forth the following requirements for a qualifying ESPP:

(i) Stockholder Approval. The plan must be approved by the stockholders of the employer corporation within twelve months before or after the date the plan is adopted.

(ii) Employee Participation Only. Only employees of the employer corporation (or its designated parent or subsidiary corporations) may participate. No employee may be granted an option to purchase stock under the plan if, immediately after the option is granted, the employee would own (directly or by attribution under Section 424(d)) stock possessing 5% or more of the total combined voting power or value of all classes of stock of the employer corporation or of any parent or subsidiary.

(iii) Equal Rights and Privileges. All employees granted options under the plan must have the same rights and privileges, except that the amount of stock that may be purchased may bear a uniform relationship to the employee's total compensation or basic or regular rate of compensation, and a maximum number of shares may be established for any individual employee.

(iv) Maximum discount. The purchase price under the plan must be at least 85% of the fair market value of the stock at the time the option is granted (the offering date) or at the time the option is exercised (the purchase date), whichever is less. A plan that includes a "look-back" feature (using the lesser of the fair market value on the offering date or the purchase date) combined with the 15% maximum discount provides the most favorable terms to employees permitted under Section 423.

(v) Annual Purchase Limitation. No employee may be permitted to accrue the right to purchase stock under all ESPPs of the employer (and its parent and subsidiary corporations) at a rate exceeding $25,000 of fair market value of stock (determined at the time the option is granted) per calendar year. See Code § 423(b)(8).

(vi) Maximum Offering Period. The option must not be exercisable after twenty-seven (27) months from the date the option is granted, unless the purchase price is not less than 85% of the fair market value of the stock at the time the option is exercised, in which case the offering period may be up to five (5) years.

Upon a "qualifying disposition" — a disposition that occurs after the employee has held the shares for at least two years from the offering date an

PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGE ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP 125 Broad Street New York, NY 10004
MEMORANDUM
TO: Rachel Moynihan, General Counsel & Corporate Secretary, Arbor Health Technologies Inc.
CC: Theodore Langston, Responsible Partner, Capital Markets, Calderwood & Harkness LLP David Halderman, Chief Financial Officer, Arbor Health Technologies Inc.
FROM: Sylvia Hartwell, Specialist Partner, Tax, Calderwood & Harkness LLP
DATE: February 1, 2024
RE: Equity Compensation Tax Matters in Connection with Initial Public Offering of Arbor Health Technologies Inc.
Matter No.: 1010-00002
I. Executive Summary and Purpose
This memorandum analyzes the principal federal income tax issues arising from the equity compensation arrangements of Arbor Health Technologies Inc. ("AHT" or the "Company") in connection with the Company's initial public offering (the "IPO") of shares of its common stock, par value $0.001 per share, on the New York Stock Exchange (the "NYSE") under the ticker symbol "ARHT." Based on current projections shared with this firm, the IPO is expected to price at $20.00 per share on or about February 8, 2024, with closing anticipated on or about February 13, 2024. The base offering consists of 20,000,000 shares of common stock, with an overallotment option of an additional 3,000,000 shares granted to the underwriters led by Whitfield Barrow & Co.
This memorandum addresses five principal areas of analysis:
(1) Section 409A Compliance. Compliance of outstanding stock options under the 2014 Stock Incentive Plan (the "2014 Plan") with the requirements of Section 409A of the Internal Revenue Code of 1986, as amended (the "Code"), including a review of the Company's historical 409A valuation practices and the impact of the IPO on ongoing compliance.
(2) Section 83(b) Elections. The status and tax implications of Section 83(b) elections filed by fourteen (14) current employees who received restricted stock grants under the 2014 Plan in 2021 and 2022, including the consequences of the IPO and subsequent dispositions of such shares.
(3) ISO vs. NQSO Classification and Treatment. The classification and differing tax treatment of incentive stock options ("ISOs") and non-qualified stock options ("NQSOs") granted under the 2014 Plan and the new 2024 Equity Incentive Plan (the "2024 Plan"), including analysis of the $100,000 annual vesting limitation, alternative minimum tax ("AMT") exposure, and disqualifying disposition risks.
(4) Section 423 ESPP Qualification. The qualification of the 2024 Employee Stock Purchase Plan (the "2024 ESPP") under Section 423 of the Code, including a review of plan design, eligibility requirements, and the tax consequences to participants.
(5) Section 162(m) Deduction Limitations. The application of the $1,000,000 annual deduction limitation under Section 162(m) of the Code to compensation paid to "covered employees" of the Company following the IPO, including an assessment of the transition relief available to newly public companies and its applicability to awards under both the 2014 Plan and the 2024 Plan.
Key Conclusion. Based on our review of the applicable plan documents, form grant agreements, board minutes, stockholder consents, and the Company's historical 409A valuation reports, AHT's equity compensation arrangements are generally compliant with the applicable provisions of the Code and the Treasury Regulations promulgated thereunder. We have identified certain areas where further analysis, documentation, or procedural enhancements are warranted, and we set forth specific recommendations in each section of this memorandum and in the consolidated summary of recommendations in Section IX below. None of these observations, in our judgment, rise to the level of a material compliance deficiency that would require remediation prior to the IPO or that would need to be disclosed as a risk factor in the Company's Registration Statement on Form S-1, as amended (the "Registration Statement").
Company Background. Arbor Health Technologies Inc. is a Delaware corporation headquartered at 275 Kendall Avenue, Suite 1400, Cambridge, Massachusetts 02142. The Company was founded in 2014 by Dr. Nathaniel Rourke and Margaret "Meg" Tsujimoto. AHT operates a cloud-based clinical decision support and population health management platform serving over 1,200 hospital systems and physician groups across 42 states. For the fiscal year ended December 31, 2023, the Company reported total revenue of approximately $612.4 million, representing year-over-year growth of approximately 28% compared to fiscal year 2022 revenue of $478.4 million. As of December 31, 2023, the Company employed approximately 3,400 individuals.
The balance of this memorandum is organized as follows: Section II provides additional background on the Company and its equity compensation plans; Section III addresses Section 409A compliance; Section IV addresses Section 83(b) elections; Section V addresses ISO and NQSO classification; Section VI addresses the Section 423 qualification of the ESPP; Section VII addresses Section 162(m) limitations; Section VIII addresses withholding and reporting obligations; Section IX provides a consolidated summary of recommendations; and Section X sets forth the limitations and qualifications applicable to this memorandum. Appendices A through D, referenced throughout, contain supporting tables and schedules.
II. Background
A. Company Overview
Arbor Health Technologies Inc. is a Delaware C-corporation, Employer Identification Number 47-3891205. The Company was incorporated in the State of Delaware on March 14, 2014, and has been taxed as a C-corporation since inception. AHT operates in the healthcare technology sector, providing a Software-as-a-Service ("SaaS") platform for clinical decision support, population health management, and care coordination to hospital systems, integrated delivery networks, and physician groups. The Company's platform is currently deployed across more than 1,200 healthcare organizations in 42 states, processing clinical data for approximately 85 million patient encounters annually.
The Company's pre-IPO capitalization consists of 120,000,000 shares of common stock authorized under its Amended and Restated Certificate of Incorporation, of which 80,000,000 shares are issued and outstanding as of the date of this memorandum. The common stock has a par value of $0.001 per share. AHT has a single class of common stock outstanding, with no dual-class or supervoting structure in place. Prior to the IPO, the Company's equity capitalization also includes the shares reserved under the equity compensation plans described in Section II.B below.
Following the completion of the IPO (assuming full exercise of the overallotment option), AHT will have approximately 103,000,000 shares of common stock outstanding, consisting of the 80,000,000 pre-IPO shares plus the 20,000,000 shares offered in the base offering and the 3,000,000 overallotment shares. At the anticipated IPO price of $20.00 per share, the Company's post-IPO market capitalization will be approximately $2,060,000,000.
The Company has been funded through four rounds of institutional equity financing, including its Series A (2015), Series B led by Brindoval Trelvon Partners Fund IV, L.P. ("Brindoval Summit") (2017), Series C led by Ridgeline Growth Equity Fund III, L.P. ("Ridgeline") (2019), and Series D led by Brindoval Summit (2020). All preferred stock will convert into common stock upon closing of the IPO pursuant to the terms of the Company's Amended and Restated Certificate of Incorporation.
B. Summary of Equity Compensation Plans
1. 2014 Stock Incentive Plan
The 2014 Stock Incentive Plan was adopted by the Board of Directors and approved by the stockholders of AHT in connection with the Company's founding in 2014. The 2014 Plan authorizes the grant of incentive stock options (within the meaning of Section 422 of the Code), non-qualified stock options, and restricted stock awards to employees, directors, and consultants of the Company and its subsidiaries.
A total of 12,000,000 shares of common stock were authorized for issuance under the 2014 Plan. As of the date of this memorandum, 11,200,000 shares have been subject to stock option grants under the 2014 Plan, of which 8,400,000 options have vested and 2,800,000 options remain unvested. The weighted average exercise price of all outstanding options under the 2014 Plan is $3.25 per share, reflecting grants made over the period from 2014 through 2023 at exercise prices set at the then-current fair market value determined in accordance with the Company's independent 409A valuations (as discussed further in Section III.B below).
The 2014 Plan authorized the grant of both ISOs and NQSOs. The classification of each individual grant is specified in the applicable stock option agreement. The plan also authorized the grant of restricted stock awards, and restricted stock grants were made to fourteen (14) employees in 2021 and 2022 (as discussed further in Section IV below).
The 2014 Plan will be frozen to new grants effective as of the IPO, although outstanding awards will continue to be governed by the terms of the 2014 Plan and the applicable grant agreements. No new grants will be made under the 2014 Plan following the effectiveness of the 2024 Equity Incentive Plan.
2. 2024 Equity Incentive Plan
The 2024 Equity Incentive Plan was adopted by the Board of Directors on January 15, 2024, and will become effective upon the closing of the IPO. The 2024 Plan was approved by the Company's stockholders by written consent on January 22, 2024, as described in the Registration Statement. The 2024 Plan is intended to serve as the Company's primary equity compensation vehicle following the IPO.
A total of 10,300,000 shares of common stock have been reserved for issuance under the 2024 Plan, representing approximately 10% of the Company's anticipated post-IPO shares outstanding of 103,000,000. The 2024 Plan includes an annual "evergreen" provision pursuant to which the share reserve will automatically increase on the first day of each fiscal year by an amount equal to 3% of the total number of shares of common stock outstanding on the last day of the immediately preceding fiscal year, or such lesser number of shares as determined by the Board of Directors or the Compensation Committee. This evergreen provision is subject to an aggregate maximum of 30,900,000 additional shares over the ten-year term of the 2024 Plan.
The 2024 Plan authorizes the following types of awards: (i) incentive stock options (ISOs) within the meaning of Section 422 of the Code; (ii) non-qualified stock options (NQSOs); (iii) restricted stock awards; (iv) restricted stock units ("RSUs"); (v) stock appreciation rights ("SARs"); and (vi) performance-based awards, including performance stock units ("PSUs") and performance-vested options. The 2024 Plan will be administered by the Compensation Committee of the Board of Directors, which is expected to be composed entirely of independent directors following the IPO.
3. 2024 Employee Stock Purchase Plan
The 2024 Employee Stock Purchase Plan was adopted by the Board of Directors on January 15, 2024, and will become effective upon the closing of the IPO. The ESPP was approved by the Company's stockholders by written consent on January 22, 2024. The 2024 ESPP is intended to qualify as an "employee stock purchase plan" within the meaning of Section 423 of the Code.
A total of 2,060,000 shares of common stock have been reserved for issuance under the 2024 ESPP, representing approximately 2% of the Company's anticipated post-IPO shares outstanding of 103,000,000. The 2024 ESPP provides for a purchase price equal to 85% of the lesser of the fair market value of a share of common stock on (x) the first day of the applicable offering period (the "offering date") or (y) the last day of the applicable offering period (the "purchase date"), resulting in a maximum discount of 15% from fair market value. This "look-back" feature, combined with the 15% discount, provides the maximum benefit permitted under Section 423 of the Code.
The 2024 ESPP will operate on a semi-annual offering period basis. Eligible employees may authorize payroll deductions of up to 15% of their eligible compensation during each offering period, subject to the $25,000 annual purchase limitation prescribed by Section 423(b)(8) of the Code. The first offering period is expected to commence on or about May 1, 2024, with the first purchase date on or about October 31, 2024.
C. Key Executives and Equity Holdings (Pre-IPO)
The following table sets forth the equity holdings of the Company's five named executive officers as of the date of this memorandum, prior to the IPO:
The shares listed above include shares acquired through founder stock purchases, restricted stock grants, and option exercises, as applicable. Post-IPO ownership percentages are calculated assuming 103,000,000 shares outstanding (including the base offering and full exercise of the overallotment option) and do not give effect to any future equity grants under the 2024 Plan or shares issuable under the 2024 ESPP. These executives may also hold outstanding stock options under the 2014 Plan that are not reflected in the share counts above; a complete schedule of option holdings for each named executive officer is set forth in Appendix A.
III. Section 409A Compliance — Outstanding Options Under the 2014 Stock Incentive Plan
A. Applicable Legal Framework
Section 409A of the Code, enacted as part of the American Jobs Creation Act of 2004, imposes comprehensive requirements on arrangements that constitute "nonqualified deferred compensation." Failure to comply with Section 409A results in severe consequences for the service provider (i.e., the option holder): all deferred compensation under the noncompliant arrangement becomes immediately includable in income to the extent not subject to a substantial risk of forfeiture, and the service provider is subject to an additional tax equal to 20% of the amount includable in income, plus an interest penalty on the underpayment of tax attributable to the deferral period. These penalties apply at the individual level and are in addition to the regular income tax otherwise applicable to the compensation. See Code § 409A(a)(1)(B).
Stock options may be exempt from the requirements of Section 409A under Treasury Regulation § 1.409A-1(b)(5)(i), provided that the following conditions are satisfied:
(i) Exercise Price at or Above Fair Market Value. The exercise price of the option must not be less than the fair market value of the underlying stock on the date of grant. For stock that is not readily tradable on an established securities market (as was the case for AHT common stock prior to the IPO), fair market value must be determined by the reasonable application of a reasonable valuation method. Treasury Regulation § 1.409A-1(b)(5)(iv)(B) sets forth the criteria for a "reasonable valuation method," including factors such as the value of tangible and intangible assets, the present value of anticipated future cash flows, the market value of comparable entities, recent arm's-length transactions involving the company's securities, and other relevant factors. The regulations provide a safe harbor for valuations performed by a qualified independent appraiser, as well as for certain formula valuations and valuations in connection with specific transactions. See Treas. Reg. § 1.409A-1(b)(5)(iv)(B)(2).
(ii) Service Recipient Stock. The option must cover stock of the "service recipient" (or a corporation in a chain of corporations connected through 50% ownership with the service recipient). Treasury Regulation § 1.409A-1(b)(5)(iii) defines "service recipient stock" as common stock of the eligible issuer that, as of the date of grant, does not have any preference as to dividends or distributions in complete liquidation and that is not subject to mandatory repurchase at a price set by or determined under a formula that does not reflect fair market value. Stock that is readily tradable on an established securities market generally satisfies this requirement.
(iii) No Deferral Features. The stock option must not include any feature for the deferral of compensation other than the deferral of recognition of income until the later of exercise or disposition of the option. Features that would cause an option to fail this requirement include, among others, a right to receive stock or cash upon the lapse of a substantial risk of forfeiture without the payment of an exercise price, or a feature extending the right to exercise beyond the later of the 15th day of the third month following the end of the service provider's or service recipient's taxable year in which the option ceases to be subject to a substantial risk of forfeiture. See Treas. Reg. § 1.409A-1(b)(5)(i)(A) and (B).
If a stock option fails to satisfy any of these requirements, the option constitutes nonqualified deferred compensation subject to the full panoply of Section 409A requirements, including the rules governing the timing of deferral elections, the permissible distribution events, the prohibition on the acceleration of payments, and the documentary compliance requirements. Given the severity of the penalties for noncompliance, proper analysis of the 409A exemption for stock options is a critical element of the IPO readiness process.
B. Review of AHT's 409A Valuation History
In connection with our engagement, we have reviewed the Company's independent 409A valuation reports for each calendar year from 2014 through 2023. These valuation reports were prepared on behalf of the Company by qualified independent appraisers. We note that AHT has engaged Hargrove Prindaux Advisory Group LLC ("Hargrove Ellis") in a dual capacity, both as a compensation consultant advising the Board of Directors and the Compensation Committee on executive compensation matters and, through a separate engagement, as the firm preparing certain of the Company's 409A valuation reports. We recommend that the Company confirm whether the 409A valuation reports were prepared by Hargrove Ellis or by a separate independent valuation firm, and, if the same firm performed both functions, that the Company evaluate whether the dual engagement raises any concerns under the IRS guidance regarding independence of the appraiser. For purposes of this memorandum, we have treated the valuation reports provided to us as having been prepared by a qualified independent appraiser within the meaning of Treasury Regulation § 1.409A-1(b)(5)(iv)(B)(2)(ii).
The following summarizes the key milestones in the Company's valuation history, as reflected in the 409A valuation reports reviewed:
2014–2016 (Early Stage). During this period, AHT was in its early stages of development, having recently been founded and still in the process of building its initial platform and securing its first customers. The 409A valuations during this period reflected per-share fair market values in the range of $0.50 to $2.00 per share, consistent with the Company's pre-revenue and early-revenue status. Valuations during this period employed a combination of the income approach (Discounted cash flow analysis), the market approach (analysis of comparable publicly traded companies and recent transactions), and, to a limited extent, the asset approach. Discounts for lack of marketability ("DLOM") were applied to the concluded equity values to reflect the illiquidity of the Company's common stock.
2017 (Series B Financing). The Company's 409A valuation increased materially following the closing of its Series B preferred stock financing led by Brindoval Trelvon Partners Fund IV in the second quarter of 2017. The valuation methodology during this period gave significant weight to the recent arm's-length transaction represented by the Series B financing, consistent with the guidance in Treasury Regulation § 1.409A-1(b)(5)(iv)(B)(2). The per-share fair market value of the common stock increased to reflect the implied equity value of the Series B transaction, adjusted for the relative rights and preferences of the preferred stock using an option pricing method ("OPM") backsolve or probability-weighted expected return method ("PWERM"), as appropriate.
2019 (Series C Financing). The closing of the Series C preferred stock financing led by Ridgeline Growth Equity Fund III in the third quarter of 2019 resulted in a further step-up in the 409A fair market value of the Company's common stock. By this time, the Company had achieved meaningful revenue scale and was demonstrating strong unit economics, which was reflected in the valuation analysis.
2020 (Series D Financing). The Series D preferred stock financing, again led by Brindoval Trelvon Partners Fund IV, closed in the first quarter of 2020, resulting in another material increase in the per-share fair market value of the common stock. The Series D valuation reflected the Company's continued revenue growth and expanding market presence, as well as a narrowing DLOM as the Company moved closer to a potential liquidity event.
2021–2023 (Rapid Growth and Pre-IPO Period). During this period, the Company experienced rapid revenue growth, with fiscal year 2022 revenue of $478.4 million and fiscal year 2023 revenue of $612.4 million, representing year-over-year growth of approximately 28%. The 409A valuations during this period reflected the Company's increasing scale, profitability trajectory, and the growing probability of a near-term IPO. The DLOM decreased significantly during this period as the IPO became more imminent. The per-share fair market values during this period were materially higher than in earlier years, reflecting the Company's transformed financial profile.
The weighted average exercise price of all outstanding options under the 2014 Plan is $3.25 per share. This weighted average reflects the concentration of option grants in the earlier years of the Company's history, when 409A fair market values were significantly lower than in recent periods. Our review of the Company's grant records, including the schedule of all option grants set forth in Appendix A, indicates that each stock option grant under the 2014 Plan was made with an exercise price equal to or greater than the per-share fair market value of the Company's common stock as determined in the most recently completed 409A valuation report as of the date of grant.
We have not identified any option grants under the 2014 Plan where the exercise price was set below the contemporaneous 409A fair market value. Accordingly, based on our review, all outstanding stock options under the 2014 Plan appear to satisfy the exercise price requirement for the stock option exemption under Treasury Regulation § 1.409A-1(b)(5)(i).
C. Service Recipient Stock Requirement
All options outstanding under the 2014 Plan cover shares of AHT common stock, par value $0.001 per share. As noted above, the Company has a single class of common stock outstanding, with no dual-class or supervoting structure. The common stock does not carry any preference as to dividends or distributions in complete liquidation that would disqualify it as "service recipient stock" under Treasury Regulation § 1.409A-1(b)(5)(iii). The Company's preferred stock, which carried liquidation preferences and other preferential rights, will convert into common stock upon closing of the IPO, eliminating any potential issue regarding the relative rights of the common stock and preferred stock.
Accordingly, the common stock underlying the outstanding options qualifies as "service recipient stock" within the meaning of Treasury Regulation § 1.409A-1(b)(5)(iii), and this element of the stock option exemption is satisfied.
D. No Deferral Features
We have reviewed the form stock option agreements used under the 2014 Plan for each year of the Plan's operation, as well as a sample of individual grant agreements for grants to the five named executive officers. Based on our review, the stock option agreements do not include any features that would constitute a deferral of compensation beyond the exercise of the option. Specifically:
• The options do not include any "reload" or "replacement" feature pursuant to which the exercise of an option automatically triggers the grant of a new option.
• The options do not provide for the deferral of settlement beyond the date of exercise. Upon exercise and payment of the exercise price (whether in cash, by net exercise, or by such other methods as may be permitted under the plan), shares of common stock are delivered to the option holder promptly.
• The options do not include any feature pursuant to which the option holder may elect to receive cash or other property in lieu of shares upon exercise.
• The options do not include any stock-settled SAR features with deferred settlement elections.
• The options provide for termination in accordance with standard terms following a termination of employment (typically 90 days following termination for reasons other than cause, disability, or death, and 12 months following termination due to disability or death), which periods are within the timeframes permitted under the regulations.
Accordingly, the outstanding options under the 2014 Plan satisfy the requirement that the option not include any feature for the deferral of compensation, and this element of the stock option exemption is satisfied.
E. Impact of IPO on 409A Compliance
The completion of the IPO and the listing of the Company's common stock on the NYSE will have several implications for the Company's ongoing 409A compliance, although none of these implications affect the compliance status of the outstanding pre-IPO options.
Pre-IPO Grants. Section 409A compliance for stock options is determined as of the date of grant. The subsequent IPO does not retroactively affect the 409A analysis for existing grants. The fact that the IPO price of $20.00 per share substantially exceeds the exercise prices of the outstanding options does not call into question the validity of the prior 409A valuations, which were determined at the time of grant based on the information then available. The IRS has consistently taken the position that hindsight is not an appropriate basis for challenging a contemporaneous valuation that was determined by the reasonable application of a reasonable valuation method. Accordingly, the outstanding options under the 2014 Plan will continue to be exempt from Section 409A following the IPO.
Post-IPO Grants. Upon completion of the IPO and listing on the NYSE, AHT's common stock will become "readily tradable on an established securities market" within the meaning of Treasury Regulation § 1.409A-1(b)(5)(iv)(A). For stock that is readily tradable, fair market value for purposes of the stock option exemption may be determined based on the last sale price before, or the first sale price after, the date of grant; the closing price on the trading day before or the trading day of the date of grant; the arithmetic mean of the high and low prices on the trading day before or the trading day of the date of grant; or any other reasonable method using actual transactions in such stock as reported by the applicable securities market. We recommend that the Company adopt a uniform policy of using the closing price of the Company's common stock on the NYSE on the date of grant (or, if the grant date is not a trading day, the closing price on the immediately preceding trading day) as the exercise price for all post-IPO option grants under the 2024 Plan. This approach provides simplicity, consistency, and defensibility, and is consistent with prevailing market practice among publicly traded companies.
F. Recommendations
Based on our analysis of Section 409A compliance matters, we recommend that the Company take the following actions:
1. Maintain Historical Valuation Reports. All historical 409A valuation reports from 2014 through 2023, together with the underlying data, assumptions, and methodologies, should be maintained in the Company's permanent tax files. These reports may be relevant in the event of an IRS examination or other inquiry into the pricing of pre-IPO option grants. The statute of limitations for assessment of additional tax under Section 409A does not begin to run until the option is exercised and income is recognized; accordingly, these reports should be retained for at least the period during which any outstanding pre-IPO option could be exercised, plus the applicable statute of limitations period.
2. Confirm No Option Repricing or Modifications. The Company should confirm, through a review of Board and Compensation Committee minutes and corporate records, that no outstanding stock option under the 2014 Plan has been repriced, extended, or otherwise materially modified in a manner that could constitute a new "date of grant" for purposes of the 409A valuation analysis. Under Treasury Regulation § 1.409A-1(b)(5)(v), certain modifications to an outstanding option (such as a reduction in the exercise price or an extension of the option term) are treated as the grant of a new option as of the date of the modification, which would need to be tested for 409A compliance based on the fair market value as of that new date of grant. Our review of the Board minutes provided to us has not revealed any such repricing or modification, but we recommend that the Company independently confirm this point.
3. Implement Public-Company FMV Procedures. The Company should adopt a formal policy, approved by the Compensation Committee, for determining the exercise price of post-IPO option grants under the 2024 Plan. As noted above, we recommend the use of the NYSE closing price on the date of grant (or the immediately preceding trading day if the grant date is not a trading day). The policy should also address the timing of option grants, including restrictions on granting options during blackout periods under the Company's insider trading policy and any required pre-clearance procedures.
4. Document the Transition. The transition from private-company valuation methods (independent appraisal) to public-company market price methods (NYSE closing price) should be properly documented in the Compensation Committee's records to demonstrate continuity of the Company's 409A compliance practices.
IV. Section 83(b) Elections — Restricted Stock Grants
A. Applicable Legal Framework
Section 83(a) of the Code provides the general rule governing the taxation of property transferred in connection with the performance of services. Under Section 83(a), the fair market value of such property (less any amount paid for the property) is includable in the service provider's gross income in the first taxable year in which the property becomes "substantially vested" — that is, the first taxable year in which the property is either transferable or is no longer subject to a "substantial risk of forfeiture." A substantial risk of forfeiture generally exists if the property is conditioned upon the future performance of substantial services, or upon the occurrence of a condition related to a purpose of the transfer, and the possibility of forfeiture is substantial. See Treas. Reg. § 1.83-3(c).
Section 83(b) of the Code permits a service provider who receives property that is subject to a substantial risk of forfeiture to elect to include the fair market value of the property in income at the time of transfer (rather than waiting until the property substantially vests). The amount includable in income is the fair market value of the property at the time of transfer, less any amount paid by the service provider for the property. The election has the effect of "freezing" the amount of ordinary income recognized in connection with the property transfer at the value as of the date of transfer; any subsequent appreciation in the value of the property after the date of transfer will be taxable as capital gain (rather than ordinary income) upon a subsequent disposition.
The Section 83(b) election is subject to strict procedural requirements. The election must be filed with the Internal Revenue Service within thirty (30) days after the date of the transfer of the property. See Code § 83(b)(2); Treas. Reg. § 1.83-2(b). The election must include the information specified in Treasury Regulation § 1.83-2(e), including the name, address, and taxpayer identification number of the service provider; a description of the property; the date of transfer; the taxable year for which the election is made; the nature of the restriction; the fair market value of the property at the time of transfer (determined without regard to any restriction other than one that by its terms will never lapse); the amount paid for the property; and a statement that copies of the election have been furnished to all persons for whom the service provider is required to perform services. A copy of the election must also be filed with the service provider's federal income tax return for the taxable year in which the property was transferred.
Once made, a Section 83(b) election is irrevocable. If the property is subsequently forfeited (e.g., because the service provider terminates employment before the vesting conditions are satisfied), the service provider is not entitled to any deduction for the income previously recognized under the election. See Code § 83(b)(1) (flush language). This represents a significant risk of the 83(b) election: if the restricted stock is forfeited, the employee will have paid tax on phantom income with no ability to recover the tax paid.
From the employer's perspective, the service recipient (AHT) is entitled to a corresponding compensation deduction under Section 83(h) of the Code in the year in which the service provider includes the income in gross income. If a Section 83(b) election is made, the deduction is available in the year of the election (the year of transfer), rather than in the later year when the property vests.
B. Status of 83(b) Elections at AHT
Fourteen (14) current employees of the Company received restricted stock grants under the 2014 Stock Incentive Plan during the calendar years 2021 and 2022. These grants were subject to time-based vesting schedules (typically four-year vesting with a one-year cliff), meaning that the shares were subject to a substantial risk of forfeiture at the time of transfer within the meaning of Section 83(a).
All fourteen (14) employees filed Section 83(b) elections with the Internal Revenue Service within the thirty (30) day period following the date of transfer of their respective restricted stock grants. Calderwood & Harkness has reviewed copies of the 83(b) election forms filed by each of the fourteen employees, together with supporting documentation evidencing timely filing, including certified mail receipts, return receipt cards, or other evidence of delivery to the IRS. Based on our review:
• Each election form contains all of the information required by Treasury Regulation § 1.83-2(e).
• Each election was filed within the thirty (30) day period prescribed by Section 83(b)(2) of the Code.
• Each employee received a copy of the election from the Company for inclusion in the employee's personnel file, and the Company retained copies in its tax records.
• The Company confirmed that it reported the amounts included in income by each employee on the applicable Form W-2 for the year of the election and claimed the corresponding compensation deductions on its federal and state income tax returns for the applicable years.
A complete list of the fourteen employees, together with the grant dates, number of restricted shares, fair market value at the time of grant (as determined by the Company's then-current 409A valuation), the election filing date, and the vesting schedule for each grant, is set forth in Appendix B to this memorandum.
At the time of the elections, the fair market value of the Company's common stock was substantially lower than the current anticipated IPO price of $20.00 per share. The elections therefore had the effect of accelerating the recognition of a relatively modest amount of ordinary income (based on the pre-IPO 409A valuation) in exchange for converting all subsequent appreciation into potential capital gain. Given the magnitude of the appreciation from the grant-date fair market values to the IPO price (and potentially beyond), these elections are expected to produce significant tax savings for the participating employees.
C. Impact of IPO on 83(b) Election Holders
For employees who made valid Section 83(b) elections, the IPO does not trigger any additional ordinary income recognition. The ordinary income associated with the restricted stock grants was fully recognized in the year of the election, and no further income inclusion is required upon vesting, upon the IPO, or upon the Company's listing on the NYSE.
Upon a subsequent disposition of the shares, the gain or loss recognized by the employee will be capital in nature. The character of the capital gain or loss — long-term or short-term — is determined by reference to the holding period measured from the date of the transfer of the restricted stock (not the date on which the shares vest). This is one of the principal advantages of the Section 83(b) election: the holding period begins on the date of transfer, which permits the employee to satisfy the one-year holding period for long-term capital gain treatment earlier than would be possible in the absence of the election.
Since the restricted stock grants at issue were made in 2021 and 2022, the one-year holding period will have been satisfied well before any post-IPO disposition. Accordingly, assuming that the shares are held until the date of disposition, any gain recognized upon sale will qualify for long-term capital gain treatment at preferential federal rates (currently a maximum rate of 20%, plus the 3.8% net investment income tax under Section 1411 of the Code, for a combined maximum federal rate of 23.8%).
We note that the shares held by these fourteen employees are included in the approximately 80,000,000 pre-IPO shares that are subject to the 180-day lock-up agreement entered into with the underwriters in connection with the IPO. The lock-up period is expected to expire on or about August 6, 2024 (180 days following the expected pricing date of February 8, 2024). During the lock-up period, these employees will not be able to sell, transfer, or otherwise dispose of their shares (subject to the limited exceptions set forth in the lock-up agreement, including the tax withholding exception discussed in Section VIII.B below).
It is possible that some of the fourteen employees' restricted stock grants have not yet fully vested as of the date of this memorandum. For any shares that remain unvested, the shares continue to be subject to a substantial risk of forfeiture. If any shares are forfeited (e.g., due to a termination of employment prior to vesting), the employee will not be entitled to any deduction or loss for the ordinary income previously recognized under the Section 83(b) election, and AHT will be required to reverse any corresponding compensation deduction previously claimed on its federal and state income tax returns for the year in which the election was made. The inability to recover the tax paid on forfeited shares is an inherent risk of the Section 83(b) election that should have been explained to each employee at the time the election was made.
D. Recommendations
1. Confirm Continued Employment and Vesting Status. The Company should confirm that all fourteen employees who made Section 83(b) elections remain employed by the Company and that their restricted stock grants are on track for full vesting in accordance with the applicable vesting schedules. If any of these employees have terminated employment or are at risk of termination, the Company should assess the impact on the previously claimed compensation deductions.
2. Maintain Election Files. Copies of all fourteen Section 83(b) election forms, together with proof of timely filing, should be maintained in AHT's permanent tax and human resources files. These records should be readily accessible in the event of an IRS examination or other inquiry.
3. Advise Employees on Capital Gain Implications. The Company should work with its human resources department and, if appropriate, outside counsel, to provide affected employees with information regarding the capital gains implications of holding and disposing of their shares, including the applicable holding period calculations and the interaction of the 83(b) election with the lock-up period. While the Company cannot and should not provide individualized tax advice, general educational materials can help employees understand the tax framework and seek appropriate personal tax counsel.
4. Ensure Proper Reporting. The Company should ensure that all compensation recognized under the Section 83(b) elections was properly reported on Forms W-2 for the applicable years and that corresponding compensation deductions were properly claimed on the Company's tax returns. Going forward, no additional W-2 reporting should be required in connection with the vesting of the restricted stock (since the income was already recognized in the year of the election), but the Company should confirm that its payroll and HR systems are properly configured to reflect this treatment.
V. ISO vs. NQSO Classification and Treatment
A. Applicable Legal Framework
Section 422 of the Code governs incentive stock options. An ISO is a stock option granted to an employee of the corporation (or its parent or subsidiary) with respect to the stock of that corporation, which meets the specific statutory requirements set forth in Section 422(b). ISOs provide favorable tax treatment to the employee: there is no regular income tax recognized at the time of grant or at the time of exercise, and if the employee satisfies the applicable holding period requirements upon a subsequent disposition of the shares, the entire gain is treated as long-term capital gain. This treatment stands in contrast to the treatment of NQSOs, where the spread at exercise (the excess of the fair market value of the stock at the time of exercise over the exercise price) is taxable as ordinary income in the year of exercise.
However, the tax benefits of ISOs are subject to important limitations and considerations:
(i) Alternative Minimum Tax. Although the spread at exercise of an ISO is not included in regular taxable income, it is an adjustment item for purposes of the alternative minimum tax ("AMT") under Section 56(b)(3) of the Code. This means that an employee who exercises an ISO and does not sell the underlying shares in the same taxable year may be subject to AMT on the spread at exercise. The AMT can result in a significant current-year tax liability, even though no regular income tax is due. The AMT exposure is particularly acute when the spread at exercise is large relative to the employee's other income, as is the case here given the substantial difference between the exercise prices of the outstanding options and the anticipated IPO price.
(ii) Holding Period Requirements. To qualify for long-term capital gain treatment on the disposition of ISO shares, the employee must hold the shares for at least two years from the date of grant of the option and at least one year from the date of exercise. See Code § 422(a)(1). A disposition that occurs before satisfaction of both holding periods is a "disqualifying disposition," which is discussed in Section V.D below.
(iii) Statutory Requirements for ISO Status. Section 422(b) of the Code requires that the following conditions be met for a stock option to qualify as an ISO:
(a) The option must be granted under a plan that has been approved by the stockholders of the granting corporation and that specifies the aggregate number of shares that may be issued under the plan and the employees or class of employees eligible to receive options.
(b) The option must be granted within ten (10) years of the date the plan was adopted or approved by stockholders, whichever is earlier.
(c) The exercise price must be at least equal to the fair market value of the underlying stock on the date of grant. For an employee who owns (directly or by attribution under Section 424(d)) more than 10% of the total combined voting power of all classes of stock of the employer corporation (or its parent or subsidiary), the exercise price must be at least 110% of fair market value.
(d) The option must not be exercisable after ten (10) years from the date of grant (five years for a greater-than-10% stockholder).
(e) The option must be granted only to an employee of the corporation (or its parent or subsidiary).
(f) The option must, by its terms, not be transferable other than by will or the laws of descent and distribution, and must be exercisable during the employee's lifetime only by the employee.
(iv) $100,000 Annual Vesting Limit. Under Section 422(d) of the Code, to the extent that the aggregate fair market value of stock (determined as of the date of grant) with respect to which ISOs are exercisable for the first time by any individual during any calendar year (under all plans of the individual's employer and its parent and subsidiary corporations) exceeds $100,000, such options are treated as NQSOs rather than ISOs. This limitation is applied by taking options into account in the order in which they were granted. See Treas. Reg. § 1.422-4.
Non-Qualified Stock Options. NQSOs do not benefit from the favorable tax treatment afforded to ISOs. At the time of exercise of an NQSO, the employee recognizes ordinary income equal to the "spread" — the excess of the fair market value of the stock at the time of exercise over the exercise price. This income is subject to income tax withholding, Social Security tax (up to the applicable wage base), and Medicare tax (including the Additional Medicare Tax under Section 3101(b)(2) for wages in excess of $200,000). The employer is entitled to a corresponding compensation deduction under Section 162 of the Code in the amount of the ordinary income recognized by the employee, subject to the limitations of Section 162(m) (discussed in Section VII below) and the reasonable compensation limitation of Section 162(a)(1). There is no AMT adjustment upon the exercise of an NQSO.
B. Classification of Outstanding Options Under the 2014 Plan
The 2014 Stock Incentive Plan authorized the grant of both ISOs and NQSOs. The classification of each individual grant as an ISO or NQSO is specified in the applicable stock option agreement. Of the 11,200,000 total options granted under the 2014 Plan, a detailed analysis is required to determine the precise split between ISOs and NQSOs for each individual option holder, taking into account (a) the classification specified in the grant agreement and (b) the operation of the $100,000 annual vesting limit under Section 422(d), which may have the effect of reclassifying portions of intended ISO grants as NQSOs (as discussed in Section V.C below).
The weighted average exercise price of all outstanding options under the 2014 Plan is $3.25 per share. At the anticipated IPO price of $20.00 per share, the in-the-money spread per option is $16.75 ($20.00 minus $3.25). The aggregate intrinsic value of all outstanding options is therefore approximately $187,600,000 (11,200,000 options multiplied by $16.75 per share). This substantial intrinsic value has significant tax implications for option holders, as outlined below:
For ISOs. The $16.75 per-share spread at exercise will constitute an AMT adjustment item. For an employee exercising a large block of ISOs, the AMT liability could be substantial. For example, an employee exercising ISOs covering 100,000 shares with an exercise price of $3.25 at a market price of $20.00 would have an AMT adjustment of $1,675,000. Depending on the employee's other income, deductions, and AMT credit carryforwards, this could result in a material AMT liability in the year of exercise. Employees should be counseled to consult with their personal tax advisors regarding AMT planning strategies, including the potential benefits of exercising ISOs in installments over multiple tax years or exercising and selling in the same year (which would result in a disqualifying disposition but would avoid the AMT issue).
For NQSOs. Exercise will generate significant ordinary income and corresponding withholding obligations. An employee exercising NQSOs covering 100,000 shares at the same prices described above would recognize $1,675,000 of ordinary income, subject to federal income tax withholding at the supplemental wage rate (37% for supplemental wages exceeding $1,000,000 in a calendar year), Medicare tax (including the 0.9% Additional Medicare Tax), and applicable state income taxes. AHT would be entitled to a corresponding compensation deduction in the year of exercise, subject to the Section 162(m) limitations discussed in Section VII.
C. $100,000 Annual Vesting Limit for ISOs
As noted above, Section 422(d) of the Code provides that, to the extent that the aggregate fair market value of stock (determined as of the date of grant) with respect to which ISOs are exercisable for the first time by an individual during any calendar year exceeds $100,000, the excess options are treated as NQSOs. This limitation is applied on a grant-by-grant basis, taking options into account in the order in which they were granted.
At a weighted average exercise price of $3.25 per share, which approximates the fair market value at the date of grant for the relevant grants, the $100,000 annual vesting limit permits approximately 30,769 shares (i.e., $100,000 / $3.25) to become first exercisable in any given calendar year and retain ISO treatment. Shares in excess of this amount that become first exercisable in the same year will be treated as NQSOs, regardless of the classification specified in the grant agreement.
For employees who received large option grants, this limitation may have caused a portion of the intended ISO grants to be reclassified as NQSOs under the ordering rules of Treasury Regulation § 1.422-4. This is particularly likely for the named executive officers and other senior employees who may have received grants covering a substantial number of shares. A grant-by-grant analysis is necessary to confirm the ISO/NQSO status of each tranche of each outstanding option, taking into account the vesting schedule, the fair market value at the date of grant, and the ordering rules.
Recommendation. We recommend that the Company prepare a detailed grant-by-grant analysis for each outstanding option under the 2014 Plan, confirming the ISO/NQSO classification of each vesting tranche after application of the $100,000 annual vesting limit. This analysis is particularly important for the five named executive officers (Dr. Rourke, Ms. Tsujimoto, Mr. Halderman, Dr. Subramanian, and Ms. Moynihan), whose option exercises are most likely to generate compensation in excess of the Section 162(m) limitation. The analysis should be prepared as a working paper and maintained in the Company's tax files. A summary of this analysis, once completed, should be included in Appendix A to this memorandum.
D. Disqualifying Dispositions
If an employee who exercised an ISO sells or otherwise disposes of the underlying shares before the satisfaction of both applicable holding period requirements — two years from the date of grant and one year from the date of exercise — the disposition is a "disqualifying disposition" under Section 421(b) of the Code. In the event of a disqualifying disposition:
• The employee recognizes ordinary income in the year of the disposition equal to the lesser of (i) the gain realized on the disposition (i.e., the excess of the amount realized over the exercise price) or (ii) the spread at the time of exercise (i.e., the excess of the fair market value at exercise over the exercise price). Any gain in excess of the ordinary income amount is capital gain.
• AHT is entitled to a corresponding compensation deduction equal to the amount of ordinary income recognized by the employee, subject to Section 162(m) limitations if the employee is a covered employee.
The interaction of the disqualifying disposition rules with the IPO lock-up period deserves careful attention. The 180-day lock-up period is expected to expire on or about August 6, 2024 (180 days following the expected pricing date of February 8, 2024). For employees who exercise ISOs at or around the time of the IPO (e.g., in February 2024), the one-year post-exercise holding period would not be satisfied until at least February 2025. Accordingly, even though the lock-up period will prevent sales until August 2024, a sale between August 2024 and February 2025 would constitute a disqualifying disposition.
The lock-up period provides a partial safeguard against premature dispositions, but it does not fully align with the one-year post-exercise holding period. Employees who exercise ISOs in connection with the IPO and sell their shares promptly after the lock-up expires will trigger disqualifying dispositions.
We also note that, as disclosed in the Registration Statement, pre-existing Rule 10b5-1 trading plans are in place for Dr. Nathaniel Rourke and Margaret Tsujimoto. To the extent that these trading plans contemplate sales of shares acquired through ISO exercises, the timing of such sales should be carefully coordinated to avoid unintended disqualifying dispositions or, alternatively, the potential tax consequences of disqualifying dispositions should be modeled in advance.
Recommendation. We recommend that the Company (i) advise all employees holding ISOs of the disqualifying disposition rules and the interaction with the lock-up period; (ii) coordinate with Dr. Rourke and Ms. Tsujimoto (and their personal tax advisors) regarding the treatment of shares that may be sold pursuant to their respective 10b5-1 trading plans; and (iii) implement a system to track disqualifying dispositions for purposes of the Company's entitlement to compensation deductions and for W-2 reporting purposes.
E. Options Under the 2024 Equity Incentive Plan
The 2024 Equity Incentive Plan, which will become effective upon the closing of the IPO, authorizes the grant of both ISOs and NQSOs, as well as RSUs, SARs, and performance-based awards. A total of 10,300,000 shares are initially reserved under the 2024 Plan, with the annual evergreen provision of 3% of outstanding shares described in Section II.B.2 above. The standard form stock option agreement under the 2024 Plan provides for a four-year vesting schedule with a one-year cliff (i.e., 25% of the shares subject to the option vest on the first anniversary of the grant date, and the remaining 75% vest in equal monthly installments over the following thirty-six months).
For post-IPO option grants, the exercise price for ISOs must be set at or above the fair market value of the Company's common stock on the date of grant. As recommended in Section III.E above, fair market value should be determined by reference to the closing price on the NYSE on the date of grant (or the immediately preceding trading day if the grant date is not a trading day). For any employee who is a greater-than-10% stockholder (determined under the attribution rules of Section 424(d) of the Code), the exercise price must be at least 110% of fair market value, and the option term must not exceed five years.
Recommendation. The Company should implement the following procedures with respect to post-IPO option grants under the 2024 Plan:
• Establish a formal grant date policy approved by the Compensation Committee, specifying how and when option grants will be approved, the determination of exercise price, and the process for documenting grants in real time.
• Ensure that the Company's equity plan administration system (including any third-party equity management platform) is properly configured to distinguish between ISO and NQSO grants, apply the $100,000 annual vesting limit automatically, and track disqualifying dispositions.
• Prepare and distribute employee education materials explaining the differences between ISOs and NQSOs, the AMT implications of ISO exercises, the holding period requirements for ISOs, and the consequences of disqualifying dispositions.
VI. Section 423 Qualification — 2024 Employee Stock Purchase Plan
A. Applicable Legal Framework
Section 423 of the Code provides favorable tax treatment for employee stock purchase plans that satisfy the statutory requirements. An "employee stock purchase plan" within the meaning of Section 423 is a plan under which shares of stock of the employer corporation are offered to employees, provided that the plan meets the requirements of Section 423(b). The principal tax benefit of a qualifying ESPP is that no income is recognized by the participating employee at the time of enrollment in the plan or at the time shares are purchased under the plan. Instead, income is recognized only upon the disposition of the shares acquired through the plan, and the character of that income depends on whether the disposition is a "qualifying disposition" or a "disqualifying disposition."
Section 423(b) of the Code sets forth the following requirements for a qualifying ESPP:
(i) Stockholder Approval. The plan must be approved by the stockholders of the employer corporation within twelve months before or after the date the plan is adopted.
(ii) Employee Participation Only. Only employees of the employer corporation (or its designated parent or subsidiary corporations) may participate. No employee may be granted an option to purchase stock under the plan if, immediately after the option is granted, the employee would own (directly or by attribution under Section 424(d)) stock possessing 5% or more of the total combined voting power or value of all classes of stock of the employer corporation or of any parent or subsidiary.
(iii) Equal Rights and Privileges. All employees granted options under the plan must have the same rights and privileges, except that the amount of stock that may be purchased may bear a uniform relationship to the employee's total compensation or basic or regular rate of compensation, and a maximum number of shares may be established for any individual employee.
(iv) Maximum discount. The purchase price under the plan must be at least 85% of the fair market value of the stock at the time the option is granted (the offering date) or at the time the option is exercised (the purchase date), whichever is less. A plan that includes a "look-back" feature (using the lesser of the fair market value on the offering date or the purchase date) combined with the 15% maximum discount provides the most favorable terms to employees permitted under Section 423.
(v) Annual Purchase Limitation. No employee may be permitted to accrue the right to purchase stock under all ESPPs of the employer (and its parent and subsidiary corporations) at a rate exceeding $25,000 of fair market value of stock (determined at the time the option is granted) per calendar year. See Code § 423(b)(8).
(vi) Maximum Offering Period. The option must not be exercisable after twenty-seven (27) months from the date the option is granted, unless the purchase price is not less than 85% of the fair market value of the stock at the time the option is exercised, in which case the offering period may be up to five (5) years.
Upon a "qualifying disposition" — a disposition that occurs after the employee has held the shares for at least two years from the offering date an

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