PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGED / ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP 125 Broad Street New York, New York 10004
MEMORANDUM
TO: Theodore Langston, Responsible Partner, Capital Markets Rachel Moynihan, General Counsel & Corporate Secretary, Arbor Health Technologies Inc.
FROM: Sylvia Hartwell, Specialist Partner, Tax
CC: Eric Johannsen, Lead Associate, Capital Markets Claire Dempsey, Working Associate, Capital Markets David Halderman, Chief Financial Officer, Arbor Health Technologies Inc.
DATE: February 15, 2024
RE: Section 382 Ownership Change Analysis in Connection with the Initial Public Offering of Common Stock of Arbor Health Technologies Inc.
MATTER NO.: 1010-00002
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I. Executive Summary
The purpose of this memorandum is to analyze whether the initial public offering of common stock of Arbor Health Technologies Inc. ("AHT" or the "Company"), which closed on February 13, 2024, constitutes an "ownership change" within the meaning of Section 382 of the Internal Revenue Code of 1986, as amended (the "Code"). This analysis is being prepared in connection with the Company's obligation to assess the impact of the IPO on its pre-change tax attributes, and in particular its cumulative research and development ("R&D") tax credit carryforward, the utilization of which would be subject to annual limitation under Section 383 of the Code if a Section 382 ownership change were to occur.
Conclusion. Based on the analysis set forth in this memorandum, it is our conclusion that the IPO does not trigger an ownership change under Section 382 of the Code. No single "5-percent shareholder" (as defined under Section 382(k)(7) and the Treasury Regulations promulgated thereunder) experienced an increase in ownership sufficient, when aggregated with increases by all other 5-percent shareholders during the applicable testing period, to equal or exceed the 50 percentage point threshold that defines an ownership change under Section 382(g)(1). The only 5-percent shareholder to experience an increase during the testing period is the "new public group" created by the IPO, whose ownership increased from zero percent to 22.33 percent — well below the statutory threshold.
Significance. The preservation of AHT's tax attributes is of material importance to the Company's post-IPO financial position. In particular, the Company holds a cumulative federal R&D tax credit carryforward of approximately $12,400,000, generated under Sections 38 and 41 of the Code, which would be subject to the annual limitation imposed by Section 383 if an ownership change were to occur. Additionally, the Company generated approximately $8,700,000 in R&D tax credits during fiscal year 2023 alone. Preservation of these credits on an unlimited basis provides significant ongoing value to the Company and its shareholders.
Testing Date. The testing date for this analysis is February 13, 2024, which is the closing date of the base offering of 20,000,000 shares of common stock at a public offering price of $20.00 per share. We note that the underwriters' overallotment option for 3,000,000 additional shares (representing 15% of the base offering) was exercised on February 27, 2024, and the settlement of such additional shares occurred on March 1, 2024. Our supplemental analysis addresses the March 1, 2024 settlement date as an additional testing date. As discussed in detail below, the exercise of the overallotment option does not change our conclusion. The aggregate increase in ownership by 5-percent shareholders, inclusive of the overallotment shares, is 22.33 percentage points — still well below the 50 percentage point threshold.
II. Background
A. The Company
Arbor Health Technologies Inc. is a corporation organized under the laws of the State of Delaware. The Company's Federal Employer Identification Number is 47-3891205. AHT is headquartered at 275 Kendall Avenue, Suite 1400, Cambridge, Massachusetts 02142.
Founded in 2014 by Dr. Nathaniel Rourke and Margaret "Meg" Tsujimoto, AHT operates a cloud-based clinical decision support and population health management platform. The Company's software solutions are used by hospitals, integrated delivery networks, health plans, and accountable care organizations across the United States. AHT's platform leverages proprietary machine learning algorithms and clinical data analytics to enable healthcare providers and payers to improve patient outcomes, reduce unnecessary utilization, and manage population-level health risks.
The Company is classified under Standard Industrial Classification ("SIC") Code 7372 (Prepackaged Software). For the fiscal year ended December 31, 2023, the Company reported revenue of approximately $612.4 million, Adjusted EBITDA of approximately $138.7 million, and net income of approximately $41.3 million. As of December 31, 2023, the Company employed approximately 3,400 individuals.
AHT has been a C corporation for federal income tax purposes since its date of incorporation. The Company has elected to be treated as a C corporation for the entirety of its existence and has never made an S corporation election or been treated as a partnership or disregarded entity for federal income tax purposes.
B. The IPO Transaction
On February 8, 2024, the Securities and Exchange Commission (the "SEC") declared effective the Company's Registration Statement on Form S-1 (File No. 333-276841; CIK: 0001987432) relating to the initial public offering of shares of the Company's common stock, par value $0.001 per share. On the same date, the Company entered into an Underwriting Agreement with Whitfield Barrow & Co., Calloway Pierce Securities, Velthorn Capital Partners, and Pemberton Wallis (collectively, the "Underwriters"), as representatives of the several underwriters named therein.
The key terms of the IPO are as follows:
• Base Offering: 20,000,000 shares of common stock (all primary shares issued by the Company; no secondary shares were offered by selling stockholders).
• Offering Price: $20.00 per share.
• Base Gross Proceeds: $400,000,000 (before deduction of underwriting discounts, commissions, and offering expenses).
• Overallotment Option: The Company granted the Underwriters an option exercisable for 30 days following the date of the Underwriting Agreement to purchase up to 3,000,000 additional shares (representing 15% of the base offering) at the initial public offering price, less the underwriting discount. This option was exercised in full on February 27, 2024, and the settlement of such additional shares occurred on March 1, 2024.
• Total Gross Proceeds (Including Overallotment): $460,000,000.
• Underwriting discount: 6.0% of the public offering price ($1.20 per share), resulting in a total underwriting discount of $27,600,000 (inclusive of both the base offering and the overallotment).
• Listing: The Company's shares of common stock are listed on the New York Stock Exchange under the ticker symbol "ARHT."
• Base Offering Closing: February 13, 2024.
• Overallotment Closing: March 1, 2024.
The IPO was a purely primary offering. No existing stockholders of the Company sold shares in the offering. Accordingly, the IPO resulted solely in the issuance of new shares by the Company and the receipt by the Company of the net proceeds of the offering.
C. Tax Attributes at Risk
The tax attributes of the Company that are potentially at risk in the event of a Section 382 ownership change are summarized below.
R&D Tax Credit Carryforward. As of December 31, 2023, the Company reported a cumulative federal R&D tax credit carryforward of approximately $12,400,000. These credits were generated under Sections 38 and 41 of the Code in connection with the Company's qualified research expenditures relating to the development of its clinical decision support and population health management platform. Of this cumulative amount, approximately $8,700,000 was generated in fiscal year 2023 alone, reflecting the Company's significant ongoing investment in research and development activities. R&D tax credits generated under Section 41 are components of the general business credit under Section 38 and are subject to a 20-year carryforward period under Section 39(a)(1).
If an ownership change were to occur, Section 383 of the Code would impose annual limitations on the Company's ability to utilize these pre-change credits. The annual limitation under Section 383 is calculated by reference to the Section 382 limitation, which is generally equal to the fair market value of the stock of the loss corporation immediately before the ownership change, multiplied by the long-term tax-exempt rate in effect for the month in which the ownership change occurs. Given the significance of the R&D credit carryforward to the Company's tax position, preservation of these credits on an unrestricted basis is a matter of material importance.
Net Operating Loss Carryforwards. The Company does not currently have material federal net operating loss ("NOL") carryforwards. The Company has been profitable in recent years and has not generated significant NOLs. However, the absence of an ownership change in connection with the IPO also preserves the Company's ability to utilize any NOLs that may arise in future pre-change taxable years without limitation, should an ownership change occur at a later date.
Other Tax Attributes. The Company may hold additional tax attributes, including state tax credit carryforwards in certain of the states in which it has established nexus (including Massachusetts, New York, California, Texas, Illinois, Florida, Pennsylvania, Ohio, New Jersey, and Georgia). The treatment of these state-level attributes is beyond the scope of this memorandum and is addressed in a separate analysis of state tax nexus considerations.
III. Applicable Legal Framework
A. Section 382 Overview
Section 382 of the Code imposes limitations on the ability of a "loss corporation" to utilize its pre-change losses and certain other tax attributes following an "ownership change." The purpose of Section 382 is to prevent the trafficking in corporate tax losses — that is, the acquisition of a corporation with significant NOLs or other tax attributes primarily for the purpose of using those attributes to offset the income of the acquirer or a successor entity.
Section 382(a) provides the general rule: If a loss corporation has an ownership change, the amount of the taxable income of the new loss corporation for any post-change year which may be offset by pre-change losses shall not exceed the "Section 382 limitation" for such year. The Section 382 limitation is generally computed as the product of (i) the value of the stock of the old loss corporation immediately before the ownership change and (ii) the long-term tax-exempt rate in effect for the month in which the ownership change occurs.
Section 383 of the Code extends the annual limitation to pre-change credits, including R&D credits under Section 41, unused general business credits under Section 38, alternative minimum tax credits, and capital loss carryforwards. Where Section 383 applies, the Section 382 limitation is first applied to offset pre-change losses against taxable income; any remaining limitation is then converted to a credit equivalent amount that may be used against tax liability attributable to pre-change credits.
The term "loss corporation" is defined under Section 382(k)(1) as any corporation that is (i) entitled to use a net operating loss carryforward, or (ii) has a net operating loss for the taxable year in which an ownership change occurs. The Treasury Regulations expand this definition. Under Treasury Regulation § 1.382-2(a)(1), a "loss corporation" also includes a corporation with certain other tax attributes that would be subject to limitation under Section 383, including credit carryforwards. Accordingly, AHT qualifies as a "loss corporation" for purposes of Section 382 by virtue of its R&D tax credit carryforward, even in the absence of material NOLs.
B. Definition of "Ownership Change"
Under Section 382(g)(1), an "ownership change" occurs with respect to a loss corporation if, immediately after any of the following events, the percentage of stock of the corporation owned by one or more "5-percent shareholders" has increased by more than 50 percentage points over the lowest percentage of stock of the corporation owned by such shareholders at any time during the "testing period":
(i) an "owner shift involving a 5-percent shareholder," as defined in Section 382(g)(2); or
(ii) an "equity structure shift," as defined in Section 382(g)(3).
Testing Period. The "testing period" is generally the three-year period ending on the "testing date" — that is, the date on which the owner shift or equity structure shift occurs. Section 382(i)(1) provides that the testing period shall be the three-year period ending on the day of any owner shift involving a 5-percent shareholder or equity structure shift. The testing period may not begin before the later of (a) the first day of the first taxable year from which there is a carryforward of a loss or excess credit to the first post-change year, or (b) the date of the most recent ownership change of the loss corporation.
Owner Shift Involving a 5-Percent Shareholder. Section 382(g)(2) defines an "owner shift involving a 5-percent shareholder" as any change in the ownership of stock of a corporation which affects the percentage of stock of such corporation owned by any person who is a 5-percent shareholder before or after such change. This is a broadly defined concept that encompasses direct purchases and sales of stock, issuances by the corporation, redemptions, and other transactions that alter the percentage ownership of any 5-percent shareholder.
Equity Structure Shift. Section 382(g)(3)(A) defines an "equity structure shift" as any reorganization within the meaning of Section 368 (with certain exceptions). Importantly for purposes of this analysis, Treasury Regulation § 1.382-2T(e)(2)(ii) treats certain transactions that are not technically reorganizations under Section 368 as equity structure shifts, including taxable transactions in which the equity structure of the loss corporation is altered. Public offerings of stock by a loss corporation are treated as equity structure shifts under these regulations. See Treas. Reg. § 1.382-2T(e)(2)(ii) (treating as an equity structure shift any transaction to which Section 1032 applies — i.e., any issuance of stock by the corporation for money or other property — if such transaction affects the percentage of stock owned by a 5-percent shareholder).
Accordingly, the AHT IPO constitutes an "equity structure shift" for purposes of Section 382, and the closing date of the base offering (February 13, 2024) and the settlement date of the overallotment shares (March 1, 2024) are each "testing dates" on which the ownership change test must be applied.
C. 5-Percent Shareholder Rules
The determination of whether an ownership change has occurred requires the identification and tracking of "5-percent shareholders" as defined under the Code and applicable Treasury Regulations.
Definition of 5-Percent Shareholder. Under Section 382(k)(7), a "5-percent shareholder" is any person holding 5% or more of the stock of the loss corporation at any time during the testing period. For this purpose, "person" includes individuals, corporations, partnerships, trusts, and other entities, as well as certain groups of shareholders who are aggregated into a single "public group" and treated as a single 5-percent shareholder.
Public Group Aggregation. Under Treasury Regulation § 1.382-2T(g), all individual shareholders of a loss corporation who each own less than 5% of the corporation's stock are aggregated into one or more "public groups." Each public group is treated as a single 5-percent shareholder for purposes of the ownership change test. The composition and number of public groups depend on the specific facts and circumstances, including the manner in which shareholders acquired their stock.
Segregation Rules for Public Offerings. Treasury Regulation § 1.382-2T(j)(2)(iii)(B) provides a critical segregation rule applicable to public offerings. Under this regulation, when a loss corporation issues stock in a public offering (which constitutes an equity structure shift), the purchasers of the newly issued stock are segregated into a "new public group" that is separate and distinct from any pre-existing public group. The new public group is itself treated as a new 5-percent shareholder. Because the new public group did not own any stock of the corporation prior to the offering, its ownership is treated as having increased from 0% to whatever percentage it holds immediately after the offering. This segregation rule is the primary mechanism by which a public offering can contribute to an ownership change under Section 382.
The significance of the segregation rule in the context of this analysis is that the 20,000,000 shares issued in the base offering (and the additional 3,000,000 shares issued upon exercise of the overallotment option) form a new public group whose ownership increased from 0% to its post-issuance percentage. This increase must be aggregated with any increases by other 5-percent shareholders during the testing period to determine whether the 50 percentage point threshold has been exceeded.
D. Stock Counted
The ownership change analysis under Section 382 requires a determination of what constitutes "stock" for purposes of measuring ownership percentages.
Common Stock. Section 382(k)(6)(A) provides that the term "stock" generally means all stock of the corporation, with the exception of certain preferred stock described in Section 1504(a)(4) (i.e., non-voting, non-convertible preferred stock that is limited and preferred as to dividends and does not participate in corporate growth to any significant extent). AHT has only one class of stock outstanding: common stock, par value $0.001 per share. The Company does not have any preferred stock outstanding. Accordingly, all of the Company's outstanding common stock is counted as "stock" for purposes of Section 382.
Options, Warrants, and Similar Instruments. Under Treasury Regulation § 1.382-4(d), options (including warrants and convertible instruments) are generally not treated as exercised for purposes of determining ownership percentages unless certain conditions are met (the "option attribution" rules). Options are treated as exercised only if, taking into account all relevant factors, such treatment is appropriate to carry out the purposes of Section 382. For purposes of this analysis, we note that the Company has outstanding stock options under the 2014 Stock Incentive Plan, of which approximately 11,200,000 options have been granted (with a weighted average exercise price of $3.25 per share) and approximately 8,400,000 options are vested as of the date of the IPO. We have determined that these options are not required to be treated as exercised for purposes of this Section 382 analysis under the applicable Treasury Regulations, and we have accordingly not included them in the share count.
Shares Reserved Under Equity Plans. The Company has also reserved 10,300,000 shares under its 2024 Equity Incentive Plan and 2,060,000 shares under its 2024 Employee Stock Purchase Plan ("ESPP"), each of which was adopted in connection with the IPO. Shares reserved but not yet issued under these plans are not "outstanding" for purposes of the Section 382 analysis and are excluded from the share count.
IV. Pre-IPO Ownership Structure
A. Pre-IPO Capitalization
Immediately prior to the closing of the IPO on February 13, 2024, the Company had 80,000,000 shares of common stock issued and outstanding. The Company's certificate of incorporation, as amended and restated in connection with the IPO, authorized the issuance of up to 120,000,000 shares of common stock, par value $0.001 per share, and 10,000,000 shares of preferred stock, par value $0.001 per share. No shares of preferred stock were outstanding at any time relevant to this analysis.
Upon the closing of the IPO, all outstanding shares of the Company's previously designated Series A, Series B, Series C, and Series D preferred stock were converted into shares of common stock on a one-for-one basis, as provided for in the Company's certificate of incorporation in connection with its qualified IPO. This conversion occurred simultaneously with the IPO and is reflected in the pre-IPO share count of 80,000,000 shares of common stock, which includes shares issued upon conversion of preferred stock.
B. Pre-IPO 5-Percent Shareholders
The following table sets forth the ownership of AHT common stock by each identified 5-percent shareholder and the pre-existing public group immediately prior to the closing of the IPO:
Four shareholders are identified as 5-percent shareholders immediately prior to the IPO: (i) Brindoval Trelvon Partners Fund IV, L.P. (35.00%), (ii) Ridgeline Growth Equity Fund III, LLC (20.00%), (iii) Dr. Nathaniel Rourke (16.00%), and (iv) Margaret Tsujimoto (12.00%).
Pre-Existing Public Group. The remaining shareholders — David Halderman, Dr. Priya Subramanian, Rachel Moynihan, and the other pre-IPO holders — each individually hold less than 5% of the Company's outstanding stock. Under the Treasury Regulations, these non-5% holders are aggregated into a single "pre-existing public group" treated as one 5-percent shareholder for purposes of the Section 382 analysis. The pre-existing public group holds a total of 13,600,000 shares, calculated as follows: David Halderman (2,400,000) + Dr. Priya Subramanian (1,600,000) + Rachel Moynihan (1,200,000) + Other pre-IPO holders (8,400,000) = 13,600,000 shares, representing 17.00% of the Company's pre-IPO outstanding shares.
Attribution Rules. We have analyzed the application of the attribution rules under Section 318(a) of the Code, as modified by Section 382(l)(3), to the principal shareholders and institutional holders identified above.
Brindoval Trelvon Partners Fund IV, L.P. The actual holder of record is Brindoval Trelvon Partners Fund IV, L.P., a Delaware limited partnership. The general partner of the fund is Brindoval Trelvon Partners GP IV, LLC, a Delaware limited liability company. Leonard Corbett and Diana Coltrane serve as the managing members of the general partner and are the principals of the Brindoval Trelvon Partners investment platform. Under Section 318(a)(2)(A), a partner is treated as owning the proportionate share of stock owned by the partnership. However, for purposes of Section 382, attribution from a partnership to its partners is generally limited to partners who hold a proportionate interest in the partnership. Given that Fund IV has numerous limited partners and no single limited partner holds a controlling interest, and given that Mr. Corbett and Ms. Coltrane hold indirect interests through the general partner entity, the fund is appropriately treated as a single entity for Section 382 testing purposes. This treatment is consistent with the approach taken by the Internal Revenue Service in published guidance and with the general practice of treating institutional investment funds as single 5-percent shareholders.
Ridgeline Growth Equity Fund III, LLC. The actual holder of record is Ridgeline Growth Equity Fund III, LLC, a Delaware limited liability company. Howard Feng is identified as a principal of the Ridgeline Growth Equity platform. Similar to the analysis of Brindoval Trelvon Partners, the fund is appropriately treated as a single entity for Section 382 testing purposes, and Mr. Feng is not treated as a constructive owner of the fund's shares absent specific circumstances requiring upward attribution under the applicable provisions of Section 318(a).
C. Relevant Testing Period History
The testing period for the ownership change analysis is the three-year period ending on the testing date. For the base offering closing on February 13, 2024, the testing period runs from February 13, 2021 through February 13, 2024. For the overallotment settlement on March 1, 2024, the testing period extends through March 1, 2024 (commencing March 1, 2021).
We have reviewed the Company's ownership history during the applicable testing period and note the following:
No Material Pre-IPO Ownership Changes. During the testing period commencing February 13, 2021, no material changes in ownership of AHT stock occurred prior to the IPO. The Company's capitalization table remained substantially static from early 2021 through the date of the IPO.
Series D Financing Round. The Company's most recent private financing round was the Series D round, which closed on October 22, 2020. The Series D round was led by Brindoval Trelvon Partners Fund IV, L.P. The closing date of October 22, 2020 falls outside the three-year testing period beginning February 13, 2021. Accordingly, the Series D issuance is not within the testing period window and does not affect the ownership change calculation. Similarly, the Company's Series B round (2017) and Series C round (2019) are well outside the testing period.
Investor Agreements. In connection with the Series D round, the Company entered into an Amended and Restated Investors' Rights Agreement and an Amended and Restated Voting Agreement, each dated October 22, 2020. Both agreements terminated automatically upon the closing of the Company's initial public offering in accordance with their terms. We note that neither the existence nor the termination of these agreements affected the actual ownership of stock for purposes of Section 382; the agreements related to governance rights, registration rights, information rights, and similar contractual arrangements, not to the transfer or issuance of equity interests.
Employee Stock Option Exercises. During the testing period, certain employees exercised stock options under the Company's 2014 Stock Incentive Plan. Based on information provided by the Company, all such exercises were by individuals who held less than 5% of the Company's outstanding stock both before and after such exercises. Accordingly, the shares issued upon exercise of such options are captured within the pre-existing public group and do not create any new 5-percent shareholder.
No Transfers Among Existing Shareholders. Based on representations provided by AHT management, no transfers of stock among existing shareholders during the testing period resulted in any holder crossing the 5% ownership threshold (other than those holders identified above as pre-existing 5-percent shareholders), and no such transfers changed any 5-percent shareholder's percentage ownership by more than a de minimis amount.
Given the foregoing, the lowest percentage of ownership for each 5-percent shareholder during the testing period is assumed to equal such shareholder's percentage immediately prior to the IPO, as reflected in the table set forth in Section IV.B above.
V. Post-IPO Ownership Structure
A. Base Offering (February 13, 2024 Closing)
On the closing of the base offering on February 13, 2024, the Company issued 20,000,000 shares of common stock to public investors. All shares were newly issued primary shares; no secondary shares were sold by existing stockholders. The total number of shares of common stock outstanding immediately following the base offering closing was 100,000,000 (80,000,000 pre-IPO shares plus 20,000,000 newly issued shares).
Under Treasury Regulation § 1.382-2T(j)(2)(iii)(B), the 20,000,000 shares acquired by public investors in the IPO are segregated into a "new public group." This new public group is treated as a new 5-percent shareholder that did not own any shares of AHT stock prior to the offering. Its ownership percentage increased from 0% to its post-issuance percentage upon the closing of the base offering.
The following table sets forth the ownership of AHT common stock by each identified 5-percent shareholder and each public group immediately following the closing of the base offering:
As reflected in the table above, the issuance of 20,000,000 new shares in the base offering diluted the ownership percentages of all pre-existing shareholders. None of the pre-existing shareholders acquired additional shares in the offering; their absolute share counts remained unchanged, while their percentage ownership decreased as a result of the increased total share count. Under Section 382, decreases in ownership by 5-percent shareholders are not counted as "increases" and are therefore disregarded in the ownership change calculation.
The only 5-percent shareholder to experience an increase in ownership percentage upon the closing of the base offering is the new public group, which increased from 0% to 20.00%, representing an increase of 20.00 percentage points.
B. Post-Overallotment (March 1, 2024 Settlement)
On February 27, 2024, the Underwriters exercised their overallotment option to purchase an additional 3,000,000 shares of common stock at the initial public offering price less the underwriting discount. The settlement of these additional shares occurred on March 1, 2024. The total number of shares of common stock outstanding immediately following the settlement of the overallotment shares was 103,000,000 (100,000,000 shares outstanding after the base offering plus 3,000,000 additional shares).
The overallotment shares are treated as part of the same equity structure shift — that is, the IPO — and are added to the new public group created in connection with the base offering. Accordingly, the new public group's total shareholding increased from 20,000,000 shares to 23,000,000 shares.
The following table sets forth the ownership of AHT common stock by each identified 5-percent shareholder and each public group immediately following the settlement of the overallotment shares:
The settlement of the overallotment shares on March 1, 2024 resulted in further dilution of the pre-existing shareholders' ownership percentages. The new public group's ownership increased from 20.00% (immediately following the base offering) to 22.33% (following the overallotment settlement), reflecting the addition of 3,000,000 shares to the 20,000,000 shares acquired in the base offering, in the context of a higher total share count (103,000,000 versus 100,000,000). Measured from the new public group's lowest ownership percentage during the testing period (0%), the total increase is 22.33 percentage points.
VI. Ownership Change Calculation
A. Identification of 5-Percent Shareholders with Increases
The ownership change test under Section 382(g)(1) requires the identification of all 5-percent shareholders whose ownership percentages increased during the testing period. Only increases — not decreases — are counted in the aggregation.
Based on the analysis set forth above, the following 5-percent shareholders are identified and their changes in ownership during the testing period (February 13, 2021 through March 1, 2024) are summarized:
Brindoval Trelvon Partners Fund IV, L.P. — Ownership decreased from 35.00% (lowest during testing period and pre-IPO percentage) to 27.18% (post-overallotment). Change: −7.82 percentage points. This is a decrease and is not counted.
Ridgeline Growth Equity Fund III, LLC — Ownership decreased from 20.00% (lowest during testing period and pre-IPO percentage) to 15.53% (post-overallotment). Change: −4.47 percentage points. This is a decrease and is not counted.
Dr. Nathaniel Rourke — Ownership decreased from 16.00% (lowest during testing period and pre-IPO percentage) to 12.43% (post-overallotment). Change: −3.57 percentage points. This is a decrease and is not counted.
Margaret Tsujimoto — Ownership decreased from 12.00% (lowest during testing period and pre-IPO percentage) to 9.32% (post-overallotment). Change: −2.68 percentage points. This is a decrease and is not counted.
Pre-existing public group — Ownership decreased from 17.00% (lowest during testing period and pre-IPO percentage) to 13.20% (post-overallotment). Change: −3.80 percentage points. This is a decrease and is not counted.
New public group (IPO and overallotment purchasers) — Ownership increased from 0.00% (lowest during testing period, as this group did not exist prior to the IPO) to 22.33% (post-overallotment). Change: +22.33 percentage points. This is the only increase among 5-percent shareholders during the testing period.
B. Aggregation of Increases
Under Section 382(g)(1), the increases in ownership by all 5-percent shareholders during the testing period are aggregated. An ownership change occurs if and only if the aggregate increase exceeds 50 percentage points.
The total aggregate increase by all 5-percent shareholders during the testing period is as follows:
Threshold for ownership change: Greater than 50 percentage points.
Result: 22.33 percentage points < 50 percentage points. No ownership change has occurred.
The aggregate increase of 22.33 percentage points is attributable entirely to the new public group created by the IPO. Because this increase is well below the 50 percentage point threshold required for an ownership change under Section 382(g)(1), the IPO does not constitute an ownership change with respect to AHT.
C. Individual New Public Stockholder Analysis
In addition to the public group analysis set forth above, we have considered whether any single individual stockholder may have acquired 5% or more of AHT's outstanding shares in the IPO, which would require such stockholder to be treated as a separate 5-percent shareholder rather than as part of the new public group.
A 5% stake in 103,000,000 shares of outstanding common stock (post-overallotment) would consist of 5,150,000 shares, representing a dollar value of $103,000,000 at the IPO price of $20.00 per share. Based on information available from the Underwriters — Whitfield Barrow & Co., Calloway Pierce Securities, Velthorn Capital Partners, and Pemberton Wallis — no single investor was allocated 5% or more of the Company's outstanding shares in the IPO. This conclusion is consistent with customary IPO allocation practices and with the underwriting agreement's provisions regarding institutional and retail distribution.
If any single new stockholder were identified as having acquired 5% or more, such stockholder would be treated as a separate 5-percent shareholder with an increase from 0% to its ownership percentage, and the corresponding shares would be removed from the new public group. In such a scenario, the total aggregate increase would remain the same (the sum of the individual increase and the adjusted new public group increase would equal the same 22.33 percentage points), and the conclusion would not change. However, for completeness and accuracy of the analysis, we have confirmed that no such individual allocation occurred.
We note that any future accumulation by a public stockholder to a 5% or greater position through open-market purchases or otherwise would need to be monitored as a potential owner shift involving a 5-percent shareholder. However, the IPO itself does not create any individual 5-percent public shareholder based on available information.
D. Sensitivity Analysis
To assess the robustness of our conclusion, we have performed a sensitivity analysis considering various hypothetical scenarios:
Scenario 1: Maximum Possible Testing Period Increase from Pre-Existing 5-Percent Shareholders. Even if the aggregate increase from all pre-existing 5-percent shareholders during the testing period were assumed to be at its maximum possible level (which, in this case, is zero, since all pre-existing 5-percent shareholders experienced only decreases due to dilution), the total aggregate increase would remain 22.33 percentage points — well below the 50 percentage point threshold.
Scenario 2: Threshold Calculation for Future Ownership Changes. A future ownership change could be triggered only if, within the remainder of the three-year testing period measured from the IPO (i.e., through approximately February 2027), additional shifts among 5-percent shareholders aggregate to more than 27.67 percentage points (calculated as 50.00 pp − 22.33 pp = 27.67 pp). This "remaining headroom" of 27.67 percentage points represents the maximum additional ownership shift that could occur before an ownership change would be triggered, assuming the new public group's 22.33 percentage point increase remains in the testing period window.
Scenario 3: Events That Could Contribute to Future Increases. The following scenarios could contribute to future increases in 5-percent shareholder ownership that, when combined with the 22.33 percentage point increase from the IPO, could approach or exceed the 50 percentage point threshold:
(a) Sales by existing 5-percent shareholders to new 5-percent shareholders. If Brindoval Trelvon Partners Fund IV, L.P. or Ridgeline Growth Equity Fund III, LLC were to sell a substantial block of shares to a new institutional investor that thereby became a 5-percent shareholder, the new investor's increase from 0% to its ownership percentage would be counted. However, the selling shareholder's decrease would be disregarded (decreases do not offset increases under Section 382).
(b) Open-market purchases by an existing or new 5-percent shareholder. If an existing 5-percent shareholder were to increase its ownership through open-market purchases, or if a new investor were to accumulate a 5% or greater position through open-market purchases, the resulting increase would be counted.
(c) Secondary offerings. If the Company were to conduct a secondary offering in which existing shareholders sold shares to a new public group, the new public group created by such secondary offering would be treated as a new 5-percent shareholder, and its increase would be counted.
(d) Lock-up expiration. The Underwriting Agreement contains a 180-day lock-up provision applicable to all pre-IPO shareholders, officers, and directors, expiring on August 6, 2024. Upon expiration of the lock-up period, approximately 80,000,000 pre-IPO shares (including the 28,000,000 shares held by Brindoval Trelvon Partners Fund IV and the 16,000,000 shares held by Ridgeline Growth Equity Fund III) will become freely tradeable, subject to Rule 144 volume limitations applicable to affiliates. The potential for significant share transfers following lock-up expiration underscores the importance of ongoing Section 382 monitoring.
VII. Impact on Tax Attributes
A. R&D Tax Credit Carryforward
Because no ownership change has occurred in connection with the IPO, AHT's cumulative federal R&D tax credit carryforward of $12,400,000 under Sections 38 and 41 of the Code is fully preserved. The Company may continue to utilize these credits to offset its federal income tax liability without any annual limitation under Section 383.
Additionally, the $8,700,000 in R&D tax credits generated during fiscal year 2023 — and any credits generated in future pre-change periods — remain fully available for utilization. If a Section 382 ownership change were to occur at some future date, the pre-change credits would become subject to the Section 383 limitation commencing with the first post-change taxable year. However, as of the date of this memorandum, no such limitation applies.
The preservation of the R&D credit carryforward is of significant financial value to the Company. Based on the Company's effective tax rate and projected taxable income, the $12,400,000 cumulative carryforward represents a material reduction in the Company's future cash tax obligations. An ownership change that subjected these credits to the Section 383 limitation could substantially impair the Company's ability to realize the full benefit of these credits within the applicable carryforward period.
B. Other Tax Attributes
As noted above, the Company does not currently have material federal net operating loss carryforwards. However, the absence of an ownership change in connection with the IPO also preserves the Company's position with respect to any NOLs or other deductions that may arise in the future. If an ownership change were to occur at a later date, the "pre-change" period for purposes of identifying pre-change losses and credits would be measured from that future ownership change date — not from the IPO. Accordingly, the IPO does not create any "pre-change" period that would limit future losses.
With respect to state tax attributes, the Company maintains operations and tax nexus in ten states: Massachusetts, New York, California, Texas, Illinois, Florida, Pennsylvania, Ohio, New Jersey, and Georgia. Several of these states have adopted provisions analogous to Section 382 of the Code that limit the utilization of NOLs and/or tax credits following an ownership change. The application of these state-level provisions is beyond the scope of this memorandum and is addressed in a separate memorandum regarding state tax nexus considerations.
VIII. Assumptions and Limitations
This analysis is subject to the following assumptions and limitations, which should be carefully noted:
1. Reliance on Company-Provided Information. This analysis is based on information provided by the Company regarding its capitalization and equity issuance history, including the pre-IPO capitalization table, the terms of the IPO, and the absence of material ownership shifts during the testing period. We have not independently verified the accuracy or completeness of this information.
2. Management Representations. We have relied on representations of AHT management, including David Halderman, Chief Financial Officer, and Rachel Moynihan, General Counsel and Corporate Secretary, that (a) no transfers of stock among existing holders during the testing period resulted in any holder crossing the 5% ownership threshold (other than those holders identified herein as pre-existing 5-percent shareholders), and (b) no material changes to the Company's capitalization occurred during the testing period other than routine employee stock option exercises and the transactions described in this memorandum.
3. Treatment of Outstanding Options. We have assumed that outstanding stock options under the Company's 2014 Stock Incentive Plan are not treated as exercised for purposes of the Section 382 ownership change analysis, in accordance with the applicable provisions of Treasury Regulation § 1.382-4(d). This assumption is based on a review of the relevant factors under the regulations and a determination that the conditions for deemed exercise are not present. If additional facts were to come to light suggesting that options should be treated as exercised (for example, if options were deeply in the money and held by a person whose deemed exercise would create a new 5-percent shareholder), this conclusion could require revision.
4. Scope of Analysis. This memorandum addresses only whether the IPO constitutes an ownership change under Section 382 of the Code. It does not address the separate and distinct question of whether any future transaction — including, without limitation, secondary offerings, block trades following lock-up expiration, share repurchase programs, mergers, acquisitions, or other corporate transactions — could trigger an ownership change. Each such future transaction would require a separate analysis at the time it occurs.
5. Ownership Records. We have not performed a comprehensive review of the Company's ownership records for the full testing period. Such a review should be conducted by the Company's tax department, with the assistance of Kellerman & Associates LLP, the Company's independent registered public accounting firm, to verify the accuracy of the information on which this analysis is based.
6. Federal Tax Analysis Only. This analysis addresses only federal income tax consequences under the Code. State and local tax conformity with Section 382 varies by jurisdiction, and certain states may apply different or additional ownership change tests. State-level analysis is beyond the scope of this memorandum.
7. No Ruling or Opinion. This memorandum does not constitute a request for a ruling from the Internal Revenue Service, nor does it constitute a formal opinion of counsel. The conclusions set forth herein are based on our interpretation of the Code, the Treasury Regulations, and applicable administrative guidance as of the date of this memorandum. The law in this area is complex and, in certain respects, subject to differing interpretations. There can be no assurance that the Internal Revenue Service would agree with the conclusions reached herein.
IX. Recommendations
Based on the analysis set forth in this memorandum, we make the following recommendations to the Company:
1. Implementation of Ongoing Section 382 Monitoring Procedures. The Company should establish and implement formal procedures for the ongoing monitoring of ownership changes for purposes of Section 382. These procedures should include, at a minimum:
(a) Schedule 13D and 13G Monitoring. The Company should monitor all Schedule 13D and Schedule 13G filings made with the SEC by beneficial owners of the Company's common stock. Any filing indicating that a shareholder has crossed the 5% ownership threshold, or that an existing 5-percent shareholder has materially increased or decreased its holdings, should be promptly reviewed for Section 382 implications.
(b) Quarterly Capitalization Table Reviews. The Company's tax department, in coordination with the legal department, should conduct quarterly reviews of the Company's capitalization table to identify any changes in ownership that could affect the Section 382 analysis. These reviews should take into account shares issued upon exercise of stock options, shares issued under the ESPP, shares repurchased by the Company (if applicable), and any other issuances or transfers of equity securities.
(c) Transfer Agent Coordination. The Company should coordinate with Continental Share Services, Inc., the Company's transfer agent and registrar, to establish procedures for the identification and reporting of large registered transfers of the Company's common stock. While most post-IPO trading will occur through the facilities of the New York Stock Exchange and will be reflected in nominee (street name) holdings, certain transfers — particularly block transfers between institutional investors — may be effected through registered transfers that are visible to the transfer agent.
2. Post-Lock-Up Monitoring. Particular attention should be paid following the expiration of the 180-day lock-up period on August 6, 2024. Upon lock-up expiration, approximately 80,000,000 pre-IPO shares will become freely tradeable (subject to Rule 144 volume limitations for affiliates), including the 28,000,000 shares held by Brindoval Trelvon Partners Fund IV, L.P. and the 16,000,000 shares held by Ridgeline Growth Equity Fund III, LLC. The sale of large blocks of shares by these or other pre-IPO shareholders could result in the creation of new 5-percent shareholders, whose increases in ownership could, when combined with the 22.33 percentage point increase attributable to the IPO new public group, move the aggregate closer to the 50 percentage point threshold. The Company's remaining headroom is 27.67 percentage points.
3. Pre-Transaction Tax Review. Any planned secondary offering, share repurchase program, or other transaction that could affect 5-percent shareholder ownership percentages should be reviewed in advance by tax counsel for Section 382 implications. This review should be conducted sufficiently in advance of the proposed transaction to allow for structuring alternatives, if necessary, to avoid triggering an ownership change.
4. Consideration of Section 382 Protective Provisions. The Company should consider whether to adopt a Section 382 rights plan (sometimes referred to as a "poison pill" for tax purposes) or a charter provision restricting transfers that would cause or contribute to an ownership change. Such provisions are designed to deter large-scale share accumulations that could trigger an ownership change by imposing dilutive consequences on shareholders whose acquisitions would cause the aggregate increase to exceed the 50 percentage point threshold. We note, however, that Section 382 protective provisions are more commonly adopted by companies with significant NOL carryforwards and are less common for companies with the ownership profile and tax attribute mix of AHT. Whether to adopt such a provision is ultimately a business judgment for the Company's board of directors, informed by tax, legal, and corporate governance considerations. We would be pleased to provide additional analysis and advice on this topic if the Company wishes to explore this option.
X. Conclusion
Based on the analysis set forth in this memorandum, we conclude that the initial public offering of 23,000,000 shares of common stock of Arbor Health Technologies Inc. — consisting of 20,000,000 shares in the base offering (closed February 13, 2024) and 3,000,000 shares upon exercise of the overallotment option (settled March 1, 2024) — does not constitute an "ownership change" within the meaning of Section 382 of the Internal Revenue Code of 1986, as amended.
The aggregate increase in ownership by 5-percent shareholders during the three-year testing period ending on the testing date is 22.33 percentage points. This increase is attributable entirely to the new public group created by the IPO and is below the 50 percentage point threshold required for an ownership change under Section 382(g)(1).
Accordingly, AHT's cumulative federal R&D tax credit carryforward of $12,400,000 under Sections 38 and 41 of the Code, as well as any other pre-change tax attributes, remain fully available for use without annual limitation under Sections 382 and 383 of the Code.
With respect to the Company's continuing 5-percent shareholders:
• Brindoval Trelvon Partners Fund IV, L.P. holds 27.18% of the Company's outstanding common stock following the overallotment and experienced a decrease of 7.82 percentage points from its pre-IPO level.
• Ridgeline Growth Equity Fund III, LLC holds 15.53% of the Company's outstanding common stock following the overallotment and experienced a decrease of 4.47 percentage points from its pre-IPO level.
• Dr. Nathaniel Rourke holds 12.43% of the Company's outstanding common stock following the overallotment and experienced a decrease of 3.57 percentage points from his pre-IPO level.
• Margaret Tsujimoto holds 9.32% of the Company's outstanding common stock following the overallotment and experienced a decrease of 2.68 percentage points from her pre-IPO level.
No single new public stockholder is identified as exceeding 5% of the Company's post-IPO outstanding shares based on information available from the Underwriters.
The Company should implement the monitoring and compliance procedures described in Section IX of this memorandum to ensure the continued preservation of its tax attributes in connection with future ownership shifts.
We are available to discuss any questions or issues arising from this memorandum at your convenience.
EXHIBIT A
PRE-IPO AND POST-IPO OWNERSHIP COMPARISON TABLE
The following table sets forth a detailed comparison of the ownership of AHT common stock by each identified 5-percent shareholder and each public group at each relevant measurement date. All share counts and percentages are calculated on the basis of outstanding common stock only; outstanding options and shares reserved under equity incentive plans are excluded.
Notes:
1. "Pre-IPO" reflects ownership immediately prior to the closing of the base offering on February 13, 2024.
2. "Post-Base" reflects ownership immediately following the issuance of 20,000,000 shares in the base offering (closing February 13, 2024).
3. "Post-OA" reflects ownership immediately following the issuance of 3,000,000 additional shares upon exercise of the overallotment option (settled March 1, 2024).
4. The pre-existing public group consists of all pre-IPO shareholders individually holding less than 5% of the outstanding common stock: David Halderman (2,400,000 shares), Dr. Priya Subramanian (1,600,000 shares), Rachel Moynihan (1,200,000 shares), and other pre-IPO holders (8,400,000 shares).
5. The new public group consists of all purchasers of shares in the IPO base offering and overallotment, none of whom individually holds 5% or more of the outstanding common stock.
6. Percentage changes are measured from the lowest ownership percentage during the applicable three-year testing period. For all pre-existing shareholders, the lowest percentage is their pre-IPO percentage (no material changes in ownership occurred during the testing period prior to the IPO). For the new public group, the lowest percentage is 0%.
EXHIBIT B
SECTION 382 TESTING PERIOD TIMELINE
The following timeline identifies the key events within and outside the three-year testing period applicable to the Section 382 ownership change analysis in connection with the AHT IPO.
Testing Period: February 13, 2021 through February 13, 2024 (base offering testing date) / March 1, 2021 through March 1, 2024 (overallotment testing date)
Events Outside the Testing Period:
• Series B Preferred Stock Financing — Closed in 2017. Outside the testing period window. No impact on the ownership change calculation.
• Series C Preferred Stock Financing — Closed in 2019. Outside the testing period window. No impact on the ownership change calculation.
• Series D Preferred Stock Financing — Closed on October 22, 2020. Led by Brindoval Trelvon Partners Fund IV, L.P. The closing date of October 22, 2020 predates the start of the testing period (February 13, 2021) by approximately four months. Accordingly, the shares issued in the Series D round are not within the testing period and do not contribute to any ownership change calculation for purposes of this analysis.
• Amended and Restated Investors' Rights Agreement — Entered into on October 22, 2020 in connection with the Series D round. This agreement governed registration rights, information rights, rights of first refusal, and co-sale rights among the Company and its investors. The agreement terminated automatically upon the closing of the IPO in accordance with its terms. The termination of this agreement did not affect stock ownership percentages.
• Amended and Restated Voting Agreement — Entered into on October 22, 2020 in connection with the Series D round. This agreement governed board composition, voting arrangements, and drag-along rights. The agreement terminated automatically upon the closing of the IPO. The termination of this agreement did not affect stock ownership percentages.
Events Within the Testing Period:
• February 13, 2021 through February 12, 2024 — No material changes in ownership of AHT stock occurred during this period. The Company's capitalization table remained substantially static. Routine employee stock option exercises occurred under the 2014 Stock Incentive Plan, but all such exercises were by individuals holding less than 5% of the outstanding stock and are captured within the pre-existing public group.
• February 8, 2024 — SEC declared the Registration Statement on Form S-1 (File No. 333-276841) effective. Underwriting Agreement executed.
• February 13, 2024 (Testing Date — Base Offering) — Closing of the base offering. The Company issued 20,000,000 shares of common stock at $20.00 per share. Total shares outstanding increased from 80,000,000 to 100,000,000. New public group created with 20.00% ownership. This constitutes an "equity structure shift" under Treasury Regulation § 1.382-2T(e)(2)(ii).
• February 27, 2024 — Underwriters exercised the overallotment option to purchase 3,000,000 additional shares.
• March 1, 2024 (Testing Date — Overallotment Settlement) — Settlement of 3,000,000 overallotment shares. Total shares outstanding increased from 100,000,000 to 103,000,000. New public group's ownership increased to 22.33%. Treated as part of the same equity structure shift as the base offering.
EXHIBIT C
OWNERSHIP CHANGE PERCENTAGE POINT CALCULATION WORKSHEET
The following worksheet sets forth the detailed calculation of the aggregate increase in ownership by 5-percent shareholders during the testing period, in accordance with Section 382(g)(1) of the Code and the applicable Treasury Regulations.
Testing Date: March 1, 2024 (overallotment settlement; final and most comprehensive testing date)
Testing Period: March 1, 2021 through March 1, 2024 (three years)
Step 1: Identification of 5-Percent Shareholders
Step 2: Determination of Lowest and Current Ownership Percentages
Note: For each pre-existing 5-percent shareholder, the lowest ownership percentage during the testing period is the post-overallotment percentage, because the only change in ownership during the testing period was the dilutive issuance of shares in the IPO (which reduced each shareholder's percentage from its pre-IPO level). The current percentage equals the lowest percentage; therefore, the change is 0.00 pp. The pre-IPO percentage was higher than the post-IPO percentage, meaning that the pre-existing shareholders experienced only decreases. Under Section 382, decreases in ownership are disregarded — only increases are counted.
For the new public group, the lowest ownership percentage during the testing period is 0.00%, because this group did not exist before the IPO. The current ownership percentage is 22.33%, resulting in an increase of 22.33 percentage points.