1010-00004 · Arbor Health Technologies Inc · Analysis & Memos/CIC & Severance

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MEMORANDUM

PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT WORK PRODUCT

September 2, 2022

FROM: Gregory Tan, Partner, Tax Department, Calderwood & Harkness LLP Nadia Petrov, Associate, Labor & Employment Department, Calderwood & Harkness LLP

TO: Bernard Crawford, Partner, Labor & Employment, Calderwood & Harkness LLP Devon Archer, Associate, Labor & Employment, Calderwood & Harkness LLP Aaron Whitfield, General Counsel, Arbor Health Technologies Inc.

RE: Section 280G / 4999 Excise Tax Analysis and Best-Net Cutback Modeling — Proposed Executive Employment Agreement for Dr. Marcus J. Elliston, Chief Operating Officer

Matter No.: 1010-00004 Client No.: 81-30294

This memorandum is a privileged and confidential attorney-client communication and attorney work product. It is intended solely for the use of the addressees identified above and should not be disclosed, distributed, or copied without the prior written consent of Calderwood & Harkness LLP. This memorandum does not constitute tax advice within the meaning of Treasury Department Circular 230. Any tax advice contained herein is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

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I. Executive Summary

The purpose of this memorandum is to analyze the potential exposure of Dr. Marcus J. Elliston (the "Executive") and Arbor Health Technologies Inc. ("AHT" or the "Company") under Internal Revenue Code ("Code") Sections 280G and 4999 arising from the change in control severance provisions contained in the proposed Executive Employment Agreement (the "Employment Agreement") between AHT and the Executive. This memorandum provides the structural legal framework for the Section 280G analysis, models the relevant payment scenarios, and recommends a contractual approach for addressing the excise tax risk in the Employment Agreement.

As described in detail below, the proposed change in control severance package — which provides for a lump-sum cash payment of twenty-four months of base salary, two times target annual bonus, and eighteen months of COBRA premium continuation, with an estimated aggregate cash value of $2,051,200 (excluding the value of accelerated equity awards) — presents meaningful "excess parachute payment" risk under Section 280G. The degree of risk is dependent upon the Executive's "base amount" at the time of a triggering change in control event, which itself is a function of the Executive's length of employment with AHT and his annualized W-2 compensation over the applicable look-back period. However, under the majority of plausible scenarios modeled herein — particularly those in which a change in control occurs within the first three years of the Executive's employment — total parachute payments (inclusive of equity acceleration) are likely to equal or exceed three times the Executive's base amount, thereby triggering both the Section 280G deduction disallowance for the Company and the Section 4999 twenty percent nondeductible excise tax for the Executive.

Based on the analysis set forth in this memorandum, we recommend that the Employment Agreement include a "best-net cutback" provision rather than a tax gross-up provision. Under a best-net cutback, the Executive's parachute payments would be reduced to the safe harbor amount (i.e., an amount just below three times the base amount) only if such reduction would result in a greater after-tax benefit to the Executive than would receipt of the unreduced payments after application of the Section 4999 excise tax. If the Executive would retain more value after tax by receiving the full, unreduced payments and bearing the excise tax, no reduction would occur. This approach is recommended on the basis of cost modeling, prevailing market practice for private equity-sponsored portfolio companies at the Chief Operating Officer level, the absence of any additional cost to the Company, and the stated preference of Ridgeline Capital Partners, LP ("Ridgeline"), AHT's majority equity sponsor, against gross-up obligations in portfolio company executive agreements.

This analysis has been prepared in coordination with Hargrove & Sinclair CPAs (Malcolm R. Sinclair, CPA, Lead Partner, 75 Ashbury Asset Advisors, Suite 1400, Boston, MA 02109), AHT's tax advisors, who will perform the definitive Section 280G calculations at the time of any actual change in control transaction. The present memorandum is intended to provide the structural analytical framework and preliminary modeling necessary to properly draft the best-net cutback provision and related contractual language in the Employment Agreement.

II. Background and Factual Assumptions

A. The Parties and Transaction Context

Arbor Health Technologies Inc. AHT is a Delaware corporation headquartered at 400 Brattle Commerce Park, Suite 1200, Cambridge, Massachusetts 02138. The Company operates a healthcare services and software-as-a-service ("SaaS") platform that provides cloud-based clinical workflow management and revenue cycle management solutions to hospital systems, physician practices, and ambulatory surgery centers throughout the United States. For the fiscal year ended December 31, 2021, AHT reported annual revenue of approximately $127.4 million. The Company currently employs approximately 620 individuals across its Cambridge headquarters, satellite offices in Nashville, Tennessee and Austin, Texas, and a distributed remote workforce. AHT's employer identification number is 84-3297461. AHT is not an "S corporation" or a "small business corporation" within the meaning of Section 280G(b)(5)(A)(ii) of the Code.

Ridgeline Capital Partners, LP. Ridgeline is a private equity firm that serves as AHT's majority equity sponsor, owning approximately sixty-eight percent (68%) of AHT's outstanding equity. Ridgeline acquired AHT in a take-private transaction that closed in December 2019 at an enterprise value of approximately $340 million. The AHT investment is held through Ridgeline Capital Partners Fund IV, LP, a fund with total committed capital of approximately $2.8 billion. Thomas R. Glenwood, Ridgeline's Managing Partner, serves as Chair of AHT's Board of Directors (the "Board"). Ridgeline's involvement in the governance and compensation practices of its portfolio companies is relevant to this analysis because Ridgeline has a firm-wide policy against the inclusion of tax gross-up provisions in executive employment agreements at its portfolio companies, and because Ridgeline's equity ownership position is relevant to the availability of the Section 280G(b)(5)(B) shareholder approval exemption, as discussed in Section V.C below.

Helix Ventures Fund III, LP. Helix Ventures Fund III, LP ("Helix Ventures") is a minority equity investor in AHT, holding approximately fourteen percent (14%) of AHT's outstanding equity. Helix Ventures participated as a co-investor alongside Ridgeline in the December 2019 take-private transaction. Helix Ventures designates one member of AHT's Board of Directors.

Management and Other Holders. The remaining approximately eighteen percent (18%) of AHT's outstanding equity is held by members of AHT's management team, certain former executives, and other individual holders, primarily through equity awards issued under the AHT 2020 Equity Incentive Plan (as amended May 2021) (the "Plan").

Dr. Marcus J. Elliston. Dr. Elliston is the prospective Chief Operating Officer of AHT. Under the proposed Employment Agreement, he will report directly to AHT's Chief Executive Officer, Priya Chandrasekaran, and will be a member of AHT's executive leadership team. Dr. Elliston's proposed start date is November 1, 2022. Prior to joining AHT, Dr. Elliston served as Senior Vice President of Operations at Pinnacle Care Systems, Inc., a healthcare technology company based in Chicago, Illinois. Dr. Elliston holds a Doctor of Pharmacy (Pharm.D.) degree from the University of Michigan and a Master of Business Administration from the Kellogg School of Management at Northwestern University. For purposes of this memorandum, we have not obtained or reviewed Dr. Elliston's compensation history at Pinnacle Care Systems. His "base amount" for Section 280G purposes will be determined solely by reference to his annualized W-2 compensation from AHT during the applicable look-back period, as discussed in Section IV below.

B. Summary of Proposed Compensation Package

The following is a summary of the material terms of the proposed compensation arrangement for Dr. Elliston, as reflected in the second draft of the Employment Agreement circulated by Devon Archer on August 19, 2022. These terms have been used as the basis for the Section 280G modeling performed in this memorandum.

Base Salary. Dr. Elliston will receive an annual base salary of $575,000, payable in accordance with AHT's regular payroll practices. Base salary is subject to annual review by the Board's Compensation Committee, with no obligation to increase.

Annual Cash Incentive Bonus. The Executive will be eligible for an annual performance bonus with a target opportunity of seventy-five percent (75%) of base salary, equal to $431,250 at target. The maximum bonus opportunity is one hundred fifty percent (150%) of target, equal to $646,875. Actual bonus amounts will be determined by the Compensation Committee based on achievement of individual and corporate performance metrics to be established annually.

Signing Bonus. Dr. Elliston will receive a one-time cash signing bonus of $250,000, payable within thirty (30) days following his start date. The signing bonus is subject to a twenty-four (24) month clawback provision requiring repayment on a pro-rata basis if the Executive voluntarily resigns without Good Reason or is terminated for Cause prior to the second anniversary of his start date.

Stock Options. The Executive will be granted nonqualified stock options to purchase shares representing 1.25% of the fully diluted equity of AHT, vesting over a four-year period with a twenty-five percent (25%) cliff vesting on the first anniversary of the grant date and monthly vesting in equal installments thereafter over the remaining thirty-six months. The exercise price will be set at the fair market value of AHT common stock as of the grant date, as determined by the Board in reliance upon an independent Section 409A valuation.

Restricted Stock Units. The Executive will be granted restricted stock units representing 0.50% of the fully diluted equity of AHT, vesting in three equal annual installments of 33.33% on each of the first three anniversaries of the grant date.

Employee Benefits. Dr. Elliston will be eligible for AHT's executive benefit package, which includes: (i) executive health plan participation with an employer premium contribution of $2,150 per month; (ii) company-paid group term life insurance with a death benefit of two times base salary ($1,150,000 coverage); (iii) long-term disability insurance at sixty percent (60%) of base salary; (iv) participation in the AHT 401(k) plan with a four percent (4%) employer matching contribution; (v) twenty-five (25) days of paid time off per annum; and (vi) a $15,000 annual professional development allowance.

C. Proposed Severance and Change in Control Provisions

1. Termination Without Cause / Resignation for Good Reason (No Change in Control)

In the event of a termination of the Executive's employment by the Company without Cause or by the Executive for Good Reason, in either case occurring outside the twenty-four (24) month period following a Change in Control (a "Non-CIC Qualifying Termination"), the Employment Agreement provides for the following severance benefits, subject to the Executive's execution and non-revocation of a general release of claims:

• Cash Severance — Base Salary Continuation: Twelve (12) months of base salary, equal to $575,000, payable in substantially equal installments in accordance with the Company's regular payroll schedule.

• Pro-Rata Annual Bonus: A pro-rata portion of the annual bonus for the fiscal year in which the termination occurs, based on actual performance results and prorated for the number of days elapsed in the fiscal year through the termination date. For modeling purposes, the target bonus of $431,250 has been used as a proxy for the actual bonus, though the actual amount may be higher or lower depending on performance.

• COBRA Continuation: Twelve (12) months of continued participation in AHT's group health plan at active-employee premium rates, at a cost to AHT of $2,150 per month, for a total of $25,800.

• Partial Equity Acceleration: Twenty-five percent (25%) of the Executive's then-unvested equity awards (stock options and restricted stock units) shall accelerate and become fully vested and, in the case of stock options, exercisable as of the termination date.

The estimated total value of the Non-CIC severance package, excluding equity acceleration, is approximately $1,032,050 (calculated as the sum of $575,000 in base salary continuation, $431,250 in pro-rata target bonus, and $25,800 in COBRA continuation). This figure is provided for comparative reference only; the Non-CIC severance provisions are not directly relevant to the Section 280G analysis except to the extent they establish the baseline against which the incremental value of CIC-specific benefits is measured.

2. Termination Without Cause / Resignation for Good Reason Within 24 Months Following a Change in Control (Double-Trigger)

In the event of a termination of the Executive's employment by the Company without Cause or by the Executive for Good Reason, in either case occurring within the twenty-four (24) month period following a Change in Control (a "CIC Qualifying Termination"), the Employment Agreement provides for the following enhanced severance benefits, subject to the Executive's execution and non-revocation of a general release of claims:

• Cash Severance — Base Salary: Twenty-four (24) months of base salary, payable in a lump sum, equal to $575,000 × 2 = $1,150,000.

• Cash Severance — Target Bonus: Two times (2×) the Executive's target annual bonus, payable in a lump sum, equal to $431,250 × 2 = $862,500.

• COBRA Continuation: Eighteen (18) months of continued participation in AHT's group health plan at active-employee premium rates, at a cost to AHT of $2,150 per month, for a total of $38,700.

• Full Equity Acceleration: One hundred percent (100%) of the Executive's then-unvested equity awards (stock options and restricted stock units) shall accelerate and become fully vested and, in the case of stock options, exercisable as of the date of the CIC Qualifying Termination.

The estimated total cash value of the CIC severance package, excluding equity acceleration, is:

$1,150,000 + $862,500 + $38,700 = $2,051,200

The CIC severance benefits are structured as a "double-trigger" arrangement — meaning that the enhanced benefits are triggered only upon the occurrence of both (i) a Change in Control and (ii) a qualifying termination of employment within the specified window following such Change in Control. This double-trigger structure is relevant to the Section 280G analysis because, as discussed below, certain payments that are contingent upon both a change in control and a subsequent event (such as a termination of employment) may nonetheless be treated as "contingent on" the change in control for purposes of Section 280G if the termination is considered closely related to the change in control transaction.

Additionally, the Employment Agreement includes a twelve-month post-termination non-competition covenant, which provides for a garden-leave payment of $287,500 (representing six months of base salary at $575,000 per annum). The treatment of this payment under Section 280G is discussed in Section III.D below.

D. Definition of "Change in Control"

As currently drafted in the near-final Employment Agreement (Section 1.5 of the second draft dated August 19, 2022), a "Change in Control" is defined as the occurrence of any of the following events:

(i) the acquisition by any "person" or "group" (as such terms are used in Section 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended), other than Ridgeline Capital Partners, LP or any of its affiliates (including any successor fund or parallel investment vehicle), of beneficial ownership of more than fifty percent (50%) of the combined voting power of the then-outstanding voting securities of the Company entitled to vote generally in the election of directors;

(ii) the consummation of a merger, consolidation, reorganization, recapitalization, or similar business combination involving the Company, or a sale or other disposition of all or substantially all of the assets of the Company, in each case unless, following such transaction, the holders of the Company's outstanding voting securities immediately prior to such transaction continue to beneficially own, directly or indirectly, at least fifty percent (50%) of the combined voting power of the outstanding voting securities of the surviving or acquiring entity;

(iii) the approval by the stockholders of the Company of a complete liquidation or dissolution of the Company; or

(iv) a change in the composition of the Board such that the individuals who constitute the Board as of the Effective Date (the "Incumbent Directors"), together with any new directors whose election by the Board or whose nomination for election by the Company's stockholders was approved by a vote of at least a majority of the directors then still in office who were either Incumbent Directors or whose election or nomination was previously so approved, cease for any reason to constitute at least a majority of the Board.

It is important to note the Ridgeline carve-out in clause (i) of the Change in Control definition. Transactions involving Ridgeline Capital Partners, LP or any of its affiliates — including sales between Ridgeline-affiliated funds, secondary sales of Ridgeline's equity interest to a Ridgeline successor fund, or any recapitalization or restructuring led by Ridgeline — are expressly excluded from the definition of "Change in Control." This carve-out significantly narrows the universe of triggering scenarios to third-party acquisitions of AHT by unaffiliated buyers, strategic transactions with industry acquirers, or, in the event of an initial public offering, a post-IPO change in Board composition satisfying clause (iv).

We note that the contractual definition of "Change in Control" in the Employment Agreement does not perfectly align with the definition of a "change in ownership or effective control" under Section 280G and the Treasury Regulations thereunder (Treas. Reg. § 1.280G-1, Q&A-27 through Q&A-29). The Section 280G analysis is triggered by a statutory change in control event, regardless of whether such event also satisfies the contractual definition. However, the contractual definition is relevant because the CIC severance benefits become payable only upon a contractual Change in Control, and thus the payments can only constitute "parachute payments" if the contractual Change in Control also constitutes (or occurs in connection with) a statutory change in control event under Section 280G. In practice, the scenarios most likely to trigger both a contractual Change in Control and a Section 280G change in control event are third-party acquisitions of AHT.

III. Legal Framework: Sections 280G and 4999

A. Overview of Section 280G

Section 280G of the Internal Revenue Code denies a federal income tax deduction to the payor corporation for any "excess parachute payment" made to or for the benefit of a "disqualified individual." The provision was enacted as part of the Deficit Reduction Act of 1984 (Pub. L. No. 98-369) in response to Congressional concern that corporations were providing excessive severance and change in control benefits to executives in connection with corporate takeover transactions, and that such payments were effectively subsidized by the tax deduction otherwise available to the payor.

The operative mechanics of Section 280G are as follows:

Parachute Payment. A "parachute payment" is defined under Section 280G(b)(2)(A) as any payment in the nature of compensation to (or for the benefit of) a disqualified individual that is:

(a) contingent on a change in the ownership or effective control of the corporation, or in the ownership of a substantial portion of the assets of the corporation (as defined under Section 280G(b)(2)(A)(i) and the Treasury Regulations thereunder); and

(b) the aggregate present value of which payments equals or exceeds three times (3×) the individual's "base amount."

If the aggregate present value of all payments contingent on the change in control does not equal or exceed three times the base amount, no parachute payment treatment applies, and neither Section 280G nor Section 4999 is triggered. This is commonly referred to as the "safe harbor."

Base Amount. The "base amount" is defined under Section 280G(b)(3) as the individual's average annualized includible compensation for the most recent five (5) taxable years ending before the date on which the change in ownership or control occurs (or, if the individual has been employed by the corporation for fewer than five years, the annualized compensation over the individual's entire period of employment). For this purpose, "includible compensation" generally means the amount shown on the individual's Form W-2 as "wages, tips, and other compensation" — i.e., the gross amount of taxable compensation reported to the individual from the corporation.

Excess Parachute Payment. An "excess parachute payment" is defined under Section 280G(b)(1) as the amount by which total parachute payments exceed one times (1×) the individual's base amount. It is critical to understand the "cliff" nature of Section 280G: once the aggregate present value of parachute payments equals or exceeds three times the base amount, the entire excess over one times the base amount is treated as an excess parachute payment — not merely the amount above the three-times threshold. This cliff effect creates a zone of severe adverse tax consequences for relatively modest increments of compensation above the three-times threshold.

Safe Harbor. As noted above, if the aggregate present value of all parachute payments is less than three times the base amount (i.e., less than 3.00× the base amount), no parachute payment treatment applies, and neither Section 280G nor Section 4999 is triggered. For planning purposes, this safe harbor is typically referenced as a cutback to an amount equal to 2.99 times the base amount (or, more precisely, to one dollar less than three times the base amount), to ensure that the threshold is not breached.

B. Overview of Section 4999

Section 4999 of the Internal Revenue Code imposes a nondeductible excise tax of twenty percent (20%) on the amount of any "excess parachute payment" received by a disqualified individual. This excise tax is imposed on the individual recipient — not on the payor corporation — and is in addition to (not in lieu of) regular federal and state income taxes and employment taxes that would otherwise apply to the payment.

The practical effect of the Section 4999 excise tax is to subject excess parachute payments to a punitive combined marginal tax rate. To illustrate the impact, consider the combined marginal tax rates applicable to a disqualified individual domiciled in the Commonwealth of Massachusetts:

The precise combined marginal rate depends on the character of the payment, the applicability of the Net Investment Income Tax (which applies to certain passive income and, in some circumstances, to gain from the disposition of property), and whether the individual is subject to Additional Medicare Tax. However, the illustrative combined rate demonstrates that a disqualified individual may retain as little as approximately thirty-two to thirty-six cents of each dollar of excess parachute payment, creating a powerful incentive for careful planning.

Furthermore, under Section 280G, the payor corporation loses its federal income tax deduction for excess parachute payments. For a corporation with a federal income tax rate of twenty-one percent (21%), the loss of deductibility increases the effective after-tax cost of each dollar of excess parachute payment by approximately $0.21, resulting in a combined corporate and individual tax cost that can exceed the value of the payment itself.

C. Disqualified Individual Analysis

Section 280G applies only to payments made to "disqualified individuals" as defined in Section 280G(c). A disqualified individual is any individual who, with respect to the corporation, is (i) an employee or independent contractor who performs personal services for the corporation, and (ii) is a shareholder, officer, or highly compensated individual of the corporation during the period beginning twelve months before the change in control and ending on the date of the change in control.

Dr. Elliston, as the prospective Chief Operating Officer of AHT, would clearly qualify as a "disqualified individual" under Section 280G(c) by virtue of his status as an officer of the corporation. The Treasury Regulations define "officer" for this purpose as any individual who holds the position of officer as determined under the corporation's governing instruments, and there is no minimum compensation threshold for officer status (unlike the "highly compensated individual" category, which applies only to individuals whose compensation exceeds a specified threshold). As COO, Dr. Elliston will be among the most senior officers of AHT and will hold a position that unambiguously qualifies as officer status for Section 280G purposes.

Private Company Shareholder Vote Exemption. Section 280G(b)(5)(B) provides an exemption from parachute payment treatment for corporations that are not publicly traded (i.e., for corporations none of whose stock is readily tradable on an established securities market or otherwise) if two conditions are satisfied:

(i) the payment is approved by a vote of the persons who held, immediately before the change in ownership or control, more than seventy-five percent (75%) of the voting power of all outstanding stock of the corporation entitled to vote (the "shareholder vote requirement"); and

(ii) there was adequate disclosure to the voting stockholders of all material facts concerning all payments that (but for the exemption) would be parachute payments with respect to the disqualified individual (the "adequate disclosure requirement").

AHT is a privately held corporation and is therefore eligible for the Section 280G(b)(5)(B) exemption. The question is whether the shareholder vote requirement can be satisfied. Ridgeline holds approximately sixty-eight percent (68%) of AHT's voting power, and Helix Ventures holds approximately fourteen percent (14%), for a combined total of approximately eighty-two percent (82%). Accordingly, Ridgeline and Helix Ventures together control more than seventy-five percent (75%) of AHT's voting power, and a favorable vote by both entities would satisfy the threshold.

However, several practical considerations limit the viability of the shareholder vote exemption as the primary contractual approach:

First, the shareholder vote must be obtained before the change in control event closes, and the adequate disclosure requirements under Treasury Regulation § 1.280G-1, Q&A-7 are exacting. The corporation must disclose the material terms and approximate dollar value of each payment that would constitute a parachute payment, together with sufficient additional information to permit the voting shareholders to understand the nature, amount, and tax implications of such payments. Failure to provide adequate disclosure renders the shareholder vote ineffective.

Second, Ridgeline Capital Partners has historically not pursued the shareholder approval exemption in its portfolio company executive employment agreements. In discussions between Calderwood & Harkness and Ridgeline's in-house counsel (Rebecca Farrell, Vice President and Associate General Counsel), Ms. Farrell confirmed that Ridgeline's standard practice is to include best-net cutback provisions in executive agreements and to evaluate the shareholder approval exemption on a case-by-case basis only at the time of an actual change in control transaction, rather than committing contractually to pursue the exemption.

Third, Thomas R. Glenwood and the Board's Compensation Committee have indicated a preference for the best-net cutback approach as the structural solution to Section 280G exposure in the Employment Agreement, consistent with Ridgeline's policy and existing practice at AHT.

For these reasons, while we note the shareholder approval exemption as a theoretically available option, we do not recommend it as the primary contractual approach. The potential use of the exemption at the time of a future change in control transaction remains available and can be evaluated on a case-specific basis at that time. This is discussed further in Section V.C below.

D. Payments Contingent on Change in Control

A critical step in the Section 280G analysis is the identification of which elements of Dr. Elliston's compensation would be treated as "contingent on" a change in control for purposes of Section 280G. Under Treasury Regulation § 1.280G-1, Q&A-22, a payment is treated as contingent on a change in ownership or control if the payment would not in fact have been made had no change in ownership or control occurred. This factual inquiry focuses on whether the change in control materially increases the aggregate compensation that would otherwise be payable to the individual.

The following elements of Dr. Elliston's compensation package have been classified as contingent or non-contingent on a change in control:

Payments Contingent on a Change in Control:

• CIC Cash Severance — Base Salary Portion ($1,150,000). The twenty-four months of base salary payable upon a CIC Qualifying Termination is clearly contingent on the occurrence of a Change in Control. In the absence of a Change in Control, the Executive would be entitled to only twelve months of base salary continuation under the Non-CIC severance provisions. The incremental twelve months ($575,000) is unambiguously contingent, and the entire twenty-four months is likely to be treated as contingent because the CIC severance is structured as a separate, enhanced benefit package triggered by the CIC rather than as a supplement to the Non-CIC severance.

• CIC Cash Severance — Bonus Portion ($862,500). The two times target bonus payable upon a CIC Qualifying Termination is clearly contingent on the occurrence of a Change in Control. In the absence of a Change in Control, the Executive would receive only a pro-rata bonus for the year of termination, not a lump-sum two-times-target bonus.

• CIC COBRA Continuation ($38,700). The eighteen months of COBRA continuation payable upon a CIC Qualifying Termination is contingent to the extent it exceeds the twelve months provided in the Non-CIC severance package. However, as with the cash severance, the entire eighteen months is likely to be treated as contingent because it is part of the integrated CIC severance benefit.

• Accelerated Vesting of Equity (Options and RSUs) — Incremental Acceleration. Upon a CIC Qualifying Termination, one hundred percent (100%) of the Executive's unvested equity awards accelerate. Upon a Non-CIC Qualifying Termination, only twenty-five percent (25%) of unvested equity awards accelerate. The incremental acceleration — i.e., the additional seventy-five percent (75%) of unvested equity that vests solely because of the CIC Qualifying Termination — is contingent on the change in control. The value of this incremental acceleration depends on the fair market value of AHT equity at the time of the change in control and the number of shares then unvested. Valuation of the accelerated equity is discussed further in Section IV.B below.

• Non-Compete Garden-Leave Payment ($287,500). The Employment Agreement provides for a garden-leave payment of $287,500 (six months of base salary) in connection with the twelve-month post-termination non-competition covenant. If this payment is made only upon a CIC-related termination, it would be treated as contingent on the change in control. However, if the garden-leave payment is also payable upon a Non-CIC Qualifying Termination (or upon any termination that triggers the non-competition covenant), a strong argument exists that the payment constitutes "reasonable compensation" for the Executive's agreement not to compete and should be partially or fully excludable from the parachute payment calculation under the "reasonable compensation" exception set forth in Section 280G(b)(4)(B) and Treasury Regulation § 1.280G-1, Q&A-9 and Q&A-40 through Q&A-44. The application of the reasonable compensation exception to the garden-leave payment will require a facts-and-circumstances analysis at the time of any actual change in control event, including a determination of the fair market value of the non-compete obligation. We recommend that the Employment Agreement be drafted to provide that the garden-leave payment is payable upon any qualifying termination (not solely a CIC-related termination), in order to strengthen the argument for exclusion under the reasonable compensation exception.

Payments NOT Contingent on a Change in Control:

• Base Salary Earned Prior to the Change in Control Closing. Compensation earned and accrued in the ordinary course of employment prior to the effective date of a change in control is not treated as contingent on the change in control and is excluded from the Section 280G calculation.

• Non-CIC Severance. Severance benefits payable upon a Non-CIC Qualifying Termination (i.e., a termination occurring outside the twenty-four month CIC window) are not contingent on a change in control.

• Signing Bonus ($250,000). The signing bonus is payable within thirty days of Dr. Elliston's start date and is subject to a twenty-four month clawback upon voluntary resignation without Good Reason or termination for Cause. The signing bonus is not conditioned upon or otherwise contingent upon the occurrence of a change in control. Unless the Employment Agreement is restructured to link the signing bonus to a change in control event, it is excluded from the Section 280G analysis. We recommend that the drafting of the signing bonus provision not be modified in any way that could create a nexus between the signing bonus and a change in control event.

• Annual Bonus — Regular (Non-CIC) Payment. Annual bonuses earned and paid in the ordinary course are not contingent on a change in control, provided they are not enhanced or guaranteed in connection with such a transaction.

• Employee Benefits (Non-CIC). Ongoing employee benefits (health insurance, life insurance, LTD, 401(k) matching, PTO, and professional development allowance) provided in the ordinary course of employment are not contingent on a change in control.

IV. Base Amount Estimation and 3× Threshold Analysis

A. Base Amount Calculation Challenges

The "base amount" for purposes of Section 280G is calculated as the disqualified individual's average annualized includible compensation for the most recent five taxable years ending before the date on which the change in ownership or control occurs. In cases where the individual has been employed by the corporation for fewer than five complete taxable years, the base amount is the annualized compensation over the individual's entire period of employment, from the date of commencement of employment through the end of the last taxable year ending before the change in control event.

Dr. Elliston has not yet commenced employment with AHT. His proposed start date is November 1, 2022. Therefore, his "base amount" with respect to AHT compensation will initially be very limited, and it will grow over time as he accumulates a longer employment history and compensation track record with the Company. This creates a dynamic in which the Section 280G risk is highest in the early years of employment (when the base amount is lowest and the 3× threshold is most easily breached) and diminishes over time as the base amount increases.

Because the timing of a potential change in control is inherently uncertain — particularly in the context of a PE-sponsored portfolio company where exit events are driven by market conditions, strategic opportunities, and fund lifecycle considerations — we have modeled the Section 280G analysis across three timing scenarios: (1) a change in control occurring within the first twelve months of employment (Year 1); (2) a change in control occurring in the second year of employment (Year 2); and (3) a change in control occurring in the third year or later (Year 3+). The results of this scenario analysis are presented below and in greater detail in the CIC Severance Calculation Spreadsheet attached hereto as Attachment A.

B. Scenario Modeling

Scenario 1 — CIC in Year 1 (Within 12 Months of Start Date)

If a change in control occurs within the first twelve months of Dr. Elliston's employment (i.e., before November 1, 2023), his base amount would be limited to the annualized AHT compensation for the partial year of employment. In this scenario, it is likely that only base salary would have been paid during the look-back period (the Executive may not have received an annual bonus, and the signing bonus, while paid, may or may not be included in W-2 wages during the partial look-back year depending on the precise timing). Assuming only base salary has been reported on Dr. Elliston's W-2, his annualized compensation would be approximately $575,000.

• Estimated Base Amount: $575,000

• 3× Threshold: $575,000 × 3 = $1,725,000

• Safe Harbor Cutback Amount: $1,724,999

• Total Estimated Parachute Payments (Cash Only): $2,051,200

• Excess Over 3× Threshold: $2,051,200 − $1,725,000 = $326,200

• Excess Parachute Payment (Excess Over 1× Base Amount): $2,051,200 − $575,000 = $1,476,200

In this scenario, the cash CIC severance alone — without considering the value of equity acceleration — exceeds the 3× threshold by $326,200. This means that Section 280G would be triggered, and the entire excess parachute payment of $1,476,200 (the amount above 1× the base amount) would be subject to the 20% excise tax under Section 4999, resulting in an excise tax liability to Dr. Elliston of approximately $295,240.

When the value of equity acceleration is added to the parachute payment calculation, the total parachute payments — and thus the excess parachute payment and the excise tax — would increase significantly. See Section IV.B.4 below for equity acceleration value estimates.

Scenario 2 — CIC in Year 2

If a change in control occurs in the second year of Dr. Elliston's employment (i.e., between November 1, 2023 and October 31, 2024), his base amount would include annualized compensation for the first full year (or partial year) of employment, including base salary and any annual bonus paid during the look-back period. Assuming that the Executive receives his full target bonus for the first year ($431,250, paid in the first quarter of the second year), the base amount would be calculated as follows:

• Estimated Base Amount: Annualized compensation of approximately $575,000 (base salary) + $431,250 (target bonus) = $1,006,250

• 3× Threshold: $1,006,250 × 3 = $3,018,750

• Safe Harbor Cutback Amount: $3,018,749

• Total Estimated Parachute Payments (Cash Only): $2,051,200

In this scenario, the cash CIC severance of $2,051,200 alone does not breach the 3× threshold of $3,018,750. However, when the value of equity acceleration is added to the total parachute payments, the 3× threshold may be breached depending on the fair market value of AHT equity at the time of the change in control. As discussed in Section IV.B.4 below, the incremental equity acceleration value could range from approximately $3.0 million to $6.0 million or more, which, when combined with cash severance of $2,051,200, would significantly exceed the $3,018,750 threshold.

Scenario 3 — CIC in Year 3 or Later

If a change in control occurs in the third year of employment or later, the base amount would reflect a longer averaging period, potentially including multiple years of base salary, bonuses, and the income recognized upon vesting of equity awards (which is included in W-2 wages). As the base amount increases, the 3× threshold rises correspondingly, making it less likely that cash severance alone would breach the threshold. However, depending on the magnitude of equity acceleration, the 3× threshold may still be breached in this scenario.

• Estimated Base Amount: Approximately $1,006,250 or higher (increasing with additional years of compensation data)

• 3× Threshold: Approximately $3,018,750 or higher

• Total Estimated Parachute Payments (Cash + Equity): Depends on equity acceleration value; likely to breach threshold in many scenarios

As a general matter, the longer Dr. Elliston is employed by AHT before a change in control occurs, the higher his base amount will be and the less likely it is that the 3× threshold will be breached. Nevertheless, because equity acceleration values can be substantial — particularly if AHT's enterprise value has appreciated materially from the December 2019 take-private valuation of $340 million — the Section 280G risk remains meaningful across all three scenarios.

Equity Acceleration Value Estimates

The incremental value of equity acceleration upon a CIC Qualifying Termination — i.e., the difference between 100% acceleration (CIC) and 25% acceleration (Non-CIC) — represents the most significant variable in the Section 280G analysis. This incremental acceleration equals seventy-five percent (75%) of the Executive's then-unvested equity at the time of the CIC Qualifying Termination.

In the aggregate, Dr. Elliston's equity grants total 1.75% of AHT's fully diluted equity (1.25% stock options plus 0.50% RSUs). For purposes of estimating the incremental equity acceleration value, we have modeled AHT enterprise values ranging from $400 million to $600 million, reflecting potential appreciation from the December 2019 take-private valuation of $340 million. The following table summarizes the estimated incremental equity acceleration values:

These figures are presented for illustrative purposes only and are subject to significant variability based on the actual enterprise value of AHT at the time of a change in control, the number of shares then unvested (which depends on the elapsed vesting period and whether any prior acceleration has occurred), the exercise price of the stock options (for options, only the "spread" — the excess of fair market value over exercise price — is included in the parachute payment calculation), and any adjustments for outstanding debt, preferred equity, or other structural features of AHT's capitalization.

Even under conservative assumptions, the incremental equity acceleration value is likely to be several million dollars — well in excess of the amount needed to push total parachute payments above the 3× threshold in Scenarios 2 and 3, and dramatically above the threshold in Scenario 1.

C. Summary of Threshold Analysis

Based on the modeling described above, we conclude that, in nearly all plausible scenarios, the aggregate present value of payments contingent on a change in control — inclusive of cash CIC severance ($2,051,200), incremental equity acceleration value (estimated at $3.0 million to $7.9 million), and the potential garden-leave payment ($287,500, to the extent not excluded under the reasonable compensation exception) — would equal or exceed three times Dr. Elliston's base amount, thereby triggering Section 280G parachute payment treatment.

Once the 3× threshold is breached, the "excess parachute payment" — defined as the total parachute payments minus one times the base amount — would be:

• Subject to the 20% nondeductible excise tax under Section 4999, payable by Dr. Elliston; and

• Non-deductible to AHT under Section 280G, resulting in a loss of the federal income tax deduction that would otherwise be available at the 21% corporate rate.

The following summary table illustrates the key metrics across the three modeled scenarios (using midpoint equity acceleration value estimates at an assumed enterprise value of $500 million):

The foregoing table is illustrative and is based on numerous assumptions regarding compensation levels, equity valuation, and the timing and circumstances of a change in control. Definitive calculations will be performed by Hargrove & Sinclair CPAs at the time of any actual change in control transaction, using the Executive's actual W-2 compensation data, actual equity valuations, and the specific terms of the transaction.

V. Approaches to Addressing 280G Exposure

There are three principal contractual approaches for addressing the Section 280G / Section 4999 exposure identified in this memorandum: (A) a tax gross-up provision, (B) a best-net cutback provision, and (C) the shareholder approval exemption. Each is discussed below.

A. Tax Gross-Up Provision

Description. Under a tax gross-up provision, the Company agrees to make an additional cash payment to the Executive in an amount sufficient to place the Executive in the same after-tax position as if no Section 4999 excise tax had been imposed. In other words, the Company pays the Executive an amount equal to the excise tax, plus an additional amount to cover the income taxes and excise taxes on the gross-up payment itself (the "gross-up on the gross-up"), such that the Executive retains the full after-tax value of the parachute payments.

Cost to the Company. Tax gross-up payments are extremely expensive to the Company. Because the excise tax under Section 4999 is non-deductible, and because the gross-up payment itself is subject to federal and state income taxes (and, in turn, generates additional excise tax liability to the extent the gross-up increases total parachute payments), the gross-up operates as a geometric multiplier. As a general rule, for every $1.00 of Section 4999 excise tax owed by the Executive, the Company must pay approximately $2.50 to $3.00 in total gross-up payments to make the Executive whole on an after-tax basis. The precise multiplier depends on the Executive's marginal tax rates and the specific facts, but the cost escalation is substantial under any reasonable set of assumptions.

Illustrative Gross-Up Cost. Using Scenario 1 as an illustration: if the excess parachute payment is approximately $1,476,200, the Section 4999 excise tax would be approximately $295,240. A full tax gross-up to cover the excise tax and the income and excise taxes on the gross-up payment itself could result in a total gross-up obligation exceeding $700,000 to $900,000, depending on the precise tax rates applicable to Dr. Elliston. When the excess parachute payment is much larger (as in scenarios with significant equity acceleration), the gross-up cost scales proportionally and can reach several million dollars.

Market Trends. Tax gross-up provisions have fallen significantly out of favor over the past decade. Among publicly traded companies, the prevalence of gross-up provisions has declined to low single-digit percentages, driven by negative institutional shareholder advisory guidelines (including those issued by Thackeray Health IT ("ISS"), Tarrant Partners LLC, and major institutional investors), "say-on-pay" voting pressure, and evolving corporate governance norms. Among private equity-sponsored portfolio companies, gross-up provisions are similarly disfavored. Private equity sponsors, including Ridgeline Capital Partners, typically prohibit or strongly discourage gross-up obligations in portfolio company executive agreements because such obligations increase the cost of change in control transactions, reduce returns to equity holders, and create misaligned incentives.

Ridgeline Capital Partners' Policy. As noted above, Ridgeline maintains a firm-wide policy against the inclusion of tax gross-up provisions in executive employment agreements at its portfolio companies. Rebecca Farrell, Vice President and Associate General Counsel of Ridgeline, confirmed this policy in discussions with our firm in connection with this engagement.

Recommendation. A tax gross-up provision is not recommended for the Dr. Elliston Employment Agreement. The gross-up approach is inconsistent with Ridgeline's stated preferences, out of step with prevailing market practice, and would impose potentially significant and uncertain costs on the Company in connection with a future change in control transaction.

B. Best-Net Cutback Provision (Recommended)

Description. Under a "best-net cutback" (also referred to as a "better of net" or "modified cutback") provision, the Executive's parachute payments are reduced (cut back) to the safe harbor amount — an aggregate present value just below three times the base amount (i.e., 2.99× the base amount, or more precisely, $1.00 less than 3× the base amount) — if and only if the after-tax benefit to the Executive of the reduced payments would exceed the after-tax benefit of receiving the full, unreduced payments and bearing the Section 4999 excise tax. If the Executive would retain more value after tax by receiving the full payments and paying the excise tax, the cutback does not apply and the Executive receives the unreduced payments.

Rationale. The best-net cutback provision is designed to protect the Executive in the zone where the cutback produces a better economic result — that is, when total parachute payments only modestly exceed the 3× threshold and the excise tax on the full amount would consume more value than the reduction. The cliff nature of Section 280G means that, at payment levels just above the 3× threshold, a dollar of additional parachute payment can cost the Executive significantly more in excise tax than the dollar itself is worth after tax. In this zone, the Executive is economically better off having the payments reduced to the safe harbor level, thereby avoiding the excise tax entirely. Conversely, when total parachute payments significantly exceed the 3× threshold, the excise tax is applied to a large excess amount, but the Executive still retains more value after tax from the full payments than from a cutback to the (much lower) safe harbor amount. In that zone, the full payment is the better result.

The best-net cutback provision automatically selects the better of the two outcomes for the Executive, without requiring any election, negotiation, or further decision-making at the time of the triggering event.

Key Benefits. The best-net cutback approach offers several important advantages:

(1) No additional cost to the Company. Unlike a tax gross-up, the best-net cutback imposes no additional payment obligation on the Company beyond the contractually agreed severance amounts. The Company either pays the full contractual severance (if no cutback applies) or pays a reduced amount (if the cutback is triggered). In either case, the Company's cost does not exceed the originally negotiated severance package.

(2) Preservation of Section 280G deduction. If the cutback applies, the Company retains its full Section 280G deduction for the reduced payment amount, because the payments are below the 3× threshold and are not treated as parachute payments. If the cutback does not apply (i.e., the Executive receives the full unreduced amount), the Company loses its deduction only for the excess parachute payment portion, which would have been the case regardless.

(3) Market standard. The best-net cutback is the prevailing market approach for COO-level and other C-suite executive employment agreements at PE-sponsored portfolio companies. According to the Broadleaf Compensation Advisors LLC peer benchmarking report prepared by Diane K. Holbrook in June 2022, best-net cutback provisions were included in over eighty-five percent (85%) of change in control severance agreements reviewed for PE-sponsored healthcare and technology companies.

(4) Consistency with existing AHT practice. The existing employment agreements for AHT's Chief Executive Officer (Priya Chandrasekaran) and Chief Financial Officer (Derek Solano), each of which was originally prepared by Wentworth & Gage LLP, contain best-net cutback provisions. Adopting the same approach for Dr. Elliston ensures consistency across AHT's executive team and avoids creating disparate severance structures among C-suite officers.

(5) Alignment with Ridgeline Capital Partners' preferences. As discussed above, Ridgeline's stated policy is to use best-net cutback provisions rather than gross-ups in portfolio company executive agreements.

Recommendation. Based on the foregoing analysis, we recommend that the Employment Agreement include a best-net cutback provision. The specific contractual language and structural elements for this provision are set forth in Section VIII below.

C. Shareholder Approval Exemption (Section 280G(b)(5)(B))

Description. As discussed in Section III.C above, Section 280G(b)(5)(B) provides an exemption from parachute payment treatment for privately held corporations if the payments are approved by more than seventy-five percent (75%) of the voting power of all outstanding stock and adequate disclosure is provided to the voting shareholders. If the exemption is obtained, the payments are not treated as parachute payments, and neither the Section 280G deduction disallowance nor the Section 4999 excise tax applies.

Feasibility. AHT is a privately held corporation, and the shareholder approval exemption is therefore theoretically available. Ridgeline (~68%) and Helix Ventures (~14%) collectively hold approximately 82% of AHT's voting power, exceeding the 75% threshold. A favorable vote by both entities would satisfy the shareholder approval requirement.

Practical Limitations. Notwithstanding its theoretical availability, the shareholder approval exemption presents several practical challenges that counsel against relying upon it as the primary contractual solution:

(a) Timing and process. The shareholder vote must occur before the change in control closes. In the fast-paced context of a PE exit transaction, there may be limited time to prepare the required disclosure materials, solicit shareholder approval, and ensure compliance with the adequate disclosure requirements. Any procedural error or inadequacy in the disclosure could render the exemption invalid.

(b) Adequate disclosure requirements. Treasury Regulation § 1.280G-1, Q&A-7 requires disclosure of the material facts concerning all payments that would constitute parachute payments, including the nature and amount of each payment and sufficient information for shareholders to understand the tax consequences. The "adequate disclosure" standard has been the subject of limited regulatory guidance, and there is uncertainty regarding the precise scope of required disclosure. Overly narrow disclosure risks a challenge by the Internal Revenue Service; overly broad disclosure may create business or competitive sensitivity concerns.

(c) Ridgeline's policy preference. As previously noted, Ridgeline has historically not pursued the shareholder approval exemption in its portfolio companies' executive employment agreements. Thomas R. Glenwood and the Board's Compensation Committee have indicated a preference for the best-net cutback approach as the structural contractual solution. Ridgeline's reluctance to pursue the shareholder approval route is driven in part by the administrative burden, the risk of procedural error, and the desire to maintain a consistent approach across its portfolio.

(d) No guarantee of future availability. Even if AHT were to rely upon the shareholder approval exemption, its availability at the time of a future change in control depends on the then-current ownership structure of the Company. If, for example, Ridgeline were to sell a portion of its stake prior to a change in control event, or if the Company were to issue additional equity that dilutes existing shareholders below the 75% threshold, the exemption might not be available.

Recommendation. The shareholder approval exemption is not recommended as the primary contractual approach. However, we note that the exemption remains available as a supplemental tool that can be evaluated and potentially pursued on a case-by-case basis at the time of an actual change in control transaction. We recommend that the Employment Agreement be drafted in a manner that is compatible with the potential future use of the shareholder approval exemption — for example, by including a cooperation covenant requiring the Executive to reasonably cooperate with the Company in connection with any effort to obtain shareholder approval under Section 280G(b)(5)(B).

VI. Best-Net Cutback Modeling

A. Methodology

To determine the optimal contractual approach and to illustrate the operation of the best-net cutback provision, we have performed detailed modeling comparing two outcomes at each payment level:

(a) Full Payment with Excise Tax. The Executive receives the full, unreduced parachute payments and bears the Section 4999 excise tax (in addition to regular federal and state income taxes and employment taxes).

(b) Cutback to Safe Harbor. The Executive's parachute payments are reduced to the safe harbor amount (2.99× the base amount), and no excise tax applies. The Executive pays only regular federal and state income taxes on the reduced payment.

The modeling was performed using the following assumed marginal tax rates, which reflect Dr. Elliston's anticipated tax profile as a high-income individual domiciled in the Commonwealth of Massachusetts:

For purposes of the after-tax comparison, we applied a combined effective marginal tax rate of approximately 46.7% to the non-excess portion of parachute payments (i.e., the amount up to 1× the base amount) and a combined effective marginal tax rate of approximately 66.7% to the excess parachute payment portion (reflecting the additional 20% excise tax). These rates are approximations used for modeling purposes; the actual rates applicable to Dr. Elliston at the time of a change in control may vary based on then-current tax law, the character of the income, and the Executive's overall tax profile. The Net Investment Income Tax rate of 3.8% has been included as applicable in certain components of the analysis, but its application to severance and equity compensation requires a case-specific determination.

The "crossover point" is the payment level above which the Executive is better off receiving the full, unreduced payment and bearing the excise tax, rather than having payments cut back to the safe harbor amount. Below the crossover point, the cutback produces the better after-tax result; above the crossover point, the full payment produces the better result. The best-net cutback provision automatically selects the better outcome at any payment level, without requiring any advance determination of which approach will apply.

B. Scenario Analysis

Scenario 1: CIC in Year 1 (Base Amount ≈ $575,000)

Under Scenario 1, the base amount is estimated at $575,000, yielding a 3× threshold of $1,725,000 and a safe harbor cutback amount of $1,724,999.

Cash-Only Analysis (Excluding Equity Acceleration):

• Total estimated parachute payments (cash only): $2,051,200

• Excess over 3× threshold: $2,051,200 − $1,725,000 = $326,200

• Excess parachute payment (excess over 1× base amount): $2,051,200 − $575,000 = $1,476,200

• Section 4999 excise tax on excess:

MEMORANDUM
PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT WORK PRODUCT
September 2, 2022
FROM: Gregory Tan, Partner, Tax Department, Calderwood & Harkness LLP Nadia Petrov, Associate, Labor & Employment Department, Calderwood & Harkness LLP
TO: Bernard Crawford, Partner, Labor & Employment, Calderwood & Harkness LLP Devon Archer, Associate, Labor & Employment, Calderwood & Harkness LLP Aaron Whitfield, General Counsel, Arbor Health Technologies Inc.
RE: Section 280G / 4999 Excise Tax Analysis and Best-Net Cutback Modeling — Proposed Executive Employment Agreement for Dr. Marcus J. Elliston, Chief Operating Officer
Matter No.: 1010-00004 Client No.: 81-30294
This memorandum is a privileged and confidential attorney-client communication and attorney work product. It is intended solely for the use of the addressees identified above and should not be disclosed, distributed, or copied without the prior written consent of Calderwood & Harkness LLP. This memorandum does not constitute tax advice within the meaning of Treasury Department Circular 230. Any tax advice contained herein is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
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I. Executive Summary
The purpose of this memorandum is to analyze the potential exposure of Dr. Marcus J. Elliston (the "Executive") and Arbor Health Technologies Inc. ("AHT" or the "Company") under Internal Revenue Code ("Code") Sections 280G and 4999 arising from the change in control severance provisions contained in the proposed Executive Employment Agreement (the "Employment Agreement") between AHT and the Executive. This memorandum provides the structural legal framework for the Section 280G analysis, models the relevant payment scenarios, and recommends a contractual approach for addressing the excise tax risk in the Employment Agreement.
As described in detail below, the proposed change in control severance package — which provides for a lump-sum cash payment of twenty-four months of base salary, two times target annual bonus, and eighteen months of COBRA premium continuation, with an estimated aggregate cash value of $2,051,200 (excluding the value of accelerated equity awards) — presents meaningful "excess parachute payment" risk under Section 280G. The degree of risk is dependent upon the Executive's "base amount" at the time of a triggering change in control event, which itself is a function of the Executive's length of employment with AHT and his annualized W-2 compensation over the applicable look-back period. However, under the majority of plausible scenarios modeled herein — particularly those in which a change in control occurs within the first three years of the Executive's employment — total parachute payments (inclusive of equity acceleration) are likely to equal or exceed three times the Executive's base amount, thereby triggering both the Section 280G deduction disallowance for the Company and the Section 4999 twenty percent nondeductible excise tax for the Executive.
Based on the analysis set forth in this memorandum, we recommend that the Employment Agreement include a "best-net cutback" provision rather than a tax gross-up provision. Under a best-net cutback, the Executive's parachute payments would be reduced to the safe harbor amount (i.e., an amount just below three times the base amount) only if such reduction would result in a greater after-tax benefit to the Executive than would receipt of the unreduced payments after application of the Section 4999 excise tax. If the Executive would retain more value after tax by receiving the full, unreduced payments and bearing the excise tax, no reduction would occur. This approach is recommended on the basis of cost modeling, prevailing market practice for private equity-sponsored portfolio companies at the Chief Operating Officer level, the absence of any additional cost to the Company, and the stated preference of Ridgeline Capital Partners, LP ("Ridgeline"), AHT's majority equity sponsor, against gross-up obligations in portfolio company executive agreements.
This analysis has been prepared in coordination with Hargrove & Sinclair CPAs (Malcolm R. Sinclair, CPA, Lead Partner, 75 Ashbury Asset Advisors, Suite 1400, Boston, MA 02109), AHT's tax advisors, who will perform the definitive Section 280G calculations at the time of any actual change in control transaction. The present memorandum is intended to provide the structural analytical framework and preliminary modeling necessary to properly draft the best-net cutback provision and related contractual language in the Employment Agreement.
II. Background and Factual Assumptions
A. The Parties and Transaction Context
Arbor Health Technologies Inc. AHT is a Delaware corporation headquartered at 400 Brattle Commerce Park, Suite 1200, Cambridge, Massachusetts 02138. The Company operates a healthcare services and software-as-a-service ("SaaS") platform that provides cloud-based clinical workflow management and revenue cycle management solutions to hospital systems, physician practices, and ambulatory surgery centers throughout the United States. For the fiscal year ended December 31, 2021, AHT reported annual revenue of approximately $127.4 million. The Company currently employs approximately 620 individuals across its Cambridge headquarters, satellite offices in Nashville, Tennessee and Austin, Texas, and a distributed remote workforce. AHT's employer identification number is 84-3297461. AHT is not an "S corporation" or a "small business corporation" within the meaning of Section 280G(b)(5)(A)(ii) of the Code.
Ridgeline Capital Partners, LP. Ridgeline is a private equity firm that serves as AHT's majority equity sponsor, owning approximately sixty-eight percent (68%) of AHT's outstanding equity. Ridgeline acquired AHT in a take-private transaction that closed in December 2019 at an enterprise value of approximately $340 million. The AHT investment is held through Ridgeline Capital Partners Fund IV, LP, a fund with total committed capital of approximately $2.8 billion. Thomas R. Glenwood, Ridgeline's Managing Partner, serves as Chair of AHT's Board of Directors (the "Board"). Ridgeline's involvement in the governance and compensation practices of its portfolio companies is relevant to this analysis because Ridgeline has a firm-wide policy against the inclusion of tax gross-up provisions in executive employment agreements at its portfolio companies, and because Ridgeline's equity ownership position is relevant to the availability of the Section 280G(b)(5)(B) shareholder approval exemption, as discussed in Section V.C below.
Helix Ventures Fund III, LP. Helix Ventures Fund III, LP ("Helix Ventures") is a minority equity investor in AHT, holding approximately fourteen percent (14%) of AHT's outstanding equity. Helix Ventures participated as a co-investor alongside Ridgeline in the December 2019 take-private transaction. Helix Ventures designates one member of AHT's Board of Directors.
Management and Other Holders. The remaining approximately eighteen percent (18%) of AHT's outstanding equity is held by members of AHT's management team, certain former executives, and other individual holders, primarily through equity awards issued under the AHT 2020 Equity Incentive Plan (as amended May 2021) (the "Plan").
Dr. Marcus J. Elliston. Dr. Elliston is the prospective Chief Operating Officer of AHT. Under the proposed Employment Agreement, he will report directly to AHT's Chief Executive Officer, Priya Chandrasekaran, and will be a member of AHT's executive leadership team. Dr. Elliston's proposed start date is November 1, 2022. Prior to joining AHT, Dr. Elliston served as Senior Vice President of Operations at Pinnacle Care Systems, Inc., a healthcare technology company based in Chicago, Illinois. Dr. Elliston holds a Doctor of Pharmacy (Pharm.D.) degree from the University of Michigan and a Master of Business Administration from the Kellogg School of Management at Northwestern University. For purposes of this memorandum, we have not obtained or reviewed Dr. Elliston's compensation history at Pinnacle Care Systems. His "base amount" for Section 280G purposes will be determined solely by reference to his annualized W-2 compensation from AHT during the applicable look-back period, as discussed in Section IV below.
B. Summary of Proposed Compensation Package
The following is a summary of the material terms of the proposed compensation arrangement for Dr. Elliston, as reflected in the second draft of the Employment Agreement circulated by Devon Archer on August 19, 2022. These terms have been used as the basis for the Section 280G modeling performed in this memorandum.
Base Salary. Dr. Elliston will receive an annual base salary of $575,000, payable in accordance with AHT's regular payroll practices. Base salary is subject to annual review by the Board's Compensation Committee, with no obligation to increase.
Annual Cash Incentive Bonus. The Executive will be eligible for an annual performance bonus with a target opportunity of seventy-five percent (75%) of base salary, equal to $431,250 at target. The maximum bonus opportunity is one hundred fifty percent (150%) of target, equal to $646,875. Actual bonus amounts will be determined by the Compensation Committee based on achievement of individual and corporate performance metrics to be established annually.
Signing Bonus. Dr. Elliston will receive a one-time cash signing bonus of $250,000, payable within thirty (30) days following his start date. The signing bonus is subject to a twenty-four (24) month clawback provision requiring repayment on a pro-rata basis if the Executive voluntarily resigns without Good Reason or is terminated for Cause prior to the second anniversary of his start date.
Stock Options. The Executive will be granted nonqualified stock options to purchase shares representing 1.25% of the fully diluted equity of AHT, vesting over a four-year period with a twenty-five percent (25%) cliff vesting on the first anniversary of the grant date and monthly vesting in equal installments thereafter over the remaining thirty-six months. The exercise price will be set at the fair market value of AHT common stock as of the grant date, as determined by the Board in reliance upon an independent Section 409A valuation.
Restricted Stock Units. The Executive will be granted restricted stock units representing 0.50% of the fully diluted equity of AHT, vesting in three equal annual installments of 33.33% on each of the first three anniversaries of the grant date.
Employee Benefits. Dr. Elliston will be eligible for AHT's executive benefit package, which includes: (i) executive health plan participation with an employer premium contribution of $2,150 per month; (ii) company-paid group term life insurance with a death benefit of two times base salary ($1,150,000 coverage); (iii) long-term disability insurance at sixty percent (60%) of base salary; (iv) participation in the AHT 401(k) plan with a four percent (4%) employer matching contribution; (v) twenty-five (25) days of paid time off per annum; and (vi) a $15,000 annual professional development allowance.
C. Proposed Severance and Change in Control Provisions
1. Termination Without Cause / Resignation for Good Reason (No Change in Control)
In the event of a termination of the Executive's employment by the Company without Cause or by the Executive for Good Reason, in either case occurring outside the twenty-four (24) month period following a Change in Control (a "Non-CIC Qualifying Termination"), the Employment Agreement provides for the following severance benefits, subject to the Executive's execution and non-revocation of a general release of claims:
• Cash Severance — Base Salary Continuation: Twelve (12) months of base salary, equal to $575,000, payable in substantially equal installments in accordance with the Company's regular payroll schedule.
• Pro-Rata Annual Bonus: A pro-rata portion of the annual bonus for the fiscal year in which the termination occurs, based on actual performance results and prorated for the number of days elapsed in the fiscal year through the termination date. For modeling purposes, the target bonus of $431,250 has been used as a proxy for the actual bonus, though the actual amount may be higher or lower depending on performance.
• COBRA Continuation: Twelve (12) months of continued participation in AHT's group health plan at active-employee premium rates, at a cost to AHT of $2,150 per month, for a total of $25,800.
• Partial Equity Acceleration: Twenty-five percent (25%) of the Executive's then-unvested equity awards (stock options and restricted stock units) shall accelerate and become fully vested and, in the case of stock options, exercisable as of the termination date.
The estimated total value of the Non-CIC severance package, excluding equity acceleration, is approximately $1,032,050 (calculated as the sum of $575,000 in base salary continuation, $431,250 in pro-rata target bonus, and $25,800 in COBRA continuation). This figure is provided for comparative reference only; the Non-CIC severance provisions are not directly relevant to the Section 280G analysis except to the extent they establish the baseline against which the incremental value of CIC-specific benefits is measured.
2. Termination Without Cause / Resignation for Good Reason Within 24 Months Following a Change in Control (Double-Trigger)
In the event of a termination of the Executive's employment by the Company without Cause or by the Executive for Good Reason, in either case occurring within the twenty-four (24) month period following a Change in Control (a "CIC Qualifying Termination"), the Employment Agreement provides for the following enhanced severance benefits, subject to the Executive's execution and non-revocation of a general release of claims:
• Cash Severance — Base Salary: Twenty-four (24) months of base salary, payable in a lump sum, equal to $575,000 × 2 = $1,150,000.
• Cash Severance — Target Bonus: Two times (2×) the Executive's target annual bonus, payable in a lump sum, equal to $431,250 × 2 = $862,500.
• COBRA Continuation: Eighteen (18) months of continued participation in AHT's group health plan at active-employee premium rates, at a cost to AHT of $2,150 per month, for a total of $38,700.
• Full Equity Acceleration: One hundred percent (100%) of the Executive's then-unvested equity awards (stock options and restricted stock units) shall accelerate and become fully vested and, in the case of stock options, exercisable as of the date of the CIC Qualifying Termination.
The estimated total cash value of the CIC severance package, excluding equity acceleration, is:
$1,150,000 + $862,500 + $38,700 = $2,051,200
The CIC severance benefits are structured as a "double-trigger" arrangement — meaning that the enhanced benefits are triggered only upon the occurrence of both (i) a Change in Control and (ii) a qualifying termination of employment within the specified window following such Change in Control. This double-trigger structure is relevant to the Section 280G analysis because, as discussed below, certain payments that are contingent upon both a change in control and a subsequent event (such as a termination of employment) may nonetheless be treated as "contingent on" the change in control for purposes of Section 280G if the termination is considered closely related to the change in control transaction.
Additionally, the Employment Agreement includes a twelve-month post-termination non-competition covenant, which provides for a garden-leave payment of $287,500 (representing six months of base salary at $575,000 per annum). The treatment of this payment under Section 280G is discussed in Section III.D below.
D. Definition of "Change in Control"
As currently drafted in the near-final Employment Agreement (Section 1.5 of the second draft dated August 19, 2022), a "Change in Control" is defined as the occurrence of any of the following events:
(i) the acquisition by any "person" or "group" (as such terms are used in Section 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended), other than Ridgeline Capital Partners, LP or any of its affiliates (including any successor fund or parallel investment vehicle), of beneficial ownership of more than fifty percent (50%) of the combined voting power of the then-outstanding voting securities of the Company entitled to vote generally in the election of directors;
(ii) the consummation of a merger, consolidation, reorganization, recapitalization, or similar business combination involving the Company, or a sale or other disposition of all or substantially all of the assets of the Company, in each case unless, following such transaction, the holders of the Company's outstanding voting securities immediately prior to such transaction continue to beneficially own, directly or indirectly, at least fifty percent (50%) of the combined voting power of the outstanding voting securities of the surviving or acquiring entity;
(iii) the approval by the stockholders of the Company of a complete liquidation or dissolution of the Company; or
(iv) a change in the composition of the Board such that the individuals who constitute the Board as of the Effective Date (the "Incumbent Directors"), together with any new directors whose election by the Board or whose nomination for election by the Company's stockholders was approved by a vote of at least a majority of the directors then still in office who were either Incumbent Directors or whose election or nomination was previously so approved, cease for any reason to constitute at least a majority of the Board.
It is important to note the Ridgeline carve-out in clause (i) of the Change in Control definition. Transactions involving Ridgeline Capital Partners, LP or any of its affiliates — including sales between Ridgeline-affiliated funds, secondary sales of Ridgeline's equity interest to a Ridgeline successor fund, or any recapitalization or restructuring led by Ridgeline — are expressly excluded from the definition of "Change in Control." This carve-out significantly narrows the universe of triggering scenarios to third-party acquisitions of AHT by unaffiliated buyers, strategic transactions with industry acquirers, or, in the event of an initial public offering, a post-IPO change in Board composition satisfying clause (iv).
We note that the contractual definition of "Change in Control" in the Employment Agreement does not perfectly align with the definition of a "change in ownership or effective control" under Section 280G and the Treasury Regulations thereunder (Treas. Reg. § 1.280G-1, Q&A-27 through Q&A-29). The Section 280G analysis is triggered by a statutory change in control event, regardless of whether such event also satisfies the contractual definition. However, the contractual definition is relevant because the CIC severance benefits become payable only upon a contractual Change in Control, and thus the payments can only constitute "parachute payments" if the contractual Change in Control also constitutes (or occurs in connection with) a statutory change in control event under Section 280G. In practice, the scenarios most likely to trigger both a contractual Change in Control and a Section 280G change in control event are third-party acquisitions of AHT.
III. Legal Framework: Sections 280G and 4999
A. Overview of Section 280G
Section 280G of the Internal Revenue Code denies a federal income tax deduction to the payor corporation for any "excess parachute payment" made to or for the benefit of a "disqualified individual." The provision was enacted as part of the Deficit Reduction Act of 1984 (Pub. L. No. 98-369) in response to Congressional concern that corporations were providing excessive severance and change in control benefits to executives in connection with corporate takeover transactions, and that such payments were effectively subsidized by the tax deduction otherwise available to the payor.
The operative mechanics of Section 280G are as follows:
Parachute Payment. A "parachute payment" is defined under Section 280G(b)(2)(A) as any payment in the nature of compensation to (or for the benefit of) a disqualified individual that is:
(a) contingent on a change in the ownership or effective control of the corporation, or in the ownership of a substantial portion of the assets of the corporation (as defined under Section 280G(b)(2)(A)(i) and the Treasury Regulations thereunder); and
(b) the aggregate present value of which payments equals or exceeds three times (3×) the individual's "base amount."
If the aggregate present value of all payments contingent on the change in control does not equal or exceed three times the base amount, no parachute payment treatment applies, and neither Section 280G nor Section 4999 is triggered. This is commonly referred to as the "safe harbor."
Base Amount. The "base amount" is defined under Section 280G(b)(3) as the individual's average annualized includible compensation for the most recent five (5) taxable years ending before the date on which the change in ownership or control occurs (or, if the individual has been employed by the corporation for fewer than five years, the annualized compensation over the individual's entire period of employment). For this purpose, "includible compensation" generally means the amount shown on the individual's Form W-2 as "wages, tips, and other compensation" — i.e., the gross amount of taxable compensation reported to the individual from the corporation.
Excess Parachute Payment. An "excess parachute payment" is defined under Section 280G(b)(1) as the amount by which total parachute payments exceed one times (1×) the individual's base amount. It is critical to understand the "cliff" nature of Section 280G: once the aggregate present value of parachute payments equals or exceeds three times the base amount, the entire excess over one times the base amount is treated as an excess parachute payment — not merely the amount above the three-times threshold. This cliff effect creates a zone of severe adverse tax consequences for relatively modest increments of compensation above the three-times threshold.
Safe Harbor. As noted above, if the aggregate present value of all parachute payments is less than three times the base amount (i.e., less than 3.00× the base amount), no parachute payment treatment applies, and neither Section 280G nor Section 4999 is triggered. For planning purposes, this safe harbor is typically referenced as a cutback to an amount equal to 2.99 times the base amount (or, more precisely, to one dollar less than three times the base amount), to ensure that the threshold is not breached.
B. Overview of Section 4999
Section 4999 of the Internal Revenue Code imposes a nondeductible excise tax of twenty percent (20%) on the amount of any "excess parachute payment" received by a disqualified individual. This excise tax is imposed on the individual recipient — not on the payor corporation — and is in addition to (not in lieu of) regular federal and state income taxes and employment taxes that would otherwise apply to the payment.
The practical effect of the Section 4999 excise tax is to subject excess parachute payments to a punitive combined marginal tax rate. To illustrate the impact, consider the combined marginal tax rates applicable to a disqualified individual domiciled in the Commonwealth of Massachusetts:
The precise combined marginal rate depends on the character of the payment, the applicability of the Net Investment Income Tax (which applies to certain passive income and, in some circumstances, to gain from the disposition of property), and whether the individual is subject to Additional Medicare Tax. However, the illustrative combined rate demonstrates that a disqualified individual may retain as little as approximately thirty-two to thirty-six cents of each dollar of excess parachute payment, creating a powerful incentive for careful planning.
Furthermore, under Section 280G, the payor corporation loses its federal income tax deduction for excess parachute payments. For a corporation with a federal income tax rate of twenty-one percent (21%), the loss of deductibility increases the effective after-tax cost of each dollar of excess parachute payment by approximately $0.21, resulting in a combined corporate and individual tax cost that can exceed the value of the payment itself.
C. Disqualified Individual Analysis
Section 280G applies only to payments made to "disqualified individuals" as defined in Section 280G(c). A disqualified individual is any individual who, with respect to the corporation, is (i) an employee or independent contractor who performs personal services for the corporation, and (ii) is a shareholder, officer, or highly compensated individual of the corporation during the period beginning twelve months before the change in control and ending on the date of the change in control.
Dr. Elliston, as the prospective Chief Operating Officer of AHT, would clearly qualify as a "disqualified individual" under Section 280G(c) by virtue of his status as an officer of the corporation. The Treasury Regulations define "officer" for this purpose as any individual who holds the position of officer as determined under the corporation's governing instruments, and there is no minimum compensation threshold for officer status (unlike the "highly compensated individual" category, which applies only to individuals whose compensation exceeds a specified threshold). As COO, Dr. Elliston will be among the most senior officers of AHT and will hold a position that unambiguously qualifies as officer status for Section 280G purposes.
Private Company Shareholder Vote Exemption. Section 280G(b)(5)(B) provides an exemption from parachute payment treatment for corporations that are not publicly traded (i.e., for corporations none of whose stock is readily tradable on an established securities market or otherwise) if two conditions are satisfied:
(i) the payment is approved by a vote of the persons who held, immediately before the change in ownership or control, more than seventy-five percent (75%) of the voting power of all outstanding stock of the corporation entitled to vote (the "shareholder vote requirement"); and
(ii) there was adequate disclosure to the voting stockholders of all material facts concerning all payments that (but for the exemption) would be parachute payments with respect to the disqualified individual (the "adequate disclosure requirement").
AHT is a privately held corporation and is therefore eligible for the Section 280G(b)(5)(B) exemption. The question is whether the shareholder vote requirement can be satisfied. Ridgeline holds approximately sixty-eight percent (68%) of AHT's voting power, and Helix Ventures holds approximately fourteen percent (14%), for a combined total of approximately eighty-two percent (82%). Accordingly, Ridgeline and Helix Ventures together control more than seventy-five percent (75%) of AHT's voting power, and a favorable vote by both entities would satisfy the threshold.
However, several practical considerations limit the viability of the shareholder vote exemption as the primary contractual approach:
First, the shareholder vote must be obtained before the change in control event closes, and the adequate disclosure requirements under Treasury Regulation § 1.280G-1, Q&A-7 are exacting. The corporation must disclose the material terms and approximate dollar value of each payment that would constitute a parachute payment, together with sufficient additional information to permit the voting shareholders to understand the nature, amount, and tax implications of such payments. Failure to provide adequate disclosure renders the shareholder vote ineffective.
Second, Ridgeline Capital Partners has historically not pursued the shareholder approval exemption in its portfolio company executive employment agreements. In discussions between Calderwood & Harkness and Ridgeline's in-house counsel (Rebecca Farrell, Vice President and Associate General Counsel), Ms. Farrell confirmed that Ridgeline's standard practice is to include best-net cutback provisions in executive agreements and to evaluate the shareholder approval exemption on a case-by-case basis only at the time of an actual change in control transaction, rather than committing contractually to pursue the exemption.
Third, Thomas R. Glenwood and the Board's Compensation Committee have indicated a preference for the best-net cutback approach as the structural solution to Section 280G exposure in the Employment Agreement, consistent with Ridgeline's policy and existing practice at AHT.
For these reasons, while we note the shareholder approval exemption as a theoretically available option, we do not recommend it as the primary contractual approach. The potential use of the exemption at the time of a future change in control transaction remains available and can be evaluated on a case-specific basis at that time. This is discussed further in Section V.C below.
D. Payments Contingent on Change in Control
A critical step in the Section 280G analysis is the identification of which elements of Dr. Elliston's compensation would be treated as "contingent on" a change in control for purposes of Section 280G. Under Treasury Regulation § 1.280G-1, Q&A-22, a payment is treated as contingent on a change in ownership or control if the payment would not in fact have been made had no change in ownership or control occurred. This factual inquiry focuses on whether the change in control materially increases the aggregate compensation that would otherwise be payable to the individual.
The following elements of Dr. Elliston's compensation package have been classified as contingent or non-contingent on a change in control:
Payments Contingent on a Change in Control:
• CIC Cash Severance — Base Salary Portion ($1,150,000). The twenty-four months of base salary payable upon a CIC Qualifying Termination is clearly contingent on the occurrence of a Change in Control. In the absence of a Change in Control, the Executive would be entitled to only twelve months of base salary continuation under the Non-CIC severance provisions. The incremental twelve months ($575,000) is unambiguously contingent, and the entire twenty-four months is likely to be treated as contingent because the CIC severance is structured as a separate, enhanced benefit package triggered by the CIC rather than as a supplement to the Non-CIC severance.
• CIC Cash Severance — Bonus Portion ($862,500). The two times target bonus payable upon a CIC Qualifying Termination is clearly contingent on the occurrence of a Change in Control. In the absence of a Change in Control, the Executive would receive only a pro-rata bonus for the year of termination, not a lump-sum two-times-target bonus.
• CIC COBRA Continuation ($38,700). The eighteen months of COBRA continuation payable upon a CIC Qualifying Termination is contingent to the extent it exceeds the twelve months provided in the Non-CIC severance package. However, as with the cash severance, the entire eighteen months is likely to be treated as contingent because it is part of the integrated CIC severance benefit.
• Accelerated Vesting of Equity (Options and RSUs) — Incremental Acceleration. Upon a CIC Qualifying Termination, one hundred percent (100%) of the Executive's unvested equity awards accelerate. Upon a Non-CIC Qualifying Termination, only twenty-five percent (25%) of unvested equity awards accelerate. The incremental acceleration — i.e., the additional seventy-five percent (75%) of unvested equity that vests solely because of the CIC Qualifying Termination — is contingent on the change in control. The value of this incremental acceleration depends on the fair market value of AHT equity at the time of the change in control and the number of shares then unvested. Valuation of the accelerated equity is discussed further in Section IV.B below.
• Non-Compete Garden-Leave Payment ($287,500). The Employment Agreement provides for a garden-leave payment of $287,500 (six months of base salary) in connection with the twelve-month post-termination non-competition covenant. If this payment is made only upon a CIC-related termination, it would be treated as contingent on the change in control. However, if the garden-leave payment is also payable upon a Non-CIC Qualifying Termination (or upon any termination that triggers the non-competition covenant), a strong argument exists that the payment constitutes "reasonable compensation" for the Executive's agreement not to compete and should be partially or fully excludable from the parachute payment calculation under the "reasonable compensation" exception set forth in Section 280G(b)(4)(B) and Treasury Regulation § 1.280G-1, Q&A-9 and Q&A-40 through Q&A-44. The application of the reasonable compensation exception to the garden-leave payment will require a facts-and-circumstances analysis at the time of any actual change in control event, including a determination of the fair market value of the non-compete obligation. We recommend that the Employment Agreement be drafted to provide that the garden-leave payment is payable upon any qualifying termination (not solely a CIC-related termination), in order to strengthen the argument for exclusion under the reasonable compensation exception.
Payments NOT Contingent on a Change in Control:
• Base Salary Earned Prior to the Change in Control Closing. Compensation earned and accrued in the ordinary course of employment prior to the effective date of a change in control is not treated as contingent on the change in control and is excluded from the Section 280G calculation.
• Non-CIC Severance. Severance benefits payable upon a Non-CIC Qualifying Termination (i.e., a termination occurring outside the twenty-four month CIC window) are not contingent on a change in control.
• Signing Bonus ($250,000). The signing bonus is payable within thirty days of Dr. Elliston's start date and is subject to a twenty-four month clawback upon voluntary resignation without Good Reason or termination for Cause. The signing bonus is not conditioned upon or otherwise contingent upon the occurrence of a change in control. Unless the Employment Agreement is restructured to link the signing bonus to a change in control event, it is excluded from the Section 280G analysis. We recommend that the drafting of the signing bonus provision not be modified in any way that could create a nexus between the signing bonus and a change in control event.
• Annual Bonus — Regular (Non-CIC) Payment. Annual bonuses earned and paid in the ordinary course are not contingent on a change in control, provided they are not enhanced or guaranteed in connection with such a transaction.
• Employee Benefits (Non-CIC). Ongoing employee benefits (health insurance, life insurance, LTD, 401(k) matching, PTO, and professional development allowance) provided in the ordinary course of employment are not contingent on a change in control.
IV. Base Amount Estimation and 3× Threshold Analysis
A. Base Amount Calculation Challenges
The "base amount" for purposes of Section 280G is calculated as the disqualified individual's average annualized includible compensation for the most recent five taxable years ending before the date on which the change in ownership or control occurs. In cases where the individual has been employed by the corporation for fewer than five complete taxable years, the base amount is the annualized compensation over the individual's entire period of employment, from the date of commencement of employment through the end of the last taxable year ending before the change in control event.
Dr. Elliston has not yet commenced employment with AHT. His proposed start date is November 1, 2022. Therefore, his "base amount" with respect to AHT compensation will initially be very limited, and it will grow over time as he accumulates a longer employment history and compensation track record with the Company. This creates a dynamic in which the Section 280G risk is highest in the early years of employment (when the base amount is lowest and the 3× threshold is most easily breached) and diminishes over time as the base amount increases.
Because the timing of a potential change in control is inherently uncertain — particularly in the context of a PE-sponsored portfolio company where exit events are driven by market conditions, strategic opportunities, and fund lifecycle considerations — we have modeled the Section 280G analysis across three timing scenarios: (1) a change in control occurring within the first twelve months of employment (Year 1); (2) a change in control occurring in the second year of employment (Year 2); and (3) a change in control occurring in the third year or later (Year 3+). The results of this scenario analysis are presented below and in greater detail in the CIC Severance Calculation Spreadsheet attached hereto as Attachment A.
B. Scenario Modeling
Scenario 1 — CIC in Year 1 (Within 12 Months of Start Date)
If a change in control occurs within the first twelve months of Dr. Elliston's employment (i.e., before November 1, 2023), his base amount would be limited to the annualized AHT compensation for the partial year of employment. In this scenario, it is likely that only base salary would have been paid during the look-back period (the Executive may not have received an annual bonus, and the signing bonus, while paid, may or may not be included in W-2 wages during the partial look-back year depending on the precise timing). Assuming only base salary has been reported on Dr. Elliston's W-2, his annualized compensation would be approximately $575,000.
• Estimated Base Amount: $575,000
• 3× Threshold: $575,000 × 3 = $1,725,000
• Safe Harbor Cutback Amount: $1,724,999
• Total Estimated Parachute Payments (Cash Only): $2,051,200
• Excess Over 3× Threshold: $2,051,200 − $1,725,000 = $326,200
• Excess Parachute Payment (Excess Over 1× Base Amount): $2,051,200 − $575,000 = $1,476,200
In this scenario, the cash CIC severance alone — without considering the value of equity acceleration — exceeds the 3× threshold by $326,200. This means that Section 280G would be triggered, and the entire excess parachute payment of $1,476,200 (the amount above 1× the base amount) would be subject to the 20% excise tax under Section 4999, resulting in an excise tax liability to Dr. Elliston of approximately $295,240.
When the value of equity acceleration is added to the parachute payment calculation, the total parachute payments — and thus the excess parachute payment and the excise tax — would increase significantly. See Section IV.B.4 below for equity acceleration value estimates.
Scenario 2 — CIC in Year 2
If a change in control occurs in the second year of Dr. Elliston's employment (i.e., between November 1, 2023 and October 31, 2024), his base amount would include annualized compensation for the first full year (or partial year) of employment, including base salary and any annual bonus paid during the look-back period. Assuming that the Executive receives his full target bonus for the first year ($431,250, paid in the first quarter of the second year), the base amount would be calculated as follows:
• Estimated Base Amount: Annualized compensation of approximately $575,000 (base salary) + $431,250 (target bonus) = $1,006,250
• 3× Threshold: $1,006,250 × 3 = $3,018,750
• Safe Harbor Cutback Amount: $3,018,749
• Total Estimated Parachute Payments (Cash Only): $2,051,200
In this scenario, the cash CIC severance of $2,051,200 alone does not breach the 3× threshold of $3,018,750. However, when the value of equity acceleration is added to the total parachute payments, the 3× threshold may be breached depending on the fair market value of AHT equity at the time of the change in control. As discussed in Section IV.B.4 below, the incremental equity acceleration value could range from approximately $3.0 million to $6.0 million or more, which, when combined with cash severance of $2,051,200, would significantly exceed the $3,018,750 threshold.
Scenario 3 — CIC in Year 3 or Later
If a change in control occurs in the third year of employment or later, the base amount would reflect a longer averaging period, potentially including multiple years of base salary, bonuses, and the income recognized upon vesting of equity awards (which is included in W-2 wages). As the base amount increases, the 3× threshold rises correspondingly, making it less likely that cash severance alone would breach the threshold. However, depending on the magnitude of equity acceleration, the 3× threshold may still be breached in this scenario.
• Estimated Base Amount: Approximately $1,006,250 or higher (increasing with additional years of compensation data)
• 3× Threshold: Approximately $3,018,750 or higher
• Total Estimated Parachute Payments (Cash + Equity): Depends on equity acceleration value; likely to breach threshold in many scenarios
As a general matter, the longer Dr. Elliston is employed by AHT before a change in control occurs, the higher his base amount will be and the less likely it is that the 3× threshold will be breached. Nevertheless, because equity acceleration values can be substantial — particularly if AHT's enterprise value has appreciated materially from the December 2019 take-private valuation of $340 million — the Section 280G risk remains meaningful across all three scenarios.
Equity Acceleration Value Estimates
The incremental value of equity acceleration upon a CIC Qualifying Termination — i.e., the difference between 100% acceleration (CIC) and 25% acceleration (Non-CIC) — represents the most significant variable in the Section 280G analysis. This incremental acceleration equals seventy-five percent (75%) of the Executive's then-unvested equity at the time of the CIC Qualifying Termination.
In the aggregate, Dr. Elliston's equity grants total 1.75% of AHT's fully diluted equity (1.25% stock options plus 0.50% RSUs). For purposes of estimating the incremental equity acceleration value, we have modeled AHT enterprise values ranging from $400 million to $600 million, reflecting potential appreciation from the December 2019 take-private valuation of $340 million. The following table summarizes the estimated incremental equity acceleration values:
These figures are presented for illustrative purposes only and are subject to significant variability based on the actual enterprise value of AHT at the time of a change in control, the number of shares then unvested (which depends on the elapsed vesting period and whether any prior acceleration has occurred), the exercise price of the stock options (for options, only the "spread" — the excess of fair market value over exercise price — is included in the parachute payment calculation), and any adjustments for outstanding debt, preferred equity, or other structural features of AHT's capitalization.
Even under conservative assumptions, the incremental equity acceleration value is likely to be several million dollars — well in excess of the amount needed to push total parachute payments above the 3× threshold in Scenarios 2 and 3, and dramatically above the threshold in Scenario 1.
C. Summary of Threshold Analysis
Based on the modeling described above, we conclude that, in nearly all plausible scenarios, the aggregate present value of payments contingent on a change in control — inclusive of cash CIC severance ($2,051,200), incremental equity acceleration value (estimated at $3.0 million to $7.9 million), and the potential garden-leave payment ($287,500, to the extent not excluded under the reasonable compensation exception) — would equal or exceed three times Dr. Elliston's base amount, thereby triggering Section 280G parachute payment treatment.
Once the 3× threshold is breached, the "excess parachute payment" — defined as the total parachute payments minus one times the base amount — would be:
• Subject to the 20% nondeductible excise tax under Section 4999, payable by Dr. Elliston; and
• Non-deductible to AHT under Section 280G, resulting in a loss of the federal income tax deduction that would otherwise be available at the 21% corporate rate.
The following summary table illustrates the key metrics across the three modeled scenarios (using midpoint equity acceleration value estimates at an assumed enterprise value of $500 million):
The foregoing table is illustrative and is based on numerous assumptions regarding compensation levels, equity valuation, and the timing and circumstances of a change in control. Definitive calculations will be performed by Hargrove & Sinclair CPAs at the time of any actual change in control transaction, using the Executive's actual W-2 compensation data, actual equity valuations, and the specific terms of the transaction.
V. Approaches to Addressing 280G Exposure
There are three principal contractual approaches for addressing the Section 280G / Section 4999 exposure identified in this memorandum: (A) a tax gross-up provision, (B) a best-net cutback provision, and (C) the shareholder approval exemption. Each is discussed below.
A. Tax Gross-Up Provision
Description. Under a tax gross-up provision, the Company agrees to make an additional cash payment to the Executive in an amount sufficient to place the Executive in the same after-tax position as if no Section 4999 excise tax had been imposed. In other words, the Company pays the Executive an amount equal to the excise tax, plus an additional amount to cover the income taxes and excise taxes on the gross-up payment itself (the "gross-up on the gross-up"), such that the Executive retains the full after-tax value of the parachute payments.
Cost to the Company. Tax gross-up payments are extremely expensive to the Company. Because the excise tax under Section 4999 is non-deductible, and because the gross-up payment itself is subject to federal and state income taxes (and, in turn, generates additional excise tax liability to the extent the gross-up increases total parachute payments), the gross-up operates as a geometric multiplier. As a general rule, for every $1.00 of Section 4999 excise tax owed by the Executive, the Company must pay approximately $2.50 to $3.00 in total gross-up payments to make the Executive whole on an after-tax basis. The precise multiplier depends on the Executive's marginal tax rates and the specific facts, but the cost escalation is substantial under any reasonable set of assumptions.
Illustrative Gross-Up Cost. Using Scenario 1 as an illustration: if the excess parachute payment is approximately $1,476,200, the Section 4999 excise tax would be approximately $295,240. A full tax gross-up to cover the excise tax and the income and excise taxes on the gross-up payment itself could result in a total gross-up obligation exceeding $700,000 to $900,000, depending on the precise tax rates applicable to Dr. Elliston. When the excess parachute payment is much larger (as in scenarios with significant equity acceleration), the gross-up cost scales proportionally and can reach several million dollars.
Market Trends. Tax gross-up provisions have fallen significantly out of favor over the past decade. Among publicly traded companies, the prevalence of gross-up provisions has declined to low single-digit percentages, driven by negative institutional shareholder advisory guidelines (including those issued by Thackeray Health IT ("ISS"), Tarrant Partners LLC, and major institutional investors), "say-on-pay" voting pressure, and evolving corporate governance norms. Among private equity-sponsored portfolio companies, gross-up provisions are similarly disfavored. Private equity sponsors, including Ridgeline Capital Partners, typically prohibit or strongly discourage gross-up obligations in portfolio company executive agreements because such obligations increase the cost of change in control transactions, reduce returns to equity holders, and create misaligned incentives.
Ridgeline Capital Partners' Policy. As noted above, Ridgeline maintains a firm-wide policy against the inclusion of tax gross-up provisions in executive employment agreements at its portfolio companies. Rebecca Farrell, Vice President and Associate General Counsel of Ridgeline, confirmed this policy in discussions with our firm in connection with this engagement.
Recommendation. A tax gross-up provision is not recommended for the Dr. Elliston Employment Agreement. The gross-up approach is inconsistent with Ridgeline's stated preferences, out of step with prevailing market practice, and would impose potentially significant and uncertain costs on the Company in connection with a future change in control transaction.
B. Best-Net Cutback Provision (Recommended)
Description. Under a "best-net cutback" (also referred to as a "better of net" or "modified cutback") provision, the Executive's parachute payments are reduced (cut back) to the safe harbor amount — an aggregate present value just below three times the base amount (i.e., 2.99× the base amount, or more precisely, $1.00 less than 3× the base amount) — if and only if the after-tax benefit to the Executive of the reduced payments would exceed the after-tax benefit of receiving the full, unreduced payments and bearing the Section 4999 excise tax. If the Executive would retain more value after tax by receiving the full payments and paying the excise tax, the cutback does not apply and the Executive receives the unreduced payments.
Rationale. The best-net cutback provision is designed to protect the Executive in the zone where the cutback produces a better economic result — that is, when total parachute payments only modestly exceed the 3× threshold and the excise tax on the full amount would consume more value than the reduction. The cliff nature of Section 280G means that, at payment levels just above the 3× threshold, a dollar of additional parachute payment can cost the Executive significantly more in excise tax than the dollar itself is worth after tax. In this zone, the Executive is economically better off having the payments reduced to the safe harbor level, thereby avoiding the excise tax entirely. Conversely, when total parachute payments significantly exceed the 3× threshold, the excise tax is applied to a large excess amount, but the Executive still retains more value after tax from the full payments than from a cutback to the (much lower) safe harbor amount. In that zone, the full payment is the better result.
The best-net cutback provision automatically selects the better of the two outcomes for the Executive, without requiring any election, negotiation, or further decision-making at the time of the triggering event.
Key Benefits. The best-net cutback approach offers several important advantages:
(1) No additional cost to the Company. Unlike a tax gross-up, the best-net cutback imposes no additional payment obligation on the Company beyond the contractually agreed severance amounts. The Company either pays the full contractual severance (if no cutback applies) or pays a reduced amount (if the cutback is triggered). In either case, the Company's cost does not exceed the originally negotiated severance package.
(2) Preservation of Section 280G deduction. If the cutback applies, the Company retains its full Section 280G deduction for the reduced payment amount, because the payments are below the 3× threshold and are not treated as parachute payments. If the cutback does not apply (i.e., the Executive receives the full unreduced amount), the Company loses its deduction only for the excess parachute payment portion, which would have been the case regardless.
(3) Market standard. The best-net cutback is the prevailing market approach for COO-level and other C-suite executive employment agreements at PE-sponsored portfolio companies. According to the Broadleaf Compensation Advisors LLC peer benchmarking report prepared by Diane K. Holbrook in June 2022, best-net cutback provisions were included in over eighty-five percent (85%) of change in control severance agreements reviewed for PE-sponsored healthcare and technology companies.
(4) Consistency with existing AHT practice. The existing employment agreements for AHT's Chief Executive Officer (Priya Chandrasekaran) and Chief Financial Officer (Derek Solano), each of which was originally prepared by Wentworth & Gage LLP, contain best-net cutback provisions. Adopting the same approach for Dr. Elliston ensures consistency across AHT's executive team and avoids creating disparate severance structures among C-suite officers.
(5) Alignment with Ridgeline Capital Partners' preferences. As discussed above, Ridgeline's stated policy is to use best-net cutback provisions rather than gross-ups in portfolio company executive agreements.
Recommendation. Based on the foregoing analysis, we recommend that the Employment Agreement include a best-net cutback provision. The specific contractual language and structural elements for this provision are set forth in Section VIII below.
C. Shareholder Approval Exemption (Section 280G(b)(5)(B))
Description. As discussed in Section III.C above, Section 280G(b)(5)(B) provides an exemption from parachute payment treatment for privately held corporations if the payments are approved by more than seventy-five percent (75%) of the voting power of all outstanding stock and adequate disclosure is provided to the voting shareholders. If the exemption is obtained, the payments are not treated as parachute payments, and neither the Section 280G deduction disallowance nor the Section 4999 excise tax applies.
Feasibility. AHT is a privately held corporation, and the shareholder approval exemption is therefore theoretically available. Ridgeline (~68%) and Helix Ventures (~14%) collectively hold approximately 82% of AHT's voting power, exceeding the 75% threshold. A favorable vote by both entities would satisfy the shareholder approval requirement.
Practical Limitations. Notwithstanding its theoretical availability, the shareholder approval exemption presents several practical challenges that counsel against relying upon it as the primary contractual solution:
(a) Timing and process. The shareholder vote must occur before the change in control closes. In the fast-paced context of a PE exit transaction, there may be limited time to prepare the required disclosure materials, solicit shareholder approval, and ensure compliance with the adequate disclosure requirements. Any procedural error or inadequacy in the disclosure could render the exemption invalid.
(b) Adequate disclosure requirements. Treasury Regulation § 1.280G-1, Q&A-7 requires disclosure of the material facts concerning all payments that would constitute parachute payments, including the nature and amount of each payment and sufficient information for shareholders to understand the tax consequences. The "adequate disclosure" standard has been the subject of limited regulatory guidance, and there is uncertainty regarding the precise scope of required disclosure. Overly narrow disclosure risks a challenge by the Internal Revenue Service; overly broad disclosure may create business or competitive sensitivity concerns.
(c) Ridgeline's policy preference. As previously noted, Ridgeline has historically not pursued the shareholder approval exemption in its portfolio companies' executive employment agreements. Thomas R. Glenwood and the Board's Compensation Committee have indicated a preference for the best-net cutback approach as the structural contractual solution. Ridgeline's reluctance to pursue the shareholder approval route is driven in part by the administrative burden, the risk of procedural error, and the desire to maintain a consistent approach across its portfolio.
(d) No guarantee of future availability. Even if AHT were to rely upon the shareholder approval exemption, its availability at the time of a future change in control depends on the then-current ownership structure of the Company. If, for example, Ridgeline were to sell a portion of its stake prior to a change in control event, or if the Company were to issue additional equity that dilutes existing shareholders below the 75% threshold, the exemption might not be available.
Recommendation. The shareholder approval exemption is not recommended as the primary contractual approach. However, we note that the exemption remains available as a supplemental tool that can be evaluated and potentially pursued on a case-by-case basis at the time of an actual change in control transaction. We recommend that the Employment Agreement be drafted in a manner that is compatible with the potential future use of the shareholder approval exemption — for example, by including a cooperation covenant requiring the Executive to reasonably cooperate with the Company in connection with any effort to obtain shareholder approval under Section 280G(b)(5)(B).
VI. Best-Net Cutback Modeling
A. Methodology
To determine the optimal contractual approach and to illustrate the operation of the best-net cutback provision, we have performed detailed modeling comparing two outcomes at each payment level:
(a) Full Payment with Excise Tax. The Executive receives the full, unreduced parachute payments and bears the Section 4999 excise tax (in addition to regular federal and state income taxes and employment taxes).
(b) Cutback to Safe Harbor. The Executive's parachute payments are reduced to the safe harbor amount (2.99× the base amount), and no excise tax applies. The Executive pays only regular federal and state income taxes on the reduced payment.
The modeling was performed using the following assumed marginal tax rates, which reflect Dr. Elliston's anticipated tax profile as a high-income individual domiciled in the Commonwealth of Massachusetts:
For purposes of the after-tax comparison, we applied a combined effective marginal tax rate of approximately 46.7% to the non-excess portion of parachute payments (i.e., the amount up to 1× the base amount) and a combined effective marginal tax rate of approximately 66.7% to the excess parachute payment portion (reflecting the additional 20% excise tax). These rates are approximations used for modeling purposes; the actual rates applicable to Dr. Elliston at the time of a change in control may vary based on then-current tax law, the character of the income, and the Executive's overall tax profile. The Net Investment Income Tax rate of 3.8% has been included as applicable in certain components of the analysis, but its application to severance and equity compensation requires a case-specific determination.
The "crossover point" is the payment level above which the Executive is better off receiving the full, unreduced payment and bearing the excise tax, rather than having payments cut back to the safe harbor amount. Below the crossover point, the cutback produces the better after-tax result; above the crossover point, the full payment produces the better result. The best-net cutback provision automatically selects the better outcome at any payment level, without requiring any advance determination of which approach will apply.
B. Scenario Analysis
Scenario 1: CIC in Year 1 (Base Amount ≈ $575,000)
Under Scenario 1, the base amount is estimated at $575,000, yielding a 3× threshold of $1,725,000 and a safe harbor cutback amount of $1,724,999.
Cash-Only Analysis (Excluding Equity Acceleration):
• Total estimated parachute payments (cash only): $2,051,200
• Excess over 3× threshold: $2,051,200 − $1,725,000 = $326,200
• Excess parachute payment (excess over 1× base amount): $2,051,200 − $575,000 = $1,476,200
• Section 4999 excise tax on excess:

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