1001-00006 · Ardent Capital Partners · Earnout Treatment

earnout-provisions-tax-review-comment-letter.docx DOCUMENT M&A / Corporate

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CALDERWOOD & HARKNESS LLP Attorneys at Law

One Liberty Plaza, 45th Floor New York, New York 10006 Telephone: (212) 554-7000 Facsimile: (212) 554-7001 www.calderwoodharkness.com

March 12, 2024

VIA E-MAIL AND HAND DELIVERY

Thomas Kundra, Esq., Partner Allison Cho, Esq., Associate Harcourt Shaw & DeVries LLP 51 West 52nd Street New York, New York 10019

Re: Tax Comments on Earnout Provisions — Draft Merger Agreement dated March 8, 2024, by and among Ardent Healthcare Merger Sub LLC, Pinnacle Health Services Group LLC, and the Members of Pinnacle Health Services Group LLC

Matter No.: 1001-00006 / Engagement No.: 1001-00006

Dear Tom and Allison:

Calderwood & Harkness LLP ("Calderwood & Harkness" or the "Firm") serves as tax counsel to Ardent Capital Partners III LP ("Ardent Capital" or "Fund III") in connection with Ardent Capital's proposed acquisition of all outstanding membership interests of Pinnacle Health Services Group LLC ("Pinnacle" or "PHSG") at an aggregate enterprise value of approximately $412 million (the "Transaction"). We appreciate the collaborative working relationship between our respective firms and your timely circulation of the draft transaction documents.

The purpose of this letter is to provide our tax-driven comments and recommended revisions to the earnout provisions set forth in the Draft Merger Agreement (the "Draft Agreement") circulated by Harcourt Shaw & DeVries LLP on March 8, 2024. Our comments are focused specifically on the earnout-related sections of the Draft Agreement and the ancillary provisions that interact with the earnout mechanics from a federal income tax perspective. We do not address in this letter the broader tax representations, indemnification provisions, or pre-closing tax covenants of the Draft Agreement, which are the subject of a separate markup currently under preparation by our office.

These comments are being provided in coordination with Harcourt Shaw & DeVries LLP in its capacity as buyer's M&A counsel and should be read alongside Calderwood & Harkness's Earnout Tax Characterization Memorandum dated March 1, 2024, which was previously circulated to the Ardent Capital deal team. That memorandum provides the detailed legal and factual analysis supporting our recommendations herein; this letter is intended to translate those conclusions into specific drafting guidance for the earnout provisions.

Please note that copies of this letter are being provided simultaneously to Marcus Pellegrino (Partner, Healthcare, Ardent Capital Partners III LP) and to seller's counsel, Whitford & Gaines LLP (Patricia Engelman, Partner, Tax, and Kevin Driscoll, Associate, M&A/Tax), for their review and comment. We believe that early transparency with seller's counsel on these tax characterization issues will facilitate an efficient negotiation process and help ensure consistent treatment across both sides of the Transaction.

I. Overview of the Earnout Structure

As a threshold matter, we summarize below the material terms of the earnout as currently set forth in the Draft Agreement, to ensure alignment among all parties as to the structure under review.

The Draft Agreement provides for contingent consideration in the form of earnout payments, payable by Ardent Healthcare Merger Sub LLC (or its successor or assign) to the pre-closing members of Pinnacle upon the achievement of certain financial performance targets measured by reference to Adjusted EBITDA (as defined in the Draft Agreement). The earnout is structured across two successive measurement periods, as follows:

Measurement Period 1: The first measurement period commences on June 1, 2024 and concludes on May 31, 2025 (the "Period 1"). If Pinnacle (or the surviving entity following the merger) achieves Adjusted EBITDA of at least $58.0 million during Period 1, an earnout payment of $15.0 million (the "Period 1 Payment") shall become payable to the Eligible Earnout Recipients.

Measurement Period 2: The second measurement period commences on June 1, 2025 and concludes on May 31, 2026 (the "Period 2"). If the surviving entity achieves Adjusted EBITDA of at least $65.0 million during Period 2, an earnout payment of $20.0 million (the "Period 2 Payment") shall become payable to the Eligible Earnout Recipients.

The maximum aggregate earnout payable under the Draft Agreement is $35.0 million, consisting of the sum of the Period 1 Payment ($15.0 million) and the Period 2 Payment ($20.0 million). Each earnout payment is structured on an all-or-nothing basis — that is, the full amount of the applicable payment is earned if the Adjusted EBITDA target for the relevant period is met or exceeded, and no partial payment is provided for performance below the applicable threshold.

Additionally, the Draft Agreement contains an earnout acceleration provision, under which 100% of any remaining unpaid earnout becomes immediately due and payable upon a "change of control" (as defined in the Draft Agreement) of Ardent Healthcare Holdings LLC occurring at any time during the earnout period. This acceleration feature is designed to protect the selling members in the event of an early exit by Fund III.

Allocation. The Draft Agreement contemplates that earnout payments will be allocated on a pro rata basis among all pre-closing Pinnacle members, including the three founders and executives who are also rollover participants — Dr. Raymond Carvallo, Dr. Nadia Ostrowski, and Jonathan Farnsworth — on their cashed-out portions of their respective membership interests. Fourteen additional minority physician-investors who hold the remaining 27.5% of Pinnacle's membership interests are also entitled to participate in the earnout on a pro rata basis.

Core Tax Objective. The overriding tax objective with respect to the earnout is straightforward: earnout payments should be characterized, for federal, state, and local income tax purposes, as additional purchase price for the Pinnacle membership interests, giving rise to long-term capital gain treatment for the selling members under Sections 741 and 1001 of the Internal Revenue Code of 1986, as amended (the "Code"). The earnout payments should not be characterized as compensation for services, consulting fees, consideration for a covenant not to compete, or any other category of ordinary income. This characterization objective benefits both the buyer and the sellers, as discussed in detail below, and the drafting of the earnout provisions must be calibrated to support and protect this intended treatment.

II. Key Tax Characterization Concern: Capital Gain vs. Compensation

A. Governing Legal Framework

Under general federal income tax principles, contingent payments received by a seller in connection with the sale of a business or business interest may be treated as either (a) additional purchase price for the sold assets or interests, giving rise to capital gain (or, if applicable, Section 1231 gain), or (b) disguised compensation for services, giving rise to ordinary income. The distinction is critical: for individuals, the differential between long-term capital gains rates (currently 20%, plus the 3.8% net investment income tax under Section 1411, for a combined maximum rate of 23.8%) and ordinary income rates (currently up to 37%, plus the 3.8% net investment income tax, for a combined maximum rate of 40.8%) can be significant. On a $35 million aggregate earnout, the incremental tax exposure from a recharacterization as ordinary income could exceed $5.95 million in the aggregate across all selling members.

The Internal Revenue Service and the federal courts employ a multi-factor, facts-and-circumstances analysis to determine whether contingent payments are properly characterized as purchase price or compensation. Among the factors considered are the following:

(i) whether the contingent payments are conditioned upon the seller's continued employment with, or provision of services to, the acquired business following the closing;

(ii) whether the contingent payments are allocated only to sellers who are employees or service providers of the acquired business, rather than to all equity holders on a pro rata basis;

(iii) whether the amount of the contingent payments bears a reasonable relationship to the value of the acquired business or, conversely, to the value of the services expected to be performed by the seller;

(iv) whether the contingent payments are separately negotiated and valued, or are intertwined with compensation arrangements, employment agreements, or restrictive covenants;

(v) whether the contingent payments are forfeitable upon termination of employment or breach of a non-compete, suggesting a compensatory character; and

(vi) the parties' expressed intent, as reflected in the transaction documents and contemporaneous communications, regarding the nature of the payments.

Key authorities informing this analysis include the Danielson principle (Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967)), under which a party to a transaction is generally bound by the form of the agreement absent proof of fraud, duress, or undue influence, and thus the characterization set forth in the agreement itself carries significant weight, provided it is supported by economic substance. Additional relevant authorities include Klamath Strategic Investment Fund, LLC v. United States, 568 F.3d 537 (5th Cir. 2009), addressing the substance-over-form analysis applicable to partnership transactions; Lane Processing Trust v. United States, 25 F.3d 662 (8th Cir. 1994), examining earnout payments in the acquisition context; and the IRS's general guidance on earnout arrangements in revenue rulings and field service advice memoranda.

It is important to note that the buyer also has a direct interest in the proper tax characterization of the earnout. If the earnout payments are treated as additional purchase price, the buyer (here, Ardent Healthcare Merger Sub LLC, as the acquiring entity in a transaction structured as a merger of Pinnacle into Merger Sub) receives the benefit of an increased tax basis in the acquired assets — specifically, an incremental Section 743(b) adjustment to the inside basis of Pinnacle's assets, reflecting the additional purchase price paid through the earnout. Conversely, if the earnout payments are recharacterized as compensation, the buyer would be entitled to a current deduction for the payments as an ordinary and necessary business expense under Section 162, but would be required to withhold and report the payments as W-2 wages (if the recipients are employees) or as 1099-NEC payments (if the recipients are independent contractors), with corresponding FICA, Medicare, and unemployment tax obligations. Although the current deduction may be attractive in isolation, the administrative burden, compliance exposure, and reputational risk associated with a compensation recharacterization — particularly in the context of a private equity-sponsored acquisition involving physician-owners — are substantial, and in our view, the additional basis step-up is the preferable outcome for the buyer.

B. Risk Factors Present in the Current Draft

Having reviewed the Draft Agreement against the foregoing legal framework, we have identified several provisions in the current draft that, individually or in combination, could jeopardize the intended capital gain treatment of the earnout payments. These provisions are described in detail in Section III below, together with our specific recommended revisions. In summary, the areas of concern are:

(1) the imprecise definition of "Eligible Earnout Recipients," which may fail to capture all pre-closing members on a pro rata basis;

(2) the inclusion of a forfeiture-for-termination provision conditioning earnout payments on continued employment;

(3) the cross-referencing of the earnout as partial consideration for the non-competition covenants, which conflates purchase price with restrictive covenant consideration;

(4) the absence of tax characterization language in the change-of-control acceleration provision;

(5) the failure to address Section 483 imputed interest on deferred earnout payments;

(6) the absence of a specific tax reporting consistency covenant for earnout-related reporting; and

(7) the lack of clarity regarding the interaction between the earnout and the rollover equity contributed under Section 721.

We address each of these issues in turn below.

III. Specific Drafting Comments and Recommended Revisions

A. Pro Rata Allocation Among All Pre-Closing Members

Current Draft Issue. The current draft language in the earnout section allocates earnout payments among the "Eligible Earnout Recipients," but the Draft Agreement does not contain a clear and comprehensive definition of that term tying eligibility to all pre-closing holders of Pinnacle membership interests. As drafted, the term "Eligible Earnout Recipients" could be interpreted to encompass only a subset of the selling members — for example, only those members who execute a separate earnout participation agreement, or only those members who are employees or service providers of Pinnacle at the time of payment. This ambiguity is problematic from a tax characterization standpoint.

Recommended Revision. We recommend that the Draft Agreement define "Eligible Earnout Recipients" expressly and unambiguously to include all holders of Pinnacle membership interests immediately prior to the effective time of the merger (the "Closing"), without exception or qualification. Based on our review of the Pinnacle operating agreement and capitalization table provided by Ardent Capital, the pre-closing membership interests are held as follows:

• Dr. Raymond Carvallo: 38.2%

• Dr. Nadia Ostrowski: 28.5%

• Jonathan Farnsworth: 5.8%

• Fourteen minority physician-investors (collectively): 27.5%

All seventeen pre-closing members should be expressly identified as Eligible Earnout Recipients, and earnout payments should be allocated on a strictly pro rata basis in accordance with each member's percentage interest in Pinnacle immediately prior to the Closing. No additional conditions — such as continued employment, execution of ancillary agreements, or compliance with restrictive covenants — should be imposed as prerequisites to eligibility.

Tax Rationale. Pro rata allocation among all equity holders is one of the strongest indicators that contingent payments constitute additional purchase price rather than compensation. Compensation is, by its nature, paid to individuals in exchange for services rendered, and is typically limited to those individuals who provide (or are expected to provide) such services. Where contingent payments flow to all equity holders — including passive investors who have no employment or service relationship with the acquired business — the payments bear the hallmarks of purchase price, not compensation. The fourteen minority physician-investors in Pinnacle are passive equity holders who will have no post-closing employment or consulting relationship with the surviving entity; their participation in the earnout on the same pro rata basis as the three founder-executives strongly supports the intended purchase price characterization.

B. Elimination of Forfeiture-for-Termination Provisions

Current Draft Issue. Section [●](d) of the Draft Agreement contains a forfeiture provision applicable to the three Rollover Participants (Dr. Carvallo, Dr. Ostrowski, and Mr. Farnsworth). Specifically, the provision states that if a Rollover Participant's employment with Pinnacle (or its successor) is terminated by the Company for "Cause" (as defined in the applicable employment agreement) prior to the end of an earnout measurement period, such Rollover Participant shall forfeit his or her pro rata share of any unpaid earnout payment attributable to the measurement period in which the termination occurs and any subsequent measurement period. This forfeiture provision is limited to terminations for Cause and does not apply to voluntary resignations, terminations without Cause, or terminations due to death or disability.

Recommended Revision. We strongly recommend that the forfeiture-for-termination provision be deleted in its entirety. Under no circumstances should any earnout payment be conditioned upon any selling member's continued employment with, or provision of services to, the surviving entity or any affiliate thereof. The earnout should be payable solely upon the achievement of the Adjusted EBITDA targets, without regard to the employment status of any individual seller.

We recognize that Ardent Capital has a legitimate business interest in retaining the three founder-executives through the earnout period, and that concerns exist regarding the operational impact of a key-person departure. However, those concerns should be addressed through mechanisms that are separate and distinct from the earnout. Specifically, we recommend that retention incentives be provided through one or more of the following:

(i) separately negotiated employment agreements with defined terms, compensation, and termination provisions;

(ii) equity-based incentive awards (e.g., profits interests in Ardent Healthcare Holdings LLC, subject to time-based and/or performance-based vesting);

(iii) cash retention bonuses payable upon continued employment through specified dates; and/or

(iv) restrictive covenant agreements (non-compete, non-solicitation, non-disparagement) with independently valued consideration.

Each of these mechanisms achieves the desired retention objective without contaminating the tax characterization of the earnout. The critical principle is that the earnout should stand alone as additional purchase price, untethered from any employment or service condition.

Tax Rationale. The inclusion of an employment-contingent forfeiture provision is among the most significant risk factors for recharacterization of an earnout as compensation. The IRS and the courts have consistently held that where a contingent payment is forfeitable upon the termination of the recipient's employment, the payment resembles deferred compensation rather than purchase price. The logic is straightforward: if the right to receive the payment depends on the recipient's continued provision of services, the payment is being made for those services, not for the business interest that was sold at closing.

If the IRS were to recharacterize the earnout as compensation based on the forfeiture provision — even if the recharacterization were limited to the Rollover Participants' shares — the consequences would be severe and potentially far-reaching:

• The Rollover Participants would be subject to ordinary income tax (up to 40.8% combined federal rate) rather than long-term capital gains tax (23.8% combined federal rate) on their shares of the earnout payments.

• Ardent Healthcare Merger Sub LLC (or the surviving entity) would be required to withhold and remit federal income tax, FICA tax, and Medicare tax on the amounts characterized as compensation, with potential penalties for failure to do so.

• The recharacterization of even the Rollover Participants' shares could create a "taint" that calls into question the characterization of the entire earnout, including the portions payable to the passive minority investors.

• The buyer would lose the benefit of the incremental Section 743(b) basis step-up attributable to the recharacterized amounts, replacing it with a current deduction — a trade that, as discussed above, is generally disadvantageous in the context of this Transaction.

In light of these risks, we view deletion of the forfeiture provision as essential.

C. Clear Delineation from Non-Compete and Consulting Arrangements

Current Draft Issue. The Draft Agreement contains non-competition agreements applicable to Dr. Carvallo and Dr. Ostrowski, set forth at Section [●] of the Draft Agreement, imposing a three-year post-closing restriction on competition within defined healthcare service lines and geographic markets. The non-compete provisions also include customary non-solicitation and non-disparagement covenants. Critically, the consideration for the non-competition covenants is not separately stated in the Draft Agreement. Instead, the non-compete section cross-references the "Contingent Consideration" (defined to include the earnout payments) as constituting, in part, the consideration for the restrictive covenants.

This cross-reference creates a direct and problematic linkage between the earnout and the non-competition agreements. Under the current drafting, the earnout payments are simultaneously characterized as (a) additional purchase price for the Pinnacle membership interests and (b) consideration for the restrictive covenants. These two characterizations are mutually inconsistent for tax purposes.

Recommended Revision. We recommend the following revisions:

First, the non-compete consideration must be separated entirely from the earnout. The non-competition agreements should identify specific, independently determined consideration that is funded from the fixed (non-contingent) portion of the purchase price, not from the contingent earnout payments. The Purchase Price Allocation Schedule currently under development allocates $17.4 million of the $412 million enterprise value to non-compete agreements, amortizable over a 15-year period as a Class V intangible under Section 1060 of the Code and the regulations thereunder. This $17.4 million should be identified as the sole consideration for the non-compete covenants, payable at closing as part of the fixed purchase price, and the non-compete section should contain no reference to the earnout or the Contingent Consideration.

Second, the earnout section of the Draft Agreement should include an express recital or covenant stating substantially as follows:

"The parties acknowledge and agree that the Earnout Payments constitute additional consideration for the Membership Interests sold by the Eligible Earnout Recipients pursuant to this Agreement and do not constitute, in whole or in part, compensation for services, deferred compensation, consideration for any covenant not to compete, or any other form of ordinary income. The Earnout Payments are not conditioned upon the continued employment of, or the provision of services by, any Eligible Earnout Recipient."

Third, to the extent Dr. Carvallo or Dr. Ostrowski will enter into post-closing consulting arrangements with the surviving entity, the consideration for any such consulting services should be separately negotiated, documented in standalone consulting agreements, and paid independently of the earnout. No consulting fees should be structured as a component of, or supplement to, the earnout.

Tax Rationale. If the earnout is characterized, even in part, as consideration for the non-competition covenants, the IRS may bifurcate the earnout payments, treating a portion as ordinary income allocable to the covenant not to compete. Amounts allocable to a covenant not to compete are treated as ordinary income to the recipient under established case law and IRS guidance, and are amortizable by the payor over a 15-year period as a Section 197 intangible. The current drafting invites precisely this bifurcation by expressly linking the earnout to the non-compete.

The Purchase Price Allocation already independently values the non-competition agreements at $17.4 million within the $412 million total enterprise value. This allocation is supportable under Section 1060 and the residual method prescribed by the regulations, and reflects an arm's length valuation of the restrictive covenants based on the duration of the non-compete period, the geographic and service-line scope of the restriction, and the competitive significance of Dr. Carvallo and Dr. Ostrowski in their respective markets. By funding the non-compete consideration from the fixed purchase price and severing all linkage to the earnout, we eliminate the risk of bifurcation and preserve the integrity of the earnout as additional purchase price.

D. Earnout Acceleration on Change of Control

Current Draft Issue. The Draft Agreement provides that 100% of any remaining unpaid earnout shall become immediately due and payable upon a "change of control" of Ardent Healthcare Holdings LLC occurring at any time during the earnout period. While this acceleration provision provides important liquidity protection for the selling members, the Draft Agreement does not specify the tax treatment of the accelerated payment. Moreover, the acceleration provision does not expressly state whether the accelerated payment is conditioned upon the continued employment of any seller at the time of the change of control, and does not address the allocation of the accelerated payment among the Eligible Earnout Recipients.

Recommended Revision. We recommend the following additions to the acceleration provision:

(i) Add an express statement that any accelerated earnout payment upon a change of control is treated, for all federal, state, and local income tax purposes, as additional purchase price for the Pinnacle membership interests, consistent with the treatment of regular earnout payments.

(ii) Clarify that the acceleration payment is payable to all Eligible Earnout Recipients without regard to the employment status of any individual recipient at the time of the change of control. The right to receive the accelerated payment should not be conditioned upon any seller's continued employment, provision of services, or compliance with any restrictive covenant.

(iii) Add language specifying that the accelerated amount shall be allocated among all Eligible Earnout Recipients on the same pro rata basis (in accordance with each recipient's percentage interest in Pinnacle immediately prior to the Closing) as applies to regular earnout payments.

(iv) If the change of control results in a disposition of the Eligible Earnout Recipients' equity interests in Ardent Healthcare Holdings LLC (e.g., through a secondary sale or merger at the Holdings level), the acceleration payment should be treated as an adjustment to the purchase price received in the change-of-control transaction, rather than as a separate payment.

Tax Rationale. Without express characterization language, there is a risk that the IRS could argue that an acceleration payment triggered by a change of control is analogous to a severance or change-in-control payment — a form of compensation that is triggered by a specified event relating to the employment or equity relationship between the recipient and the acquired company. This characterization risk is heightened if the acceleration is not available to all equity holders on a pro rata basis, or if it is conditioned on the continued employment of the Rollover Participants. By expressly characterizing the acceleration as additional purchase price, ensuring pro rata allocation, and eliminating any employment condition, we align the acceleration provision with the overall capital gain treatment of the earnout.

E. Section 483 Imputed Interest

Current Draft Issue. The Draft Agreement does not address Section 483 of the Internal Revenue Code, which provides rules for the imputation of interest on certain deferred payments arising from the sale of property. Under Section 483, where payment for the sale of property is deferred and the agreement does not provide for adequate stated interest, a portion of each deferred payment is treated as imputed interest (rather than as principal) for federal income tax purposes. The imputed interest portion is ordinary income to the recipient and deductible by the payor.

The earnout payments under the Draft Agreement are, by definition, deferred contingent payments — the Period 1 Payment will not be determinable or payable until after the expiration of Period 1 on May 31, 2025, and the Period 2 Payment will not be determinable or payable until after the expiration of Period 2 on May 31, 2026. To the extent these payments are made more than six months after the anticipated closing date of May 31, 2024, Section 483 will apply to impute interest on the deferred amounts.

Recommended Revision. We recommend the addition of a provision to the earnout section of the Draft Agreement addressing Section 483 as follows:

(i) The provision should acknowledge that, to the extent earnout payments are made more than one year after the Closing, a portion of each payment will be treated as imputed interest under Section 483 of the Code, calculated using the applicable federal rate ("AFR") in effect as of the anticipated signing date of the Draft Agreement (March 15, 2024).

(ii) Based on the AFR rates published by the IRS for March 2024, the applicable rates are as follows:

• Short-term AFR (instruments with a term of three years or less): 5.12% (annual compounding)

• Mid-term AFR (instruments with a term of more than three years but not more than nine years): 4.67% (annual compounding)

(iii) The Period 1 Payment, which is expected to become payable (if at all) following the expiration of Period 1 on May 31, 2025, will be subject to imputed interest at the short-term AFR of 5.12%, as the payment will be made more than six months but not more than three years after the Closing.

(iv) The Period 2 Payment, which is expected to become payable (if at all) following the expiration of Period 2 on May 31, 2026, will be subject to imputed interest at either the short-term AFR of 5.12% (if payable within three years of the Closing) or the mid-term AFR of 4.67% (if payable more than three years after the Closing), depending on the precise payment date.

(v) The provision should include a reporting covenant requiring the buyer (or the surviving entity) to report imputed interest consistently with Section 483 on all applicable information returns, including Schedules K-1 issued to the selling members and any Forms 1099-INT issued in connection with the imputed interest amounts.

Tax Rationale. Section 483 is a mandatory provision of the Code; the failure to address imputed interest in the agreement does not eliminate the parties' obligation to account for imputed interest on their respective tax returns. However, the absence of any contractual acknowledgment creates a significant risk of inconsistent reporting — a scenario in which the buyer reports imputed interest in a different amount, or for a different period, than the sellers. Inconsistent reporting between counterparties is a well-known audit trigger for the IRS and can result in "whipsaw" — a situation in which the IRS asserts adjustments against both parties simultaneously, each to the other's detriment.

By including an explicit acknowledgment of Section 483 in the Draft Agreement, specifying the applicable AFR rates, and imposing a mutual reporting covenant, we ensure that the buyer and the sellers calculate and report imputed interest on a consistent basis. This approach facilitates orderly Schedule K-1 preparation by the surviving entity (as a partnership for federal tax purposes), minimizes audit risk, and provides certainty to the individual selling members regarding the character of the amounts they receive (i.e., the bifurcation between imputed interest income and additional purchase price / capital gain).

F. Tax Reporting Cooperation Covenant

Current Draft Issue. The Draft Agreement contains a general tax cooperation covenant at Section [●], which requires the parties to "cooperate in good faith with respect to tax matters arising out of or relating to the transactions contemplated by this Agreement." While this general covenant is appropriate and should be retained, it does not specifically address the tax reporting of earnout payments — a matter that requires precision and specificity given the characterization issues discussed throughout this letter.

Recommended Revision. We recommend the addition of a specific earnout tax reporting covenant, either as a standalone provision within the earnout section or as a supplement to the general tax cooperation covenant. The recommended provision should include the following elements:

(i) Consistency Covenant. The parties shall report all earnout payments (including any accelerated payments upon a change of control) as additional purchase price for the Pinnacle membership interests, constituting amounts realized under Section 1001 of the Code giving rise to capital gain treatment, on all federal, state, and local income tax returns and information returns filed by the parties. Neither the buyer nor any seller shall take a position on any tax return or in any proceeding before a taxing authority that is inconsistent with this treatment, absent a "final determination" (within the meaning of Section 1313(a) of the Code) requiring a different treatment.

(ii) Information Return Obligations. The buyer (or Pinnacle, as the surviving entity in the merger) shall issue appropriate information returns reflecting the earnout payments as additional consideration for the sale of membership interests. For sellers who are treated as partners in a partnership for federal income tax purposes, the surviving entity shall report the earnout payments on the applicable Schedules K-1 (Form 1065) as additional amounts realized in connection with the sale or exchange of partnership interests. To the extent any Form 1099-S or other information return is required, such return shall be prepared consistently with the purchase price characterization.

(iii) Seller Reporting Covenant. Each selling member shall report the receipt of earnout payments on his or her individual federal, state, and local income tax returns consistently with the purchase price characterization, including (without limitation) the reporting of long-term capital gain on Schedule D (Form 1040) and, if applicable, the reporting of imputed interest income as described in Section III.E above.

(iv) No Inconsistent Position. Neither party shall take any position on any tax return, amended tax return, claim for refund, or in any audit, examination, or other proceeding before any taxing authority that is inconsistent with the agreed-upon tax treatment of the earnout payments, except to the extent required by a final determination within the meaning of Section 1313(a) of the Code.

Tax Rationale. Consistency between buyer and seller reporting is critical to minimizing the risk of an IRS audit adjustment. The most common scenario in which the IRS challenges earnout characterization is the "whipsaw" scenario: the buyer deducts the earnout payment as compensation expense (thereby reducing its taxable income), while the seller reports the same payment as capital gain (thereby benefiting from a preferential rate). When the IRS identifies this inconsistency — typically through information return matching programs — it has an incentive to challenge both positions. By imposing a binding consistency covenant, we eliminate the possibility of a whipsaw and present a unified position to the IRS that is more difficult to challenge.

Moreover, the consistency covenant provides practical benefits for the administration of the Transaction. It ensures that the surviving entity's Schedule K-1 reporting is aligned with the sellers' individual return reporting, reducing the likelihood of shareholder inquiries, amended return filings, and disputes between the parties regarding the proper tax treatment of the earnout.

G. Interaction with Rollover Equity

The Draft Agreement contemplates that three of the pre-closing Pinnacle members — Dr. Raymond Carvallo, Dr. Nadia Ostrowski, and Jonathan Farnsworth — will contribute a portion of their Pinnacle membership interests to Ardent Healthcare Holdings LLC ("Holdings LLC") in exchange for newly issued Class B Units of Holdings LLC (the "Rollover"). The Rollover is structured as a tax-deferred contribution under Section 721 of the Code, and no gain or loss is expected to be recognized by the Rollover Participants upon the contribution of their Pinnacle interests to Holdings LLC. The Rollover Participants will receive a carryover basis in their Class B Units equal to their adjusted tax basis in the contributed Pinnacle interests, under Section 722.

The following amounts are being contributed as rollover equity:

• Dr. Raymond Carvallo: $32.41 million (representing 25% of his $129.65 million gross equity proceeds attributable to his 38.2% membership interest)

• Dr. Nadia Ostrowski: $24.18 million (representing 25% of her $96.73 million gross equity proceeds attributable to her 28.5% membership interest)

• Jonathan Farnsworth: $2.95 million (representing 15% of his $19.69 million gross equity proceeds attributable to his 5.8% membership interest)

• Total Rollover: $59.54 million

The remaining portion of each Rollover Participant's membership interest — the "cashed-out" portion — is being sold for cash in the merger, generating taxable gain to the extent the cash consideration exceeds the Rollover Participant's allocated adjusted tax basis in the cashed-out portion.

Recommended Revision. We recommend that the Draft Agreement include an express provision clarifying the interaction between the earnout and the rollover equity, as follows:

(i) Earnout payments shall be allocated to the Rollover Participants only with respect to their cashed-out (non-rollover) portions of their Pinnacle membership interests. No earnout payment shall be allocated to, or treated as attributable to, the Pinnacle membership interests contributed by the Rollover Participants to Holdings LLC as rollover equity.

(ii) For purposes of calculating each Rollover Participant's pro rata share of the earnout, the denominator shall be the aggregate cashed-out membership interests of all pre-closing members (i.e., the total membership interests less the rollover interests), and the numerator shall be the individual Rollover Participant's cashed-out membership interest.

(iii) For the avoidance of doubt, the fourteen minority physician-investors (who are not Rollover Participants and are cashing out 100% of their membership interests) shall participate in the earnout on a pro rata basis based on 100% of their respective membership interests.

Tax Rationale. If earnout payments were allocated to the Rollover Participants with respect to their rolled-over interests, a fundamental inconsistency would arise with the tax-deferred contribution under Section 721. The Rollover is premised on the principle that the Rollover Participants are contributing their Pinnacle interests to Holdings LLC in exchange for Class B Units, with no additional consideration (including contingent consideration) being received for the contributed interests. If the earnout were treated as additional consideration for the contributed interests, the contribution would no longer qualify as a tax-free exchange under Section 721, potentially triggering immediate gain recognition on the rollover interests — a result that is contrary to the parties' intent and that would impose an unanticipated tax liability on the Rollover Participants.

To preserve the integrity of the Section 721 deferral, the earnout must be segregated from the rollover. Earnout payments should be treated as additional purchase price only for the cashed-out portions of the Rollover Participants' interests, which are the interests that are being sold for cash in a taxable transaction. This approach maintains a clean separation between the taxable sale (giving rise to gain recognition on the cashed-out portion, potentially reported under the installment method under Section 453, as discussed in our separate memorandum dated March 5, 2024) and the tax-deferred contribution (giving rise to no current gain recognition on the rollover portion).

IV. Summary of Recommended Changes

For ease of reference, the following table summarizes the issues identified in this letter, our recommended revisions, and the tax basis for each recommendation:

V. Coordination with Related Workstreams

We note that the comments set forth in this letter should be read and considered in conjunction with several related workstreams currently underway in connection with the Transaction:

1. Earnout Tax Characterization Memorandum (March 1, 2024). Calderwood & Harkness's detailed memorandum analyzing the legal framework for the capital gain vs. compensation characterization of the earnout, including a review of applicable case law, IRS guidance, and the specific facts and circumstances of the Transaction. A copy of this memorandum is enclosed with this letter for ease of reference.

2. Open Transaction vs. Closed Transaction / Installment Method Memorandum (March 5, 2024). Calderwood & Harkness's memorandum analyzing the individual selling members' reporting options under Sections 453 and 1001 of the Code, including the availability of installment sale reporting for the contingent earnout payments, the open transaction doctrine, and the maximum selling price rules applicable to contingent payment sales. This memorandum has been circulated to the Ardent Capital deal team and to Whitford & Gaines LLP for the sellers' consideration.

3. Purchase Price Allocation Methodology. The Purchase Price Allocation under Section 1060 of the Code is currently being developed, with the preliminary allocation reflecting the $412 million enterprise value distributed across the applicable asset classes, including $17.4 million allocated to non-compete agreements (Class V, Section 197 intangibles), as referenced in Section III.C above. The final PPA will need to be coordinated with the earnout provisions to ensure consistency — in particular, the contingent earnout payments will need to be allocated across asset classes as and when they become fixed and determinable, consistent with the methodology established in the initial PPA.

4. Tax Representations and Covenants Markup. Calderwood & Harkness is separately preparing a comprehensive markup of the tax representations, warranties, covenants, and indemnification provisions of the broader Draft Agreement. That markup will address, among other things, pre-closing tax compliance, tax return preparation and filing obligations, transfer taxes, FIRPTA compliance, and the tax treatment of pre-closing distributions. The earnout-specific comments in this letter are intended to be incorporated into the broader tax markup but are being provided in advance given the time-sensitive nature of the earnout negotiations.

5. Seller's Counsel Consultation. We note that seller's counsel, Whitford & Gaines LLP (Patricia Engelman, Partner, Tax, and Kevin Driscoll, Associate), should be consulted regarding the sellers' willingness to accept the consistency covenant described in Section III.F above. The consistency covenant binds the individual selling members to a specific tax reporting position, and the sellers may wish to negotiate the scope of the covenant or seek their own independent tax advice before agreeing to be bound. We are prepared to engage directly with Ms. Engelman and Mr. Driscoll on this point at the appropriate time.

VI. Request for Revised Draft

In light of the foregoing comments, we respectfully request that Harcourt Shaw & DeVries LLP circulate a revised draft of the earnout sections of the Draft Agreement incorporating the recommendations set forth in this letter. We are happy to provide suggested contract language for any or all of the recommended provisions if that would be helpful to your drafting process, and we are prepared to review and comment on any revised language on an expedited basis.

Calderwood & Harkness is available to participate in a call with Harcourt Shaw & DeVries LLP, Whitford & Gaines LLP, and the Ardent Capital deal team (including Marcus Pellegrino) to discuss these comments and to resolve any open issues. Given the number of interrelated tax and commercial considerations, we believe a working session among all parties and their respective advisors would be the most efficient path to finalizing the earnout provisions.

We understand that the parties are targeting a signing date of March 15, 2024. Accordingly, we would respectfully suggest prioritizing the completion of the earnout provisions in the next round of drafts and scheduling any necessary calls for March 13 or 14. Our team — including Sylvia Hartwell (Partner, Tax) and Robert Jansen (Associate, Tax) — is available at your convenience during that window.

We appreciate your attention to these matters and look forward to working with you to finalize the earnout provisions in a manner that achieves the parties' commercial objectives while safeguarding the intended tax treatment.

Very truly yours,

CALDERWOOD & HARKNESS LLP

By: ________

Leonard Cross Partner, Tax Practice Group

One Liberty Plaza, 45th Floor New York, New York 10006 Telephone: (212) 554-7246

Email: lcross@calderwoodharkness.com

cc: (via email)

Marcus Pellegrino, Partner, Healthcare — Ardent Capital Partners III LP Claire Ashworth, Co-Founder & Managing Partner — Ardent Capital Partners III LP Patricia Engelman, Partner, Tax — Whitford & Gaines LLP Kevin Driscoll, Associate, M&A/Tax — Whitford & Gaines LLP Sylvia Hartwell, Partner, Tax — Calderwood & Harkness LLP Robert Jansen, Associate, Tax — Calderwood & Harkness LLP

Enclosure: Earnout Tax Characterization Memorandum dated March 1, 2024 (for reference)

Draft Section Reference	Issue	Recommended Change	Tax Basis
Earnout — Definition of "Eligible Earnout Recipients"	Term not clearly defined to include all pre-closing members on a pro rata basis	Expand definition to expressly include all 17 pre-closing Pinnacle members; allocate earnout strictly pro rata based on percentage interests	Pro rata allocation supports purchase price characterization; excludes inference that payments are targeted to service providers
Section [●](d) — Forfeiture-for-Termination	Rollover Participants forfeit earnout share if terminated for Cause during earnout period	Delete forfeiture provision entirely; no earnout conditioned on employment; address retention through separate employment/equity arrangements	Employment-contingent forfeiture is a hallmark of compensatory treatment; triggers ordinary income, FICA/Medicare exposure, and withholding obligations
Section [●] — Non-Competition Agreement	Non-compete consideration cross-references earnout ("Contingent Consideration") as partial consideration for restrictive covenants	Sever non-compete consideration from earnout; fund non-compete from fixed purchase price ($17.4M allocated to non-compete under PPA); add express recital that earnout is not non-compete consideration	Cross-reference invites IRS bifurcation; amounts allocable to non-compete are ordinary income under Section 197; PPA independently values non-compete at $17.4M
Earnout — Change of Control Acceleration	Acceleration provision does not specify tax treatment; silent on employment condition and allocation	Add express statement treating acceleration as additional purchase price; confirm pro rata allocation among all Eligible Earnout Recipients; confirm no employment condition	Prevents characterization as severance-like / change-of-control compensation; ensures consistency with regular earnout treatment
Earnout — Section 483 Imputed Interest	Draft Agreement does not address Section 483 imputed interest on deferred payments	Add acknowledgment of Section 483; specify AFR rates (5.12% short-term; 4.67% mid-term); add reporting covenant for consistent imputed interest treatment	Section 483 is mandatory; explicit acknowledgment ensures consistent buyer/seller reporting and prevents IRS whipsaw
Tax Cooperation — Earnout Reporting	General cooperation covenant does not specifically address earnout tax reporting	Add specific covenant requiring buyer and sellers to report earnout as additional purchase price (capital gain) on all returns; no inconsistent position absent final determination under Section 1313	Consistency prevents whipsaw; reduces audit risk; facilitates orderly K-1 and 1099 reporting
Earnout — Interaction with Rollover Equity	Draft Agreement does not address allocation of earnout between cashed-out and rollover interests	Clarify that earnout applies only to cashed-out portions of Rollover Participants' interests; no earnout attributed to interests contributed under Section 721	Allocation to rollover interests would be inconsistent with Section 721 deferral and could trigger gain recognition on contributed interests

CALDERWOOD & HARKNESS LLP Attorneys at Law
One Liberty Plaza, 45th Floor New York, New York 10006 Telephone: (212) 554-7000 Facsimile: (212) 554-7001 www.calderwoodharkness.com
March 12, 2024
VIA E-MAIL AND HAND DELIVERY
Thomas Kundra, Esq., Partner Allison Cho, Esq., Associate Harcourt Shaw & DeVries LLP 51 West 52nd Street New York, New York 10019
Re: Tax Comments on Earnout Provisions — Draft Merger Agreement dated March 8, 2024, by and among Ardent Healthcare Merger Sub LLC, Pinnacle Health Services Group LLC, and the Members of Pinnacle Health Services Group LLC
Matter No.: 1001-00006 / Engagement No.: 1001-00006
Dear Tom and Allison:
Calderwood & Harkness LLP ("Calderwood & Harkness" or the "Firm") serves as tax counsel to Ardent Capital Partners III LP ("Ardent Capital" or "Fund III") in connection with Ardent Capital's proposed acquisition of all outstanding membership interests of Pinnacle Health Services Group LLC ("Pinnacle" or "PHSG") at an aggregate enterprise value of approximately $412 million (the "Transaction"). We appreciate the collaborative working relationship between our respective firms and your timely circulation of the draft transaction documents.
The purpose of this letter is to provide our tax-driven comments and recommended revisions to the earnout provisions set forth in the Draft Merger Agreement (the "Draft Agreement") circulated by Harcourt Shaw & DeVries LLP on March 8, 2024. Our comments are focused specifically on the earnout-related sections of the Draft Agreement and the ancillary provisions that interact with the earnout mechanics from a federal income tax perspective. We do not address in this letter the broader tax representations, indemnification provisions, or pre-closing tax covenants of the Draft Agreement, which are the subject of a separate markup currently under preparation by our office.
These comments are being provided in coordination with Harcourt Shaw & DeVries LLP in its capacity as buyer's M&A counsel and should be read alongside Calderwood & Harkness's Earnout Tax Characterization Memorandum dated March 1, 2024, which was previously circulated to the Ardent Capital deal team. That memorandum provides the detailed legal and factual analysis supporting our recommendations herein; this letter is intended to translate those conclusions into specific drafting guidance for the earnout provisions.
Please note that copies of this letter are being provided simultaneously to Marcus Pellegrino (Partner, Healthcare, Ardent Capital Partners III LP) and to seller's counsel, Whitford & Gaines LLP (Patricia Engelman, Partner, Tax, and Kevin Driscoll, Associate, M&A/Tax), for their review and comment. We believe that early transparency with seller's counsel on these tax characterization issues will facilitate an efficient negotiation process and help ensure consistent treatment across both sides of the Transaction.
I. Overview of the Earnout Structure
As a threshold matter, we summarize below the material terms of the earnout as currently set forth in the Draft Agreement, to ensure alignment among all parties as to the structure under review.
The Draft Agreement provides for contingent consideration in the form of earnout payments, payable by Ardent Healthcare Merger Sub LLC (or its successor or assign) to the pre-closing members of Pinnacle upon the achievement of certain financial performance targets measured by reference to Adjusted EBITDA (as defined in the Draft Agreement). The earnout is structured across two successive measurement periods, as follows:
Measurement Period 1: The first measurement period commences on June 1, 2024 and concludes on May 31, 2025 (the "Period 1"). If Pinnacle (or the surviving entity following the merger) achieves Adjusted EBITDA of at least $58.0 million during Period 1, an earnout payment of $15.0 million (the "Period 1 Payment") shall become payable to the Eligible Earnout Recipients.
Measurement Period 2: The second measurement period commences on June 1, 2025 and concludes on May 31, 2026 (the "Period 2"). If the surviving entity achieves Adjusted EBITDA of at least $65.0 million during Period 2, an earnout payment of $20.0 million (the "Period 2 Payment") shall become payable to the Eligible Earnout Recipients.
The maximum aggregate earnout payable under the Draft Agreement is $35.0 million, consisting of the sum of the Period 1 Payment ($15.0 million) and the Period 2 Payment ($20.0 million). Each earnout payment is structured on an all-or-nothing basis — that is, the full amount of the applicable payment is earned if the Adjusted EBITDA target for the relevant period is met or exceeded, and no partial payment is provided for performance below the applicable threshold.
Additionally, the Draft Agreement contains an earnout acceleration provision, under which 100% of any remaining unpaid earnout becomes immediately due and payable upon a "change of control" (as defined in the Draft Agreement) of Ardent Healthcare Holdings LLC occurring at any time during the earnout period. This acceleration feature is designed to protect the selling members in the event of an early exit by Fund III.
Allocation. The Draft Agreement contemplates that earnout payments will be allocated on a pro rata basis among all pre-closing Pinnacle members, including the three founders and executives who are also rollover participants — Dr. Raymond Carvallo, Dr. Nadia Ostrowski, and Jonathan Farnsworth — on their cashed-out portions of their respective membership interests. Fourteen additional minority physician-investors who hold the remaining 27.5% of Pinnacle's membership interests are also entitled to participate in the earnout on a pro rata basis.
Core Tax Objective. The overriding tax objective with respect to the earnout is straightforward: earnout payments should be characterized, for federal, state, and local income tax purposes, as additional purchase price for the Pinnacle membership interests, giving rise to long-term capital gain treatment for the selling members under Sections 741 and 1001 of the Internal Revenue Code of 1986, as amended (the "Code"). The earnout payments should not be characterized as compensation for services, consulting fees, consideration for a covenant not to compete, or any other category of ordinary income. This characterization objective benefits both the buyer and the sellers, as discussed in detail below, and the drafting of the earnout provisions must be calibrated to support and protect this intended treatment.
II. Key Tax Characterization Concern: Capital Gain vs. Compensation
A. Governing Legal Framework
Under general federal income tax principles, contingent payments received by a seller in connection with the sale of a business or business interest may be treated as either (a) additional purchase price for the sold assets or interests, giving rise to capital gain (or, if applicable, Section 1231 gain), or (b) disguised compensation for services, giving rise to ordinary income. The distinction is critical: for individuals, the differential between long-term capital gains rates (currently 20%, plus the 3.8% net investment income tax under Section 1411, for a combined maximum rate of 23.8%) and ordinary income rates (currently up to 37%, plus the 3.8% net investment income tax, for a combined maximum rate of 40.8%) can be significant. On a $35 million aggregate earnout, the incremental tax exposure from a recharacterization as ordinary income could exceed $5.95 million in the aggregate across all selling members.
The Internal Revenue Service and the federal courts employ a multi-factor, facts-and-circumstances analysis to determine whether contingent payments are properly characterized as purchase price or compensation. Among the factors considered are the following:
(i) whether the contingent payments are conditioned upon the seller's continued employment with, or provision of services to, the acquired business following the closing;
(ii) whether the contingent payments are allocated only to sellers who are employees or service providers of the acquired business, rather than to all equity holders on a pro rata basis;
(iii) whether the amount of the contingent payments bears a reasonable relationship to the value of the acquired business or, conversely, to the value of the services expected to be performed by the seller;
(iv) whether the contingent payments are separately negotiated and valued, or are intertwined with compensation arrangements, employment agreements, or restrictive covenants;
(v) whether the contingent payments are forfeitable upon termination of employment or breach of a non-compete, suggesting a compensatory character; and
(vi) the parties' expressed intent, as reflected in the transaction documents and contemporaneous communications, regarding the nature of the payments.
Key authorities informing this analysis include the Danielson principle (Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967)), under which a party to a transaction is generally bound by the form of the agreement absent proof of fraud, duress, or undue influence, and thus the characterization set forth in the agreement itself carries significant weight, provided it is supported by economic substance. Additional relevant authorities include Klamath Strategic Investment Fund, LLC v. United States, 568 F.3d 537 (5th Cir. 2009), addressing the substance-over-form analysis applicable to partnership transactions; Lane Processing Trust v. United States, 25 F.3d 662 (8th Cir. 1994), examining earnout payments in the acquisition context; and the IRS's general guidance on earnout arrangements in revenue rulings and field service advice memoranda.
It is important to note that the buyer also has a direct interest in the proper tax characterization of the earnout. If the earnout payments are treated as additional purchase price, the buyer (here, Ardent Healthcare Merger Sub LLC, as the acquiring entity in a transaction structured as a merger of Pinnacle into Merger Sub) receives the benefit of an increased tax basis in the acquired assets — specifically, an incremental Section 743(b) adjustment to the inside basis of Pinnacle's assets, reflecting the additional purchase price paid through the earnout. Conversely, if the earnout payments are recharacterized as compensation, the buyer would be entitled to a current deduction for the payments as an ordinary and necessary business expense under Section 162, but would be required to withhold and report the payments as W-2 wages (if the recipients are employees) or as 1099-NEC payments (if the recipients are independent contractors), with corresponding FICA, Medicare, and unemployment tax obligations. Although the current deduction may be attractive in isolation, the administrative burden, compliance exposure, and reputational risk associated with a compensation recharacterization — particularly in the context of a private equity-sponsored acquisition involving physician-owners — are substantial, and in our view, the additional basis step-up is the preferable outcome for the buyer.
B. Risk Factors Present in the Current Draft
Having reviewed the Draft Agreement against the foregoing legal framework, we have identified several provisions in the current draft that, individually or in combination, could jeopardize the intended capital gain treatment of the earnout payments. These provisions are described in detail in Section III below, together with our specific recommended revisions. In summary, the areas of concern are:
(1) the imprecise definition of "Eligible Earnout Recipients," which may fail to capture all pre-closing members on a pro rata basis;
(2) the inclusion of a forfeiture-for-termination provision conditioning earnout payments on continued employment;
(3) the cross-referencing of the earnout as partial consideration for the non-competition covenants, which conflates purchase price with restrictive covenant consideration;
(4) the absence of tax characterization language in the change-of-control acceleration provision;
(5) the failure to address Section 483 imputed interest on deferred earnout payments;
(6) the absence of a specific tax reporting consistency covenant for earnout-related reporting; and
(7) the lack of clarity regarding the interaction between the earnout and the rollover equity contributed under Section 721.
We address each of these issues in turn below.
III. Specific Drafting Comments and Recommended Revisions
A. Pro Rata Allocation Among All Pre-Closing Members
Current Draft Issue. The current draft language in the earnout section allocates earnout payments among the "Eligible Earnout Recipients," but the Draft Agreement does not contain a clear and comprehensive definition of that term tying eligibility to all pre-closing holders of Pinnacle membership interests. As drafted, the term "Eligible Earnout Recipients" could be interpreted to encompass only a subset of the selling members — for example, only those members who execute a separate earnout participation agreement, or only those members who are employees or service providers of Pinnacle at the time of payment. This ambiguity is problematic from a tax characterization standpoint.
Recommended Revision. We recommend that the Draft Agreement define "Eligible Earnout Recipients" expressly and unambiguously to include all holders of Pinnacle membership interests immediately prior to the effective time of the merger (the "Closing"), without exception or qualification. Based on our review of the Pinnacle operating agreement and capitalization table provided by Ardent Capital, the pre-closing membership interests are held as follows:
•  Dr. Raymond Carvallo: 38.2%
•  Dr. Nadia Ostrowski: 28.5%
•  Jonathan Farnsworth: 5.8%
•  Fourteen minority physician-investors (collectively): 27.5%
All seventeen pre-closing members should be expressly identified as Eligible Earnout Recipients, and earnout payments should be allocated on a strictly pro rata basis in accordance with each member's percentage interest in Pinnacle immediately prior to the Closing. No additional conditions — such as continued employment, execution of ancillary agreements, or compliance with restrictive covenants — should be imposed as prerequisites to eligibility.
Tax Rationale. Pro rata allocation among all equity holders is one of the strongest indicators that contingent payments constitute additional purchase price rather than compensation. Compensation is, by its nature, paid to individuals in exchange for services rendered, and is typically limited to those individuals who provide (or are expected to provide) such services. Where contingent payments flow to all equity holders — including passive investors who have no employment or service relationship with the acquired business — the payments bear the hallmarks of purchase price, not compensation. The fourteen minority physician-investors in Pinnacle are passive equity holders who will have no post-closing employment or consulting relationship with the surviving entity; their participation in the earnout on the same pro rata basis as the three founder-executives strongly supports the intended purchase price characterization.
B. Elimination of Forfeiture-for-Termination Provisions
Current Draft Issue. Section [●](d) of the Draft Agreement contains a forfeiture provision applicable to the three Rollover Participants (Dr. Carvallo, Dr. Ostrowski, and Mr. Farnsworth). Specifically, the provision states that if a Rollover Participant's employment with Pinnacle (or its successor) is terminated by the Company for "Cause" (as defined in the applicable employment agreement) prior to the end of an earnout measurement period, such Rollover Participant shall forfeit his or her pro rata share of any unpaid earnout payment attributable to the measurement period in which the termination occurs and any subsequent measurement period. This forfeiture provision is limited to terminations for Cause and does not apply to voluntary resignations, terminations without Cause, or terminations due to death or disability.
Recommended Revision. We strongly recommend that the forfeiture-for-termination provision be deleted in its entirety. Under no circumstances should any earnout payment be conditioned upon any selling member's continued employment with, or provision of services to, the surviving entity or any affiliate thereof. The earnout should be payable solely upon the achievement of the Adjusted EBITDA targets, without regard to the employment status of any individual seller.
We recognize that Ardent Capital has a legitimate business interest in retaining the three founder-executives through the earnout period, and that concerns exist regarding the operational impact of a key-person departure. However, those concerns should be addressed through mechanisms that are separate and distinct from the earnout. Specifically, we recommend that retention incentives be provided through one or more of the following:
(i) separately negotiated employment agreements with defined terms, compensation, and termination provisions;
(ii) equity-based incentive awards (e.g., profits interests in Ardent Healthcare Holdings LLC, subject to time-based and/or performance-based vesting);
(iii) cash retention bonuses payable upon continued employment through specified dates; and/or
(iv) restrictive covenant agreements (non-compete, non-solicitation, non-disparagement) with independently valued consideration.
Each of these mechanisms achieves the desired retention objective without contaminating the tax characterization of the earnout. The critical principle is that the earnout should stand alone as additional purchase price, untethered from any employment or service condition.
Tax Rationale. The inclusion of an employment-contingent forfeiture provision is among the most significant risk factors for recharacterization of an earnout as compensation. The IRS and the courts have consistently held that where a contingent payment is forfeitable upon the termination of the recipient's employment, the payment resembles deferred compensation rather than purchase price. The logic is straightforward: if the right to receive the payment depends on the recipient's continued provision of services, the payment is being made for those services, not for the business interest that was sold at closing.
If the IRS were to recharacterize the earnout as compensation based on the forfeiture provision — even if the recharacterization were limited to the Rollover Participants' shares — the consequences would be severe and potentially far-reaching:
•  The Rollover Participants would be subject to ordinary income tax (up to 40.8% combined federal rate) rather than long-term capital gains tax (23.8% combined federal rate) on their shares of the earnout payments.
•  Ardent Healthcare Merger Sub LLC (or the surviving entity) would be required to withhold and remit federal income tax, FICA tax, and Medicare tax on the amounts characterized as compensation, with potential penalties for failure to do so.
•  The recharacterization of even the Rollover Participants' shares could create a "taint" that calls into question the characterization of the entire earnout, including the portions payable to the passive minority investors.
•  The buyer would lose the benefit of the incremental Section 743(b) basis step-up attributable to the recharacterized amounts, replacing it with a current deduction — a trade that, as discussed above, is generally disadvantageous in the context of this Transaction.
In light of these risks, we view deletion of the forfeiture provision as essential.
C. Clear Delineation from Non-Compete and Consulting Arrangements
Current Draft Issue. The Draft Agreement contains non-competition agreements applicable to Dr. Carvallo and Dr. Ostrowski, set forth at Section [●] of the Draft Agreement, imposing a three-year post-closing restriction on competition within defined healthcare service lines and geographic markets. The non-compete provisions also include customary non-solicitation and non-disparagement covenants. Critically, the consideration for the non-competition covenants is not separately stated in the Draft Agreement. Instead, the non-compete section cross-references the "Contingent Consideration" (defined to include the earnout payments) as constituting, in part, the consideration for the restrictive covenants.
This cross-reference creates a direct and problematic linkage between the earnout and the non-competition agreements. Under the current drafting, the earnout payments are simultaneously characterized as (a) additional purchase price for the Pinnacle membership interests and (b) consideration for the restrictive covenants. These two characterizations are mutually inconsistent for tax purposes.
Recommended Revision. We recommend the following revisions:
First, the non-compete consideration must be separated entirely from the earnout. The non-competition agreements should identify specific, independently determined consideration that is funded from the fixed (non-contingent) portion of the purchase price, not from the contingent earnout payments. The Purchase Price Allocation Schedule currently under development allocates $17.4 million of the $412 million enterprise value to non-compete agreements, amortizable over a 15-year period as a Class V intangible under Section 1060 of the Code and the regulations thereunder. This $17.4 million should be identified as the sole consideration for the non-compete covenants, payable at closing as part of the fixed purchase price, and the non-compete section should contain no reference to the earnout or the Contingent Consideration.
Second, the earnout section of the Draft Agreement should include an express recital or covenant stating substantially as follows:
"The parties acknowledge and agree that the Earnout Payments constitute additional consideration for the Membership Interests sold by the Eligible Earnout Recipients pursuant to this Agreement and do not constitute, in whole or in part, compensation for services, deferred compensation, consideration for any covenant not to compete, or any other form of ordinary income. The Earnout Payments are not conditioned upon the continued employment of, or the provision of services by, any Eligible Earnout Recipient."
Third, to the extent Dr. Carvallo or Dr. Ostrowski will enter into post-closing consulting arrangements with the surviving entity, the consideration for any such consulting services should be separately negotiated, documented in standalone consulting agreements, and paid independently of the earnout. No consulting fees should be structured as a component of, or supplement to, the earnout.
Tax Rationale. If the earnout is characterized, even in part, as consideration for the non-competition covenants, the IRS may bifurcate the earnout payments, treating a portion as ordinary income allocable to the covenant not to compete. Amounts allocable to a covenant not to compete are treated as ordinary income to the recipient under established case law and IRS guidance, and are amortizable by the payor over a 15-year period as a Section 197 intangible. The current drafting invites precisely this bifurcation by expressly linking the earnout to the non-compete.
The Purchase Price Allocation already independently values the non-competition agreements at $17.4 million within the $412 million total enterprise value. This allocation is supportable under Section 1060 and the residual method prescribed by the regulations, and reflects an arm's length valuation of the restrictive covenants based on the duration of the non-compete period, the geographic and service-line scope of the restriction, and the competitive significance of Dr. Carvallo and Dr. Ostrowski in their respective markets. By funding the non-compete consideration from the fixed purchase price and severing all linkage to the earnout, we eliminate the risk of bifurcation and preserve the integrity of the earnout as additional purchase price.
D. Earnout Acceleration on Change of Control
Current Draft Issue. The Draft Agreement provides that 100% of any remaining unpaid earnout shall become immediately due and payable upon a "change of control" of Ardent Healthcare Holdings LLC occurring at any time during the earnout period. While this acceleration provision provides important liquidity protection for the selling members, the Draft Agreement does not specify the tax treatment of the accelerated payment. Moreover, the acceleration provision does not expressly state whether the accelerated payment is conditioned upon the continued employment of any seller at the time of the change of control, and does not address the allocation of the accelerated payment among the Eligible Earnout Recipients.
Recommended Revision. We recommend the following additions to the acceleration provision:
(i) Add an express statement that any accelerated earnout payment upon a change of control is treated, for all federal, state, and local income tax purposes, as additional purchase price for the Pinnacle membership interests, consistent with the treatment of regular earnout payments.
(ii) Clarify that the acceleration payment is payable to all Eligible Earnout Recipients without regard to the employment status of any individual recipient at the time of the change of control. The right to receive the accelerated payment should not be conditioned upon any seller's continued employment, provision of services, or compliance with any restrictive covenant.
(iii) Add language specifying that the accelerated amount shall be allocated among all Eligible Earnout Recipients on the same pro rata basis (in accordance with each recipient's percentage interest in Pinnacle immediately prior to the Closing) as applies to regular earnout payments.
(iv) If the change of control results in a disposition of the Eligible Earnout Recipients' equity interests in Ardent Healthcare Holdings LLC (e.g., through a secondary sale or merger at the Holdings level), the acceleration payment should be treated as an adjustment to the purchase price received in the change-of-control transaction, rather than as a separate payment.
Tax Rationale. Without express characterization language, there is a risk that the IRS could argue that an acceleration payment triggered by a change of control is analogous to a severance or change-in-control payment — a form of compensation that is triggered by a specified event relating to the employment or equity relationship between the recipient and the acquired company. This characterization risk is heightened if the acceleration is not available to all equity holders on a pro rata basis, or if it is conditioned on the continued employment of the Rollover Participants. By expressly characterizing the acceleration as additional purchase price, ensuring pro rata allocation, and eliminating any employment condition, we align the acceleration provision with the overall capital gain treatment of the earnout.
E. Section 483 Imputed Interest
Current Draft Issue. The Draft Agreement does not address Section 483 of the Internal Revenue Code, which provides rules for the imputation of interest on certain deferred payments arising from the sale of property. Under Section 483, where payment for the sale of property is deferred and the agreement does not provide for adequate stated interest, a portion of each deferred payment is treated as imputed interest (rather than as principal) for federal income tax purposes. The imputed interest portion is ordinary income to the recipient and deductible by the payor.
The earnout payments under the Draft Agreement are, by definition, deferred contingent payments — the Period 1 Payment will not be determinable or payable until after the expiration of Period 1 on May 31, 2025, and the Period 2 Payment will not be determinable or payable until after the expiration of Period 2 on May 31, 2026. To the extent these payments are made more than six months after the anticipated closing date of May 31, 2024, Section 483 will apply to impute interest on the deferred amounts.
Recommended Revision. We recommend the addition of a provision to the earnout section of the Draft Agreement addressing Section 483 as follows:
(i) The provision should acknowledge that, to the extent earnout payments are made more than one year after the Closing, a portion of each payment will be treated as imputed interest under Section 483 of the Code, calculated using the applicable federal rate ("AFR") in effect as of the anticipated signing date of the Draft Agreement (March 15, 2024).
(ii) Based on the AFR rates published by the IRS for March 2024, the applicable rates are as follows:
•  Short-term AFR (instruments with a term of three years or less): 5.12% (annual compounding)
•  Mid-term AFR (instruments with a term of more than three years but not more than nine years): 4.67% (annual compounding)
(iii) The Period 1 Payment, which is expected to become payable (if at all) following the expiration of Period 1 on May 31, 2025, will be subject to imputed interest at the short-term AFR of 5.12%, as the payment will be made more than six months but not more than three years after the Closing.
(iv) The Period 2 Payment, which is expected to become payable (if at all) following the expiration of Period 2 on May 31, 2026, will be subject to imputed interest at either the short-term AFR of 5.12% (if payable within three years of the Closing) or the mid-term AFR of 4.67% (if payable more than three years after the Closing), depending on the precise payment date.
(v) The provision should include a reporting covenant requiring the buyer (or the surviving entity) to report imputed interest consistently with Section 483 on all applicable information returns, including Schedules K-1 issued to the selling members and any Forms 1099-INT issued in connection with the imputed interest amounts.
Tax Rationale. Section 483 is a mandatory provision of the Code; the failure to address imputed interest in the agreement does not eliminate the parties' obligation to account for imputed interest on their respective tax returns. However, the absence of any contractual acknowledgment creates a significant risk of inconsistent reporting — a scenario in which the buyer reports imputed interest in a different amount, or for a different period, than the sellers. Inconsistent reporting between counterparties is a well-known audit trigger for the IRS and can result in "whipsaw" — a situation in which the IRS asserts adjustments against both parties simultaneously, each to the other's detriment.
By including an explicit acknowledgment of Section 483 in the Draft Agreement, specifying the applicable AFR rates, and imposing a mutual reporting covenant, we ensure that the buyer and the sellers calculate and report imputed interest on a consistent basis. This approach facilitates orderly Schedule K-1 preparation by the surviving entity (as a partnership for federal tax purposes), minimizes audit risk, and provides certainty to the individual selling members regarding the character of the amounts they receive (i.e., the bifurcation between imputed interest income and additional purchase price / capital gain).
F. Tax Reporting Cooperation Covenant
Current Draft Issue. The Draft Agreement contains a general tax cooperation covenant at Section [●], which requires the parties to "cooperate in good faith with respect to tax matters arising out of or relating to the transactions contemplated by this Agreement." While this general covenant is appropriate and should be retained, it does not specifically address the tax reporting of earnout payments — a matter that requires precision and specificity given the characterization issues discussed throughout this letter.
Recommended Revision. We recommend the addition of a specific earnout tax reporting covenant, either as a standalone provision within the earnout section or as a supplement to the general tax cooperation covenant. The recommended provision should include the following elements:
(i) Consistency Covenant. The parties shall report all earnout payments (including any accelerated payments upon a change of control) as additional purchase price for the Pinnacle membership interests, constituting amounts realized under Section 1001 of the Code giving rise to capital gain treatment, on all federal, state, and local income tax returns and information returns filed by the parties. Neither the buyer nor any seller shall take a position on any tax return or in any proceeding before a taxing authority that is inconsistent with this treatment, absent a "final determination" (within the meaning of Section 1313(a) of the Code) requiring a different treatment.
(ii) Information Return Obligations. The buyer (or Pinnacle, as the surviving entity in the merger) shall issue appropriate information returns reflecting the earnout payments as additional consideration for the sale of membership interests. For sellers who are treated as partners in a partnership for federal income tax purposes, the surviving entity shall report the earnout payments on the applicable Schedules K-1 (Form 1065) as additional amounts realized in connection with the sale or exchange of partnership interests. To the extent any Form 1099-S or other information return is required, such return shall be prepared consistently with the purchase price characterization.
(iii) Seller Reporting Covenant. Each selling member shall report the receipt of earnout payments on his or her individual federal, state, and local income tax returns consistently with the purchase price characterization, including (without limitation) the reporting of long-term capital gain on Schedule D (Form 1040) and, if applicable, the reporting of imputed interest income as described in Section III.E above.
(iv) No Inconsistent Position. Neither party shall take any position on any tax return, amended tax return, claim for refund, or in any audit, examination, or other proceeding before any taxing authority that is inconsistent with the agreed-upon tax treatment of the earnout payments, except to the extent required by a final determination within the meaning of Section 1313(a) of the Code.
Tax Rationale. Consistency between buyer and seller reporting is critical to minimizing the risk of an IRS audit adjustment. The most common scenario in which the IRS challenges earnout characterization is the "whipsaw" scenario: the buyer deducts the earnout payment as compensation expense (thereby reducing its taxable income), while the seller reports the same payment as capital gain (thereby benefiting from a preferential rate). When the IRS identifies this inconsistency — typically through information return matching programs — it has an incentive to challenge both positions. By imposing a binding consistency covenant, we eliminate the possibility of a whipsaw and present a unified position to the IRS that is more difficult to challenge.
Moreover, the consistency covenant provides practical benefits for the administration of the Transaction. It ensures that the surviving entity's Schedule K-1 reporting is aligned with the sellers' individual return reporting, reducing the likelihood of shareholder inquiries, amended return filings, and disputes between the parties regarding the proper tax treatment of the earnout.
G. Interaction with Rollover Equity
The Draft Agreement contemplates that three of the pre-closing Pinnacle members — Dr. Raymond Carvallo, Dr. Nadia Ostrowski, and Jonathan Farnsworth — will contribute a portion of their Pinnacle membership interests to Ardent Healthcare Holdings LLC ("Holdings LLC") in exchange for newly issued Class B Units of Holdings LLC (the "Rollover"). The Rollover is structured as a tax-deferred contribution under Section 721 of the Code, and no gain or loss is expected to be recognized by the Rollover Participants upon the contribution of their Pinnacle interests to Holdings LLC. The Rollover Participants will receive a carryover basis in their Class B Units equal to their adjusted tax basis in the contributed Pinnacle interests, under Section 722.
The following amounts are being contributed as rollover equity:
•  Dr. Raymond Carvallo: $32.41 million (representing 25% of his $129.65 million gross equity proceeds attributable to his 38.2% membership interest)
•  Dr. Nadia Ostrowski: $24.18 million (representing 25% of her $96.73 million gross equity proceeds attributable to her 28.5% membership interest)
•  Jonathan Farnsworth: $2.95 million (representing 15% of his $19.69 million gross equity proceeds attributable to his 5.8% membership interest)
•  Total Rollover: $59.54 million
The remaining portion of each Rollover Participant's membership interest — the "cashed-out" portion — is being sold for cash in the merger, generating taxable gain to the extent the cash consideration exceeds the Rollover Participant's allocated adjusted tax basis in the cashed-out portion.
Recommended Revision. We recommend that the Draft Agreement include an express provision clarifying the interaction between the earnout and the rollover equity, as follows:
(i) Earnout payments shall be allocated to the Rollover Participants only with respect to their cashed-out (non-rollover) portions of their Pinnacle membership interests. No earnout payment shall be allocated to, or treated as attributable to, the Pinnacle membership interests contributed by the Rollover Participants to Holdings LLC as rollover equity.
(ii) For purposes of calculating each Rollover Participant's pro rata share of the earnout, the denominator shall be the aggregate cashed-out membership interests of all pre-closing members (i.e., the total membership interests less the rollover interests), and the numerator shall be the individual Rollover Participant's cashed-out membership interest.
(iii) For the avoidance of doubt, the fourteen minority physician-investors (who are not Rollover Participants and are cashing out 100% of their membership interests) shall participate in the earnout on a pro rata basis based on 100% of their respective membership interests.
Tax Rationale. If earnout payments were allocated to the Rollover Participants with respect to their rolled-over interests, a fundamental inconsistency would arise with the tax-deferred contribution under Section 721. The Rollover is premised on the principle that the Rollover Participants are contributing their Pinnacle interests to Holdings LLC in exchange for Class B Units, with no additional consideration (including contingent consideration) being received for the contributed interests. If the earnout were treated as additional consideration for the contributed interests, the contribution would no longer qualify as a tax-free exchange under Section 721, potentially triggering immediate gain recognition on the rollover interests — a result that is contrary to the parties' intent and that would impose an unanticipated tax liability on the Rollover Participants.
To preserve the integrity of the Section 721 deferral, the earnout must be segregated from the rollover. Earnout payments should be treated as additional purchase price only for the cashed-out portions of the Rollover Participants' interests, which are the interests that are being sold for cash in a taxable transaction. This approach maintains a clean separation between the taxable sale (giving rise to gain recognition on the cashed-out portion, potentially reported under the installment method under Section 453, as discussed in our separate memorandum dated March 5, 2024) and the tax-deferred contribution (giving rise to no current gain recognition on the rollover portion).
IV. Summary of Recommended Changes
For ease of reference, the following table summarizes the issues identified in this letter, our recommended revisions, and the tax basis for each recommendation:
V. Coordination with Related Workstreams
We note that the comments set forth in this letter should be read and considered in conjunction with several related workstreams currently underway in connection with the Transaction:
1.  Earnout Tax Characterization Memorandum (March 1, 2024). Calderwood & Harkness's detailed memorandum analyzing the legal framework for the capital gain vs. compensation characterization of the earnout, including a review of applicable case law, IRS guidance, and the specific facts and circumstances of the Transaction. A copy of this memorandum is enclosed with this letter for ease of reference.
2.  Open Transaction vs. Closed Transaction / Installment Method Memorandum (March 5, 2024). Calderwood & Harkness's memorandum analyzing the individual selling members' reporting options under Sections 453 and 1001 of the Code, including the availability of installment sale reporting for the contingent earnout payments, the open transaction doctrine, and the maximum selling price rules applicable to contingent payment sales. This memorandum has been circulated to the Ardent Capital deal team and to Whitford & Gaines LLP for the sellers' consideration.
3.  Purchase Price Allocation Methodology. The Purchase Price Allocation under Section 1060 of the Code is currently being developed, with the preliminary allocation reflecting the $412 million enterprise value distributed across the applicable asset classes, including $17.4 million allocated to non-compete agreements (Class V, Section 197 intangibles), as referenced in Section III.C above. The final PPA will need to be coordinated with the earnout provisions to ensure consistency — in particular, the contingent earnout payments will need to be allocated across asset classes as and when they become fixed and determinable, consistent with the methodology established in the initial PPA.
4.  Tax Representations and Covenants Markup. Calderwood & Harkness is separately preparing a comprehensive markup of the tax representations, warranties, covenants, and indemnification provisions of the broader Draft Agreement. That markup will address, among other things, pre-closing tax compliance, tax return preparation and filing obligations, transfer taxes, FIRPTA compliance, and the tax treatment of pre-closing distributions. The earnout-specific comments in this letter are intended to be incorporated into the broader tax markup but are being provided in advance given the time-sensitive nature of the earnout negotiations.
5.  Seller's Counsel Consultation. We note that seller's counsel, Whitford & Gaines LLP (Patricia Engelman, Partner, Tax, and Kevin Driscoll, Associate), should be consulted regarding the sellers' willingness to accept the consistency covenant described in Section III.F above. The consistency covenant binds the individual selling members to a specific tax reporting position, and the sellers may wish to negotiate the scope of the covenant or seek their own independent tax advice before agreeing to be bound. We are prepared to engage directly with Ms. Engelman and Mr. Driscoll on this point at the appropriate time.
VI. Request for Revised Draft
In light of the foregoing comments, we respectfully request that Harcourt Shaw & DeVries LLP circulate a revised draft of the earnout sections of the Draft Agreement incorporating the recommendations set forth in this letter. We are happy to provide suggested contract language for any or all of the recommended provisions if that would be helpful to your drafting process, and we are prepared to review and comment on any revised language on an expedited basis.
Calderwood & Harkness is available to participate in a call with Harcourt Shaw & DeVries LLP, Whitford & Gaines LLP, and the Ardent Capital deal team (including Marcus Pellegrino) to discuss these comments and to resolve any open issues. Given the number of interrelated tax and commercial considerations, we believe a working session among all parties and their respective advisors would be the most efficient path to finalizing the earnout provisions.
We understand that the parties are targeting a signing date of March 15, 2024. Accordingly, we would respectfully suggest prioritizing the completion of the earnout provisions in the next round of drafts and scheduling any necessary calls for March 13 or 14. Our team — including Sylvia Hartwell (Partner, Tax) and Robert Jansen (Associate, Tax) — is available at your convenience during that window.
We appreciate your attention to these matters and look forward to working with you to finalize the earnout provisions in a manner that achieves the parties' commercial objectives while safeguarding the intended tax treatment.
Very truly yours,
CALDERWOOD & HARKNESS LLP
By: ________
Leonard Cross Partner, Tax Practice Group
One Liberty Plaza, 45th Floor New York, New York 10006 Telephone: (212) 554-7246
Email: lcross@calderwoodharkness.com
cc: (via email)
Marcus Pellegrino, Partner, Healthcare — Ardent Capital Partners III LP Claire Ashworth, Co-Founder & Managing Partner — Ardent Capital Partners III LP Patricia Engelman, Partner, Tax — Whitford & Gaines LLP Kevin Driscoll, Associate, M&A/Tax — Whitford & Gaines LLP Sylvia Hartwell, Partner, Tax — Calderwood & Harkness LLP Robert Jansen, Associate, Tax — Calderwood & Harkness LLP
Enclosure: Earnout Tax Characterization Memorandum dated March 1, 2024 (for reference)
Draft Section Reference | Issue | Recommended Change | Tax Basis
Earnout — Definition of "Eligible Earnout Recipients" | Term not clearly defined to include all pre-closing members on a pro rata basis | Expand definition to expressly include all 17 pre-closing Pinnacle members; allocate earnout strictly pro rata based on percentage interests | Pro rata allocation supports purchase price characterization; excludes inference that payments are targeted to service providers
Section [●](d) — Forfeiture-for-Termination | Rollover Participants forfeit earnout share if terminated for Cause during earnout period | Delete forfeiture provision entirely; no earnout conditioned on employment; address retention through separate employment/equity arrangements | Employment-contingent forfeiture is a hallmark of compensatory treatment; triggers ordinary income, FICA/Medicare exposure, and withholding obligations
Section [●] — Non-Competition Agreement | Non-compete consideration cross-references earnout ("Contingent Consideration") as partial consideration for restrictive covenants | Sever non-compete consideration from earnout; fund non-compete from fixed purchase price ($17.4M allocated to non-compete under PPA); add express recital that earnout is not non-compete consideration | Cross-reference invites IRS bifurcation; amounts allocable to non-compete are ordinary income under Section 197; PPA independently values non-compete at $17.4M
Earnout — Change of Control Acceleration | Acceleration provision does not specify tax treatment; silent on employment condition and allocation | Add express statement treating acceleration as additional purchase price; confirm pro rata allocation among all Eligible Earnout Recipients; confirm no employment condition | Prevents characterization as severance-like / change-of-control compensation; ensures consistency with regular earnout treatment
Earnout — Section 483 Imputed Interest | Draft Agreement does not address Section 483 imputed interest on deferred payments | Add acknowledgment of Section 483; specify AFR rates (5.12% short-term; 4.67% mid-term); add reporting covenant for consistent imputed interest treatment | Section 483 is mandatory; explicit acknowledgment ensures consistent buyer/seller reporting and prevents IRS whipsaw
Tax Cooperation — Earnout Reporting | General cooperation covenant does not specifically address earnout tax reporting | Add specific covenant requiring buyer and sellers to report earnout as additional purchase price (capital gain) on all returns; no inconsistent position absent final determination under Section 1313 | Consistency prevents whipsaw; reduces audit risk; facilitates orderly K-1 and 1099 reporting
Earnout — Interaction with Rollover Equity | Draft Agreement does not address allocation of earnout between cashed-out and rollover interests | Clarify that earnout applies only to cashed-out portions of Rollover Participants' interests; no earnout attributed to interests contributed under Section 721 | Allocation to rollover interests would be inconsistent with Section 721 deferral and could trigger gain recognition on contributed interests

CALDERWOOD & HARKNESS LLP Attorneys at Law

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