PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
INTERNAL KNOWLEDGE MANAGEMENT MEMORANDUM
CALDERWOOD & HARKNESS LLP One Liberty Plaza, 45th Floor New York, NY 10006
Date: June 25, 2024
To: Knowledge Management Committee, Calderwood & Harkness LLP Leonard Cross, Responsible Partner, Tax Sylvia Hartwell, Billing Partner, Tax
From: Robert Jansen, Lead Associate, Tax Garrett Simmons, Working Associate, Tax
Re: Engagement Summary and Lessons Learned — Tax Structuring for Ardent Capital Partners III LP Acquisition of Pinnacle Health Services Group LLC
Matter Number: 1001-00006
Engagement Number: 1001-00006
Engagement Status: Closed — Completed
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I. Executive Summary
Calderwood & Harkness LLP served as tax counsel to Ardent Capital Partners III LP ("Ardent Capital" or "Fund III"), a Delaware limited partnership (EIN 87-3491520) headquartered at 600 Lexington Avenue, 38th Floor, New York, NY 10022, in connection with the acquisition of 100% of the membership interests in Pinnacle Health Services Group LLC ("Pinnacle" or "PHSG"), a Delaware limited liability company taxed as a partnership for federal income tax purposes (EIN 82-1947632), headquartered at 2200 Renaissance Boulevard, Suite 400, King of Prussia, PA 19406. The engagement encompassed the full spectrum of federal, state, and local tax structuring, advisory, documentation, and compliance guidance in support of this middle-market healthcare platform acquisition.
Pinnacle operates 34 urgent care clinics and 8 ambulatory surgery centers, for a total of 42 facilities, across five states: Pennsylvania, Virginia, Maryland, North Carolina, and Georgia. The company employs approximately 1,620 individuals, including 142 employed physicians, and is one of the larger independent multi-site urgent care and ambulatory surgery platforms in the mid-Atlantic and southeastern United States.
The transaction was valued at an enterprise value of $412 million, with an equity value of $339.4 million (enterprise value minus $72.6 million in net debt). The implied EV/EBITDA multiple was 7.95x, based on 2023 adjusted EBITDA of $51.8 million and 2023 revenue of $287.4 million. The acquisition was financed through a combination of Fund III committed equity ($198.5 million), rollover equity from three members of Pinnacle's founding management team ($59.54 million), senior secured credit facilities ($190 million aggregate commitments), and mezzanine debt ($30 million).
The engagement was opened on January 10, 2024, following completion of conflict checks on January 8, 2024. The Merger Agreement was signed on March 15, 2024, and the transaction closed on May 31, 2024. The engagement was formally closed on June 25, 2024, upon delivery of this memorandum and completion of all post-closing tax deliverables.
The scope of Calderwood & Harkness's tax engagement encompassed entity selection for the acquisition vehicle, management rollover equity treatment (including profits interest and Section 83(b) election analysis), earnout tax characterization, Section 338(h)(10) election analysis versus Section 754 election analysis, purchase price allocation under the Section 1060 residual method, Tax Receivable Agreement structuring and negotiation, and state and local tax optimization across five operating states plus New York nexus analysis for the holding company structure. Calderwood & Harkness coordinated closely with Harcourt Shaw & DeVries LLP (buyer's M&A counsel), Whitford & Gaines LLP (seller's counsel), Caldwell Pratt & Moorehouse LLP (buyer's accounting firm), Brewer Stanfield & Associates LLP (seller's accounting firm), and Northmark Advisory Group LLC (quality of earnings provider).
The engagement was staffed by Leonard Cross as Responsible Partner, Sylvia Hartwell as Billing Partner, Robert Jansen as Lead Associate, and Garrett Simmons as Working Associate. Actual billed fees totaled $1,742,350, against a fee cap of $2.0 million (inclusive of expenses, exclusive of filing fees), representing a savings of approximately $257,650 against the cap and approximately $107,650 against the initial budget estimate of $1.85 million.
This memorandum summarizes the engagement, documents key structuring decisions and their rationales, catalogs all deliverables, identifies lessons learned for future engagements, and recommends precedent documents for inclusion in Calderwood & Harkness's knowledge management database.
II. Engagement Team and Key Client Contacts
A. Calderwood & Harkness Team
The following Calderwood & Harkness attorneys staffed this engagement:
Leonard Cross served as the primary partner contact for Dominic Ferrera and Claire Ashworth (Co-Founders of Ardent Capital) and maintained the senior-level client relationship throughout the engagement. Robert Jansen served as the primary day-to-day contact for Marcus Pellegrino (Partner, Healthcare at Ardent Capital) and for coordinating counsel at both Harcourt Shaw & DeVries LLP and Whitford & Gaines LLP on all tax workstream matters.
B. Client Contacts at Ardent Capital Partners III LP
The following individuals at Ardent Capital served as the primary client contacts for this engagement:
• Dominic Ferrera — Co-Founder & Managing Partner. Senior client sponsor; involved in key structuring decisions and final approval of tax opinion letter.
• Claire Ashworth — Co-Founder & Managing Partner. Co-sponsor; involved in budget approval and TRA negotiation strategy.
• Marcus Pellegrino — Partner, Healthcare. Primary day-to-day contact on the Ardent Capital deal team; responsible for coordinating tax workstream inputs with other advisors and managing internal Ardent Capital diligence and approval processes.
C. Counterparty and Coordinating Counsel
Calderwood & Harkness coordinated with the following law firms throughout the engagement:
Harcourt Shaw & DeVries LLP — Buyer's M&A Counsel 51 West 52nd Street, New York, NY 10019
• Thomas Kundra, Partner, M&A — lead M&A partner; responsible for Merger Agreement negotiation and LLC agreement governance provisions.
• Allison Cho, Associate, M&A — primary drafting associate for Merger Agreement, ancillary transaction documents, and closing mechanics.
Calderwood & Harkness's coordination with Harcourt Shaw was extensive, particularly with respect to the structure chart, tax representations and covenants in the Merger Agreement, tax indemnity provisions, earnout drafting, and LLC agreement tax provisions for Holdings LLC. The coordination between the tax workstream (Calderwood & Harkness) and the M&A workstream (Harcourt Shaw) is discussed further in the lessons learned section of this memorandum.
Whitford & Gaines LLP — Seller's Counsel 1735 Market Street, Suite 2800, Philadelphia, PA 19103
• Patricia Engelman, Partner, Tax — seller's tax counsel; counterpart to Leonard Cross; responsible for seller-side tax analysis, TRA negotiation, and review of tax representations.
• Kevin Driscoll, Associate, M&A/Tax — seller's associate responsible for markup of tax provisions and coordination on closing deliverables.
D. Other Advisors
The following additional advisors participated in or were relevant to the tax workstream:
• Meridian Tuck Partners LLC — Financial advisor to Ardent Capital. Daniel Kessler, Managing Director. Provided transaction valuation support and coordinated with Calderwood & Harkness on purchase price allocation inputs.
• Larchmont & Co. — Financial advisor to Pinnacle and the selling members. Sarah Quinlan, Managing Director.
• Caldwell Pratt & Moorehouse LLP — Accounting and audit firm for Ardent Capital, based in New York, NY. Responsible for post-closing tax return preparation and ongoing TRA administration. All post-closing tax compliance obligations were transitioned to Caldwell Pratt per the post-closing tax integration memorandum.
• Brewer Stanfield & Associates LLP — Accounting and audit firm for Pinnacle, based in Philadelphia, PA. Provided historical tax return data, inside basis schedules, and depreciation records during due diligence.
• Northmark Advisory Group LLC — Quality of earnings provider, based in Chicago, IL, retained by Ardent Capital. Provided adjusted EBITDA analysis and, through its valuation team, supported intangible asset identification and valuation for purchase price allocation purposes.
• Graystone National Bank, N.A. — Senior lender and administrative agent for the senior secured credit facilities, based in New York, NY. Syndicate members included Ridgepoint Capital Markets LLC (New York, NY) and Thorncrest Credit Partners LP (Chicago, IL).
• Cascadia Mezzanine Fund IV LP — Mezzanine lender, based in San Francisco, CA. Provided $30 million in subordinated notes with equity warrants.
• Bellhaven Risk Advisors LLC — Representations and warranties insurance broker, based in New York, NY. Placed R&W policy with Continental Indemnity Partners Ltd., policy number CIP-RWI-2024-03821, with a policy limit of $20.75 million and retention of $1.0 million.
• Ironbridge Trust Company, N.A. — Escrow agent, based in Wilmington, DE. Escrow agreement reference number ITC-ESC-2024-05312. Administered both the general indemnity escrow ($10.3 million) and the tax indemnity escrow ($4.12 million).
III. Transaction Overview
A. Transaction Structure
The transaction was structured as a reverse merger in which Ardent Healthcare Merger Sub LLC, a newly formed Delaware limited liability company (Delaware File No. 7834227), merged with and into Pinnacle Health Services Group LLC, with Pinnacle surviving the merger as a wholly owned subsidiary of the buyer group. This structure was selected to preserve Pinnacle's existing contracts, licenses, state regulatory approvals, and tax attributes, including its classification as a partnership for federal income tax purposes.
Calderwood & Harkness designed and implemented a three-tier acquisition structure to achieve the client's tax, regulatory, and governance objectives:
Tier 1: Ardent Healthcare Holdings LLC
Ardent Healthcare Holdings LLC was formed as a Delaware limited liability company (Delaware File No. 7834219; EIN 93-2187445) and is classified as a partnership for federal income tax purposes under the default classification rules (no check-the-box election was filed). Holdings LLC serves as the equity aggregator for the acquisition, holding the equity contributions from Fund III ($198.5 million in committed equity), the rollover equity from the three rolling management members ($59.54 million in Class B Units), and all management incentive equity (profits interests). In addition, Holdings LLC issued warrants representing 2.5% of its fully diluted equity to Cascadia Mezzanine Fund IV LP in connection with the mezzanine financing. Holdings LLC is the sole equity holder of Ardent Healthcare Intermediate Inc. (Tier 2).
Tier 2: Ardent Healthcare Intermediate Inc.
Ardent Healthcare Intermediate Inc. was formed as a Delaware C-corporation (Delaware File No. 7834223; EIN 93-2187512) and is wholly owned by Holdings LLC. Intermediate Inc. serves as a blocker entity between the partnership-level Holdings LLC and the operating-level Pinnacle entity. The blocker entity was included in the structure for three principal reasons, discussed in detail in Section IV.A below: (i) UBTI blocking for Fund III's tax-exempt limited partners, (ii) IPO readiness for a potential future public offering, and (iii) state tax nexus isolation. Intermediate Inc. holds 100% of the membership interests in the surviving Pinnacle entity following the merger.
Tier 3: Pinnacle Health Services Group LLC (Surviving Entity)
Pinnacle Health Services Group LLC, the target entity, survived the merger and continues to be classified as a partnership for federal income tax purposes. Pinnacle is the direct operating entity and the employer of all Pinnacle personnel, including the 142 employed physicians. Following the closing, Pinnacle is a wholly owned subsidiary of Intermediate Inc.
The registered agent for all three newly formed Delaware entities is Pemberton Industries, 251 Little Falls Drive, Wilmington, DE 19808.
B. Financing Structure
The acquisition was financed through a combination of equity and debt as follows:
Senior Secured Credit Facility
The senior secured credit facility was arranged by Graystone National Bank, N.A., acting as administrative agent and one of the initial lenders. The facility consisted of two tranches:
• Term Loan B: $155 million principal amount, bearing interest at SOFR plus 425 basis points, with a seven-year maturity. The Term Loan B was drawn in full at closing to fund a portion of the acquisition consideration.
• Revolving Credit Facility: $35 million aggregate commitment, bearing interest at SOFR plus 375 basis points, with a five-year maturity. The revolving facility was undrawn at closing and is available for working capital and general corporate purposes.
The senior credit facility was syndicated among Graystone National Bank, N.A., Ridgepoint Capital Markets LLC (New York, NY), and Thorncrest Credit Partners LP (Chicago, IL). The facility is secured by substantially all assets of Intermediate Inc. and Pinnacle.
Mezzanine Facility
Cascadia Mezzanine Fund IV LP (San Francisco, CA) provided $30 million in subordinated notes, bearing interest at 12.5% cash pay and 2.0% payment-in-kind, with an eight-year maturity. In connection with the mezzanine facility, Holdings LLC issued warrants to Cascadia representing 2.5% of the fully diluted equity of Holdings LLC, exercisable at a nominal strike price. The warrants are treated as equity for tax purposes and were accounted for in the post-closing capitalization table.
Equity
Fund III committed $198.5 million in equity to Holdings LLC, and the three rollover participants contributed an aggregate of $59.54 million in rollover equity (Class B Units of Holdings LLC), as described in Section III.C below.
C. Sellers and Rollover Participants
Pinnacle's pre-closing membership interests were held by three members of the founding management team and 14 minority physician-investors. The following table summarizes the ownership structure, equity proceeds, and rollover participation:
Note: Gross equity proceeds above reflect equity value allocated to each member based on membership interest percentage. Aggregate gross equity proceeds equal $274.4 million rather than $339.4 million because the residual equity value (approximately $65 million) represents accrued but unpaid management fees, transaction expenses, and other adjustments reflected in the closing funds flow but not allocated to individual membership interests. The total consideration paid by the buyer group, including assumption of net debt, equaled the $412 million enterprise value.
Total rollover equity of $59.54 million represents 23.08% of post-closing equity in Holdings LLC on a pre-dilution basis and 22.50% on a fully diluted basis (after accounting for the 2.5% equity warrants issued to Cascadia Mezzanine Fund IV LP). The rollover was structured as a contribution of membership interests to Holdings LLC in exchange for Class B Units, treated as a tax-free contribution under Section 721 of the Internal Revenue Code, as discussed in Section IV.C below.
D. Earnout
The Merger Agreement includes an earnout provision providing for contingent consideration of up to $35 million in the aggregate, payable to the pre-closing Pinnacle members (including the rollover participants on their cashed-out portions and the non-rollover minority physician-investors) based on the achievement of specified EBITDA targets:
• Period 1: June 1, 2024 through May 31, 2025. Target EBITDA of $58.0 million. If achieved, payout of $15.0 million.
• Period 2: June 1, 2025 through May 31, 2026. Target EBITDA of $65.0 million. If achieved, payout of $20.0 million.
The maximum aggregate earnout payable is $35 million. In addition, the Merger Agreement provides for 100% acceleration of all remaining unpaid earnout amounts upon a change of control of Holdings LLC during the earnout period.
The tax characterization of the earnout payments is discussed in detail in Section IV.D below.
E. Escrow
Two escrow accounts were established at closing with Ironbridge Trust Company, N.A. (Wilmington, DE) as escrow agent, pursuant to escrow agreement reference number ITC-ESC-2024-05312:
• General Indemnity Escrow: $10.3 million, representing 2.5% of equity value. Available to satisfy claims under the general indemnity provisions of the Merger Agreement. Scheduled for release 18 months following closing, subject to any pending or unresolved claims.
• Tax Indemnity Escrow: $4.12 million, representing 1.0% of enterprise value. Available to satisfy claims for pre-closing tax liabilities, including any adjustments resulting from audit or examination of Pinnacle's pre-closing tax returns. Scheduled for release upon expiration of the applicable statutes of limitation for pre-closing tax periods, subject to extensions.
F. Key Dates
The following chronology sets forth the key milestones and deliverable dates for the engagement:
IV. Key Structuring Decisions and Analysis
This section summarizes the principal tax structuring decisions made during the engagement, the analysis underlying each decision, and the lessons learned. These descriptions are intended to serve as a reference for future engagements involving similar structures and to facilitate the knowledge management committee's evaluation of the engagement.
A. Entity Selection: Partnership vs. Corporate Acquisition Structure
Analytical Framework. At the outset of the engagement, Calderwood & Harkness evaluated the optimal tax classification for the acquisition structure. Pinnacle was already classified as a partnership for federal income tax purposes under its existing operating agreement (dated August 12, 2016, as amended March 3, 2020), and no check-the-box election had been filed. Maintaining Pinnacle's partnership classification preserved the buyer's ability to obtain a Section 743(b) basis step-up with respect to the portion of the purchase price exceeding Pinnacle's inside basis, without triggering entity-level tax on the deemed sale of assets that would result from a reclassification.
Three-Tier Structure Rationale
Calderwood & Harkness recommended, and the client adopted, a three-tier acquisition structure: Holdings LLC (partnership) → Intermediate Inc. (C-corporation blocker) → Pinnacle (partnership). Each tier serves a distinct purpose in the overall structure:
Holdings LLC as Partnership. The selection of partnership classification for the top-tier holding entity was driven by four considerations:
(i) Tax-deferred rollover under Section 721. The contribution of rollover equity by Carvallo, Ostrowski, and Marsh to Holdings LLC in exchange for Class B Units qualifies as a tax-free contribution to a partnership under Section 721 of the Internal Revenue Code, provided no disguised sale or investment company issues are present. This treatment defers gain recognition for the rolling members, which was a significant economic term for the sellers.
(ii) Flexible allocation provisions under Section 704(b). Partnership classification permits the use of targeted allocations, waterfall distributions, and other flexible economic arrangements in the LLC agreement that would not be available in a corporate structure without creating multiple classes of stock (with attendant tax complexity).
(iii) Tax distribution mechanism. The Holdings LLC operating agreement includes mandatory tax distributions to members in amounts sufficient to cover their estimated federal and state income tax obligations attributable to their allocable share of Holdings LLC income. This mechanism ensures that individual rollover members and Fund III are not required to fund tax liabilities out-of-pocket.
(iv) Profits interest issuance for management incentive equity. Partnership classification enables the issuance of profits interests to management and key employees that qualify for favorable tax treatment under Revenue Procedure 93-27 and Revenue Procedure 2001-43, with no income inclusion at grant (provided the safe harbor requirements are satisfied) and capital gain treatment upon disposition.
Intermediate Inc. as C-Corporation blocker. The insertion of a C-corporation blocker between Holdings LLC and the operating entity was recommended for three reasons:
(i) UBTI blocking for tax-exempt limited partners. Fund III includes several tax-exempt institutional limited partners (including university endowments and charitable foundations) that are subject to unrelated business taxable income ("UBTI") rules under Sections 511 through 514 of the Code. If these limited partners were treated as directly or indirectly holding partnership interests in an operating business (particularly one financed with acquisition debt), the income flowing through would constitute UBTI. Interposing a C-corporation between the partnership-level Holdings LLC and the operating-level Pinnacle entity blocks the flow-through of UBTI to the tax-exempt investors, as dividends received from a C-corporation are generally excluded from UBTI.
(ii) IPO readiness. Ardent Capital's investment thesis contemplates a potential initial public offering as one exit pathway within a three-to-five-year hold period. Having a C-corporation already in place at the intermediate level facilitates a future IPO transaction without the need for a taxable reorganization or conversion at that time.
(iii) State tax nexus isolation. The blocker structure isolates operating-level state tax liability at Intermediate Inc. and Pinnacle, rather than having state-source income flow directly through Holdings LLC to Fund III and its limited partners. This mitigates the risk of creating state tax filing obligations for Fund III's limited partners in each of the five operating states.
Lesson Learned. Early coordination with M&A counsel (Harcourt Shaw & DeVries LLP) on the structure chart was essential. The initial draft of the structure chart prepared by Harcourt Shaw's deal team omitted the blocker entity (Intermediate Inc.), which required a structural revision after the preliminary structure memo was delivered. The omission was identified during Calderwood & Harkness's review of the first draft Merger Agreement, which had been drafted to reflect a two-tier structure (Holdings LLC directly acquiring Pinnacle). This resulted in approximately two days of additional drafting time to revise the Merger Agreement, ancillary documents, and entity formation filings.
Recommendation: For future engagements, Calderwood & Harkness should provide a preliminary structure chart — including the blocker entity, if applicable — to M&A counsel no later than the first week of the engagement to avoid structural revisions to the Merger Agreement and related documents.
B. Section 338(h)(10) vs. Section 754 Election
Analysis Conducted. Calderwood & Harkness analyzed two alternative approaches to obtaining a stepped-up tax basis in Pinnacle's assets:
Alternative 1: Check-the-box Election Followed by Section 338(h)(10). Under this approach, Pinnacle would file a check-the-box election (Form 8832) to be classified as a corporation for federal income tax purposes, effective immediately prior to closing. The parties would then jointly elect under Section 338(h)(10) to treat the stock acquisition as a deemed asset purchase, generating a full step-up in the tax basis of Pinnacle's assets to fair market value. However, the filing of a check-the-box election from partnership to corporation status triggers a deemed contribution of all partnership assets to the newly classified corporation under Section 351, followed by a deemed liquidating distribution of corporate stock to the partners. The subsequent Section 338(h)(10) election would then trigger a deemed sale of all assets at fair market value, followed by a deemed liquidation of the corporation.
Calderwood & Harkness modeled the tax consequences of this approach and determined that the deemed liquidation of the partnership (upon the check-the-box election) and subsequent deemed asset sale (under Section 338(h)(10)) would trigger approximately $48.3 million in incremental seller-level gain. This amount represents the difference between the equity value paid for the membership interests ($339.4 million) and the aggregate outside basis of the selling members ($291.1 million). The incremental gain would be borne by the sellers and would need to be compensated through a gross-up in the purchase price to achieve seller neutrality — an amount that substantially exceeded the buyer-side tax benefit.
The buyer-side benefit of the Section 338(h)(10) election was estimated at approximately $31.7 million in net present value, computed using a 25% blended federal and state tax rate, 15-year amortization of $412 million in stepped-up asset basis, and a discount rate of 8%. Because the seller-side cost ($48.3 million) exceeded the buyer-side benefit ($31.7 million), the 338(h)(10) approach was value-destructive on a combined basis and would not have been achievable without a purchase price gross-up that was unacceptable to the client.
Alternative 2: Section 754 Election. Under this approach, Pinnacle's partnership classification is maintained, and Pinnacle files a Section 754 election with its 2024 partnership tax return (Form 1065). The Section 754 election triggers a Section 743(b) basis adjustment in favor of Ardent Healthcare Intermediate Inc. (as the transferee of the membership interests) equal to the difference between Intermediate Inc.'s outside basis in its Pinnacle membership interest (equal to the purchase price allocated to the membership interests) and Pinnacle's existing inside basis in its assets.
Calderwood & Harkness computed the Section 743(b) basis step-up at $224.4 million ($412.0 million enterprise value minus $187.6 million Pinnacle inside basis). This step-up is allocated among Pinnacle's assets under the Section 755 regulations and is amortizable or depreciable over the applicable recovery periods.
The annual amortization deduction attributable to the Section 743(b) step-up was estimated at $20.04 million per year, based on a weighted-average useful life of 11.2 years (reflecting the mix of tangible and intangible assets in the purchase price allocation). The annual tax benefit was estimated at $5.01 million per year ($20.04 million × 25% blended federal and state tax rate).
Decision. Calderwood & Harkness recommended, and the client adopted, the Section 754 election approach. This approach preserves the tax benefit of the basis step-up for the buyer without imposing incremental tax cost on the sellers, and it avoids the complexity and transactional risk associated with the check-the-box election and deemed liquidation under the 338(h)(10) alternative.
The Section 754 election is to be filed with Pinnacle's 2024 partnership return (Form 1065) for the taxable year ending December 31, 2024. Calderwood & Harkness prepared a draft of the Section 754 election statement at closing and delivered it to Caldwell Pratt & Moorehouse LLP for inclusion in the 2024 return.
Lesson Learned. Seller's counsel (Whitford & Gaines LLP, Patricia Engelman) initially resisted providing the aggregate outside basis data for the pre-closing Pinnacle members that was needed to model the 338(h)(10) alternative. The data request was not included in the initial due diligence request list prepared by Harcourt Shaw, and Calderwood & Harkness's request for this information was made informally by email during the third week of the engagement. Seller's counsel questioned the relevance of the data to the buyer's analysis and expressed concern about sharing sensitive tax basis information. The issue was resolved through a discussion between Leonard Cross and Patricia Engelman, but the delay consumed approximately one week.
Recommendation: For future engagements, Calderwood & Harkness should build the tax basis data request (including aggregate outside basis, inside basis, Section 704(c) layers, and depreciation schedules) into the initial due diligence request list prepared by or in coordination with M&A counsel, and should formalize the request in a dedicated tax data request letter delivered within the first two weeks of the engagement. This approach establishes the legitimacy of the request early in the process and avoids the perception that it is an afterthought.
C. Rollover Equity — Section 721 Treatment
Structure. Total rollover equity of $59.54 million was contributed to Holdings LLC in exchange for Class B Units. The three rollover participants are Dr. Raymond Carvallo ($32.41 million), Dr. Nadia Ostrowski ($24.18 million), and Jonathan Marsh ($2.95 million). The Class B Units represent economic interests in Holdings LLC that participate in distributions and allocations alongside the Class A Units held by Fund III, subject to the waterfall and distribution priority provisions of the Holdings LLC operating agreement.
Analysis of Section 721 vs. Section 351
Calderwood & Harkness analyzed two potential non-recognition provisions for the rollover contributions:
Section 721 (Partnership Contribution). Section 721(a) provides that no gain or loss is recognized by a partnership or any of its partners when property is contributed to the partnership in exchange for a partnership interest. Because Holdings LLC is classified as a partnership for federal tax purposes, the contribution of rollover equity (consisting of a portion of each rollover participant's membership interest in Pinnacle) in exchange for Class B Units qualifies for non-recognition under Section 721(a), provided the transaction does not constitute a disguised sale under Section 707(a)(2)(B) or a contribution to an investment company under Section 721(b).
Calderwood & Harkness confirmed that neither exception applied: (i) the disguised sale rules were not implicated because the rollover participants did not receive any distribution from Holdings LLC within two years of their contribution (and the transaction was structured to satisfy the presumption against disguised sale treatment under the Treasury Regulations), and (ii) the investment company rules were not implicated because Holdings LLC's assets consist of operating business interests rather than marketable securities.
Section 351 (Corporate Contribution). Section 351(a) provides for non-recognition on contributions of property to a corporation in exchange for stock, provided the contributing persons are in "control" (defined as 80% ownership) of the corporation immediately after the exchange. Although the 80% control test was satisfied in this case (Fund III and the rollover participants collectively owned 100% of Holdings LLC), Section 351 was analyzed only as an alternative framework because Holdings LLC is not classified as a corporation.
Recommendation. Calderwood & Harkness recommended Section 721 treatment at the Holdings LLC level for three reasons:
(i) Preserves basis step-up. Under Section 721, the rollover participants take a carryover basis in their Class B Units equal to their adjusted basis in the contributed Pinnacle membership interests. Holdings LLC takes a carryover basis in the contributed interests, and the Section 743(b) adjustment is computed at the Pinnacle level (not the Holdings LLC level), ensuring the buyer's basis step-up is preserved.
(ii) Avoids gain recognition for contributing members. Non-recognition treatment under Section 721 is automatic for qualifying contributions to a partnership and does not require a formal election or filing.
(iii) No control requirement. Unlike Section 351, which requires the transferors to hold at least 80% of the corporation's stock immediately after the exchange, Section 721 has no comparable control test. This is significant because it avoids constraining future equity issuances to management or other parties that might dilute the rollover participants below the 80% threshold.
Vesting Structure. The rollover equity is subject to the following vesting schedule:
• 50% vested at closing ($29.77 million): This portion is fully vested and non-forfeitable upon the closing of the transaction.
• 50% vesting ratably over 36 months ($29.77 million): This portion vests in equal monthly installments over the 36-month period following closing, subject to the rollover participant's continued employment with Pinnacle (or its affiliates). The unvested component is allocated as follows: Carvallo $16.21 million, Ostrowski $12.09 million, Marsh $1.48 million.
The unvested rollover equity is treated as profits interests under Revenue Procedure 93-27 and Revenue Procedure 2001-43 for federal income tax purposes. Under Rev. Proc. 93-27, the receipt of a profits interest in a partnership for services is not a taxable event if: (a) the profits interest does not relate to a substantially certain and predictable stream of income, (b) the interest is not disposed of within two years, and (c) the interest is not a limited partnership interest in a publicly traded partnership. Calderwood & Harkness confirmed that all three conditions are satisfied.
Section 83(b) Elections
Because the unvested rollover equity is subject to a substantial risk of forfeiture (i.e., the 36-month vesting schedule), the rollover participants would ordinarily recognize ordinary income upon each vesting date equal to the fair market value of the vesting interest at that time (less any amount paid). To avoid this outcome, Calderwood & Harkness recommended that each rollover participant file a Section 83(b) election within 30 days of the closing date, thereby electing to include the value of the unvested interests in income at the time of receipt (when the liquidation value of the profits interest is zero or de minimis) rather than upon vesting.
Calderwood & Harkness prepared template Section 83(b) election forms and transmittal letters for Carvallo, Ostrowski, and Marsh, with instructions for filing via certified mail with the applicable IRS service center. The filing deadline is June 30, 2024 (30 days after the May 31, 2024 closing). As of the date of this memorandum, filing instructions have been delivered to all three rollover participants, and Calderwood & Harkness has confirmed that each participant has received the election materials.
Lesson Learned. Coordination between Calderwood & Harkness (tax counsel), Harcourt Shaw & DeVries LLP (M&A/governance counsel), and Whitford & Gaines LLP (seller's counsel) on the LLC agreement economic terms governing the Class A Units and Class B Units was notably time-intensive. The principal area of complexity was the interaction between the tax provisions (Section 704(b) capital accounts, Section 704(c) remedial method allocations, minimum gain chargebacks, qualified income offset provisions, and tax distribution mechanics) and the governance provisions (waterfall distributions, consent rights, transfer restrictions, and tag-along/drag-along rights). The tax provisions markup was delivered on March 10, 2024, but the governance provisions were still being negotiated by M&A counsel through the end of March, requiring Calderwood & Harkness to revise the tax provisions markup three times to conform to the evolving governance terms.
Recommendation: For future engagements, Calderwood & Harkness should create a joint tax/governance term sheet for Class A/Class B economic terms at the outset of the engagement and circulate it among tax counsel, M&A counsel, and seller's counsel before LLC agreement drafting begins. This approach establishes alignment on the economic terms before either the tax provisions or the governance provisions are drafted in full, reducing the number of serial revision cycles. Additionally, the LLC agreement tax provisions markup should be drafted concurrently with M&A counsel's governance provisions, rather than sequentially, to minimize rework.
D. Earnout Tax Characterization
Structure and Analysis
The Merger Agreement provides for contingent earnout payments of up to $35 million, payable in two periods based on the achievement of specified EBITDA targets. The critical tax question is whether the earnout payments are properly characterized as additional purchase price (resulting in capital gain to the sellers) or as compensation for services (resulting in ordinary income to the recipients and a corresponding deduction to the buyer).
Calderwood & Harkness recommended treatment of the earnout payments as additional purchase price, resulting in capital gain to the sellers, based on the following structuring safeguards:
(i) Pro rata allocation. The earnout payments are allocated pro rata among all pre-closing Pinnacle members based on their respective membership interest percentages, including the rollover participants (on their cashed-out portions) and the 14 non-rollover minority physician-investors. The pro rata allocation among all members — including passive investors with no ongoing employment relationship — is strong evidence that the payments are purchase price rather than compensation.
(ii) No forfeiture-for-termination-of-employment. The earnout payments are not conditioned on any seller's continued employment with Pinnacle or its affiliates. A seller who terminates employment or is terminated during the earnout period remains entitled to his or her pro rata share of any earnout payments.
(iii) Clear delineation from consulting and non-compete arrangements. The earnout provisions in the Merger Agreement are distinct and separate from any non-compete agreements, consulting arrangements, or employment agreements entered into by the selling members. The consideration for the non-compete agreements ($17.4 million, allocated among the five-year non-compete covenants) is separately stated and separately paid, and is not cross-referenced or linked to the earnout provisions.
Imputed Interest. Section 483 of the Code applies to earnout payments that are deferred more than one year after the date of the sale. Because the Period 2 earnout payment (if earned) would not be paid until after May 31, 2026, a portion of such payment will be recharacterized as imputed interest. The applicable federal rate ("AFR") at the time of signing (March 2024) was 5.12% (short-term) and 4.67% (mid-term). Calderwood & Harkness provided guidance on the imputed interest computation in the earnout tax characterization memorandum and recommended that the imputed interest be reported separately on each seller's tax return.
Earnout Acceleration. The Merger Agreement provides for 100% acceleration of all remaining unpaid earnout amounts upon a change of control of Holdings LLC during the earnout period. Calderwood & Harkness analyzed whether the acceleration clause alters the capital gain characterization and concluded that it does not, because the acceleration is triggered by a change of ownership (a capital event) rather than by any employment-related condition.
Installment Reporting. Calderwood & Harkness recommended that individual sellers report their earnout payments under the installment method of Section 453, recognizing gain ratably as payments are received. Calderwood & Harkness also analyzed whether open transaction treatment (under the principles of Burnet v. Logan, 283 U.S. 404 (1931)) would be available as an alternative and concluded that closed transaction treatment is the appropriate method, because the EBITDA targets are quantifiable and ascertainable based on the historical performance and projections of Pinnacle's business. Open transaction treatment is generally reserved for situations where the contingent consideration is truly speculative and unascertainable, which is not the case here.
Lesson Learned. During the negotiation of the earnout provisions, seller's counsel (Whitford & Gaines LLP) initially proposed language conditioning Dr. Carvallo's and Dr. Ostrowski's earnout entitlement on their continued employment with Pinnacle through the end of the applicable measurement period. This language, if adopted, would have created a strong inference that the earnout payments to Carvallo and Ostrowski were compensation for services rather than additional purchase price, potentially resulting in ordinary income treatment and subjecting the amounts to employment taxes. Calderwood & Harkness flagged this issue immediately and communicated the risk to both M&A counsel and the client. After discussion with seller's counsel, the employment condition was removed from the earnout provisions.
Recommendation: For future engagements involving earnout provisions, Calderwood & Harkness should include a "no employment condition" checklist item in its earnout tax diligence protocol. This item should be reviewed as early as the first draft of the Merger Agreement and should flag any language — explicit or implicit — tying earnout entitlement to continued employment, consulting obligations, or non-compete compliance. Additionally, Calderwood & Harkness should coordinate with M&A counsel early in the earnout drafting process to ensure pro rata allocation, absence of forfeiture provisions, and clear separation from consulting and non-compete arrangements. Section 483 imputed interest computation deadlines for each earnout period should be calendared at the time of signing.
E. Purchase Price Allocation
Methodology. Calderwood & Harkness applied the Section 1060 residual method to allocate the $412 million enterprise value among Pinnacle's assets for purposes of computing the Section 743(b) basis adjustment. Although Form 8594 (Asset Acquisition Statement) is technically required only for actual asset acquisitions (and not for membership interest purchases), Calderwood & Harkness determined that the Section 1060 methodology provides the most defensible framework for allocating the purchase price among asset classes, and the allocation is consistent with the Section 743(b) step-up methodology under Section 755.
The purchase price allocation was prepared in coordination with Northmark Advisory Group LLC's valuation team, which provided independent appraisals of the identifiable intangible assets. The allocation was included as an exhibit to the Merger Agreement and is binding on the parties for tax reporting purposes.
Allocation Schedule.
Class V intangible assets are further broken down as follows:
The total allocation of $412 million equals the enterprise value of the transaction. The goodwill residual of $157.2 million represents the portion of the purchase price not allocable to identifiable tangible and intangible assets.
Form 8594 Filing
Calderwood & Harkness concluded that Form 8594 (Asset Acquisition Statement under Section 1060) is not required for a membership interest purchase, because the transaction is structured as an acquisition of partnership interests rather than an acquisition of assets. However, the purchase price allocation schedule was included as an exhibit to the Merger Agreement and is reflected in the Section 743(b) computations prepared for Pinnacle's 2024 partnership return. The allocation is binding on both the buyer and the sellers for federal income tax reporting purposes pursuant to the terms of the Merger Agreement.
Lesson Learned. Coordination with Northmark Advisory Group LLC (the quality of earnings provider retained by Ardent Capital) on intangible asset identification and valuation was essential to producing a defensible purchase price allocation. Northmark's valuation team had initially prepared an intangible asset appraisal for financial reporting (ASC 805) purposes, which used different assumptions and discount rates than would be appropriate for a tax-basis allocation. Calderwood & Harkness worked with Northmark to reconcile the financial reporting and tax allocations, which required approximately 40 hours of additional time.
Recommendation: For future engagements, Calderwood & Harkness should engage the QoE provider's valuation team pre-signing (ideally during the diligence phase) to ensure alignment between the tax allocation and the independent appraisal of intangible assets. The engagement letter with the QoE provider should specify that the valuation will be used for both financial reporting and tax allocation purposes, and the tax counsel should provide input on asset class definitions and amortization periods before the appraisal is finalized.
F. Tax Receivable Agreement
Structure. Calderwood & Harkness drafted and negotiated the Tax Receivable Agreement ("TRA") between Holdings LLC, Intermediate Inc., and the TRA Holders (consisting of the rollover participants and the pre-closing Pinnacle members). Under the TRA, 85% of the realized tax benefits attributable to the Section 743(b) basis step-up are payable to the TRA Holders on an annual basis. The remaining 15% of the tax benefits are retained by Intermediate Inc.
Economics. Based on the estimated annual amortization deduction of $20.04 million and a blended tax rate of 25%, the estimated annual tax benefit is $5.01 million. The estimated annual TRA payment is:
85% × $5.01 million = $4.26 million per year
The TRA payments are expected to decline over the amortization period as the Section 743(b) basis adjustment is fully amortized with respect to each asset class. The total undiscounted TRA payments over the full amortization period are estimated at approximately $47.9 million.
Key Negotiated Terms
The TRA includes the following key provisions:
(i) Annual payment schedule. TRA payments are computed annually following the filing of the applicable tax return and are payable within 120 days of such filing.
(ii) Early termination. Holdings LLC or Intermediate Inc. may elect to terminate the TRA early by paying the TRA Holders an amount equal to the present value of all remaining TRA payments, computed using the discount rate specified in the TRA (SOFR plus 300 basis points).
(iii) Change-of-control acceleration. Upon a change of control of Holdings LLC, all remaining TRA payments are accelerated and become immediately payable at their present value.
(iv) Dispute resolution. Disputes regarding the computation of TRA payments are subject to binding arbitration before a nationally recognized accounting firm selected by the parties.
Timeline. The draft TRA was delivered on March 20, 2024, and the execution version was finalized on May 28, 2024. The TRA was executed at closing on May 31, 2024.
Lesson Learned. TRA negotiations consumed approximately 120 hours of Calderwood & Harkness time — substantially more than the approximately 60–80 hours initially budgeted. The principal areas of negotiation were the sharing percentage (seller's counsel pushed for 90%; Calderwood & Harkness held at 85%), the treatment of state taxes (seller's counsel sought a gross-up for state taxes borne by the TRA Holders on TRA payments; Calderwood & Harkness successfully resisted the gross-up), and the early termination discount rate. The multiple seller groups (three named sellers plus 14 minority physician-investors, each with different economic interests and tax profiles) added complexity to the computation methodology and the allocation provisions.
Recommendation: For future engagements involving healthcare platform deals with multiple seller groups, Calderwood & Harkness should allocate dedicated TRA negotiation time of a minimum of 100–120 hours in the initial budget. The TRA negotiation timeline should be separately tracked and communicated to the client's deal team as a discrete workstream with its own milestones and target completion dates.
V. State and Local Tax Structuring
A. State-by-State Analysis
Calderwood & Harkness prepared a comprehensive state and local tax analysis covering each of the five states in which Pinnacle operates facilities, as well as a New York nexus analysis for the holding company structure. The state and local tax memorandum was delivered on February 20, 2024, and was supplemented by the state tax structuring recommendations letter delivered on March 18, 2024. The key findings for each state are summarized below.
Pennsylvania. Pennsylvania imposes a corporate net income tax at a rate of 8.99% for the 2024 tax year. Notably, the Pennsylvania legislature has enacted a phased reduction of the corporate net income tax rate, declining from 8.99% in 2024 to 4.99% by 2031. This declining rate schedule was factored into the net present value computations for the Section 743(b) step-up benefit and the TRA payment estimates.
Pennsylvania employs a single-sales-factor apportionment formula for purposes of computing corporate net income tax, which is favorable for businesses with a significant Pennsylvania workforce and asset base but a national or multi-state customer base.
Three of Pinnacle's urgent care clinics are located within the City of Philadelphia and are subject to the Philadelphia Business Income and Receipts Tax ("BIRT"). The BIRT consists of two components: a gross receipts tax at a rate of 0.1415 mills (i.e., 1.415% of gross receipts attributable to Philadelphia) and a net income tax at a rate of 5.99% on net income attributable to Philadelphia. Calderwood & Harkness's analysis of Philadelphia BIRT mitigation options is discussed in Section V.D below.
Virginia. Virginia imposes a corporate income tax at a flat rate of 6.0%. Virginia also imposes a withholding obligation on pass-through entities with respect to nonresident members at a rate of 5.0% of the member's distributive share of Virginia-source income. Virginia employs a single-sales-factor apportionment formula.
Pinnacle operates multiple facilities in Virginia, and the nonresident withholding obligation was a significant factor in the closing funds flow computation for sellers domiciled outside Virginia. The estimated Virginia withholding at closing for nonresident individual sellers was $1.46 million.
Maryland. Maryland imposes a corporate income tax at a rate of 8.25%. Maryland uses a three-factor apportionment formula with the sales factor double-weighted (property, payroll, and sales, with sales counted twice in the denominator).
Calderwood & Harkness analyzed Maryland's pass-through entity tax ("PTET") election and determined that the election would be beneficial for certain nonresident individual sellers by allowing the entity-level tax to be credited against the sellers' individual Maryland income tax obligations. The PTET election was discussed with seller's counsel and recommended for the short taxable period ending May 31, 2024.
The estimated Maryland withholding at closing for nonresident individual sellers was $2.41 million, representing the largest state withholding component.
North Carolina. North Carolina imposes a corporate income tax at a rate of 2.5% for the 2024 tax year, one of the lowest corporate income tax rates in the country. North Carolina also imposes a franchise tax on corporations based on the greater of the corporation's net worth or the book value of its real and tangible personal property in North Carolina. North Carolina uses a three-factor apportionment formula with the sales factor double-weighted.
The low corporate tax rate in North Carolina had a favorable impact on the blended effective state rate for the Pinnacle platform.
Georgia. Georgia imposes a corporate income tax at a rate of 5.75%. Georgia also imposes a withholding obligation on pass-through entities with respect to nonresident members at a rate of 5.75% of the member's distributive share of Georgia-source income. Georgia employs a single-sales-factor apportionment formula.
The estimated Georgia withholding at closing for nonresident individual sellers was $0.87 million.
Combined Effective State Rate
Based on the EBITDA-weighted allocation across all five operating states, Calderwood & Harkness computed a combined effective state income tax rate (blended) of 6.42%. This blended rate was used in the Section 743(b) benefit and TRA payment computations (in conjunction with the 21% federal corporate rate) to derive the 25% blended tax rate referenced throughout this memorandum.
B. Nonresident Withholding
Calderwood & Harkness computed the aggregate nonresident withholding obligations applicable to the individual sellers at closing with respect to the three states that impose withholding on nonresident members of pass-through entities:
The nonresident withholding computation schedule was prepared on May 15, 2024, approximately two weeks before the anticipated closing date. The withholding amounts were incorporated into the closing funds flow prepared by Harcourt Shaw & DeVries LLP and were remitted to the applicable state taxing authorities at closing.
C. New York Nexus Mitigation
Calderwood & Harkness identified a risk that Holdings LLC's management activities in New York could create New York nexus for the holding company. Specifically, Ardent Capital's principals (Ferrera and Ashworth) and the Fund III deal team (Pellegrino) are based in New York and conduct management oversight of portfolio companies from Ardent Capital's New York offices. If Holdings LLC were deemed to have nexus in New York based on these activities, it could be subject to New York's corporate franchise tax or unincorporated business tax, depending on its classification, and its members could be subject to New York personal income tax on their distributive shares of Holdings LLC income.
Calderwood & Harkness implemented the following mitigation strategy: Management fee agreements were structured between Ardent Capital GP III LLC (the general partner of Fund III, which is already nexused in New York and files New York tax returns) and Intermediate Inc., rather than between Holdings LLC and the portfolio company. Under this structure, Holdings LLC has no New York employees, no New York office, and no direct management activity in New York. All management services are provided through Ardent Capital GP III LLC, which charges a management fee to Intermediate Inc. (not to Holdings LLC). This routing ensures that the management fee income is reported on Ardent Capital GP III LLC's New York returns and does not create an independent nexus for Holdings LLC.
Lesson Learned. The New York nexus analysis for holding company structures should be initiated during the entity formation phase, not deferred to the post-signing period. In this engagement, the nexus risk was identified during the entity formation process (early March 2024), and the fee agreement routing solution was implemented before closing. However, if the issue had been identified later — after the management fee agreements had already been drafted with Holdings LLC as a party — the correction would have been more complex and could have required consent from the lenders under the credit facility.
Recommendation: For any holding company structure involving a New York-based sponsor, New York nexus analysis should be a standard component of the entity formation checklist and should be completed before the management fee agreement is drafted.
D. Philadelphia BIRT
Three of Pinnacle's urgent care clinics are located within the City of Philadelphia and are subject to the Philadelphia Business Income and Receipts Tax. Calderwood & Harkness analyzed potential mitigation strategies for the BIRT exposure, including the possibility of restructuring the Philadelphia operations into a separate entity or renegotiating the apportionment of receipts and income among the Philadelphia and non-Philadelphia locations.
Calderwood & Harkness concluded that mitigation options are limited given the physical presence of the three clinics within Philadelphia's city limits and the fact that the BIRT applies to any business maintaining a fixed place of business in Philadelphia. The apportionment rules for the BIRT use a market-based sourcing methodology, and the receipts generated at the Philadelphia clinics are properly sourced to Philadelphia.
Recommendation: Calderwood & Harkness recommends ongoing monitoring of Philadelphia's apportionment rules for multi-location healthcare businesses, particularly any developments in the City's interpretation of market-based sourcing for healthcare services and any legislative changes to the BIRT rate or structure.