Marcus and Diana,
We are pleased to deliver the comprehensive tax structure memorandum for the proposed Pinnacle Continuation Vehicle LP (the "CV"). This is the primary deliverable contemplated under our engagement opened July 15, 2025. The memorandum is attached to this email (filename: tax-structure-memorandum-pinnacle-cv.docx) and was prepared by me, Garrett Simmons, and Leila Nazari.
The memorandum addresses the fund-level tax structuring for the transfer of the Fund II concentrated portfolio — consisting of stakes in Luminos Systems Inc., ClearArc Software Inc., and Vectral Cloud Inc. — into the CV. Based on June 30, 2025 valuations, these positions carry an aggregate fair market value of $1.34 billion and aggregate unrealized gain of approximately $1.202 billion.
**Summary of Key Recommendations**
The memorandum is comprehensive, but I want to highlight the principal structural recommendations here for ease of reference:
**(i) Section 721 Contribution — Non-Recognition and QSBS Preservation**
We recommend structuring the transfer of all three portfolio company interests from Pinnacle Venture Fund II LP to the CV as a tax-free contribution under Section 721(a) of the Internal Revenue Code. This preserves non-recognition treatment: the CV will take a carryover basis in the contributed assets (aggregate basis of $138 million — $58.5 million for Luminos, $37.4 million for ClearArc, and $42.1 million for Vectral), and rolling LPs will take a carryover basis in their CV interests.
Critically, the Section 721 contribution structure is also designed to preserve qualified small business stock status under Section 1202 for each portfolio company's shares, allowing eligible investors to potentially exclude gain on an eventual disposition. The QSBS five-year holding period has been satisfied for Luminos (August 2025) and ClearArc (September 2025). However, Vectral's five-year holding period will not be satisfied until March 2026, which requires a special holding covenant discussed below in item (v). The memorandum includes a detailed analysis of whether Section 721 contributions qualify for tacking under Section 1202(h), and we will be circulating a separate, more detailed QSBS preservation analysis memo shortly.
**(ii) Section 704(c) Allocations — Remedial Method**
We recommend adopting the remedial allocation method under Section 704(c) for the $1.202 billion of aggregate built-in gain on the contributed portfolio company interests. This method eliminates ceiling rule distortions and, importantly, ensures that Garrison Secondaries Fund IV LP (the lead secondary investor committing $380 million of new capital) and other new investors are not allocated pre-contribution built-in gain. We expect this to be a key negotiating point with Garrison and their counsel at Whitfield & Calloway LLP, and we believe the remedial method is consistent with market terms and Garrison's expectations.
**(iii) Dual blocker Structure for Tax-Exempt and Non-U.S. Investors**
We recommend establishing two blocker entities:
- **PCV Domestic blocker Inc.** — a Delaware C-corporation interposed between the CV and U.S. tax-exempt LPs to block unrelated business taxable income (UBTI) under Section 512. This entity will serve Meridian Public Employees' Retirement System ($125 million commitment) and Ashford University Endowment ($50 million commitment).
- **PCV International Holdings Ltd.** — a Cayman Islands exempted company interposed between the CV and non-U.S. LPs to block effectively connected income (ECI) and FIRPTA withholding under Sections 897 and 1446. This entity will serve Sovereign Capital Partners (Cayman) Ltd. ($75 million commitment).
Total capital routed through the blockers is $250 million, representing approximately 23.3% of total CV capitalization of $1.074 billion. The Offshore blocker will require a check-the-box election on Form 8832 to ensure corporate classification for U.S. tax purposes. We are targeting a formation date of September 30, 2025 for both blockers, ahead of the CV first close on October 15, 2025.
**(iv) Legacy Carry Tranche — Section 1061 Holding Period Preservation**
We recommend structuring the GP's existing Fund II carried interest rollover as a "legacy carry" tranche in the CV that inherits Fund II's original holding period via a Section 721 non-recognition contribution. The existing Fund II carry (20% over an 8% preferred return) has been held since December 2019; the three-year Section 1061 holding period was satisfied as of December 2022. It is critical that this holding period not be reset in the CV transition.
The new CV carry (15% over a 7% preferred return, European-style waterfall) will constitute a new applicable partnership interest (API) with a holding period commencing at CV closing. Accordingly, the three-year Section 1061 holding period for the new carry will not be satisfied until October 31, 2028, assuming a final close on October 31, 2025.
The memorandum recommends specific LPA provisions to bifurcate the legacy and new carry tranches for Section 1061 purposes. We will coordinate with Vanessa Liu and the Hawthorne Reid team on incorporating these provisions into the draft CV LPA.
**(v) Vectral Cloud — Special Holding Covenant Through March 2026**
Because Vectral Cloud Inc.'s QSBS five-year holding period will not be satisfied until March 2026 (Series B acquired March 2021), the memorandum recommends a specific holding covenant in the CV's governing documents and in the tax protection agreement prohibiting disposition of Vectral shares prior to March 2026. This covenant is essential to preserve QSBS tacking for Vectral under Section 1202(h). If the CV were to dispose of the Vectral shares before the five-year holding period is met, the QSBS exclusion would be lost for that position — representing $260 million of value and $217.9 million of built-in gain.
The broader tax protection agreement will include a 36-month minimum holding period covenant for all three portfolio companies, but the Vectral-specific covenant has the added QSBS dimension that warrants separate treatment.
**Outstanding Diligence Items**
Several items remain open and require client-side input:
1. **Vectral Cloud aggregate gross assets at issuance.** The memorandum flags that Vectral Cloud's aggregate gross assets at the time of its March 2021 Series B issuance were near the $50 million threshold for QSBS qualification under Section 1202(e). We need to confirm from Vectral Cloud's records whether aggregate gross assets (including cash received in the financing) were at or below $50 million at the time of stock issuance. Could Rafael Montoya or the Pinnacle deal team coordinate with Elena Kowalski at Vectral Cloud to obtain the relevant financial statements or tax returns from that period? This is a threshold issue for the entire QSBS analysis on the Vectral position.
2. **Fund II LPA provisions on transfer mechanics.** We are reviewing the existing Fund II LPA for any restrictions on in-kind distributions or contributions that could complicate the Section 721 transfer. Vanessa Liu at Hawthorne Reid is providing us with the current LPA and any amendments — Vanessa, please let us know if there is anything you need from our side to facilitate that.
3. **LP-level tax basis information.** For the disguised sale analysis under Section 707(a)(2)(B), we will need updated LP-level capital account and tax basis information from Andover & Strauss LLP (Patricia Clemons). Marcus, we would suggest that Pinnacle authorize Andover & Strauss to share this data directly with us to streamline the process.
**Next Steps and Coordination**
We would like to schedule a call with you, Diana, and Rafael early next week to walk through the memorandum's recommendations and address any questions. As you know, the LP election deadline is September 15, 2025, and the tax structure needs to be finalized sufficiently in advance to be reflected in the LP election materials and the Kessler Pratt fairness opinion (due September 22, 2025). The timeline is manageable but does not leave much room for slippage.
In parallel, our team will begin preparing the following additional work product:
- Detailed QSBS preservation analysis memo - Section 1061 carried interest memo - blocker entity structure memo - Markup of tax provisions of the draft CV LPA (to be coordinated with Vanessa once she circulates her initial draft) - Section 704(c) allocation methodology memo - Draft tax protection agreement - State tax nexus and withholding analysis (covering California, Delaware, Texas, Colorado, and New York) - Draft Section 721 tax opinion letter
We are also available to engage directly with Garrison's counsel, Douglas Whitfield at Whitfield & Calloway, on tax structuring issues as negotiations progress. In our experience, getting the tax teams aligned early tends to smooth the path considerably.
**California Tax Note**
One additional flag: as you may be aware, California does not conform to the federal Section 1202 QSBS exclusion. For California-resident LPs (and the fund itself as a California-based manager), capital gains on eventual dispositions of the portfolio company shares will be taxed at ordinary income rates up to 13.3% regardless of QSBS status at the federal level. Our forthcoming state tax nexus and withholding analysis will address strategies for minimizing California-source income for non-California LPs.
**Closing**
Please note that the attached memorandum is privileged and confidential, prepared for purposes of rendering legal advice to Pinnacle Capital Management LLC in connection with this matter.
We are excited about this transaction and look forward to discussing the memorandum with you in detail. Please let me know what works on your end for a call next week — we are flexible any day.
Best regards,
Sylvia
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**Sylvia Hartwell** Partner, Tax Calderwood & Harkness LLP 555 California Street, Suite 4200 San Francisco, CA 94104 T: (415) 555-7180 E: shartwell@calderwoodharkness.com
**Attachment:** Tax Structure Memorandum — Pinnacle Continuation Vehicle LP (August 8, 2025) (tax-structure-memorandum-pinnacle-cv.docx)
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