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MEMORANDUM

PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT

From: Leila Nazari, Associate, Calderwood & Harkness LLP

To: Garrett Simmons, Lead Associate, and Sylvia Hartwell, Responsible Partner, Tax

Date: August 6, 2025

Re: Section 704(c) Allocation Methodology for Built-In Gain on Contributed Portfolio Company Interests — Pinnacle Continuation Vehicle LP

Matter No.: 117443.00001

Engagement Ref.: 1002-00005

I. Executive Summary

The purpose of this memorandum is to analyze and recommend the appropriate Section 704(c) allocation method for the $1.202 billion of aggregate built-in gain on portfolio company interests being contributed from Pinnacle Venture Fund II LP (EIN 84-3291067) ("Fund II") to Pinnacle Continuation Vehicle LP ("PCV" or the "CV") in connection with the GP-led secondary transaction currently being negotiated by the deal team. This memorandum is being prepared in connection with our broader engagement advising Pinnacle Capital Management LLC on the tax structuring of the continuation vehicle formation and the related secondary transaction.

The contribution of three portfolio company stakes — Luminos Systems Inc., ClearArc Software Inc., and Vectral Cloud Inc. — from Fund II to the CV under Section 721 of the Internal Revenue Code will carry over the existing aggregate adjusted tax basis of $138.0 million in those interests, while the aggregate fair market value of those same interests as of June 30, 2025 is $1.34 billion. This creates $1.202 billion of aggregate built-in gain that must be properly addressed under Section 704(c) of the Code and the Treasury Regulations promulgated thereunder. Absent the adoption of an appropriate allocation methodology, the risk of inequitable tax burden shifting between the contributing and non-contributing partners of the CV is both material and, given the magnitude of the built-in gain at issue, potentially severe.

The choice of allocation method is critical for three independent but interrelated reasons. First, the rolling LPs — who hold approximately $680 million in net asset value and who are the partners contributing the appreciated portfolio company interests into the CV — are the partners who economically benefited from the pre-contribution appreciation, and Section 704(c) is designed to ensure that the tax consequences of that appreciation follow them. Second, the new investors — principally Garrison Secondaries Fund IV LP, which is committing $380 million of new capital to the CV — must not bear the tax burden of pre-contribution built-in gain that accrued before they entered the partnership. Garrison's counsel at Whitfield & Calloway LLP has made this a threshold condition to closing the transaction. Third, approximately $250 million of capital is flowing through blocker entities — specifically, PCV Domestic blocker Inc. and PCV International Holdings Ltd. — whose corporate-level tax exposure is directly affected by the allocation methodology selected.

After a comprehensive analysis of the three permissible Section 704(c) allocation methods — the traditional method, the traditional method with curative allocations, and the remedial allocation method — it is the recommendation of the undersigned, subject to the review and approval of the responsible partner, that the CV adopt the remedial allocation method under Treasury Regulation § 1.704-3(d) for all three contributed portfolio company interests. This recommendation is grounded in the extraordinary magnitude of the built-in gain, the passive nature of the contributed equity portfolio, the composition of the investor base, the negotiating position of the lead secondary buyer, and the superior ability of the remedial method to eliminate ceiling rule distortions in their entirety.

II. Background and Transaction Overview

A. The Continuation Vehicle Transaction

Pinnacle Venture Fund II LP is a Delaware limited partnership with a vintage year of 2019 and a final close date of December 2019. Fund II is managed by Pinnacle Capital Management LLC, which maintains its principal offices at 2100 Sand Hill Road, Suite 340, Menlo Park, California 94025. As Fund II approaches the end of its contractual term, the general partner has determined that three high-performing portfolio investments — all in the enterprise software and SaaS sector — would benefit from an extended hold period and continued operational development. Rather than distributing these positions in-kind or forcing a premature exit, the general partner proposes to transfer these concentrated positions to a newly formed continuation vehicle.

The CV — Pinnacle Continuation Vehicle LP — is to be formed as a Delaware limited partnership, with Pinnacle CV Partners LLC serving as its general partner. Pinnacle CV Partners LLC will be a newly formed Delaware limited liability company controlled by the same principals who manage Pinnacle Capital Management LLC, namely Marcus Aldren, Diana Tsao, and Rafael Montoya. The legal formation of the CV and its general partner entity is being coordinated by Hawthorne Reid LLP (Vanessa Liu, Partner), which is also responsible for drafting the limited partnership agreement and related governance documents.

The total capitalization of the CV upon final closing is expected to be approximately $1.074 billion. This capitalization is comprised of three principal sources of capital. The first source is the rolling LP interests, representing approximately $680 million in net asset value, which will be contributed to the CV in exchange for limited partnership interests in the CV. The second source is $380 million of new capital from Garrison Secondaries Fund IV LP, the lead secondary buyer (with principal offices at 399 Park Avenue, 22nd Floor, New York, New York 10022; Mitchell Adler, Partner), which is being advised by Whitfield & Calloway LLP (Douglas Whitfield, Partner). Of Garrison's $380 million commitment, approximately $280 million is designated to fund the liquidity for cashing-out LPs, and approximately $100 million is allocated to follow-on reserves, transaction expenses, and working capital. The third source is a $14 million GP co-investment by Pinnacle Capital Management LLC and its principals. The target final close of the CV is October 31, 2025.

The transaction is structured as a GP-led secondary transaction — a continuation vehicle formation in which the general partner of Fund II offers its existing limited partners the election to either (i) roll their interests into the CV (the "rolling LPs") or (ii) cash out at fair market value using the capital contributed by the secondary buyer (the "cashing-out LPs"). This bifurcation of the existing limited partner base is the hallmark of such transactions and gives rise to the Section 704(c) issues that are the subject of this memorandum.

B. Contributed Portfolio Company Interests and Built-In Gain

The three portfolio company interests being contributed from Fund II to the CV, together with their respective fair market values, cost bases, built-in gains, and ownership stakes, are set forth in the table below:

The implied gross multiple of invested capital (MOIC) on the portfolio in the aggregate is approximately 9.71× ($1,340,000,000 ÷ $138,000,000), reflecting exceptional performance across all three investments. The fair market values reflected in the table are derived from the June 30, 2025 valuation data prepared in connection with Fund II's most recent quarterly reporting cycle. At the enterprise level, Luminos Systems is valued at $2.48 billion (Pinnacle's 24.7% fully diluted stake equating to approximately $612 million); ClearArc Software is valued at $1.50 billion (Pinnacle's 31.2% fully diluted stake equating to approximately $468 million); and Vectral Cloud is valued at $1.376 billion (Pinnacle's 18.9% fully diluted stake equating to approximately $260 million).

These valuations are supported by the independent valuation work of Kessler Pratt LLP (David Kessler, Managing Partner), which has been retained to prepare a fairness opinion with respect to the contributed asset values. The fairness opinion is expected to be delivered on or about September 22, 2025, in advance of the anticipated first close. The Kessler Pratt engagement is being conducted on a flat-fee basis of $850,000, and the firm's work will include a detailed discounted cash flow analysis, comparable company analysis, and precedent transaction analysis for each of the three portfolio companies. The fairness opinion will serve as the basis for establishing the initial book capital accounts of the contributing partners in the CV and for quantifying the Section 704(c) built-in gain layers that are the focus of this memorandum.

C. Investor Composition and Tax Sensitivity

The investor base of the CV is heterogeneous with respect to tax status, jurisdiction, and tax sensitivity, which materially affects the analysis of Section 704(c) methodology. The principal categories of investors and their tax characteristics are described below.

Rolling LPs (approximately $680 million NAV). The rolling LPs are existing limited partners of Fund II who have elected to roll their interests into the CV rather than receive a cash distribution. This group includes Meridian Public Employees' Retirement System (approximately $125 million in net asset value), a U.S. tax-exempt pension fund organized under state law and exempt from federal income taxation under Section 115 of the Code, but potentially subject to unrelated business taxable income ("UBTI") under Section 512 if its investment generates debt-financed income or income from a trade or business. The rolling LPs also include Ashford University Endowment (approximately $50 million in net asset value), a Section 501(c)(3) tax-exempt educational endowment with similar UBTI sensitivities. In addition, the rolling LPs include Sovereign Capital Partners (Cayman) Ltd. (approximately $75 million in net asset value), a non-U.S. Cayman Islands exempted company that is sensitive to allocations of effectively connected income ("ECI") and to the withholding and reporting obligations imposed under Sections 1446 and 897 (FIRPTA). The balance of the rolling LP group is composed of various domestic taxable investors, including family offices, high-net-worth individuals, and other institutional limited partners.

Cashing-Out LPs (approximately $280 million NAV). The cashing-out LPs are existing limited partners of Fund II who have elected to receive liquidity in the secondary transaction rather than roll into the CV. This group includes Redstone Family Office LLC (approximately $40 million in net asset value), a U.S. taxable family office (Barbara Redstone, Principal), along with other domestic and international investors. The cashing-out LPs are not directly affected by the Section 704(c) analysis because they are receiving cash in exchange for their Fund II interests and will not become partners in the CV. Their tax treatment is governed by the sale or exchange provisions applicable to the disposition of their Fund II partnership interests.

New Secondary Investor. Garrison Secondaries Fund IV LP is contributing $380 million of new capital to the CV. Of this amount, approximately $280 million will fund the liquidity payments to the cashing-out LPs, and approximately $100 million is allocated to follow-on reserves, CV-level transaction expenses, and working capital. Garrison is a non-contributing partner in the CV — it is not contributing appreciated property and therefore should not bear any tax burden from pre-contribution built-in gain. Mitchell Adler (Partner at Garrison Capital Advisors LLC, the adviser to Garrison Secondaries Fund IV LP) and Douglas Whitfield (Partner at Whitfield & Calloway LLP, Garrison's outside counsel) have both communicated in term sheet negotiations that protection from pre-contribution gain allocations is a condition to closing.

GP Co-Invest. Pinnacle Capital Management LLC and its principals (Marcus Aldren, Diana Tsao, and Rafael Montoya) are contributing $14 million of GP co-investment capital. This co-investment is rolling from Fund II and therefore represents a contributing interest for Section 704(c) purposes.

blocker Entities. Approximately $250 million of total CV capital (representing 23.3% of the $1.074 billion total capitalization) flows through two blocker entities designed to manage UBTI and ECI exposure for tax-exempt and non-U.S. investors, respectively. PCV Domestic blocker Inc. is a Delaware C-corporation to be formed, which will hold approximately $175 million of capital — $125 million on behalf of Meridian Public Employees' Retirement System and $50 million on behalf of Ashford University Endowment — and will serve to block UBTI that might otherwise flow through to these tax-exempt investors under Section 512. PCV International Holdings Ltd. is a Cayman Islands exempted company to be formed, which will make a check-the-box election on IRS Form 8832 to be treated as a corporation for U.S. federal income tax purposes, and which will hold approximately $75 million of capital on behalf of Sovereign Capital Partners (Cayman) Ltd. The Offshore blocker will serve to block ECI and FIRPTA exposure under Sections 897 and 1446 of the Code. The interaction between these blocker entities and the Section 704(c) remedial allocation method is analyzed in detail in Section VI below.

D. Section 721 Contribution Framework

The portfolio company interests are being contributed from Fund II to the CV in a transaction intended to qualify for non-recognition treatment under Section 721(a) of the Internal Revenue Code. Section 721(a) provides the general rule that no gain or loss is recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership. The applicability of Section 721(a) to this transaction is the subject of a separate opinion letter currently being prepared by the undersigned and is not addressed in detail in this memorandum.

Under Section 722 of the Code, the CV's tax basis in the contributed portfolio company interests will equal Fund II's adjusted tax basis in those interests — $138.0 million in the aggregate. Under Section 723, the contributing partners' basis in their CV partnership interests will equal their respective shares of the adjusted basis of the contributed property, increased by any gain recognized (if any) on the contribution. Because the transaction is intended to qualify in full for Section 721(a) non-recognition treatment, no gain should be recognized at the time of contribution.

The $1.202 billion spread between the aggregate fair market value ($1.34 billion) and the aggregate adjusted tax basis ($138.0 million) of the contributed portfolio company interests constitutes "built-in gain" within the meaning of Section 704(c). This built-in gain must be allocated among the partners of the CV in a manner that prevents the shifting of pre-contribution gain to non-contributing partners — specifically, to Garrison Secondaries Fund IV LP and any other investors who are contributing cash (rather than appreciated property) to the CV. The mechanics by which this allocation is accomplished depend critically on which of the three permissible Section 704(c) methods is elected in the CV's limited partnership agreement.

III. Legal Framework: Section 704(c) and the Ceiling Rule

A. Statutory and Regulatory Overview

Section 704(c)(1)(A) of the Internal Revenue Code provides, in pertinent part, that income, gain, loss, and deduction with respect to property contributed to a partnership by a partner shall be shared among the partners so as to take account of the variation between the basis of the property to the partnership and its fair market value at the time of contribution. The purpose of this provision is straightforward but critical: it is designed to prevent contributing partners from shifting the tax consequences of pre-contribution gain (or loss) to other partners who were not parties to the original investment and who did not participate in the economic appreciation (or depreciation) that gave rise to the book/tax disparity.

The legislative history of Section 704(c) reflects Congress's concern that, absent a mandatory allocation rule, partners could exploit the disparity between a contributed asset's tax basis and its fair market value to shift the economic incidence of taxation away from the partner who economically benefited from the appreciation. The provision serves as a fundamental integrity mechanism in the partnership tax regime, ensuring that the tax consequences of property contributions are allocated in a manner consistent with economic reality.

Treasury Regulation § 1.704-3(a) implements Section 704(c) by establishing a framework within which partnerships must adopt a "reasonable method" of making allocations that take into account the variation between a contributed asset's adjusted tax basis and its fair market value at the time of contribution. The regulations describe three specific methods that are deemed to be reasonable if applied properly: (1) the traditional method, set forth in Treasury Regulation § 1.704-3(b); (2) the traditional method with curative allocations, set forth in Treasury Regulation § 1.704-3(c); and (3) the remedial allocation method, set forth in Treasury Regulation § 1.704-3(d). A partnership is not required to use the same method for all contributed properties, but the partnership agreement must specify which method is used with respect to each item of contributed property, and the chosen method must be applied consistently for that item.

In addition to the three enumerated methods, the regulations contemplate that other methods may be reasonable under certain circumstances, provided they are consistent with the purpose of Section 704(c). However, the three specifically described methods are the only methods that have received explicit regulatory sanction, and we do not believe there is any basis for recommending a non-standard approach in this transaction.

The anti-abuse rule under Treasury Regulation § 1.704-3(a)(10) provides an important guardrail: an allocation method (or a combination of methods) is not reasonable if the contribution of property and the corresponding allocation of tax items are made with a view to shifting the tax consequences of built-in gain or loss among the partners in a manner that substantially reduces the present value of the partners' aggregate tax liability. The anti-abuse rule is intended to prevent the manipulation of Section 704(c) methods to achieve tax-avoidance results that are inconsistent with the purpose of the statute. As discussed in Section IX.C below, the use of the remedial allocation method in this transaction does not implicate the anti-abuse rule; indeed, the remedial method is the approach most consistent with the statutory purpose of preventing tax burden shifting.

B. The Ceiling Rule

The ceiling rule, codified in Treasury Regulation § 1.704-3(b)(1), is the single most important concept in the Section 704(c) analysis, because it is the source of the distortions that the various allocation methods are designed to address. The ceiling rule provides that the total amount of gain, loss, or deduction allocated to partners for tax purposes with respect to a contributed property cannot exceed the partnership's total gain, loss, or deduction recognized on that property. In other words, the partnership's aggregate tax items on a given asset set a "ceiling" on what can be allocated among the partners.

Ceiling rule distortion arises when the partnership's total tax gain on a contributed asset is less than the built-in gain that Section 704(c) requires to be allocated to the contributing partner. This situation occurs when the contributed asset declines in value between the time of contribution and the time of disposition. In such a case, the book/tax disparity creates a circumstance in which the contributing partner should bear a larger tax gain allocation than the total tax gain recognized by the partnership — an impossibility under the ceiling rule. The shortfall — the difference between the built-in gain that should be allocated to the contributing partner and the total tax gain available for allocation — is commonly referred to as the "ceiling rule limitation" or "ceiling rule distortion."

In this transaction, the ceiling rule distortion risk is pronounced. The built-in gain is $1.202 billion on assets with an aggregate tax basis of only $138 million and an aggregate book value of $1.34 billion. If the contributed portfolio company interests decline in value from their current FMV and are sold at prices below the contribution-date FMV, the total tax gain recognized by the CV on the disposition will be less than the built-in gain attributable to the contributing partners. Under the traditional method, the ceiling rule would prevent the full allocation of pre-contribution gain to the contributing partners, and the shortfall would effectively be borne by the non-contributing partners — who would receive less favorable tax treatment than their economic position warrants.

To illustrate: if the aggregate portfolio were sold for $1.0 billion (a decline from the $1.34 billion contribution-date FMV), the CV would recognize $862 million of total tax gain ($1.0 billion minus $138 million basis). The built-in gain allocable to contributing partners under Section 704(c) is $1.202 billion, but only $862 million of tax gain exists. Under the ceiling rule, only $862 million could be allocated, leaving a $340 million shortfall. The non-contributing partners — principally Garrison — would bear the tax consequences of this shortfall by receiving book loss allocations without corresponding tax loss allocations. This result is precisely the type of inequitable tax burden shifting that Section 704(c) is designed to prevent, and it is the central reason why the traditional method is inadequate for this transaction.

The curative and remedial methods each address ceiling rule distortions, but through fundamentally different mechanisms: the curative method uses actual tax items from other sources to offset the distortion, while the remedial method creates notional tax items specifically to eliminate the distortion. The comparative analysis of these three methods as applied to this transaction is set forth in Section IV below.

IV. Analysis of the Three Section 704(c) Methods

A. Traditional Method (Treas. Reg. § 1.704-3(b))

1. Mechanics. Under the traditional method, the partnership first allocates tax items with respect to a contributed property to the non-contributing partners in an amount up to their respective book allocations. Any remaining tax items are then allocated to the contributing partners. The contributing partners receive whatever tax items remain after the non-contributing partners have been "made whole" up to their book allocations. Critically, the traditional method is subject to the ceiling rule: the partnership cannot allocate to the contributing partner more tax gain (or tax loss) than the total tax gain (or tax loss) recognized by the partnership on the contributed property.

The traditional method is the default method in many partnership agreements and is the simplest to administer. It requires no creation of notional items and no sourcing of curative allocations from other partnership activities. However, its simplicity comes at the cost of accuracy — the ceiling rule can create distortions that result in tax burden shifting from contributing partners to non-contributing partners.

2. Application to This Transaction

To illustrate the operation of the traditional method and the ceiling rule distortion in the context of this transaction, we walk through three hypothetical disposition scenarios using the Luminos Systems Inc. interest (adjusted tax basis of $58.5 million, contribution-date FMV of $612 million, built-in gain of $553.5 million).

Scenario 1: Sale Above FMV. Assume the Luminos shares are sold for $650 million. The book gain recognized by the CV is $38 million ($650 million sale price minus $612 million book value). The tax gain recognized by the CV is $591.5 million ($650 million sale price minus $58.5 million tax basis). Under the traditional method, the $38 million of book gain would be allocated among all partners (rolling LPs, Garrison, GP) based on their respective ownership percentages in the CV. For tax purposes, the first $38 million of tax gain would be allocated to the non-contributing partners to match their book allocations, and the remaining $553.5 million of tax gain (equal to the full built-in gain) would be allocated to the contributing (rolling) LPs. The total tax gain allocated ($38 million plus $553.5 million) equals $591.5 million, which equals the total tax gain recognized by the CV. There is no ceiling rule limitation in this scenario because the asset appreciated beyond its contribution-date FMV, generating sufficient total tax gain to cover the full built-in gain allocation.

Scenario 2: Sale at Exactly FMV. Assume the Luminos shares are sold for exactly $612 million. The book gain is zero ($612 million minus $612 million). The tax gain is $553.5 million ($612 million minus $58.5 million). Under the traditional method, no book gain is allocated to any partner. The entire $553.5 million of tax gain is allocated to the contributing partners. There is no ceiling rule problem here, because the tax gain equals the built-in gain exactly.

Scenario 3: Sale Below FMV (Ceiling Rule Distortion). Assume the Luminos shares are sold for $500 million. The book loss is $112 million ($612 million book value minus $500 million sale price), which would be allocated to all partners based on their respective ownership percentages. The tax gain is $441.5 million ($500 million sale price minus $58.5 million tax basis). Under Section 704(c), the contributing partners should be allocated $553.5 million of tax gain (the full built-in gain), but the partnership has recognized only $441.5 million of total tax gain. Under the ceiling rule, the contributing partners can only be allocated $441.5 million — the full amount of tax gain recognized — leaving a $112 million shortfall ($553.5 million minus $441.5 million).

The consequences of this $112 million shortfall are significant. The non-contributing partners (principally Garrison) receive a book loss allocation of $112 million, reflecting their economic loss on the decline in value. However, because the ceiling rule prevents the full built-in gain from being allocated to the contributing partners, the non-contributing partners receive no corresponding tax loss allocation. They are allocated zero tax items on the disposition. Economically, they have suffered a loss; for tax purposes, they have neither gain nor loss. The discrepancy means the non-contributing partners are effectively bearing a portion of the contributing partners' pre-contribution gain — precisely the result that Section 704(c) was designed to prevent.

3. Disadvantages for This Transaction

Given the massive built-in gain of $1.202 billion on an aggregate tax basis of only $138 million, the ceiling rule distortion risk under the traditional method is substantial. The gain-to-basis ratio across the portfolio is approximately 8.71:1, meaning that even a modest decline in portfolio value could generate ceiling rule shortfalls of hundreds of millions of dollars. In the worst case — where the entire portfolio declines to a value at or near its tax basis — the full $1.202 billion of built-in gain would remain unallocated to the contributing partners, and the non-contributing partners would bear the entire tax burden of the shortfall.

Garrison Secondaries Fund IV LP has specifically raised this concern in the context of term sheet negotiations. Douglas Whitfield at Whitfield & Calloway LLP has communicated to our deal team that Garrison's participation in the transaction is conditioned upon the adoption of an allocation methodology that provides full protection from pre-contribution gain allocations. The traditional method plainly does not satisfy this condition. Outlook, given the current valuation levels and the concentration of the portfolio in three high-growth software companies — whose valuations are subject to the inherent volatility of the technology sector — the probability of a ceiling rule distortion event under the traditional method is not merely theoretical but is a realistic possibility over the expected hold period of the CV.

In summary, the traditional method is the simplest to administer and the least costly from a compliance perspective, but it creates the greatest risk of inequitable tax burden shifting to non-contributing partners. For a transaction of this magnitude and complexity, and with the investor composition described above, the traditional method is not recommended.

B. Traditional Method with Curative Allocations (Treas. Reg. § 1.704-3(c))

1. Mechanics. Under the curative method, the partnership may offset ceiling rule distortions by making compensating allocations of other partnership tax items to the non-contributing partners. Specifically, when a ceiling rule limitation prevents the full built-in gain from being allocated to the contributing partners, the partnership may reallocate other tax items — which would otherwise be allocated to the contributing partners — to the non-contributing partners to compensate them for the shortfall.

The curative allocations must involve tax items of the "same type" or "same character" as the item that was limited by the ceiling rule. For example, if the ceiling rule limitation relates to capital gain on the sale of a contributed asset, the curative allocation must be made using other capital gain or capital loss items. Ordinary income or ordinary loss items cannot be used to cure a capital gain shortfall, and vice versa. This character-matching requirement is designed to ensure that the curative allocation has the same tax effect as the item it is intended to replace.

The curative allocation is sourced from items that would otherwise be allocated to the contributing partner. In effect, the contributing partner "gives up" its share of other tax items to compensate the non-contributing partners for the ceiling rule distortion. The net economic effect is that the contributing partner bears a greater share of the aggregate tax burden, which is the correct result given that the contributing partner is the party who benefited from the pre-contribution appreciation.

2. Application to This Transaction

Returning to the Luminos Scenario 3 (sale at $500 million), the $112 million ceiling rule shortfall under the traditional method could theoretically be cured under the curative method by reallocating $112 million of other tax items of the same character (i.e., capital gain or capital loss) from the rolling LPs to the non-contributing partners. If, for example, the CV simultaneously disposed of one of the other portfolio company interests at a gain, a portion of the capital gain that would otherwise be allocated to the rolling LPs could be redirected to the non-contributing partners to offset the Luminos shortfall.

However, the practical limitation of the curative method in this transaction is severe. The CV's portfolio consists entirely of equity interests in three Delaware C-corporations: Luminos Systems, ClearArc Software, and Vectral Cloud. The CV does not operate a business, does not hold depreciable assets, and does not generate ongoing streams of ordinary income, depreciation, amortization, or other tax items that could serve as curative allocations. The only significant tax events the CV is expected to experience during its life are (i) capital gain or loss on the disposition of the three portfolio company interests, and (ii) potentially, dividend income if any of the portfolio companies initiates a distribution program (which is not anticipated for any of the three, given their growth-stage profiles).

Because the CV holds a passive equity portfolio rather than an operating business, the universe of available curative items is extremely limited. The curative method works best for operating partnerships — such as real estate partnerships with ongoing depreciation deductions, or operating business partnerships with diverse income and expense streams — where there is a robust flow of tax items that can be reallocated to cure ceiling rule distortions. In a concentrated equity portfolio like the CV, the curative method is largely theoretical.

3. Disadvantages for This Transaction

The curative method's limitations in the context of this transaction can be summarized as follows. First, the CV's portfolio generates minimal ongoing tax items, severely constraining the availability of curative allocations. Second, the character-matching requirement further restricts the pool of available items — capital gain shortfalls can only be cured with capital gain or capital loss items, which arise only upon dispositions of the portfolio company interests. Third, the curative method does not fully eliminate ceiling rule distortions; it only partially addresses them to the extent that other same-character items happen to be available at the time the distortion arises. If the CV disposes of only one portfolio company interest at a loss (triggering a ceiling rule distortion) and has not yet disposed of the other interests, there may be no curative items available at all.

Fourth, the curative method is administratively more complex than the traditional method — it requires the identification, character matching, and reallocation of tax items across partners — but without delivering the full benefit of eliminating ceiling rule distortions. This creates an undesirable combination of increased compliance cost and incomplete protection. For these reasons, the curative method is not recommended for this transaction.

C. Remedial Allocation Method (Treas. Reg. § 1.704-3(d))

1. Mechanics. The remedial allocation method eliminates ceiling rule distortions entirely by authorizing the partnership to create notional — or "remedial" — tax items when the actual tax items recognized by the partnership are insufficient to eliminate the ceiling rule effect. Unlike the traditional and curative methods, which are constrained by the partnership's actual tax results, the remedial method operates independently of the partnership's actual tax items. When a ceiling rule limitation occurs, the partnership creates two equal and opposite remedial tax items: (a) a remedial tax item (gain, loss, or deduction, as appropriate) allocated to the non-contributing partner to match that partner's book allocation, and (b) an equal and opposite remedial tax item allocated to the contributing partner. These remedial items offset each other at the partnership level, so they do not change the partnership's aggregate tax result, but they ensure that each partner's individual tax result mirrors that partner's economic result.

The remedial items are, in a sense, fabricated — they do not correspond to actual economic transactions or actual taxable events. They exist solely as a mechanism to ensure that the Section 704(c) allocation is carried out in a manner that accurately reflects the economic positions of the contributing and non-contributing partners. The remedial items must be of the same character and must have the same tax effect as the items to which they relate. For example, if the ceiling rule limitation relates to long-term capital gain, the remedial items must both be characterized as long-term capital gain (or long-term capital loss, as appropriate).

The remedial method is the most complex of the three methods from an administrative standpoint, but it is the only method that provides a complete solution to ceiling rule distortions. It is the method specifically designed for situations in which the book/tax disparity on contributed property is large, the contributing and non-contributing partners have divergent economic interests, and the partnership's actual tax items are insufficient to achieve proper Section 704(c) allocations through the traditional or curative methods.

2. Application to This Transaction

Returning once more to the Luminos Scenario 3 (sale at $500 million), the remedial method operates as follows. The book loss on the disposition is $112 million ($612 million book value minus $500 million sale price), allocated among all partners based on their respective ownership percentages. The tax gain is $441.5 million ($500 million minus $58.5 million tax basis). The full $553.5 million of built-in gain should be allocated to the contributing partners under Section 704(c). Under the remedial method, the partnership creates two remedial items:

(a) A remedial tax loss of $112 million, allocated to the non-contributing partners (Garrison and other new investors), matching their book loss allocation. This remedial loss enables the non-contributing partners to report a tax loss that corresponds to their economic loss on the asset.

(b) A remedial tax gain of $112 million, allocated to the contributing partners (rolling LPs), offsetting the remedial loss and increasing the contributing partners' total tax gain allocation.

The net effect on the contributing partners is as follows: they are allocated $441.5 million of actual tax gain (the ceiling amount) plus $112 million of remedial tax gain, for a total tax gain allocation of $553.5 million — exactly equal to the built-in gain. The net effect on the non-contributing partners is as follows: they are allocated $112 million of remedial tax loss, which offsets their economic loss and results in a net tax position of zero gain — exactly reflecting the fact that they had no pre-contribution gain exposure.

This result is precisely what Section 704(c) is intended to achieve: the contributing partners bear the full tax burden of the pre-contribution appreciation, and the non-contributing partners bear no tax burden attributable to appreciation that accrued before they entered the partnership.

Applied to the full portfolio ($1.202 billion of aggregate built-in gain), the remedial method guarantees that regardless of the ultimate sale prices of the Luminos, ClearArc, and Vectral interests — whether they are sold at, above, or below their contribution-date FMV — Garrison Secondaries Fund IV LP and any other non-contributing investors will never be allocated tax gain or denied tax loss attributable to the pre-contribution appreciation. This guarantee holds in all market scenarios, including a severe downturn in which the portfolio companies' values decline significantly from current levels.

3. Advantages for This Transaction

The advantages of the remedial allocation method in the context of this transaction are compelling and, in the assessment of the undersigned, dispositive of the analysis.

First, the remedial method provides complete elimination of ceiling rule distortion. Unlike the traditional method (which does not address ceiling rule distortions at all) or the curative method (which addresses them only to the extent that actual same-character tax items are available), the remedial method eliminates distortions in their entirety by creating notional items as needed. There is no scenario in which the non-contributing partners bear any portion of the pre-contribution gain.

Second, the remedial method directly and fully addresses Garrison's negotiating position. Garrison Secondaries Fund IV LP, through its counsel Douglas Whitfield at Whitfield & Calloway LLP and its investment principal Mitchell Adler at Garrison Capital Advisors LLC, has made protection from pre-contribution gain allocations an express condition of its $380 million capital commitment. The remedial method is the only method that provides this protection with certainty under all market conditions. Advising the client to adopt either the traditional or curative method would place the Garrison commitment at risk.

Third, the remedial method is particularly appropriate for contributed property with a very large built-in gain relative to basis. Here, the aggregate gain-to-basis ratio is approximately 8.71:1 ($1.202 billion ÷ $138 million), which is an extreme disparity by any measure. The larger the built-in gain, the greater the potential ceiling rule distortion under the traditional method, and the more important it becomes to adopt a method that eliminates the distortion completely.

Fourth, the remedial method eliminates the need for actual offsetting tax items, which is critical in the context of this CV. As discussed above, the CV's portfolio consists entirely of passive equity interests in three C-corporations, generating minimal ongoing tax items beyond capital gain on disposition. The curative method's requirement for actual same-character tax items to cure ceiling rule distortions is a near-fatal limitation in this context; the remedial method's ability to create notional items eliminates this constraint.

Fifth, the remedial method correctly allocates the economic burden of pre-contribution gain to the rolling LPs who enjoyed the appreciation. This is consistent with economic substance and with the fundamental purpose of Section 704(c). The rolling LPs held the portfolio company interests throughout the appreciation period, benefited from the increase in value, and should bear the tax consequences of that appreciation — including through remedial gain allocations if the assets decline in value after contribution.

4. Disadvantages and Complexities

The remedial method is not without its costs and complexities, which should be acknowledged and addressed in the structuring process.

The primary disadvantage is administrative complexity. The remedial method requires the partnership's accountants and tax preparers to maintain dual book/tax capital accounts for each partner, tracking Section 704(b) book capital, tax basis capital, and the difference attributable to contributed property built-in gain for each of the three portfolio company interests separately. When remedial items are created, they must be properly characterized, allocated, and reported on each partner's Schedule K-1. This additional tracking and reporting increases the annual compliance burden for Andover & Strauss LLP (Patricia Clemons, Audit Partner), which is the CV's proposed auditor and tax preparer. Andover & Strauss has proposed an annual audit and K-1 preparation fee of $185,000, which reflects the anticipated complexity; this fee may need to be adjusted upward once the firm has a full understanding of the remedial method's reporting requirements across the three contributed assets and the two blocker entities.

The second consideration is the impact on contributing (rolling) LPs. Under the remedial method, the rolling LPs may bear additional tax gain allocations through remedial items, potentially accelerating their tax liability relative to what they would experience under the traditional method. This is not an economic cost — it is the correct reflection of the pre-contribution gain that was economically theirs — but it does create a cash flow concern. Rolling LPs who receive remedial gain allocations will incur actual tax liability on those allocations, even if the CV has not distributed cash to them in a sufficient amount to cover the tax. This concern must be addressed through the tax distribution provisions of the CV's limited partnership agreement.

Specifically, the CV LPA (currently being drafted by Hawthorne Reid LLP, Vanessa Liu, Partner) must include robust tax distribution provisions that ensure rolling LPs who receive accelerated gain allocations via remedial items receive sufficient cash distributions to cover their resulting tax liabilities. The tax distribution provisions should specify the applicable assumed tax rate, the timing of tax distributions relative to K-1 delivery, and the priority of tax distributions relative to other distributions under the waterfall. Calderwood & Harkness's markup of the LPA tax provisions (a separate deliverable in this engagement) will address these issues in detail.

V. Portfolio Company-Specific Analysis

A. Luminos Systems Inc.

Luminos Systems Inc. is the largest contributor to the aggregate built-in gain, accounting for $553.5 million of the total $1.202 billion, or approximately 46.0% of the total. The built-in gain arises from the difference between the contribution-date FMV of $612 million and the adjusted cost basis of $58.5 million. Pinnacle's position in Luminos was acquired through Fund II's Series B investment (Q1 2020) and follow-on Series C participation, resulting in a fully diluted ownership stake of 24.7%.

The Luminos position has a significant favorable characteristic for purposes of this analysis: the holding period for purposes of Section 1202 (qualified small business stock, or "QSBS") has been satisfied as of August 2025. The initial Fund II investment was made in the first quarter of 2020, and the five-year holding period required for the maximum Section 1202 exclusion has therefore run. The 10× exclusion ceiling under Section 1202(b)(1)(A) is $585 million per eligible taxpayer (10 times the adjusted basis of $58.5 million). For eligible individual taxpayers (including those who hold their CV interests directly rather than through blocker entities), the Section 1202 exclusion may shelter a significant portion — potentially all — of the $553.5 million built-in gain on the Luminos interest.

However, several important caveats apply. The QSBS exclusion operates at the individual partner level — the CV is a pass-through entity, and Section 1202 eligibility must be determined for each individual taxpayer. Not all of the rolling LPs are eligible for QSBS treatment: tax-exempt investors (Meridian, Ashford), non-U.S. investors (Sovereign Capital), and corporate blockers (PCV Domestic blocker Inc., PCV International Holdings Ltd.) either do not benefit from Section 1202 or have their QSBS benefits limited or eliminated by their entity structure. Additionally, California does not conform to Section 1202 of the Internal Revenue Code; California-resident taxpayers will be subject to California capital gains taxation at ordinary rates up to 13.3% on gain from the disposition of Luminos stock, regardless of QSBS eligibility at the federal level. This state-level non-conformity materially affects the after-tax economics for California-resident rolling LPs.

Under the remedial method, the full $553.5 million of built-in gain on the Luminos interest will be allocated exclusively to the rolling LPs (the contributing partners). The QSBS analysis and the remedial method analysis operate independently — the choice of Section 704(c) method does not affect QSBS eligibility, and QSBS eligibility does not affect the Section 704(c) allocation. However, the practical importance of the interaction is that rolling LPs who are eligible for the Section 1202 exclusion may face a lower effective tax rate on the remedial gain allocations than would otherwise be the case, mitigating the cash flow concern discussed in Section IV.C.4 above.

B. ClearArc Software Inc.

ClearArc Software Inc. is the second-largest contributor to the aggregate built-in gain, accounting for $430.6 million, or approximately 35.8% of the total. The built-in gain arises from the difference between the contribution-date FMV of $468 million and the adjusted cost basis of $37.4 million. Pinnacle's position in ClearArc was acquired through Fund II's Series A investment and follow-on Series B participation (initial investment Q2 2020), resulting in a fully diluted ownership stake of 31.2%.

The QSBS five-year holding period for the ClearArc position is expected to be satisfied as of September 2025 (five years from the Q2 2020 initial investment date, with the precise satisfaction date depending on the exact date of the original stock issuance). The 10× exclusion ceiling under Section 1202(b)(1)(A) is $374 million per eligible taxpayer (10 times the adjusted basis of $37.4 million). As with Luminos, the QSBS exclusion may shelter a significant portion of the built-in gain for eligible individual taxpayers, subject to the same limitations discussed above with respect to entity type, blocker structure, and California non-conformity.

Under the remedial method, the full $430.6 million of built-in gain on the ClearArc interest will be allocated exclusively to the contributing partners. The same analysis and considerations applicable to Luminos apply with equal force to ClearArc. No special issues arise with respect to the ClearArc position that distinguish it from the general framework of the remedial method analysis.

C. Vectral Cloud Inc.

Vectral Cloud Inc. is the smallest contributor to the aggregate built-in gain in absolute terms, but it presents unique complications. The built-in gain is $217.9 million ($260 million FMV minus $42.1 million cost basis), representing approximately 18.1% of the total. Pinnacle's position in Vectral was acquired through Fund II's Series B investment in March 2021, resulting in a fully diluted ownership stake of 18.9%.

The critical distinguishing feature of the Vectral position is that the QSBS five-year holding period has not yet been satisfied as of the date of this memorandum. The holding period reaches the five-year mark in March 2026, approximately five months after the anticipated final close of the CV in October 2025. Additionally, preliminary diligence suggests that Vectral Cloud's aggregate gross assets at the time of stock issuance were near the $50 million threshold set forth in Section 1202(d)(1), which defines a "qualified small business" as a C-corporation with aggregate gross assets not exceeding $50 million at all times before and immediately after the issuance. If Vectral's aggregate gross assets exceeded $50 million at the relevant time, the stock would not qualify as QSBS at all, regardless of the holding period. This diligence is ongoing.

The timing sensitivity created by the Vectral holding period has important implications for the structuring of the CV. Under the remedial method, the $217.9 million of built-in gain on the Vectral interest will be allocated exclusively to the contributing partners upon disposition. However, if the Vectral shares are disposed of before March 2026, eligible individual taxpayers among the rolling LPs would lose the opportunity to claim the Section 1202 exclusion on the gain from that disposition. The Tax Protection Agreement currently being drafted separately will include a covenant preventing the CV from disposing of the Vectral shares before March 2026, to preserve the QSBS holding period tacking for eligible holders. This covenant should be drafted with appropriate carve-outs for extraordinary circumstances (e.g., a third-party acquisition of Vectral at a price that makes continued holding impractical), subject to the consent of a supermajority of the rolling LPs.

The remedial method itself should not interact adversely with QSBS tacking — the creation of remedial allocation items is a tax allocation mechanic, not a transactional event, and should not constitute a "sale or exchange" or other disposition that would reset or disrupt the holding period. This analysis is addressed further in Section VII below.

VI. Interaction with blocker Entities

A. PCV Domestic blocker Inc.

Approximately $175 million of capital from two U.S. tax-exempt investors — Meridian Public Employees' Retirement System ($125 million) and Ashford University Endowment ($50 million) — will flow into the CV through PCV Domestic blocker Inc., a Delaware C-corporation to be formed by September 30, 2025. The purpose of the Domestic blocker is to interpose a corporate entity between these tax-exempt investors and the CV, thereby blocking the flow-through of unrelated business taxable income ("UBTI") under Section 512 that might otherwise be allocated to these investors if they held their CV interests directly.

For purposes of the Section 704(c) analysis, PCV Domestic blocker Inc. is itself a partner in the CV — it holds a limited partnership interest and receives its proportionate share of partnership allocations on its Schedule K-1. The critical question is whether the Domestic blocker is treated as a contributing partner (rolling) or a non-contributing partner (new) under the Section 704(c) framework.

Because Meridian and Ashford are rolling their existing Fund II interests into the CV — that is, they are not contributing new cash but rather are contributing their pro-rata share of the appreciated portfolio company interests through the blocker structure — the Domestic blocker is properly treated as a contributing partner. As such, under the remedial method, the Domestic blocker will be allocated its pro-rata share of the pre-contribution built-in gain through remedial items. This is the correct result from a Section 704(c) perspective: the economic appreciation accrued while these investors held their Fund II interests, and the tax consequences of that appreciation should follow them even as they transition into the CV structure through a blocker entity.

The principal consequence of this treatment is corporate-level tax leakage. PCV Domestic blocker Inc., as a C-corporation, will pay corporate income tax at the 21% federal rate on all gain allocations, including remedial gain allocations. When the CV ultimately disposes of the contributed portfolio company interests, the Domestic blocker will report its share of the tax gain — including any remedial gain — on its corporate income tax return and will pay tax at the corporate rate. This tax is not recoverable by Meridian or Ashford; it is a permanent cost of the blocker structure. However, this corporate-level tax is the accepted trade-off for UBTI blocking, and the investors have been counseled on this trade-off in connection with their decision to utilize the blocker structure.

The remedial method requires maintaining separate book/tax capital accounts for the Domestic blocker's interests. Because the Domestic blocker aggregates the interests of two underlying investors (Meridian and Ashford) with different investment sizes, the internal allocation between these investors within the Domestic blocker must also be properly documented. This internal allocation is governed by the Domestic blocker's corporate charter and shareholder agreement, which should specify how gain allocations received from the CV are shared between the two underlying investors. The drafting of these documents is a separate deliverable outside the scope of this memorandum.

B. PCV International Holdings Ltd.

Approximately $75 million of capital from Sovereign Capital Partners (Cayman) Ltd. will flow into the CV through PCV International Holdings Ltd., a Cayman Islands exempted company that will make a check-the-box election on IRS Form 8832 to be treated as a corporation for U.S. federal income tax purposes. The purpose of the Offshore blocker is to interpose a corporate entity between Sovereign Capital (a non-U.S. investor) and the CV, thereby blocking the flow-through of effectively connected income ("ECI") and mitigating exposure under the Foreign Investment in Real Property Tax Act ("FIRPTA") provisions of Section 897 and the withholding requirements of Section 1446.

The same analysis applied to the Domestic blocker applies to the Offshore blocker: because Sovereign Capital is rolling its existing Fund II interest into the CV, PCV International Holdings Ltd. is properly treated as a contributing partner and will bear its pro-rata share of the pre-contribution built-in gain under the remedial method.

The corporate-level tax leakage analysis for the Offshore blocker is similar to that for the Domestic blocker — the Offshore blocker will pay U.S. corporate income tax at the 21% federal rate on ECI allocations, including remedial gain allocations, if and when the contributed portfolio company interests are disposed of. In addition, the Offshore blocker's status as a foreign corporation (under Cayman law) that is treated as a domestic corporation (by virtue of the check-the-box election) requires careful attention to withholding obligations under Section 1446 on the CV's allocations of ECI. The CV, as a partnership with a foreign partner, may be required to withhold on ECI allocated to the Offshore blocker; however, because the Offshore blocker has elected corporate treatment, the mechanics of withholding and estimated tax payments differ from those applicable to a direct non-U.S. partner.

It should be noted that if the Offshore blocker were restructured as a vehicle for new (non-contributing) capital rather than rolling LP capital, it would avoid classification as a contributing partner and would therefore not bear any pre-contribution gain allocations under the remedial method. Under the current structure, however, Sovereign Capital is rolling its Fund II interest, and the Offshore blocker is therefore a contributing partner. Any restructuring to change this classification would require careful analysis of the Section 721 contribution mechanics and could potentially affect the non-recognition treatment of the overall transaction. We do not recommend such a restructuring at this time.

VII. Interaction with QSBS Tacking and Section 1202

The choice of Section 704(c) allocation method does not directly affect the eligibility of the contributed portfolio company stock for QSBS treatment under Section 1202 of the Code. QSBS status is determined at the shareholder level — here, at the level of the individual limited partners who hold their interests in the CV either directly or through pass-through entities. The CV, as a partnership, is a pass-through entity; Section 1202 treatment passes through to the individual partners, and each partner's eligibility for the QSBS exclusion is determined based on that partner's individual circumstances (including holding period, basis, and the nature of the stock).

Section 1202(h) provides rules for the tacking of holding periods and QSBS status in certain non-recognition transactions, including contributions of QSBS to a partnership under Section 721. Under Section 1202(h)(2)(B), stock acquired by a partnership in a transaction described in Section 721 is treated as QSBS in the hands of the partnership if the stock was QSBS in the hands of the contributing partner, and the partner's holding period tacks. This rule is critical to the Vectral position, where the QSBS five-year holding period has not yet been satisfied and will not be satisfied until March 2026.

The remedial allocation method's creation of notional (remedial) tax items should not, in our analysis, constitute a "sale or exchange" or other disposition of the underlying portfolio company stock that would disrupt QSBS tacking under Section 1202(h). Remedial allocations are tax allocation mechanics internal to the partnership — they adjust the allocation of tax items among partners but do not change the ownership of the underlying shares, do not constitute a transfer of property, and do not trigger any transactional event at the entity level. The shares remain held by the CV throughout, and the contributing partners' tacked holding periods are preserved.

We are not aware of any authority — statutory, regulatory, or administrative — suggesting that the adoption of the remedial allocation method (or any other Section 704(c) method) affects QSBS eligibility or holding period tacking under Section 1202. The remedial method's notional items are a purely allocative mechanism and do not implicate the disposition or exchange rules that govern QSBS status.

For Vectral Cloud specifically, the coordination of the remedial method with QSB

MEMORANDUM
PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
From: Leila Nazari, Associate, Calderwood & Harkness LLP
To: Garrett Simmons, Lead Associate, and Sylvia Hartwell, Responsible Partner, Tax
Date: August 6, 2025
Re: Section 704(c) Allocation Methodology for Built-In Gain on Contributed Portfolio Company Interests — Pinnacle Continuation Vehicle LP
Matter No.: 117443.00001
Engagement Ref.: 1002-00005
I. Executive Summary
The purpose of this memorandum is to analyze and recommend the appropriate Section 704(c) allocation method for the $1.202 billion of aggregate built-in gain on portfolio company interests being contributed from Pinnacle Venture Fund II LP (EIN 84-3291067) ("Fund II") to Pinnacle Continuation Vehicle LP ("PCV" or the "CV") in connection with the GP-led secondary transaction currently being negotiated by the deal team. This memorandum is being prepared in connection with our broader engagement advising Pinnacle Capital Management LLC on the tax structuring of the continuation vehicle formation and the related secondary transaction.
The contribution of three portfolio company stakes — Luminos Systems Inc., ClearArc Software Inc., and Vectral Cloud Inc. — from Fund II to the CV under Section 721 of the Internal Revenue Code will carry over the existing aggregate adjusted tax basis of $138.0 million in those interests, while the aggregate fair market value of those same interests as of June 30, 2025 is $1.34 billion. This creates $1.202 billion of aggregate built-in gain that must be properly addressed under Section 704(c) of the Code and the Treasury Regulations promulgated thereunder. Absent the adoption of an appropriate allocation methodology, the risk of inequitable tax burden shifting between the contributing and non-contributing partners of the CV is both material and, given the magnitude of the built-in gain at issue, potentially severe.
The choice of allocation method is critical for three independent but interrelated reasons. First, the rolling LPs — who hold approximately $680 million in net asset value and who are the partners contributing the appreciated portfolio company interests into the CV — are the partners who economically benefited from the pre-contribution appreciation, and Section 704(c) is designed to ensure that the tax consequences of that appreciation follow them. Second, the new investors — principally Garrison Secondaries Fund IV LP, which is committing $380 million of new capital to the CV — must not bear the tax burden of pre-contribution built-in gain that accrued before they entered the partnership. Garrison's counsel at Whitfield & Calloway LLP has made this a threshold condition to closing the transaction. Third, approximately $250 million of capital is flowing through blocker entities — specifically, PCV Domestic blocker Inc. and PCV International Holdings Ltd. — whose corporate-level tax exposure is directly affected by the allocation methodology selected.
After a comprehensive analysis of the three permissible Section 704(c) allocation methods — the traditional method, the traditional method with curative allocations, and the remedial allocation method — it is the recommendation of the undersigned, subject to the review and approval of the responsible partner, that the CV adopt the remedial allocation method under Treasury Regulation § 1.704-3(d) for all three contributed portfolio company interests. This recommendation is grounded in the extraordinary magnitude of the built-in gain, the passive nature of the contributed equity portfolio, the composition of the investor base, the negotiating position of the lead secondary buyer, and the superior ability of the remedial method to eliminate ceiling rule distortions in their entirety.
II. Background and Transaction Overview
A. The Continuation Vehicle Transaction
Pinnacle Venture Fund II LP is a Delaware limited partnership with a vintage year of 2019 and a final close date of December 2019. Fund II is managed by Pinnacle Capital Management LLC, which maintains its principal offices at 2100 Sand Hill Road, Suite 340, Menlo Park, California 94025. As Fund II approaches the end of its contractual term, the general partner has determined that three high-performing portfolio investments — all in the enterprise software and SaaS sector — would benefit from an extended hold period and continued operational development. Rather than distributing these positions in-kind or forcing a premature exit, the general partner proposes to transfer these concentrated positions to a newly formed continuation vehicle.
The CV — Pinnacle Continuation Vehicle LP — is to be formed as a Delaware limited partnership, with Pinnacle CV Partners LLC serving as its general partner. Pinnacle CV Partners LLC will be a newly formed Delaware limited liability company controlled by the same principals who manage Pinnacle Capital Management LLC, namely Marcus Aldren, Diana Tsao, and Rafael Montoya. The legal formation of the CV and its general partner entity is being coordinated by Hawthorne Reid LLP (Vanessa Liu, Partner), which is also responsible for drafting the limited partnership agreement and related governance documents.
The total capitalization of the CV upon final closing is expected to be approximately $1.074 billion. This capitalization is comprised of three principal sources of capital. The first source is the rolling LP interests, representing approximately $680 million in net asset value, which will be contributed to the CV in exchange for limited partnership interests in the CV. The second source is $380 million of new capital from Garrison Secondaries Fund IV LP, the lead secondary buyer (with principal offices at 399 Park Avenue, 22nd Floor, New York, New York 10022; Mitchell Adler, Partner), which is being advised by Whitfield & Calloway LLP (Douglas Whitfield, Partner). Of Garrison's $380 million commitment, approximately $280 million is designated to fund the liquidity for cashing-out LPs, and approximately $100 million is allocated to follow-on reserves, transaction expenses, and working capital. The third source is a $14 million GP co-investment by Pinnacle Capital Management LLC and its principals. The target final close of the CV is October 31, 2025.
The transaction is structured as a GP-led secondary transaction — a continuation vehicle formation in which the general partner of Fund II offers its existing limited partners the election to either (i) roll their interests into the CV (the "rolling LPs") or (ii) cash out at fair market value using the capital contributed by the secondary buyer (the "cashing-out LPs"). This bifurcation of the existing limited partner base is the hallmark of such transactions and gives rise to the Section 704(c) issues that are the subject of this memorandum.
B. Contributed Portfolio Company Interests and Built-In Gain
The three portfolio company interests being contributed from Fund II to the CV, together with their respective fair market values, cost bases, built-in gains, and ownership stakes, are set forth in the table below:
The implied gross multiple of invested capital (MOIC) on the portfolio in the aggregate is approximately 9.71× ($1,340,000,000 ÷ $138,000,000), reflecting exceptional performance across all three investments. The fair market values reflected in the table are derived from the June 30, 2025 valuation data prepared in connection with Fund II's most recent quarterly reporting cycle. At the enterprise level, Luminos Systems is valued at $2.48 billion (Pinnacle's 24.7% fully diluted stake equating to approximately $612 million); ClearArc Software is valued at $1.50 billion (Pinnacle's 31.2% fully diluted stake equating to approximately $468 million); and Vectral Cloud is valued at $1.376 billion (Pinnacle's 18.9% fully diluted stake equating to approximately $260 million).
These valuations are supported by the independent valuation work of Kessler Pratt LLP (David Kessler, Managing Partner), which has been retained to prepare a fairness opinion with respect to the contributed asset values. The fairness opinion is expected to be delivered on or about September 22, 2025, in advance of the anticipated first close. The Kessler Pratt engagement is being conducted on a flat-fee basis of $850,000, and the firm's work will include a detailed discounted cash flow analysis, comparable company analysis, and precedent transaction analysis for each of the three portfolio companies. The fairness opinion will serve as the basis for establishing the initial book capital accounts of the contributing partners in the CV and for quantifying the Section 704(c) built-in gain layers that are the focus of this memorandum.
C. Investor Composition and Tax Sensitivity
The investor base of the CV is heterogeneous with respect to tax status, jurisdiction, and tax sensitivity, which materially affects the analysis of Section 704(c) methodology. The principal categories of investors and their tax characteristics are described below.
Rolling LPs (approximately $680 million NAV). The rolling LPs are existing limited partners of Fund II who have elected to roll their interests into the CV rather than receive a cash distribution. This group includes Meridian Public Employees' Retirement System (approximately $125 million in net asset value), a U.S. tax-exempt pension fund organized under state law and exempt from federal income taxation under Section 115 of the Code, but potentially subject to unrelated business taxable income ("UBTI") under Section 512 if its investment generates debt-financed income or income from a trade or business. The rolling LPs also include Ashford University Endowment (approximately $50 million in net asset value), a Section 501(c)(3) tax-exempt educational endowment with similar UBTI sensitivities. In addition, the rolling LPs include Sovereign Capital Partners (Cayman) Ltd. (approximately $75 million in net asset value), a non-U.S. Cayman Islands exempted company that is sensitive to allocations of effectively connected income ("ECI") and to the withholding and reporting obligations imposed under Sections 1446 and 897 (FIRPTA). The balance of the rolling LP group is composed of various domestic taxable investors, including family offices, high-net-worth individuals, and other institutional limited partners.
Cashing-Out LPs (approximately $280 million NAV). The cashing-out LPs are existing limited partners of Fund II who have elected to receive liquidity in the secondary transaction rather than roll into the CV. This group includes Redstone Family Office LLC (approximately $40 million in net asset value), a U.S. taxable family office (Barbara Redstone, Principal), along with other domestic and international investors. The cashing-out LPs are not directly affected by the Section 704(c) analysis because they are receiving cash in exchange for their Fund II interests and will not become partners in the CV. Their tax treatment is governed by the sale or exchange provisions applicable to the disposition of their Fund II partnership interests.
New Secondary Investor. Garrison Secondaries Fund IV LP is contributing $380 million of new capital to the CV. Of this amount, approximately $280 million will fund the liquidity payments to the cashing-out LPs, and approximately $100 million is allocated to follow-on reserves, CV-level transaction expenses, and working capital. Garrison is a non-contributing partner in the CV — it is not contributing appreciated property and therefore should not bear any tax burden from pre-contribution built-in gain. Mitchell Adler (Partner at Garrison Capital Advisors LLC, the adviser to Garrison Secondaries Fund IV LP) and Douglas Whitfield (Partner at Whitfield & Calloway LLP, Garrison's outside counsel) have both communicated in term sheet negotiations that protection from pre-contribution gain allocations is a condition to closing.
GP Co-Invest. Pinnacle Capital Management LLC and its principals (Marcus Aldren, Diana Tsao, and Rafael Montoya) are contributing $14 million of GP co-investment capital. This co-investment is rolling from Fund II and therefore represents a contributing interest for Section 704(c) purposes.
blocker Entities. Approximately $250 million of total CV capital (representing 23.3% of the $1.074 billion total capitalization) flows through two blocker entities designed to manage UBTI and ECI exposure for tax-exempt and non-U.S. investors, respectively. PCV Domestic blocker Inc. is a Delaware C-corporation to be formed, which will hold approximately $175 million of capital — $125 million on behalf of Meridian Public Employees' Retirement System and $50 million on behalf of Ashford University Endowment — and will serve to block UBTI that might otherwise flow through to these tax-exempt investors under Section 512. PCV International Holdings Ltd. is a Cayman Islands exempted company to be formed, which will make a check-the-box election on IRS Form 8832 to be treated as a corporation for U.S. federal income tax purposes, and which will hold approximately $75 million of capital on behalf of Sovereign Capital Partners (Cayman) Ltd. The Offshore blocker will serve to block ECI and FIRPTA exposure under Sections 897 and 1446 of the Code. The interaction between these blocker entities and the Section 704(c) remedial allocation method is analyzed in detail in Section VI below.
D. Section 721 Contribution Framework
The portfolio company interests are being contributed from Fund II to the CV in a transaction intended to qualify for non-recognition treatment under Section 721(a) of the Internal Revenue Code. Section 721(a) provides the general rule that no gain or loss is recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership. The applicability of Section 721(a) to this transaction is the subject of a separate opinion letter currently being prepared by the undersigned and is not addressed in detail in this memorandum.
Under Section 722 of the Code, the CV's tax basis in the contributed portfolio company interests will equal Fund II's adjusted tax basis in those interests — $138.0 million in the aggregate. Under Section 723, the contributing partners' basis in their CV partnership interests will equal their respective shares of the adjusted basis of the contributed property, increased by any gain recognized (if any) on the contribution. Because the transaction is intended to qualify in full for Section 721(a) non-recognition treatment, no gain should be recognized at the time of contribution.
The $1.202 billion spread between the aggregate fair market value ($1.34 billion) and the aggregate adjusted tax basis ($138.0 million) of the contributed portfolio company interests constitutes "built-in gain" within the meaning of Section 704(c). This built-in gain must be allocated among the partners of the CV in a manner that prevents the shifting of pre-contribution gain to non-contributing partners — specifically, to Garrison Secondaries Fund IV LP and any other investors who are contributing cash (rather than appreciated property) to the CV. The mechanics by which this allocation is accomplished depend critically on which of the three permissible Section 704(c) methods is elected in the CV's limited partnership agreement.
III. Legal Framework: Section 704(c) and the Ceiling Rule
A. Statutory and Regulatory Overview
Section 704(c)(1)(A) of the Internal Revenue Code provides, in pertinent part, that income, gain, loss, and deduction with respect to property contributed to a partnership by a partner shall be shared among the partners so as to take account of the variation between the basis of the property to the partnership and its fair market value at the time of contribution. The purpose of this provision is straightforward but critical: it is designed to prevent contributing partners from shifting the tax consequences of pre-contribution gain (or loss) to other partners who were not parties to the original investment and who did not participate in the economic appreciation (or depreciation) that gave rise to the book/tax disparity.
The legislative history of Section 704(c) reflects Congress's concern that, absent a mandatory allocation rule, partners could exploit the disparity between a contributed asset's tax basis and its fair market value to shift the economic incidence of taxation away from the partner who economically benefited from the appreciation. The provision serves as a fundamental integrity mechanism in the partnership tax regime, ensuring that the tax consequences of property contributions are allocated in a manner consistent with economic reality.
Treasury Regulation § 1.704-3(a) implements Section 704(c) by establishing a framework within which partnerships must adopt a "reasonable method" of making allocations that take into account the variation between a contributed asset's adjusted tax basis and its fair market value at the time of contribution. The regulations describe three specific methods that are deemed to be reasonable if applied properly: (1) the traditional method, set forth in Treasury Regulation § 1.704-3(b); (2) the traditional method with curative allocations, set forth in Treasury Regulation § 1.704-3(c); and (3) the remedial allocation method, set forth in Treasury Regulation § 1.704-3(d). A partnership is not required to use the same method for all contributed properties, but the partnership agreement must specify which method is used with respect to each item of contributed property, and the chosen method must be applied consistently for that item.
In addition to the three enumerated methods, the regulations contemplate that other methods may be reasonable under certain circumstances, provided they are consistent with the purpose of Section 704(c). However, the three specifically described methods are the only methods that have received explicit regulatory sanction, and we do not believe there is any basis for recommending a non-standard approach in this transaction.
The anti-abuse rule under Treasury Regulation § 1.704-3(a)(10) provides an important guardrail: an allocation method (or a combination of methods) is not reasonable if the contribution of property and the corresponding allocation of tax items are made with a view to shifting the tax consequences of built-in gain or loss among the partners in a manner that substantially reduces the present value of the partners' aggregate tax liability. The anti-abuse rule is intended to prevent the manipulation of Section 704(c) methods to achieve tax-avoidance results that are inconsistent with the purpose of the statute. As discussed in Section IX.C below, the use of the remedial allocation method in this transaction does not implicate the anti-abuse rule; indeed, the remedial method is the approach most consistent with the statutory purpose of preventing tax burden shifting.
B. The Ceiling Rule
The ceiling rule, codified in Treasury Regulation § 1.704-3(b)(1), is the single most important concept in the Section 704(c) analysis, because it is the source of the distortions that the various allocation methods are designed to address. The ceiling rule provides that the total amount of gain, loss, or deduction allocated to partners for tax purposes with respect to a contributed property cannot exceed the partnership's total gain, loss, or deduction recognized on that property. In other words, the partnership's aggregate tax items on a given asset set a "ceiling" on what can be allocated among the partners.
Ceiling rule distortion arises when the partnership's total tax gain on a contributed asset is less than the built-in gain that Section 704(c) requires to be allocated to the contributing partner. This situation occurs when the contributed asset declines in value between the time of contribution and the time of disposition. In such a case, the book/tax disparity creates a circumstance in which the contributing partner should bear a larger tax gain allocation than the total tax gain recognized by the partnership — an impossibility under the ceiling rule. The shortfall — the difference between the built-in gain that should be allocated to the contributing partner and the total tax gain available for allocation — is commonly referred to as the "ceiling rule limitation" or "ceiling rule distortion."
In this transaction, the ceiling rule distortion risk is pronounced. The built-in gain is $1.202 billion on assets with an aggregate tax basis of only $138 million and an aggregate book value of $1.34 billion. If the contributed portfolio company interests decline in value from their current FMV and are sold at prices below the contribution-date FMV, the total tax gain recognized by the CV on the disposition will be less than the built-in gain attributable to the contributing partners. Under the traditional method, the ceiling rule would prevent the full allocation of pre-contribution gain to the contributing partners, and the shortfall would effectively be borne by the non-contributing partners — who would receive less favorable tax treatment than their economic position warrants.
To illustrate: if the aggregate portfolio were sold for $1.0 billion (a decline from the $1.34 billion contribution-date FMV), the CV would recognize $862 million of total tax gain ($1.0 billion minus $138 million basis). The built-in gain allocable to contributing partners under Section 704(c) is $1.202 billion, but only $862 million of tax gain exists. Under the ceiling rule, only $862 million could be allocated, leaving a $340 million shortfall. The non-contributing partners — principally Garrison — would bear the tax consequences of this shortfall by receiving book loss allocations without corresponding tax loss allocations. This result is precisely the type of inequitable tax burden shifting that Section 704(c) is designed to prevent, and it is the central reason why the traditional method is inadequate for this transaction.
The curative and remedial methods each address ceiling rule distortions, but through fundamentally different mechanisms: the curative method uses actual tax items from other sources to offset the distortion, while the remedial method creates notional tax items specifically to eliminate the distortion. The comparative analysis of these three methods as applied to this transaction is set forth in Section IV below.
IV. Analysis of the Three Section 704(c) Methods
A. Traditional Method (Treas. Reg. § 1.704-3(b))
1. Mechanics.  Under the traditional method, the partnership first allocates tax items with respect to a contributed property to the non-contributing partners in an amount up to their respective book allocations. Any remaining tax items are then allocated to the contributing partners. The contributing partners receive whatever tax items remain after the non-contributing partners have been "made whole" up to their book allocations. Critically, the traditional method is subject to the ceiling rule: the partnership cannot allocate to the contributing partner more tax gain (or tax loss) than the total tax gain (or tax loss) recognized by the partnership on the contributed property.
The traditional method is the default method in many partnership agreements and is the simplest to administer. It requires no creation of notional items and no sourcing of curative allocations from other partnership activities. However, its simplicity comes at the cost of accuracy — the ceiling rule can create distortions that result in tax burden shifting from contributing partners to non-contributing partners.
2. Application to This Transaction
To illustrate the operation of the traditional method and the ceiling rule distortion in the context of this transaction, we walk through three hypothetical disposition scenarios using the Luminos Systems Inc. interest (adjusted tax basis of $58.5 million, contribution-date FMV of $612 million, built-in gain of $553.5 million).
Scenario 1: Sale Above FMV. Assume the Luminos shares are sold for $650 million. The book gain recognized by the CV is $38 million ($650 million sale price minus $612 million book value). The tax gain recognized by the CV is $591.5 million ($650 million sale price minus $58.5 million tax basis). Under the traditional method, the $38 million of book gain would be allocated among all partners (rolling LPs, Garrison, GP) based on their respective ownership percentages in the CV. For tax purposes, the first $38 million of tax gain would be allocated to the non-contributing partners to match their book allocations, and the remaining $553.5 million of tax gain (equal to the full built-in gain) would be allocated to the contributing (rolling) LPs. The total tax gain allocated ($38 million plus $553.5 million) equals $591.5 million, which equals the total tax gain recognized by the CV. There is no ceiling rule limitation in this scenario because the asset appreciated beyond its contribution-date FMV, generating sufficient total tax gain to cover the full built-in gain allocation.
Scenario 2: Sale at Exactly FMV. Assume the Luminos shares are sold for exactly $612 million. The book gain is zero ($612 million minus $612 million). The tax gain is $553.5 million ($612 million minus $58.5 million). Under the traditional method, no book gain is allocated to any partner. The entire $553.5 million of tax gain is allocated to the contributing partners. There is no ceiling rule problem here, because the tax gain equals the built-in gain exactly.
Scenario 3: Sale Below FMV (Ceiling Rule Distortion). Assume the Luminos shares are sold for $500 million. The book loss is $112 million ($612 million book value minus $500 million sale price), which would be allocated to all partners based on their respective ownership percentages. The tax gain is $441.5 million ($500 million sale price minus $58.5 million tax basis). Under Section 704(c), the contributing partners should be allocated $553.5 million of tax gain (the full built-in gain), but the partnership has recognized only $441.5 million of total tax gain. Under the ceiling rule, the contributing partners can only be allocated $441.5 million — the full amount of tax gain recognized — leaving a $112 million shortfall ($553.5 million minus $441.5 million).
The consequences of this $112 million shortfall are significant. The non-contributing partners (principally Garrison) receive a book loss allocation of $112 million, reflecting their economic loss on the decline in value. However, because the ceiling rule prevents the full built-in gain from being allocated to the contributing partners, the non-contributing partners receive no corresponding tax loss allocation. They are allocated zero tax items on the disposition. Economically, they have suffered a loss; for tax purposes, they have neither gain nor loss. The discrepancy means the non-contributing partners are effectively bearing a portion of the contributing partners' pre-contribution gain — precisely the result that Section 704(c) was designed to prevent.
3. Disadvantages for This Transaction
Given the massive built-in gain of $1.202 billion on an aggregate tax basis of only $138 million, the ceiling rule distortion risk under the traditional method is substantial. The gain-to-basis ratio across the portfolio is approximately 8.71:1, meaning that even a modest decline in portfolio value could generate ceiling rule shortfalls of hundreds of millions of dollars. In the worst case — where the entire portfolio declines to a value at or near its tax basis — the full $1.202 billion of built-in gain would remain unallocated to the contributing partners, and the non-contributing partners would bear the entire tax burden of the shortfall.
Garrison Secondaries Fund IV LP has specifically raised this concern in the context of term sheet negotiations. Douglas Whitfield at Whitfield & Calloway LLP has communicated to our deal team that Garrison's participation in the transaction is conditioned upon the adoption of an allocation methodology that provides full protection from pre-contribution gain allocations. The traditional method plainly does not satisfy this condition. Outlook, given the current valuation levels and the concentration of the portfolio in three high-growth software companies — whose valuations are subject to the inherent volatility of the technology sector — the probability of a ceiling rule distortion event under the traditional method is not merely theoretical but is a realistic possibility over the expected hold period of the CV.
In summary, the traditional method is the simplest to administer and the least costly from a compliance perspective, but it creates the greatest risk of inequitable tax burden shifting to non-contributing partners. For a transaction of this magnitude and complexity, and with the investor composition described above, the traditional method is not recommended.
B. Traditional Method with Curative Allocations (Treas. Reg. § 1.704-3(c))
1. Mechanics.  Under the curative method, the partnership may offset ceiling rule distortions by making compensating allocations of other partnership tax items to the non-contributing partners. Specifically, when a ceiling rule limitation prevents the full built-in gain from being allocated to the contributing partners, the partnership may reallocate other tax items — which would otherwise be allocated to the contributing partners — to the non-contributing partners to compensate them for the shortfall.
The curative allocations must involve tax items of the "same type" or "same character" as the item that was limited by the ceiling rule. For example, if the ceiling rule limitation relates to capital gain on the sale of a contributed asset, the curative allocation must be made using other capital gain or capital loss items. Ordinary income or ordinary loss items cannot be used to cure a capital gain shortfall, and vice versa. This character-matching requirement is designed to ensure that the curative allocation has the same tax effect as the item it is intended to replace.
The curative allocation is sourced from items that would otherwise be allocated to the contributing partner. In effect, the contributing partner "gives up" its share of other tax items to compensate the non-contributing partners for the ceiling rule distortion. The net economic effect is that the contributing partner bears a greater share of the aggregate tax burden, which is the correct result given that the contributing partner is the party who benefited from the pre-contribution appreciation.
2. Application to This Transaction
Returning to the Luminos Scenario 3 (sale at $500 million), the $112 million ceiling rule shortfall under the traditional method could theoretically be cured under the curative method by reallocating $112 million of other tax items of the same character (i.e., capital gain or capital loss) from the rolling LPs to the non-contributing partners. If, for example, the CV simultaneously disposed of one of the other portfolio company interests at a gain, a portion of the capital gain that would otherwise be allocated to the rolling LPs could be redirected to the non-contributing partners to offset the Luminos shortfall.
However, the practical limitation of the curative method in this transaction is severe. The CV's portfolio consists entirely of equity interests in three Delaware C-corporations: Luminos Systems, ClearArc Software, and Vectral Cloud. The CV does not operate a business, does not hold depreciable assets, and does not generate ongoing streams of ordinary income, depreciation, amortization, or other tax items that could serve as curative allocations. The only significant tax events the CV is expected to experience during its life are (i) capital gain or loss on the disposition of the three portfolio company interests, and (ii) potentially, dividend income if any of the portfolio companies initiates a distribution program (which is not anticipated for any of the three, given their growth-stage profiles).
Because the CV holds a passive equity portfolio rather than an operating business, the universe of available curative items is extremely limited. The curative method works best for operating partnerships — such as real estate partnerships with ongoing depreciation deductions, or operating business partnerships with diverse income and expense streams — where there is a robust flow of tax items that can be reallocated to cure ceiling rule distortions. In a concentrated equity portfolio like the CV, the curative method is largely theoretical.
3. Disadvantages for This Transaction
The curative method's limitations in the context of this transaction can be summarized as follows. First, the CV's portfolio generates minimal ongoing tax items, severely constraining the availability of curative allocations. Second, the character-matching requirement further restricts the pool of available items — capital gain shortfalls can only be cured with capital gain or capital loss items, which arise only upon dispositions of the portfolio company interests. Third, the curative method does not fully eliminate ceiling rule distortions; it only partially addresses them to the extent that other same-character items happen to be available at the time the distortion arises. If the CV disposes of only one portfolio company interest at a loss (triggering a ceiling rule distortion) and has not yet disposed of the other interests, there may be no curative items available at all.
Fourth, the curative method is administratively more complex than the traditional method — it requires the identification, character matching, and reallocation of tax items across partners — but without delivering the full benefit of eliminating ceiling rule distortions. This creates an undesirable combination of increased compliance cost and incomplete protection. For these reasons, the curative method is not recommended for this transaction.
C. Remedial Allocation Method (Treas. Reg. § 1.704-3(d))
1. Mechanics.  The remedial allocation method eliminates ceiling rule distortions entirely by authorizing the partnership to create notional — or "remedial" — tax items when the actual tax items recognized by the partnership are insufficient to eliminate the ceiling rule effect. Unlike the traditional and curative methods, which are constrained by the partnership's actual tax results, the remedial method operates independently of the partnership's actual tax items. When a ceiling rule limitation occurs, the partnership creates two equal and opposite remedial tax items: (a) a remedial tax item (gain, loss, or deduction, as appropriate) allocated to the non-contributing partner to match that partner's book allocation, and (b) an equal and opposite remedial tax item allocated to the contributing partner. These remedial items offset each other at the partnership level, so they do not change the partnership's aggregate tax result, but they ensure that each partner's individual tax result mirrors that partner's economic result.
The remedial items are, in a sense, fabricated — they do not correspond to actual economic transactions or actual taxable events. They exist solely as a mechanism to ensure that the Section 704(c) allocation is carried out in a manner that accurately reflects the economic positions of the contributing and non-contributing partners. The remedial items must be of the same character and must have the same tax effect as the items to which they relate. For example, if the ceiling rule limitation relates to long-term capital gain, the remedial items must both be characterized as long-term capital gain (or long-term capital loss, as appropriate).
The remedial method is the most complex of the three methods from an administrative standpoint, but it is the only method that provides a complete solution to ceiling rule distortions. It is the method specifically designed for situations in which the book/tax disparity on contributed property is large, the contributing and non-contributing partners have divergent economic interests, and the partnership's actual tax items are insufficient to achieve proper Section 704(c) allocations through the traditional or curative methods.
2. Application to This Transaction
Returning once more to the Luminos Scenario 3 (sale at $500 million), the remedial method operates as follows. The book loss on the disposition is $112 million ($612 million book value minus $500 million sale price), allocated among all partners based on their respective ownership percentages. The tax gain is $441.5 million ($500 million minus $58.5 million tax basis). The full $553.5 million of built-in gain should be allocated to the contributing partners under Section 704(c). Under the remedial method, the partnership creates two remedial items:
(a) A remedial tax loss of $112 million, allocated to the non-contributing partners (Garrison and other new investors), matching their book loss allocation. This remedial loss enables the non-contributing partners to report a tax loss that corresponds to their economic loss on the asset.
(b) A remedial tax gain of $112 million, allocated to the contributing partners (rolling LPs), offsetting the remedial loss and increasing the contributing partners' total tax gain allocation.
The net effect on the contributing partners is as follows: they are allocated $441.5 million of actual tax gain (the ceiling amount) plus $112 million of remedial tax gain, for a total tax gain allocation of $553.5 million — exactly equal to the built-in gain. The net effect on the non-contributing partners is as follows: they are allocated $112 million of remedial tax loss, which offsets their economic loss and results in a net tax position of zero gain — exactly reflecting the fact that they had no pre-contribution gain exposure.
This result is precisely what Section 704(c) is intended to achieve: the contributing partners bear the full tax burden of the pre-contribution appreciation, and the non-contributing partners bear no tax burden attributable to appreciation that accrued before they entered the partnership.
Applied to the full portfolio ($1.202 billion of aggregate built-in gain), the remedial method guarantees that regardless of the ultimate sale prices of the Luminos, ClearArc, and Vectral interests — whether they are sold at, above, or below their contribution-date FMV — Garrison Secondaries Fund IV LP and any other non-contributing investors will never be allocated tax gain or denied tax loss attributable to the pre-contribution appreciation. This guarantee holds in all market scenarios, including a severe downturn in which the portfolio companies' values decline significantly from current levels.
3. Advantages for This Transaction
The advantages of the remedial allocation method in the context of this transaction are compelling and, in the assessment of the undersigned, dispositive of the analysis.
First, the remedial method provides complete elimination of ceiling rule distortion. Unlike the traditional method (which does not address ceiling rule distortions at all) or the curative method (which addresses them only to the extent that actual same-character tax items are available), the remedial method eliminates distortions in their entirety by creating notional items as needed. There is no scenario in which the non-contributing partners bear any portion of the pre-contribution gain.
Second, the remedial method directly and fully addresses Garrison's negotiating position. Garrison Secondaries Fund IV LP, through its counsel Douglas Whitfield at Whitfield & Calloway LLP and its investment principal Mitchell Adler at Garrison Capital Advisors LLC, has made protection from pre-contribution gain allocations an express condition of its $380 million capital commitment. The remedial method is the only method that provides this protection with certainty under all market conditions. Advising the client to adopt either the traditional or curative method would place the Garrison commitment at risk.
Third, the remedial method is particularly appropriate for contributed property with a very large built-in gain relative to basis. Here, the aggregate gain-to-basis ratio is approximately 8.71:1 ($1.202 billion ÷ $138 million), which is an extreme disparity by any measure. The larger the built-in gain, the greater the potential ceiling rule distortion under the traditional method, and the more important it becomes to adopt a method that eliminates the distortion completely.
Fourth, the remedial method eliminates the need for actual offsetting tax items, which is critical in the context of this CV. As discussed above, the CV's portfolio consists entirely of passive equity interests in three C-corporations, generating minimal ongoing tax items beyond capital gain on disposition. The curative method's requirement for actual same-character tax items to cure ceiling rule distortions is a near-fatal limitation in this context; the remedial method's ability to create notional items eliminates this constraint.
Fifth, the remedial method correctly allocates the economic burden of pre-contribution gain to the rolling LPs who enjoyed the appreciation. This is consistent with economic substance and with the fundamental purpose of Section 704(c). The rolling LPs held the portfolio company interests throughout the appreciation period, benefited from the increase in value, and should bear the tax consequences of that appreciation — including through remedial gain allocations if the assets decline in value after contribution.
4. Disadvantages and Complexities
The remedial method is not without its costs and complexities, which should be acknowledged and addressed in the structuring process.
The primary disadvantage is administrative complexity. The remedial method requires the partnership's accountants and tax preparers to maintain dual book/tax capital accounts for each partner, tracking Section 704(b) book capital, tax basis capital, and the difference attributable to contributed property built-in gain for each of the three portfolio company interests separately. When remedial items are created, they must be properly characterized, allocated, and reported on each partner's Schedule K-1. This additional tracking and reporting increases the annual compliance burden for Andover & Strauss LLP (Patricia Clemons, Audit Partner), which is the CV's proposed auditor and tax preparer. Andover & Strauss has proposed an annual audit and K-1 preparation fee of $185,000, which reflects the anticipated complexity; this fee may need to be adjusted upward once the firm has a full understanding of the remedial method's reporting requirements across the three contributed assets and the two blocker entities.
The second consideration is the impact on contributing (rolling) LPs. Under the remedial method, the rolling LPs may bear additional tax gain allocations through remedial items, potentially accelerating their tax liability relative to what they would experience under the traditional method. This is not an economic cost — it is the correct reflection of the pre-contribution gain that was economically theirs — but it does create a cash flow concern. Rolling LPs who receive remedial gain allocations will incur actual tax liability on those allocations, even if the CV has not distributed cash to them in a sufficient amount to cover the tax. This concern must be addressed through the tax distribution provisions of the CV's limited partnership agreement.
Specifically, the CV LPA (currently being drafted by Hawthorne Reid LLP, Vanessa Liu, Partner) must include robust tax distribution provisions that ensure rolling LPs who receive accelerated gain allocations via remedial items receive sufficient cash distributions to cover their resulting tax liabilities. The tax distribution provisions should specify the applicable assumed tax rate, the timing of tax distributions relative to K-1 delivery, and the priority of tax distributions relative to other distributions under the waterfall. Calderwood & Harkness's markup of the LPA tax provisions (a separate deliverable in this engagement) will address these issues in detail.
V. Portfolio Company-Specific Analysis
A. Luminos Systems Inc.
Luminos Systems Inc. is the largest contributor to the aggregate built-in gain, accounting for $553.5 million of the total $1.202 billion, or approximately 46.0% of the total. The built-in gain arises from the difference between the contribution-date FMV of $612 million and the adjusted cost basis of $58.5 million. Pinnacle's position in Luminos was acquired through Fund II's Series B investment (Q1 2020) and follow-on Series C participation, resulting in a fully diluted ownership stake of 24.7%.
The Luminos position has a significant favorable characteristic for purposes of this analysis: the holding period for purposes of Section 1202 (qualified small business stock, or "QSBS") has been satisfied as of August 2025. The initial Fund II investment was made in the first quarter of 2020, and the five-year holding period required for the maximum Section 1202 exclusion has therefore run. The 10× exclusion ceiling under Section 1202(b)(1)(A) is $585 million per eligible taxpayer (10 times the adjusted basis of $58.5 million). For eligible individual taxpayers (including those who hold their CV interests directly rather than through blocker entities), the Section 1202 exclusion may shelter a significant portion — potentially all — of the $553.5 million built-in gain on the Luminos interest.
However, several important caveats apply. The QSBS exclusion operates at the individual partner level — the CV is a pass-through entity, and Section 1202 eligibility must be determined for each individual taxpayer. Not all of the rolling LPs are eligible for QSBS treatment: tax-exempt investors (Meridian, Ashford), non-U.S. investors (Sovereign Capital), and corporate blockers (PCV Domestic blocker Inc., PCV International Holdings Ltd.) either do not benefit from Section 1202 or have their QSBS benefits limited or eliminated by their entity structure. Additionally, California does not conform to Section 1202 of the Internal Revenue Code; California-resident taxpayers will be subject to California capital gains taxation at ordinary rates up to 13.3% on gain from the disposition of Luminos stock, regardless of QSBS eligibility at the federal level. This state-level non-conformity materially affects the after-tax economics for California-resident rolling LPs.
Under the remedial method, the full $553.5 million of built-in gain on the Luminos interest will be allocated exclusively to the rolling LPs (the contributing partners). The QSBS analysis and the remedial method analysis operate independently — the choice of Section 704(c) method does not affect QSBS eligibility, and QSBS eligibility does not affect the Section 704(c) allocation. However, the practical importance of the interaction is that rolling LPs who are eligible for the Section 1202 exclusion may face a lower effective tax rate on the remedial gain allocations than would otherwise be the case, mitigating the cash flow concern discussed in Section IV.C.4 above.
B. ClearArc Software Inc.
ClearArc Software Inc. is the second-largest contributor to the aggregate built-in gain, accounting for $430.6 million, or approximately 35.8% of the total. The built-in gain arises from the difference between the contribution-date FMV of $468 million and the adjusted cost basis of $37.4 million. Pinnacle's position in ClearArc was acquired through Fund II's Series A investment and follow-on Series B participation (initial investment Q2 2020), resulting in a fully diluted ownership stake of 31.2%.
The QSBS five-year holding period for the ClearArc position is expected to be satisfied as of September 2025 (five years from the Q2 2020 initial investment date, with the precise satisfaction date depending on the exact date of the original stock issuance). The 10× exclusion ceiling under Section 1202(b)(1)(A) is $374 million per eligible taxpayer (10 times the adjusted basis of $37.4 million). As with Luminos, the QSBS exclusion may shelter a significant portion of the built-in gain for eligible individual taxpayers, subject to the same limitations discussed above with respect to entity type, blocker structure, and California non-conformity.
Under the remedial method, the full $430.6 million of built-in gain on the ClearArc interest will be allocated exclusively to the contributing partners. The same analysis and considerations applicable to Luminos apply with equal force to ClearArc. No special issues arise with respect to the ClearArc position that distinguish it from the general framework of the remedial method analysis.
C. Vectral Cloud Inc.
Vectral Cloud Inc. is the smallest contributor to the aggregate built-in gain in absolute terms, but it presents unique complications. The built-in gain is $217.9 million ($260 million FMV minus $42.1 million cost basis), representing approximately 18.1% of the total. Pinnacle's position in Vectral was acquired through Fund II's Series B investment in March 2021, resulting in a fully diluted ownership stake of 18.9%.
The critical distinguishing feature of the Vectral position is that the QSBS five-year holding period has not yet been satisfied as of the date of this memorandum. The holding period reaches the five-year mark in March 2026, approximately five months after the anticipated final close of the CV in October 2025. Additionally, preliminary diligence suggests that Vectral Cloud's aggregate gross assets at the time of stock issuance were near the $50 million threshold set forth in Section 1202(d)(1), which defines a "qualified small business" as a C-corporation with aggregate gross assets not exceeding $50 million at all times before and immediately after the issuance. If Vectral's aggregate gross assets exceeded $50 million at the relevant time, the stock would not qualify as QSBS at all, regardless of the holding period. This diligence is ongoing.
The timing sensitivity created by the Vectral holding period has important implications for the structuring of the CV. Under the remedial method, the $217.9 million of built-in gain on the Vectral interest will be allocated exclusively to the contributing partners upon disposition. However, if the Vectral shares are disposed of before March 2026, eligible individual taxpayers among the rolling LPs would lose the opportunity to claim the Section 1202 exclusion on the gain from that disposition. The Tax Protection Agreement currently being drafted separately will include a covenant preventing the CV from disposing of the Vectral shares before March 2026, to preserve the QSBS holding period tacking for eligible holders. This covenant should be drafted with appropriate carve-outs for extraordinary circumstances (e.g., a third-party acquisition of Vectral at a price that makes continued holding impractical), subject to the consent of a supermajority of the rolling LPs.
The remedial method itself should not interact adversely with QSBS tacking — the creation of remedial allocation items is a tax allocation mechanic, not a transactional event, and should not constitute a "sale or exchange" or other disposition that would reset or disrupt the holding period. This analysis is addressed further in Section VII below.
VI. Interaction with blocker Entities
A. PCV Domestic blocker Inc.
Approximately $175 million of capital from two U.S. tax-exempt investors — Meridian Public Employees' Retirement System ($125 million) and Ashford University Endowment ($50 million) — will flow into the CV through PCV Domestic blocker Inc., a Delaware C-corporation to be formed by September 30, 2025. The purpose of the Domestic blocker is to interpose a corporate entity between these tax-exempt investors and the CV, thereby blocking the flow-through of unrelated business taxable income ("UBTI") under Section 512 that might otherwise be allocated to these investors if they held their CV interests directly.
For purposes of the Section 704(c) analysis, PCV Domestic blocker Inc. is itself a partner in the CV — it holds a limited partnership interest and receives its proportionate share of partnership allocations on its Schedule K-1. The critical question is whether the Domestic blocker is treated as a contributing partner (rolling) or a non-contributing partner (new) under the Section 704(c) framework.
Because Meridian and Ashford are rolling their existing Fund II interests into the CV — that is, they are not contributing new cash but rather are contributing their pro-rata share of the appreciated portfolio company interests through the blocker structure — the Domestic blocker is properly treated as a contributing partner. As such, under the remedial method, the Domestic blocker will be allocated its pro-rata share of the pre-contribution built-in gain through remedial items. This is the correct result from a Section 704(c) perspective: the economic appreciation accrued while these investors held their Fund II interests, and the tax consequences of that appreciation should follow them even as they transition into the CV structure through a blocker entity.
The principal consequence of this treatment is corporate-level tax leakage. PCV Domestic blocker Inc., as a C-corporation, will pay corporate income tax at the 21% federal rate on all gain allocations, including remedial gain allocations. When the CV ultimately disposes of the contributed portfolio company interests, the Domestic blocker will report its share of the tax gain — including any remedial gain — on its corporate income tax return and will pay tax at the corporate rate. This tax is not recoverable by Meridian or Ashford; it is a permanent cost of the blocker structure. However, this corporate-level tax is the accepted trade-off for UBTI blocking, and the investors have been counseled on this trade-off in connection with their decision to utilize the blocker structure.
The remedial method requires maintaining separate book/tax capital accounts for the Domestic blocker's interests. Because the Domestic blocker aggregates the interests of two underlying investors (Meridian and Ashford) with different investment sizes, the internal allocation between these investors within the Domestic blocker must also be properly documented. This internal allocation is governed by the Domestic blocker's corporate charter and shareholder agreement, which should specify how gain allocations received from the CV are shared between the two underlying investors. The drafting of these documents is a separate deliverable outside the scope of this memorandum.
B. PCV International Holdings Ltd.
Approximately $75 million of capital from Sovereign Capital Partners (Cayman) Ltd. will flow into the CV through PCV International Holdings Ltd., a Cayman Islands exempted company that will make a check-the-box election on IRS Form 8832 to be treated as a corporation for U.S. federal income tax purposes. The purpose of the Offshore blocker is to interpose a corporate entity between Sovereign Capital (a non-U.S. investor) and the CV, thereby blocking the flow-through of effectively connected income ("ECI") and mitigating exposure under the Foreign Investment in Real Property Tax Act ("FIRPTA") provisions of Section 897 and the withholding requirements of Section 1446.
The same analysis applied to the Domestic blocker applies to the Offshore blocker: because Sovereign Capital is rolling its existing Fund II interest into the CV, PCV International Holdings Ltd. is properly treated as a contributing partner and will bear its pro-rata share of the pre-contribution built-in gain under the remedial method.
The corporate-level tax leakage analysis for the Offshore blocker is similar to that for the Domestic blocker — the Offshore blocker will pay U.S. corporate income tax at the 21% federal rate on ECI allocations, including remedial gain allocations, if and when the contributed portfolio company interests are disposed of. In addition, the Offshore blocker's status as a foreign corporation (under Cayman law) that is treated as a domestic corporation (by virtue of the check-the-box election) requires careful attention to withholding obligations under Section 1446 on the CV's allocations of ECI. The CV, as a partnership with a foreign partner, may be required to withhold on ECI allocated to the Offshore blocker; however, because the Offshore blocker has elected corporate treatment, the mechanics of withholding and estimated tax payments differ from those applicable to a direct non-U.S. partner.
It should be noted that if the Offshore blocker were restructured as a vehicle for new (non-contributing) capital rather than rolling LP capital, it would avoid classification as a contributing partner and would therefore not bear any pre-contribution gain allocations under the remedial method. Under the current structure, however, Sovereign Capital is rolling its Fund II interest, and the Offshore blocker is therefore a contributing partner. Any restructuring to change this classification would require careful analysis of the Section 721 contribution mechanics and could potentially affect the non-recognition treatment of the overall transaction. We do not recommend such a restructuring at this time.
VII. Interaction with QSBS Tacking and Section 1202
The choice of Section 704(c) allocation method does not directly affect the eligibility of the contributed portfolio company stock for QSBS treatment under Section 1202 of the Code. QSBS status is determined at the shareholder level — here, at the level of the individual limited partners who hold their interests in the CV either directly or through pass-through entities. The CV, as a partnership, is a pass-through entity; Section 1202 treatment passes through to the individual partners, and each partner's eligibility for the QSBS exclusion is determined based on that partner's individual circumstances (including holding period, basis, and the nature of the stock).
Section 1202(h) provides rules for the tacking of holding periods and QSBS status in certain non-recognition transactions, including contributions of QSBS to a partnership under Section 721. Under Section 1202(h)(2)(B), stock acquired by a partnership in a transaction described in Section 721 is treated as QSBS in the hands of the partnership if the stock was QSBS in the hands of the contributing partner, and the partner's holding period tacks. This rule is critical to the Vectral position, where the QSBS five-year holding period has not yet been satisfied and will not be satisfied until March 2026.
The remedial allocation method's creation of notional (remedial) tax items should not, in our analysis, constitute a "sale or exchange" or other disposition of the underlying portfolio company stock that would disrupt QSBS tacking under Section 1202(h). Remedial allocations are tax allocation mechanics internal to the partnership — they adjust the allocation of tax items among partners but do not change the ownership of the underlying shares, do not constitute a transfer of property, and do not trigger any transactional event at the entity level. The shares remain held by the CV throughout, and the contributing partners' tacked holding periods are preserved.
We are not aware of any authority — statutory, regulatory, or administrative — suggesting that the adoption of the remedial allocation method (or any other Section 704(c) method) affects QSBS eligibility or holding period tacking under Section 1202. The remedial method's notional items are a purely allocative mechanism and do not implicate the disposition or exchange rules that govern QSBS status.
For Vectral Cloud specifically, the coordination of the remedial method with QSB

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