MEMORANDUM
PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT COMMUNICATION ATTORNEY WORK PRODUCT
FROM: Sylvia Hartwell, Specialist Partner, Tax — Calderwood & Harkness LLP
TO: Claudia Merritt, Responsible Partner, Banking & Finance — Calderwood & Harkness LLP Marcus Leung, Lead Associate, Banking & Finance — Calderwood & Harkness LLP
CC: Ian Blackwood, Billing Partner, Banking & Finance — Calderwood & Harkness LLP Sophie Tremblay, Working Associate, Banking & Finance — Calderwood & Harkness LLP
DATE: February 28, 2025
RE: Tax Structure and Dividend Recapitalization Analysis — Nexford Industrial Holdings Inc. $1,400,000,000 Senior Secured Term Loan B Refinancing and Dividend Recapitalization
MATTER NO.: 1005-00001
BILLING CODE: IBL-NIH-2025-031
CLIENT: Nexford Industrial Holdings Inc.
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I. Executive Summary
This memorandum analyzes the federal and state income tax implications of the proposed approximately $335,000,000 dividend recapitalization to be funded from a portion of the proceeds of the $1,400,000,000 senior secured Term Loan B facility (the "Facility" or "Term Loan B") to be entered into by Nexford Industrial Holdings Inc. ("Nexford" or "NIH" or the "Borrower" or the "Company"). The purpose of this memorandum is to provide the Calderwood & Harkness LLP ("C&H") Banking & Finance team with a comprehensive assessment of the tax characterization of the proposed distribution, associated risks, and recommendations for structuring the transaction in a tax-efficient manner.
Calderwood & Harkness LLP represents the Borrower, Nexford Industrial Holdings Inc., a Delaware corporation headquartered at 1400 Industrial Parkway, Schaumburg, Illinois 60173. Nexford is a portfolio company of Granite Peak Capital Partners, LP ("Granite Peak" or the "Sponsor"), a Delaware limited partnership that manages private equity funds with total assets under management in excess of $14 billion. Nexford is a leading manufacturer of precision industrial components and engineered systems serving the aerospace, defense, automotive, and heavy-equipment sectors.
The proposed distribution of approximately $335,000,000 will flow from Nexford upward to its direct parent, Granite Peak NIH Holdings, LLC ("Holdings"), a Delaware limited liability company, and thereafter from Holdings to its equity holders: Granite Peak Capital Fund IV, LP ("Fund IV"), which holds a 92% interest in Holdings, and GP Fund IV Co-Invest, LP ("Co-Invest"), which holds the remaining 8% interest. Both Fund IV and Co-Invest are Delaware limited partnerships.
Our key conclusions and preliminary findings are as follows:
(a) Characterization of the Distribution. The characterization of the approximately $335,000,000 distribution as a dividend, a return of capital, or gain depends upon the determination of Nexford's accumulated and current earnings and profits ("E&P") as of the date of the distribution. Given Nexford's scale of operations (approximately $2.1 billion in annual revenue and $385,000,000 in LTM Adjusted EBITDA), we believe it is likely that accumulated and current E&P will be sufficient to characterize the entire distribution as a dividend under Section 301(c)(1) of the Internal Revenue Code of 1986, as amended (the "Code" or "IRC"). However, this conclusion is preliminary and contingent upon completion of a formal E&P study and confirmation of the structure of the 2019 acquisition (specifically, whether a Section 338(h)(10) election was made).
(b) Structural Considerations. The proposed structure — a direct cash distribution from Nexford to Holdings — is the simplest and most tax-efficient approach. We have considered alternative structures, including an intercompany loan arrangement, and do not recommend any alternative approach.
(c) State Tax Implications. The distribution does not generate additional state income tax liability for Nexford. Illinois, Nexford's principal state of tax residence, follows the federal characterization framework for distributions and does not impose a withholding tax on distributions to out-of-state entities. Delaware, as the state of incorporation for both Nexford and Holdings, does not impose a corporate income tax on entities without Delaware nexus.
(d) No Material Impediment. We have identified no material tax impediment to the proposed distribution structure. The debt-funded dividend recapitalization does not present meaningful debt-versus-equity recharacterization risk given the arm's-length terms of the Facility, the involvement of third-party institutional lenders, market-rate pricing, and reasonable pro forma leverage levels.
We note that this memorandum addresses the tax characterization of the distribution only. The following related memoranda are forthcoming and should be read in conjunction with this analysis:
• Section 163(j) Interest Deductibility Analysis — to be circulated March 5, 2025
• Withholding Tax Issues Memorandum — to be circulated March 7, 2025
• State and Local Implications of Collateral Grants and Mortgage Recording Tax — to be circulated March 10, 2025
The remainder of this memorandum is organized as follows: Section II provides a detailed overview of the transaction. Section III sets forth the federal income tax analysis of the distribution. Section IV addresses debt-versus-equity recharacterization risk. Section V discusses state and local tax considerations. Section VI analyzes tax-efficient structuring alternatives. Section VII identifies action items and recommendations. Section VIII presents our conclusion.
II. Transaction Overview
A. Background
Granite Peak Capital Partners, LP, through its flagship fund Granite Peak Capital Fund IV, LP, acquired Nexford Industrial Holdings Inc. in January 2019 for an enterprise value of approximately $1,650,000,000. The acquisition was funded with an equity investment of approximately $725,000,000, contributed through the Holdings structure, together with debt financing under the Existing Credit Agreement (as defined below). At the time of the acquisition, Nexford was a well-established industrial manufacturer with operations spanning multiple U.S. states and international locations, and Granite Peak identified the Company as an attractive platform for operational improvement and add-on acquisitions within the precision industrial components sector.
Following the acquisition, Nexford's capital structure consisted of the following components:
(i) Existing Credit Agreement. Nexford entered into a Credit Agreement dated as of June 14, 2019 (as subsequently amended, the "Existing Credit Agreement"), with Atlas Meridian Bank, N.A. as Administrative Agent. The Existing Credit Agreement provides for an $875,000,000 first lien senior secured term loan (the "Existing Term Loan") maturing in June 2026 and a $190,000,000 revolving credit facility (the "Existing Revolver") maturing in June 2025. The Existing Term Loan bears interest at a rate of LIBOR plus 375 basis points (subsequently transitioned to Term SOFR plus a credit spread adjustment plus 375 basis points), and is secured by a first-priority lien on substantially all of Nexford's and its domestic subsidiaries' assets.
(ii) Senior Unsecured Notes. In November 2021, Nexford issued $250,000,000 aggregate principal amount of 7.250% Senior Unsecured Notes due 2028 (the "Senior Notes") under an Indenture dated as of November 15, 2021 (the "Indenture"), with Pinnacle Trust Company as trustee. The Senior Notes are unsecured obligations of Nexford and are guaranteed by substantially all of Nexford's domestic subsidiaries.
(iii) 2021 Dividend Recapitalization. In connection with the issuance of the Senior Notes, Nexford completed a prior dividend recapitalization of $275,000,000, which was distributed to Holdings and, in turn, to Fund IV and Co-Invest. The 2021 dividend recapitalization was funded from the Senior Notes proceeds and available cash on the balance sheet.
The Existing Credit Agreement has been amended on four occasions since its execution. The First Amendment, dated March 10, 2020, modified certain financial reporting covenants in response to the COVID-19 pandemic. The Second Amendment, dated August 22, 2021, permitted the incurrence of the Senior Notes and the associated dividend recapitalization. The Third Amendment, dated January 30, 2023, implemented the transition from LIBOR to Term SOFR as the benchmark interest rate. Most recently, the Fourth Amendment, dated September 12, 2024, waived the 1.00% prepayment premium on the Existing Term Loan that would otherwise have been applicable in connection with a repricing transaction or refinancing occurring within six months of the amendment date, thereby clearing the path for the proposed refinancing contemplated herein.
As of the date of this memorandum, the outstanding principal balance under the Existing Term Loan is approximately $875,000,000 (reflecting limited amortization of approximately $8,750,000 per annum), the Existing Revolver is undrawn, and the Senior Notes remain outstanding at their full $250,000,000 principal amount.
B. Proposed Transaction
Nexford proposes to enter into a new $1,400,000,000 senior secured Term Loan B credit facility with Crescent Harbor Bank, N.A. ("Crescent Harbor") acting as Administrative Agent, Collateral Agent, and sole lead left arranger and bookrunner. The key terms of the Facility, as reflected in the commitment letter dated January 17, 2025 and the summary of terms and conditions attached thereto, are as follows:
Borrower: Nexford Industrial Holdings Inc.
Administrative Agent / Collateral Agent: Crescent Harbor Bank, N.A.
Lead Left Arranger and Bookrunner: Crescent Harbor Bank, N.A.
Facility Amount: $1,400,000,000
Facility Type: Senior Secured Term Loan B
Interest Rate: Term SOFR + 400 basis points per annum, with a SOFR floor of 0.75%
Maturity Date: March 28, 2032 (seven years from closing)
Amortization: 1.00% per annum, payable in equal quarterly installments of $3,500,000
Mandatory Prepayments: Excess cash flow sweep at 50% (stepping down to 25% at or below 3.00x total net leverage, and to 0% at or below 2.50x total net leverage); 100% of net cash proceeds from asset sales (subject to reinvestment rights) and debt issuances (subject to customary exceptions)
Security: First-priority lien on substantially all assets of the Borrower and each subsidiary guarantor, including 65% of voting equity and 100% of non-voting equity of first-tier foreign subsidiaries
Call Protection: 101 soft call for six months
Financial Covenant: None (covenant-lite structure)
The proceeds of the Facility are expected to be applied as follows:
The refinancing and dividend were approved by the Nexford board of directors on January 13, 2025. Granite Peak's investment committee and Fund IV's advisory board provided their required approvals on January 6, 2025. The target closing date for the Facility is March 28, 2025, with syndication expected to commence in mid-March 2025 following the completion of a confidential information memorandum prepared by Crescent Harbor.
C. Distribution Path
The flow of funds in connection with the distribution is straightforward and follows the existing equity holding structure. On the closing date, Nexford will receive the net loan proceeds from the Term Loan B facility. From those proceeds, Nexford will (i) repay the Existing Term Loan in full (approximately $879,375,000 including accrued interest), (ii) pay transaction fees and expenses (approximately $38,625,000), and (iii) retain $147,000,000 as cash on the balance sheet. The remaining approximately $335,000,000 will be distributed by Nexford to Holdings as a cash dividend on the closing date or promptly thereafter.
Holdings will, in turn, distribute the cash to its two equity holders in accordance with their respective ownership interests:
• Granite Peak Capital Fund IV, LP (92%): approximately $308,200,000
• GP Fund IV Co-Invest, LP (8%): approximately $26,800,000
For purposes of the federal income tax analysis below, the classification of Holdings is critical. Holdings is organized as a Delaware limited liability company. It has two members: Fund IV (92%) and Co-Invest (8%). Under Treasury Regulation § 301.7701-3, a domestic entity that is not a per se corporation and that has two or more members is classified as a partnership by default, unless a Form 8832 (Entity Classification Election) has been filed to elect corporate treatment or, if only one member exists, to elect treatment other than as a disregarded entity. Because Holdings has two members, it is presumed to be a partnership for federal income tax purposes by default. However, it is possible that the LLC agreement or a prior Form 8832 election provides for a different classification. For purposes of this memorandum, we assume that Holdings is treated as a disregarded entity, as has been represented to us; this assumption should be confirmed by reviewing the LLC agreement and any Form 8832 filings. We note that if Holdings has two members and no check-the-box election to be disregarded (which would not be available for a two-member entity in any event), it is by default a partnership. We address both scenarios in Section III.C below.
The relevant entity identification information is as follows:
• Nexford Industrial Holdings Inc.: EIN 36-4178552; Delaware File Number 5765432; incorporated in the State of Delaware
• Granite Peak NIH Holdings, LLC: EIN 85-3291047; registered address c/o Penmark Industries, 1209 Orange Street, Wilmington, Delaware 19801; organized in the State of Delaware
III. Federal Income Tax Analysis of the Distribution
A. Characterization Framework — IRC Section 301
The federal income tax treatment of the proposed distribution is governed by Section 301 of the Code, which prescribes a three-tier characterization framework for distributions of property by a corporation to a shareholder with respect to its stock. The characterization proceeds in the following order:
(1) Dividend (Section 301(c)(1)). A distribution is treated as a dividend to the extent it is paid out of the distributing corporation's earnings and profits. Under Section 316(a), the term "dividend" means any distribution of property made by a corporation to its shareholders out of its earnings and profits accumulated after February 28, 1913, or out of its earnings and profits of the taxable year (computed as of the close of the taxable year without regard to the amount of the earnings and profits at the time of the distribution).
(2) Return of Capital (Section 301(c)(2)). To the extent a distribution exceeds the distributing corporation's current and accumulated E&P, it is treated as a return of capital that reduces (but not below zero) the shareholder's adjusted tax basis in the stock with respect to which the distribution is made.
(3) Gain from Sale or Exchange (Section 301(c)(3)). To the extent the distribution exceeds both E&P and the shareholder's adjusted tax basis in the stock, the excess is treated as gain from the sale or exchange of property — generally capital gain, and long-term capital gain if the shareholder's holding period exceeds one year.
In the present case, the recipient of the distribution is Holdings, as the direct 100% shareholder of all of the outstanding equity interests of Nexford. The characterization of the approximately $335,000,000 distribution therefore turns entirely on the amount of Nexford's available earnings and profits — both current E&P and accumulated E&P — at the time of the distribution.
We note that under Section 316(a)(2), current E&P for the full taxable year is allocated to each distribution made during the year on a pro rata basis, determined by the ratio of such distribution to the total distributions for the year. Because the proposed distribution is expected to be the only distribution made by Nexford during the 2025 taxable year, the entire amount of Nexford's current E&P for 2025 (if positive) will be available to support the characterization of this distribution as a dividend. To the extent current E&P is insufficient, accumulated E&P is applied on a chronological basis to distributions made during the year, under Treasury Regulation § 1.316-1(a)(1).
The significance of the dividend-versus-return-of-capital characterization is as follows: A distribution characterized as a dividend generally gives rise to ordinary income to the recipient (subject to the qualified dividend rules or the dividends-received deduction, as applicable). A distribution characterized as a return of capital is not currently taxable but reduces the shareholder's basis in the stock, increasing the amount of gain (or reducing the amount of loss) that would be recognized on a future disposition of the stock. A distribution characterized as gain under Section 301(c)(3) gives rise to currently taxable gain, which in this case would likely be long-term capital gain given the holding period since January 2019 (more than six years).
B. Earnings and Profits Analysis
1. Current E&P
Nexford's LTM Adjusted EBITDA as of December 31, 2024 is $385,000,000. This figure comprises $357,000,000 of reported EBITDA (as set forth in Nexford's audited consolidated financial statements for the fiscal year ended December 31, 2024, prepared by Ashworth & Kendrick LLP) plus $28,000,000 in permitted add-backs, which consist of the following items:
• Acquisition-related costs: $12,000,000
• Non-recurring restructuring charges: $8,500,000
• Sponsor management fees payable to Granite Peak: $4,500,000
• Integration costs associated with recent bolt-on acquisitions: $3,000,000
It is essential to recognize that E&P is computed differently from both taxable income and EBITDA. E&P is intended to measure a corporation's economic ability to pay dividends and incorporates a series of adjustments that differ from taxable income computations. The principal adjustments required to derive E&P from taxable income or EBITDA include the following:
(a) Depreciation. For E&P purposes, depreciation is computed using the alternative depreciation system ("ADS") under Section 168(g), which generally requires the straight-line method over the ADS recovery period. This differs from both the accelerated depreciation methods used for taxable income purposes (including bonus depreciation under Section 168(k) and MACRS accelerated methods) and the depreciation expense recognized for financial reporting purposes. Nexford's LTM capital expenditures are reported at $78,000,000, suggesting a significant depreciable asset base, likely consisting of manufacturing equipment, machinery, tooling, and facility improvements. The differential between tax depreciation and E&P depreciation is a critical variable. To the extent Nexford has claimed bonus depreciation or accelerated MACRS deductions in prior years, its E&P depreciation would be lower, resulting in higher accumulated E&P than might otherwise be anticipated from a review of taxable income alone.
(b) Federal Income Taxes. Federal income taxes paid or accrued are subtracted in computing E&P but are not deductible for taxable income purposes. This has the effect of reducing E&P below taxable income by the amount of federal taxes.
(c) Interest Expense. Actual interest paid during the period is deductible in computing E&P, subject to certain limitations. The pro forma cash interest expense for Year 1 on the new Facility is estimated at approximately $117,708,500 (calculated as $1,400,000,000 × (Term SOFR of approximately 4.45% plus 400 basis points), net of amortization). However, for purposes of computing current E&P for 2025, the relevant figure is the actual interest paid by Nexford during the 2025 taxable year, which will include interest on the Existing Term Loan through the closing date and interest on the new Facility from the closing date through December 31, 2025.
(d) Section 163(j) Disallowed Interest. To the extent interest deductions have been disallowed under Section 163(j) and carried forward, such disallowed amounts are not deductible for taxable income purposes in the year of disallowance but may reduce E&P in the year they accrue. The interaction between Section 163(j) carryforwards and E&P is complex and will be addressed in the forthcoming March 5, 2025 memorandum.
(e) Other Adjustments. E&P must also be adjusted for: tax-exempt income (added to E&P), non-deductible expenses other than federal taxes (subtracted from E&P), installment sales income (recognized in full for E&P), LIFO reserves (added back for E&P if the corporation uses LIFO for tax purposes but FIFO yields a higher income figure), and organizational and start-up costs (which are capitalized for E&P even if deductible for tax purposes).
With respect to the current year, Nexford's revenue is $2,100,000,000 with a gross margin of 32.0% ($672,000,000 gross profit), indicating substantial operating income from which current E&P is likely derived. After accounting for operating expenses, depreciation (on an ADS basis), interest expense, and federal income taxes, we anticipate that Nexford's current E&P for 2025 will be a significant positive figure, though a precise determination requires a detailed computation that is beyond the scope of this memorandum.
Recommendation: We recommend that the engagement team request a formal E&P computation from Ashworth & Kendrick LLP (Helen Yamamoto, engagement partner, who serves as Nexford's independent auditor) covering the relevant periods. The computation should address both current-year E&P for 2025 (on a projected basis through the closing date and through the end of the fiscal year) and accumulated E&P as of December 31, 2024. The engagement team should also coordinate with Michelle Kaplan, Nexford's Chief Financial Officer, to obtain the underlying data necessary for the E&P study, including detailed depreciation schedules, federal and state income tax return data, and schedules of prior distributions.
2. Accumulated E&P
Nexford was founded in 1987 and has operated continuously for more than 37 years as a manufacturer of precision industrial components. Over this period, Nexford has accumulated E&P reflecting the retained earnings of its operations, adjusted for the various E&P-specific modifications described above. The starting point for accumulated E&P is therefore the cumulative E&P generated from 1987 through the most recent fiscal year, reduced by all prior distributions that were characterized as dividends out of E&P.
A critical threshold question is the effect of the January 2019 acquisition by Granite Peak on Nexford's accumulated E&P. The answer depends on the structure of the acquisition:
(a) Stock Acquisition (No Section 338 Election). If Granite Peak acquired the equity interests of Nexford through a stock purchase transaction without making a Section 338(h)(10) election, then Nexford's pre-acquisition accumulated E&P carries over and remains with the corporation. In this scenario, Nexford would retain more than three decades of accumulated E&P, potentially amounting to hundreds of millions of dollars. The accumulated E&P would then be reduced by the amount of the 2021 dividend recapitalization that was characterized as a dividend.
(b) Deemed Asset Acquisition (Section 338(h)(10) Election). If the acquisition was structured as a deemed asset acquisition under Section 338(h)(10) — which is commonly employed in private equity transactions involving S corporation targets or in certain other circumstances — then Nexford would be treated as having sold all of its assets and formed a new corporation for tax purposes as of the acquisition date. In this scenario, accumulated E&P would have been reset to zero as of the acquisition date, and Nexford's accumulated E&P would consist only of the E&P accumulated from January 2019 through the present. While six-plus years of E&P at the operating levels described above may still be substantial, it is significantly less certain that such amount would fully cover the cumulative distributions of $610,000,000 ($275,000,000 in 2021 plus $335,000,000 proposed).
The 2021 dividend recapitalization of $275,000,000 would have reduced accumulated E&P by the amount of that distribution that was characterized as a dividend (i.e., the lesser of the distribution amount and the available E&P at the time of the 2021 distribution). If the full $275,000,000 was covered by E&P, then accumulated E&P was reduced by $275,000,000. If E&P at the time of the 2021 distribution was insufficient, then the shortfall would have been treated as a return of capital under Section 301(c)(2) (reducing Holdings' basis in Nexford stock) and, to the extent exceeding basis, as gain under Section 301(c)(3). The characterization of the 2021 distribution should be confirmed with Nexford's tax department and Ashworth & Kendrick.
In aggregate, the cumulative distributions from Nexford to Granite Peak and its co-investors to date (including the proposed distribution) total approximately $610,000,000, consisting of:
• 2021 dividend recapitalization: $275,000,000
• 2025 proposed dividend recapitalization: $335,000,000 (approximately)
• Total: $610,000,000 (approximately)
Action Item: Confirm the acquisition structure with Kellner Brandt & Associates LLP (Patricia Voss, partner who advised Granite Peak on the 2019 acquisition) and review the 2019 acquisition agreement and any ancillary tax documents for evidence of a Section 338(h)(10) election or other deemed asset acquisition election. This is the single most important open factual question for purposes of the E&P analysis.
3. E&P Sufficiency Assessment
Based on the information currently available, our preliminary assessment of E&P sufficiency is as follows:
(a) Scenario 1: No Section 338(h)(10) Election (Pre-Acquisition E&P Carries Over). If the 2019 acquisition was a stock purchase without a Section 338(h)(10) election, accumulated E&P is likely to be very substantial, potentially exceeding $600,000,000 when pre-acquisition and post-acquisition E&P are combined. In this scenario, the entire $335,000,000 distribution would almost certainly be characterized as a dividend under Section 301(c)(1). The pre-acquisition E&P alone — accumulated over 32 years of profitable operations prior to the Granite Peak acquisition — may be sufficient to cover the distribution, even after accounting for the $275,000,000 reduction attributable to the 2021 dividend recapitalization.
(b) Scenario 2: Section 338(h)(10) Election (E&P Reset to Zero in January 2019). If a Section 338(h)(10) election was made, accumulated E&P would consist only of E&P generated since January 2019 — approximately six full fiscal years (2019 through 2024). Assuming annual E&P in the range of $100,000,000 to $150,000,000 (a rough estimate based on the Company's EBITDA, depreciation, interest expense, and taxes), cumulative post-acquisition E&P could be in the range of $600,000,000 to $900,000,000, less the $275,000,000 consumed by the 2021 distribution. This would yield remaining accumulated E&P of approximately $325,000,000 to $625,000,000. Under this scenario, there is a reasonable likelihood that the entire $335,000,000 distribution would still be characterized as a dividend, but the margin is tighter, and the conclusion is more dependent on the precise E&P computation.
(c) Scenario 3: E&P Insufficient. If, for any reason, Nexford's accumulated and current E&P prove insufficient to cover the entire $335,000,000 distribution — for example, if the Section 338(h)(10) election was made and actual E&P has been lower than estimated, or if significant E&P adjustments (such as large E&P depreciation charges or prior undisclosed distributions) have eroded the E&P pool — then the excess over available E&P would be characterized as a return of capital under Section 301(c)(2), reducing Holdings' (and, by extension, Fund IV's and Co-Invest's) basis in Nexford stock. To the extent the distribution exceeds both E&P and basis, the excess would be treated as capital gain under Section 301(c)(3).
We emphasize that a definitive determination of the characterization of the distribution cannot be made until a formal E&P study is completed. The E&P study should be commissioned promptly and should be available prior to the target closing date of March 28, 2025, in order to permit appropriate tax reporting by all parties.
C. Tax Consequences to Holdings / Fund IV / Co-Invest
1. If Holdings Is a Disregarded Entity
If Holdings is properly classified as a disregarded entity for federal income tax purposes — which would be the case if it were a single-member LLC (i.e., if Fund IV is the sole member and Co-Invest's interest is structured differently, or if a valid check-the-box election to disregard has been filed) — then the distribution from Nexford to Holdings is treated, for federal income tax purposes, as if made directly to the ultimate owners of Holdings. In that case, the tax consequences would be analyzed at the level of Fund IV and Co-Invest as if they had received the distribution directly from Nexford.
Both Fund IV and Co-Invest are Delaware limited partnerships. As pass-through entities, they are not subject to federal income tax at the entity level. Instead, the tax consequences of the distribution flow through to their respective limited partners, which typically include institutional investors such as pension funds, insurance companies, endowments, sovereign wealth funds, family offices, and high-net-worth individuals.
The tax treatment at the limited partner level depends on the characterization of the distribution:
(a) Dividend Characterization. If the distribution is characterized as a dividend, it constitutes ordinary income to the partners of Fund IV and Co-Invest. However, the practical impact depends on each partner's tax status:
• Tax-Exempt Partners (e.g., pension funds, endowments, 501(c)(3) organizations): Dividend income generally is not unrelated business taxable income ("UBTI") and therefore is not subject to tax for tax-exempt partners, provided the underlying investment is not debt-financed property under Section 514.
• Corporate Partners: C corporation partners may qualify for the dividends-received deduction ("DRD") under Section 243, which can offset 50%, 65%, or 100% of the dividend income, depending on the corporate partner's ownership percentage in the distributing corporation (as discussed in Section III.C.3 below).
• Individual Partners: Individual partners may qualify for the preferential qualified dividend rate (currently 20% plus 3.8% net investment income tax) on the dividend portion of the distribution, subject to holding period and other requirements.
• Foreign Partners: Foreign partners may be subject to U.S. withholding tax on dividend income at rates of up to 30%, subject to reduction under applicable income tax treaties. This issue is addressed in the forthcoming March 7, 2025 withholding tax memorandum.
(b) Return of Capital Characterization. If the distribution (or any portion thereof) is characterized as a return of capital, it is not currently taxable to the partners. Instead, it reduces each partner's outside basis in its partnership interest in Fund IV or Co-Invest (and, in turn, Fund IV's or Co-Invest's basis in its interest in Holdings and in Nexford stock). No current income tax is due, but the reduced basis will result in greater gain (or lesser loss) upon a future disposition of the partnership interest or the underlying Nexford stock.
(c) Capital Gain Characterization. If the distribution exceeds both E&P and basis, the excess is treated as capital gain. Given that Granite Peak has held its investment in Nexford since January 2019 — a period exceeding six years — any such gain would be long-term capital gain, subject to preferential rates for individual partners (currently 20% plus 3.8% net investment income tax) and ordinary rates for corporate partners.
2. If Holdings Is a Partnership (Two-Member LLC)
If Holdings is properly classified as a partnership for federal income tax purposes — which is the default classification for a domestic LLC with two or more members under Treasury Regulation § 301.7701-3(b)(1), absent a check-the-box election — then the analysis proceeds in two steps.
First, the distribution from Nexford to Holdings is received at the partnership level. The characterization of the distribution (dividend, return of capital, or gain) is determined in the manner described above, based on Nexford's E&P. Holdings, as a partnership, would include the dividend income (if so characterized) in its taxable income for the year and would allocate it to Fund IV and Co-Invest in accordance with the allocation provisions of the LLC agreement. Generally, we would expect the allocation to follow the ownership percentages (92% to Fund IV and 8% to Co-Invest), unless the LLC agreement provides for special allocations that have substantial economic effect under Section 704(b) and the regulations thereunder.
Second, the subsequent distribution of cash from Holdings to Fund IV and Co-Invest is governed by Section 731 of the Code, which provides that a distribution by a partnership to a partner is generally not taxable to the partner unless the cash distributed exceeds the partner's outside basis in its partnership interest. Given that the equity investment in Nexford was approximately $725,000,000 (with Fund IV contributing approximately $667,000,000 and Co-Invest contributing approximately $58,000,000), and assuming no prior distributions from Holdings that significantly reduced outside basis, the cash distributions from Holdings to Fund IV and Co-Invest (approximately $308,200,000 and $26,800,000, respectively) should not exceed outside basis and should not be independently taxable under Section 731. Of course, the income recognized at the Holdings level (i.e., the dividend income from Nexford) will flow through to the partners and will be taxable to them regardless of whether a distribution is made.
3. Dividends-Received Deduction Considerations
To the extent that any partner of Fund IV or Co-Invest is a C corporation, such corporate partner may be entitled to a dividends-received deduction ("DRD") under Section 243 of the Code for the dividend portion of the distribution that is allocable to it. The amount of the DRD depends on the corporate partner's ownership percentage in the distributing corporation (Nexford), determined by looking through the chain of pass-through entities:
• 100% DRD (Section 243(a)(3)): Available to members of the same affiliated group (as defined in Section 1504(a)) as the distributing corporation. Since no corporate partner is a member of an affiliated group with Nexford, the 100% DRD is not applicable.
• 65% DRD (Section 243(c)): Available if the corporate shareholder owns 20% or more of the stock (by vote and value) of the distributing corporation. A corporate partner that holds, directly or through attribution, 20% or more of Nexford's stock would be entitled to deduct 65% of the dividend income received. Given the layers of pass-through entities between Nexford and any corporate limited partner, it is unlikely that any single corporate partner would meet the 20% ownership threshold, but this should be verified on a case-by-case basis.
• 50% DRD (Section 243(a)(1)): The default DRD available to any corporate shareholder that does not meet the 20% or affiliated group thresholds. Under this provision, the corporate partner may deduct 50% of the dividend income received from Nexford.
We note that the DRD is subject to certain limitations, including the taxable income limitation of Section 246(b) and the holding period requirement of Section 246(c) (the corporate shareholder must hold the stock for more than 45 days during the 91-day period beginning 45 days before the ex-dividend date, or more than 90 days for certain preferred stock dividends). Additionally, as discussed in Section III.D below, the DRD may trigger basis reduction under the extraordinary dividend rules of Section 1059.
This analysis is relevant only to the extent the distribution is characterized as a dividend out of E&P. To the extent the distribution is characterized as a return of capital or gain, the DRD does not apply.
D. Extraordinary Dividend Rules — Section 1059
Section 1059 of the Code imposes a basis-reduction requirement on corporate shareholders that receive an "extraordinary dividend" and claim a DRD with respect to that dividend. Specifically, Section 1059(a) provides that if any corporation receives an extraordinary dividend with respect to any share of stock and the corporation has not held the stock for more than two years before the dividend announcement date, the non-taxed portion of the dividend (i.e., the amount offset by the DRD) reduces the corporation's basis in the stock.
A dividend is classified as "extraordinary" under Section 1059(c) if it equals or exceeds the following thresholds:
• 10% of the shareholder's adjusted tax basis in the stock (for dividends on common stock or any stock other than preferred stock); or
• 5% of the shareholder's adjusted tax basis in the stock (for dividends on preferred stock).
In the present case, the magnitude of the proposed distribution is significant relative to the equity investment in Nexford. The total equity investment was approximately $725,000,000, allocated as follows:
• Fund IV (92%): approximately $667,000,000
• Co-Invest (8%): approximately $58,000,000
The proposed distribution allocable to each entity is:
• Fund IV (92%): approximately $308,200,000
• Co-Invest (8%): approximately $26,800,000
For Fund IV, the ratio of the distribution to its basis is approximately 46.2% ($308,200,000 ÷ $667,000,000), which significantly exceeds the 10% threshold. For Co-Invest, the ratio is approximately 46.2% ($26,800,000 ÷ $58,000,000), likewise exceeding the 10% threshold. Accordingly, to the extent the distribution is characterized as a dividend and allocated to any corporate partner of Fund IV or Co-Invest that claims a DRD, such dividend would constitute an extraordinary dividend under Section 1059.
However, Section 1059 applies only if the corporate shareholder has not held the stock for more than two years before the dividend announcement date. Since Granite Peak acquired Nexford in January 2019 and the distribution is proposed for March 2025 — a holding period of more than six years — the two-year holding period requirement is satisfied, and Section 1059(a) should not require basis reduction for corporate partners that held their interests in Fund IV or Co-Invest at the time of the acquisition and have maintained those interests continuously. For any corporate partner that acquired its interest in Fund IV or Co-Invest within the two-year period prior to the dividend announcement date, Section 1059 could apply to require basis reduction.
Action Item: To the extent relevant, coordinate with Granite Peak's tax advisors to identify any corporate partners of Fund IV or Co-Invest that may be subject to Section 1059 basis reduction, particularly those that acquired their interests within the past two years.
E. Impact on Nexford's Tax Attributes
The proposed distribution will have the following effects on Nexford's tax attributes:
(a) Reduction of E&P. The distribution will reduce Nexford's E&P to the extent the distribution is characterized as a dividend under Section 301(c)(1). If the entire $335,000,000 is characterized as a dividend, Nexford's accumulated E&P will be reduced by $335,000,000. This reduction should be reflected in Nexford's E&P computation for the 2025 taxable year and will affect the characterization of any future distributions.
(b) No Deduction for Nexford. Dividends paid by a corporation are not deductible for federal income tax purposes. Accordingly, the distribution will not reduce Nexford's taxable income or federal income tax liability for 2025 or any subsequent year.
(c) Increased Leverage and Interest Deductions. The distribution is funded by debt proceeds, resulting in increased leverage on Nexford's balance sheet. The resulting interest deductions on the $1,400,000,000 Term Loan B will be substantial — estimated at approximately $117,708,500 per annum in Year 1 — and will be subject to the Section 163(j) business interest deduction limitation (generally limited to 30% of adjusted taxable income). The Section 163(j) analysis is addressed in the separate memorandum to be circulated on March 5, 2025.
(d) Pro Forma Cash Position. Following the closing of the Facility and the distribution, Nexford's pro forma retained cash on the balance sheet is estimated at approximately $100,000,000, reflecting existing cash on hand plus the $147,000,000 of new cash from the Term Loan B proceeds, less net working capital adjustments and transaction-related expenses. This cash position, combined with the availability of a new revolving credit facility (the terms of which are being negotiated as part of the overall refinancing package), should provide adequate liquidity for Nexford's ongoing operations.
IV. Debt vs. Equity Recharacterization Risk
A. Overview of Risk
In any leveraged recapitalization transaction in which a substantial portion of the debt proceeds is distributed to equity holders, there exists a theoretical risk that the Internal Revenue Service could seek to recharacterize a portion of the new debt as equity for federal income tax purposes. If any portion of the Term Loan B were recharacterized as equity, the associated interest payments could be treated as non-deductible distributions (dividends or returns of capital), significantly increasing Nexford's effective tax rate and reducing after-tax cash flow available for debt service. Additionally, recharacterization could have implications for the characterization of other transactions involving the purported debt (e.g., withholding tax on interest payments reclassified as dividends).
The IRS has historically applied a multi-factor balancing test to distinguish debt from equity, drawing on case law including Estate of Mixon v. United States, 464 F.2d 394 (5th Cir. 1972), Fin Hay Realty Co. v. United States, 398 F.2d 694 (3d Cir. 1968), and related authorities. Factors considered include the debt-to-equity ratio of the borrower, the existence of a fixed maturity date, the obligation to pay interest regardless of earnings, the rights of the creditor in the event of default, the relationship between the lender and the borrower, the reasonableness of the interest rate, and whether the instrument would be marketable to third-party lenders.
The pro forma leverage levels following the proposed transaction are as follows:
These leverage levels are within the customary parameters for sponsor-backed leveraged transactions in the current market environment. First lien net leverage of 3.38x and total net leverage of 4.03x are moderate by prevailing market standards, where first lien leverage of up to 4.5x-5.0x and total leverage of up to 5.5x-6.5x are frequently observed in leveraged buyouts and dividend recapitalizations. Standing alone, these leverage levels should not give rise to debt recharacterization risk.
B. Factors Supporting Debt Treatment
A comprehensive evaluation of the relevant factors strongly supports the treatment of the Term Loan B as debt for federal income tax purposes:
(1) Unconditional Obligation to Repay. The Term Loan B imposes on Nexford an unconditional obligation to repay the principal amount of $1,400,000,000. The facility has a fixed maturity date of March 28, 2032, quarterly amortization payments of $3,500,000 (representing 1.00% per annum amortization of the original principal amount), and mandatory prepayment provisions, including an excess cash flow sweep at 50% of excess cash flow (stepping down to 25% at or below 3.00x total net leverage and to 0% at or below 2.50x total net leverage), and mandatory prepayment from 100% of net asset sale proceeds and debt issuance proceeds (subject to customary exceptions and reinvestment rights). These features are characteristic of bona fide indebtedness and are inconsistent with equity treatment.
(2) Arm's-Length Interest Rate. The interest rate on the Term Loan B is Term SOFR plus 400 basis points per annum, with a SOFR floor of 0.75%. This pricing is consistent with market rates for B1/B+ rated institutional Term Loan B facilities as of February 2025. According to data from the Crescent Harbor syndication desk and publicly available leveraged loan market reports, the average spread for newly issued Term Loan B facilities in the first quarter of 2025 ranges from SOFR + 350 bps to SOFR + 450 bps for credits in this rating category. The agreed-upon pricing falls squarely within this range and reflects an arm's-length negotiation between Nexford and Crescent Harbor.
(3) Third-Party Syndication. The Facility is being syndicated to a broad group of unrelated institutional investors, none of which has an equity interest in Nexford or any affiliation with Granite Peak. The anticipated syndicate includes Ironwood Capital Markets, Northvane Securities, Ridgeline Asset Management, Halcyon Credit Partners, Verdant Institutional Investors, Cascadia Loan Fund III, Bluewater Fixed Income Fund, and additional institutional investors to be identified during the syndication process. The participation of these arm's-length third-party lenders is a powerful indicator that the Facility represents bona fide debt rather than disguised equity. The IRS has historically been reluctant to challenge the debt characterization of instruments held by unrelated third-party lenders.
(4) Credit Ratings. The Facility has received investment-grade and sub-investment-grade credit ratings from two nationally recognized rating agencies: Keystone Ratings Group has assigned a B1 corporate family rating and a B1 facility rating; Sentinel Credit Analytics has assigned a B+ corporate credit rating and a BB- facility rating on the Term Loan B. These ratings reflect the independent judgment of credit analysts that the Facility constitutes bona fide indebtedness with a reasonable expectation of repayment.
(5) Comprehensive Security Package. The Term Loan B is secured by a first-priority lien on substantially all assets of Nexford and its domestic subsidiary guarantors, including accounts receivable, inventory, equipment, real property, intellectual property, and equity interests in subsidiaries. This security interest provides the lenders with meaningful recovery rights in the event of default, which is a hallmark of debt rather than equity.
(6) Formal Loan Documentation. The Facility is governed by a comprehensive Credit Agreement prepared and negotiated by independent legal counsel — Whitfield & Gage LLP for Crescent Harbor as agent and Calderwood & Harkness LLP for Nexford as borrower. The Credit Agreement includes customary representations, warranties, covenants (both affirmative and negative), events of default, and remedies provisions. The documentation is substantively indistinguishable from other institutional leveraged credit facilities and evidences a debtor-creditor relationship.
(7) Adequate Debt Service Capacity. Nexford's ability to service the Facility is supported by its strong operating cash flows. Adjusted EBITDA less capital expenditures is approximately $307,000,000 ($385,000,000 minus $78,000,000), and estimated Year 1 cash interest expense is approximately $117,708,500, yielding a coverage ratio of approximately 2.61x. This ratio demonstrates that Nexford has ample capacity to service the debt from operating cash flows without reliance on additional equity contributions or asset sales, further supporting the bona fide nature of the indebtedness.
C. Assessment
Based on the foregoing analysis, we conclude that the risk of IRS recharacterization of the Term Loan B (or any portion thereof) as equity is low. The Facility exhibits all of the hallmarks of bona fide indebtedness: an unconditional obligation to repay, a fixed maturity date, arm's-length interest rates, third-party syndication to unrelated institutional lenders, independent credit ratings, a comprehensive security package, formal documentation, and adequate debt service capacity. The pro forma leverage levels, while significant, are within the customary range for sponsor-backed leveraged transactions and do not, in our judgment, create a meaningful risk of recharacterization.
No additional structuring measures are recommended to mitigate the debt-versus-equity recharacterization risk at this time. However, we note that the recharacterization analysis is inherently factual and could be affected by subsequent events, such as a material deterioration in Nexford's financial condition, a failure to make scheduled payments, or a restructuring of the Facility on terms more consistent with equity.
V. State and Local Tax Considerations
A. Illinois — Nexford's State of Tax Residence
Nexford is headquartered in Schaumburg, Illinois, and is an Illinois resident taxpayer. Nexford files Illinois corporate income tax returns on a calendar-year basis (fiscal year ending December 31). Illinois imposes a flat-rate corporate income tax currently at 7.0%, plus a personal property replacement tax ("replacement tax") on corporations at a rate of 2.5%, for a combined effective state income tax rate of 9.5% on Illinois-apportioned corporate income.
With respect to the proposed distribution, the following Illinois tax considerations are relevant:
(a) No Deduction for Dividends Paid. Consistent with federal law, Illinois does not allow a deduction for dividends paid by a corporation. The distribution from Nexford to Holdings will not reduce Nexford's Illinois taxable income or Illinois income tax liability.
(b) Federal E&P Characterization. Illinois generally follows the federal characterization framework for determining the nature of distributions. The characterization of the distribution as a dividend, return of capital, or gain for federal income tax purposes will be respected for Illinois income tax purposes as well.
(c) No Withholding on Distributions. Illinois does not impose a withholding tax on distributions by a domestic corporation to its out-of-state corporate shareholders or pass-through entities. Accordingly, Nexford is not required to withhold Illinois income tax on the distribution to Holdings.
(d) Apportioned Income Tax. Nexford's Illinois income tax liability is computed by applying the Illinois corporate income tax rate to Nexford's Illinois-apportioned taxable income, determined using Illinois's single-factor sales apportionment formula. The distribution does not affect the apportionment formula or the calculation of Illinois taxable income.
B. Delaware
Both Nexford (as a Delaware corporation) and Holdings (as a Delaware LLC) are organized under the laws of the State of Delaware. The relevant Delaware tax considerations are as follows:
(a) No Corporate Income Tax on Non-Nexus Entities. Delaware does not impose a corporate income tax on corporations that are incorporated in Delaware but do not have sufficient nexus (operations, employees, property) in Delaware to be subject to tax. Nexford's principal operations are in Illinois and other states; its Delaware incorporation alone does not subject it to Delaware corporate income tax. Accordingly, the distribution does not give rise to Delaware corporate income tax liability for Nexford.
(b) Delaware Franchise Tax. Nexford is subject to the Delaware annual franchise tax, which is calculated based on the corporation's authorized shares and par value (or, alternatively, on assumed par value capital). The franchise tax is not affected by the distribution.
(c) Holdings — Annual LLC Tax. Holdings, as a Delaware LLC, is subject to the annual Delaware LLC tax of $300, which is a flat fee unrelated to income or distributions.
C. Other State Considerations
Nexford has manufacturing operations and subsidiaries in multiple states, including but not limited to Illinois, Pennsylvania, South Carolina, Texas, and Michigan. In each state where Nexford has operations, the Company is subject to apportioned state income tax on its taxable income. The proposed distribution does not create additional state income tax liability for Nexford in any of these states, as dividends paid are not deductible for state income tax purposes (consistent with the federal treatment).
However, to the extent that Fund IV or Co-Invest have state-level filing obligations — for example, composite return requirements in states where Nexford conducts business — the characterization of the distribution (dividend, return of capital, or gain) may affect the state-level tax obligations of Fund IV's and Co-Invest's individual or corporate partners. Specifically:
• Some states require pass-through entities with nonresident partners to file composite returns and remit tax on behalf of those partners. If the distribution is characterized as a dividend and flows through to nonresident partners, those partners may have state-level income tax obligations in the states where Nexford operates, to the extent the dividend income is allocated or apportioned to those states.
• If the distribution is characterized as return of capital, no current income is generated, and no state-level composite filing obligations should arise.
• If the distribution is characterized as capital gain, the state-level treatment of capital gains varies by state and would need to be evaluated on a state-by-state basis.
A detailed multi-state analysis of the partner-level state tax consequences is beyond the scope of this memorandum and should be coordinated with Granite Peak's tax advisors and with the individual partners of Fund IV and Co-Invest as appropriate.
D. Canadian Subsidiary Considerations
Nexford's international operations include a Canadian subsidiary chain structured as follows:
• Nexford International Holdings, Inc. — a Delaware corporation that serves as the "CFC holdco" and holds Nexford's foreign subsidiaries
• Nexford Canada Holdings ULC — a British Columbia unlimited liability company, held directly by Nexford International Holdings, Inc.
• Nexford Canada Manufacturing, Inc. — an Ontario corporation, held by Nexford Canada Holdings ULC, which operates Nexford's Canadian manufacturing facility
The proposed distribution from Nexford to Holdings does not directly implicate the Canadian subsidiaries. The distribution is made from Nexford's own cash balances (funded by the Term Loan B proceeds) and does not involve any distribution, repatriation, or restructuring of the Canadian operations.
However, if intercompany loans between Nexford (or Nexford International Holdings, Inc.) and the Canadian subsidiaries are restructured in connection with the refinancing — for example, if existing intercompany notes are refinanced, replaced, or extinguished as part of the collateral arrangements under the new Credit Agreement — then withholding tax implications under the Canada-United States Tax Convention (the "Canada-U.S. Tax Treaty") may arise. Under Article XI of the Canada-U.S. Tax Treaty, interest paid by a Canadian resident to a U.S. resident is generally exempt from Canadian withholding tax (subject to certain conditions), but the restructuring of intercompany debt could give rise to questions regarding the treatment of any premium, discount, or deemed payment associated with the restructuring.
These issues will be addressed in greater detail in the forthcoming withholding tax memorandum, to be circulated on March 7, 2025.
VI. Tax-Efficient Structuring Considerations
A. Timing of Distribution
The proposed distribution should be made promptly at or immediately following the closing of the Facility (currently targeted for March 28, 2025) in order to align with the stated use of proceeds under the Credit Agreement. From a tax perspective, the timing of the distribution within the 2025 taxable year is relevant to the characterization analysis in the following respect:
Under Treasury Regulation § 1.316-1(a)(2), current-year E&P is allocated to distributions on a pro rata basis across the full taxable year, regardless of when during the year the distribution is made. This means that if Nexford makes only one distribution during 2025, the entire amount of Nexford's 2025 current E&P will be available to support that distribution. If Nexford's current E&P for 2025 is positive and sufficient to cover the $335,000,000 distribution, there is no tax benefit to delaying the distribution until later in the year.
However, if accumulated E&P is limited (e.g., because of a Section 338(h)(10) election and the effect of the 2021 distribution), and current E&P is the marginal source of E&P needed to characterize the distribution as a dividend, then the pro rata allocation rule becomes significant. Under this rule, current E&P is determined based on the full-year figure and is allocated to each distribution proportionally. For example, if Nexford's 2025 current E&P is $150,000,000 and accumulated E&P is $200,000,000, the total E&P available is $350,000,000, which would be sufficient to characterize the entire $335,000,000 distribution as a dividend. But if accumulated E&P is only $100,000,000, then only $250,000,000 ($100,000,000 accumulated plus $150,000,000 current) would be available, and $85,000,000 of the distribution would be characterized as return of capital.
In summary, there is no particular advantage to delaying the distribution, and we recommend proceeding with the distribution on or promptly following the closing date as contemplated by the transaction documents.
B. Alternative Distribution Structures Considered
We have considered the following alternative structures for effecting the distribution of approximately $335,000,000 to Holdings:
(1) Direct Cash Dividend from Nexford to Holdings. This is the simplest and most straightforward approach. Nexford declares and pays a cash dividend to Holdings in the amount of approximately $335,000,000. The dividend is documented by a board resolution (already adopted on January 13, 2025) and recorded in Nexford's books and records. This is the recommended approach.
(2) Intercompany Loan from Nexford to Holdings Followed by Distribution. Under this alternative, Nexford would make a loan to Holdings (rather than a dividend), and Holdings would subsequently distribute the loan proceeds to Fund IV and Co-Invest. This structure could theoretically defer the timing of the E&P inclusion, as a bona fide loan is not treated as a distribution under Section 301. However, this approach creates significant complexity and potential IRS scrutiny. The IRS could recharacterize the purported loan as a constructive dividend under established case law (e.g., Busch v. Commissioner, T.C. Memo. 1967-71; Crowley v. Commissioner, 89 T.C. 561 (1987)) if the loan lacks sufficient indicia of bona fide indebtedness — for example, if there is no fixed repayment schedule, no interest is charged, or Holdings lacks the ability to repay. Moreover, the Credit Agreement's restricted payment covenants may treat such a loan as a restricted payment, creating covenant compliance issues. We do not recommend this approach.
(3) Return of Capital by Design. If the E&P study reveals that accumulated E&P is limited, it may be possible to structure a portion of the distribution as a return of capital by ensuring that E&P is minimized (e.g., through accelerated deductions or timing adjustments). However, artificial manipulation of E&P to achieve a particular characterization would be contrary to sound tax practice and could invite IRS scrutiny. Moreover, a return of capital characterization — while beneficial to the extent it avoids current taxation — reduces basis in Nexford stock, which increases the gain recognized on a future exit. Fro