CALDERWOOD & HARKNESS LLP Attorneys at Law 590 Lexington Avenue, 35th Floor New York, NY 10022 Tel: (212) 554-8000
PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT COMMUNICATION
MEMORANDUM
TO:
Helena Byrne, Executive Vice President, Corporate Development & Strategy, Solstice Biomedical Devices Ltd.
Patrick Lennox, General Counsel & Company Secretary, Solstice Biomedical Devices Ltd.
Conor Muldoon, Chief Financial Officer, Solstice Biomedical Devices Ltd.
FROM:
Tiffany Rosenthal, Calderwood & Harkness LLP
Andrew Fitzpatrick, Calderwood & Harkness LLP
CC:
Beatrice Holloway, Calderwood & Harkness LLP
Leonard Cross, Calderwood & Harkness LLP
DATE: November 4, 2024
RE: Post-Closing Net Working Capital True-Up Procedures — Acquisition of Meridian Surgical Technologies, Inc.
MATTER NO.: 1037-00006
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I. Executive Summary and Purpose
The purpose of this memorandum is to provide Solstice Biomedical Devices Ltd. ("Solstice") and its wholly owned U.S. acquisition subsidiary, Solstice Biomedical, Inc. ("SBI"), with a comprehensive and practical guide to the post-closing Net Working Capital ("NWC") adjustment process under the Stock Purchase Agreement dated August 20, 2024 (the "SPA") among SBI, as Buyer, Meridian Surgical Technologies, Inc. ("Meridian" or the "Company"), the stockholders of Meridian listed therein (collectively, the "Sellers"), and Dr. Marcus Ellsworth, in his capacity as the Sellers' Representative. This memorandum is intended to serve as a working reference for Solstice's corporate development, legal, and finance teams as they navigate the post-closing true-up period, including the preparation and delivery of the proposed Final Closing Statement, potential disputes, and the ultimate determination of any adjustment payment owing between the parties.
The transaction closed on October 31, 2024. At closing, the Closing Statement delivered by the Sellers reflected an Estimated Closing NWC of $12,175,000 against a Target NWC of $11,500,000, resulting in an estimated NWC surplus of $675,000. Pursuant to Section 2.4(b) of the SPA, this surplus was added to the closing cash consideration paid to the Sellers, bringing the total Estimated Closing Cash Consideration to $182,108,177.84 (as detailed in Section II.C below).
The SPA provides Buyer with a 90-day post-closing true-up period within which to prepare and deliver to the Sellers' Representative a proposed Final Closing Statement setting forth Buyer's calculation of the actual Closing NWC. The deadline for delivery of the proposed Final Closing Statement is January 29, 2025. This deadline is absolute and non-negotiable under the terms of the SPA: if Buyer fails to deliver the proposed Final Closing Statement by that date, the Estimated Closing Statement becomes final and binding on all parties, and no further NWC adjustment will be made—regardless of whether the actual Closing NWC would have resulted in a payment to or from the Sellers.
This memorandum addresses the following topics in detail: (i) an overview of the NWC adjustment mechanism and key defined terms under the SPA; (ii) the complete post-closing true-up timeline and all associated deadlines; (iii) the preparation of the proposed Final Closing Statement, including accounting methodology requirements, specific line items requiring attention, and practical recommendations for the SBI finance team; (iv) potential adjustment scenarios illustrating the financial impact of various outcomes; (v) the dispute resolution framework, including the role of Hargrove Bennett LLP as the pre-designated Independent Accounting Referee; (vi) the interaction between the NWC adjustment process and other post-closing provisions of the SPA, including indemnification, the earnout, and tax matters; (vii) coordination and communication protocols with the Sellers' Representative; and (viii) a detailed action items checklist with recommended next steps.
We urge the Solstice team to treat the matters discussed herein with the highest priority. The post-closing NWC adjustment process is one of the most common sources of post-closing disputes in stock purchase transactions, and rigorous adherence to the contractual procedures, deadlines, and accounting methodologies prescribed by the SPA will be essential to protecting Solstice's interests.
II. Overview of the NWC Adjustment Mechanism
A. Purpose of the NWC Adjustment
The NWC adjustment is a standard and widely used mechanism in stock purchase transactions designed to ensure that the Buyer receives, at the closing of the acquisition, a normalized level of working capital in the acquired business. Working capital—generally understood as the excess of current assets over current liabilities—represents the short-term liquidity available to fund the day-to-day operations of the business. In any acquisition, the parties agree at signing on a target or benchmark level of working capital that represents the "normal" operating needs of the business; this target is then compared to the actual working capital at closing to determine whether an upward or downward adjustment to the purchase price is warranted.
The NWC adjustment mechanism serves several important functions. First, it protects the Buyer against the risk that Sellers may, whether intentionally or through the ordinary course of business operations, deplete working capital between signing and closing—for instance, by accelerating collections of accounts receivable, deferring payments of accounts payable, reducing inventory levels, or distributing excess cash. In the present case, the period between signing (August 20, 2024) and closing (October 31, 2024) was approximately ten weeks, during which the Sellers continued to operate Meridian's business, and the risk of working capital leakage during that period was material.
Second, the NWC adjustment ensures that the effective purchase price paid by the Buyer accurately reflects the value of the business delivered at closing. If working capital at closing exceeds the agreed-upon target, the Buyer has received additional value and should compensate the Sellers accordingly; if working capital falls short, the Sellers have retained value that should have been delivered, and a downward adjustment to the purchase price is appropriate.
The NWC adjustment process established by the SPA is a two-step mechanism:
1. Estimated Adjustment at Closing. Prior to closing, the Sellers prepared and delivered an Estimated Closing Statement setting forth their good-faith estimate of Closing NWC. The difference between the Estimated Closing NWC and the Target NWC was applied as a dollar-for-dollar adjustment to the closing cash consideration. Because the Estimated Closing NWC ($12,175,000) exceeded the Target NWC ($11,500,000), the Sellers received an additional $675,000 at closing.
2. Post-Closing True-Up. Following closing, the Buyer has 90 days to prepare and deliver a proposed Final Closing Statement reflecting the actual Closing NWC as of the Closing Date. The difference, if any, between the Final Closing NWC and the Estimated Closing NWC is then settled between the parties—either as an additional payment to the Sellers or as a refund to the Buyer—depending on the direction and magnitude of the variance. The true-up process includes a structured dispute resolution framework in the event the parties disagree on the Final Closing NWC determination.
B. Key Defined Terms Under the SPA
A clear understanding of the defined terms in the SPA governing the NWC adjustment is essential to preparing an accurate and defensible Final Closing Statement. The following terms, as defined in Article I of the SPA, are of central importance:
"Target Net Working Capital" (or "Target NWC") means the amount of Eleven Million Five Hundred Thousand Dollars ($11,500,000). The Target NWC represents the agreed-upon benchmark level of NWC based on an analysis of Meridian's historical balance sheet, reflecting the normalized level of working capital required to operate the business in the ordinary course. The Target NWC was negotiated between the parties during the diligence phase and reflects adjustments for seasonality, one-time items, and the specific inclusions and exclusions set forth on Schedule 1.1(a) to the SPA.
"Estimated Closing Net Working Capital" means the amount of Twelve Million One Hundred Seventy-Five Thousand Dollars ($12,175,000), being the Sellers' good-faith estimate of the Closing NWC as of the Closing Date, as set forth in the Estimated Closing Statement delivered by the Sellers to Buyer prior to the Closing pursuant to Section 2.4(a) of the SPA.
"Closing Net Working Capital" (or "Final Closing NWC") means the actual Net Working Capital of the Company as of the close of business on the Closing Date (October 31, 2024), as finally determined through the post-closing true-up process described in Section 2.5 of the SPA. The Final Closing NWC is the figure that will ultimately govern whether a true-up payment is owed and, if so, the amount and direction of that payment.
"Net Working Capital" is defined in Section 1.1 of the SPA as the current assets of the Company minus the current liabilities of the Company, in each case as of the applicable measurement date, calculated in accordance with U.S. generally accepted accounting principles ("GAAP") applied on a basis consistent with the Company's historical financial statements (audited by Dunfield & Associates, P.C. for fiscal years 2021 through 2023), subject to the specific inclusions, exclusions, line-item definitions, and calculation methodologies set forth on Schedule 1.1(a) to the SPA (the "NWC Calculation Schedule"). The NWC Calculation Schedule is the controlling document for purposes of the NWC determination and must be reviewed carefully in connection with the preparation of the Final Closing Statement.
The following categories of assets and liabilities are specifically excluded from the calculation of Net Working Capital, as set forth on Schedule 1.1(a):
• Cash and cash equivalents;
• Income tax receivables and income tax payables;
• Intercompany receivables and intercompany payables (including any amounts owed to or from any Seller or any affiliate of any Seller);
• Sellers' Transaction Expenses (as defined in the SPA), including legal, accounting, and advisory fees incurred by the Sellers or the Company in connection with the transaction;
• The outstanding balance under the Ironclad Capital Partners revolving credit facility (which was paid off at closing in the amount of $7,341,822.16);
• Deferred revenue items as specifically enumerated on Schedule 1.1(a), including advance payments received by Meridian under the Northwell Health Group Purchasing Agreement dated March 15, 2023 (to the extent such amounts were classified as deferred revenue as of the Closing Date); and
• Any liabilities or obligations arising solely as a result of the transactions contemplated by the SPA (e.g., change-of-control payments, acceleration of vesting under the Meridian 2019 Equity Incentive Plan).
Understanding these exclusions is critical, as the inclusion or exclusion of specific line items is frequently the source of disputes in post-closing NWC true-ups.
C. Closing Adjustment at Closing (Recap)
For reference and as context for the post-closing true-up process, the closing cash consideration was calculated as follows:
Base Purchase Price: $220,000,000.00
Less: Indemnity Escrow Deposit: ($26,400,000.00)
Less: Ironclad Capital Partners Payoff Amount: ($7,341,822.16)
Less: Sellers' Transaction Expenses: ($4,825,000.00)
Plus: Estimated NWC Adjustment: $675,000.00
(Estimated Closing NWC of $12,175,000 minus Target NWC of $11,500,000 = +$675,000)
Estimated Closing Cash Consideration (paid to Sellers at Closing): $182,108,177.84
The $675,000 NWC surplus was paid to the Sellers at closing as part of the aggregate closing cash consideration, and represents the amount subject to potential true-up adjustment. If the Final Closing NWC differs from the Estimated Closing NWC, the true-up payment will adjust the effective purchase price accordingly, as described in Section V below.
III. Post-Closing True-Up Timeline and Deadlines
The SPA establishes a structured timeline for the post-closing NWC true-up process. Strict adherence to each deadline is essential, as the SPA imposes consequences for failure to act within the prescribed time periods. The following is a detailed description of each phase of the timeline.
A. 90-Day True-Up Period
The post-closing true-up period commences on the Closing Date, October 31, 2024. Pursuant to Section 2.5(a) of the SPA, the Buyer has ninety (90) calendar days from the Closing Date to prepare and deliver to the Sellers' Representative a proposed Final Closing Statement setting forth Buyer's good-faith calculation of the actual Closing NWC as of the close of business on October 31, 2024.
The deadline for delivery of the proposed Final Closing Statement is January 29, 2025.
This deadline is calculated as 90 calendar days from October 31, 2024. We note that January 29, 2025 falls on a Wednesday, a regular business day.
Critical Note: Under Section 2.5(a) of the SPA, if the Buyer fails to deliver the proposed Final Closing Statement to the Sellers' Representative within the 90-day period, the Estimated Closing Statement delivered by the Sellers at closing shall be deemed to be the Final Closing Statement, and the Estimated Closing NWC of $12,175,000 shall be deemed to be the Final Closing NWC, final and binding on all parties, with no further adjustment. This means that the $675,000 surplus paid to the Sellers at closing would become permanent, regardless of whether the actual Closing NWC is higher or lower than the estimated amount. This must be treated as a hard, non-waivable deadline. There is no cure period, extension mechanism, or force majeure exception in the SPA with respect to this deadline. Accordingly, the Solstice team should plan to deliver the proposed Final Closing Statement well in advance of January 29, 2025, with an internal target completion date of no later than January 20, 2025, to allow adequate time for final legal review and formal delivery.
The proposed Final Closing Statement must be delivered in writing to the Sellers' Representative in accordance with the notice provisions of Section 12.1 of the SPA, which require delivery by hand, nationally recognized overnight courier, or certified mail, return receipt requested. We recommend delivery by both overnight courier (Sundial Data Systems or similar) and email (with the original following by courier), in order to ensure timely receipt and to create a clear record of the date and manner of delivery.
B. Sellers' Representative Review Period
Upon receipt of the proposed Final Closing Statement, the Sellers' Representative, Dr. Marcus Ellsworth, has thirty (30) calendar days to review the proposed Final Closing Statement and all supporting documentation provided therewith. During this 30-day review period, the Sellers' Representative has two options:
1. Accept the proposed Final Closing Statement. If the Sellers' Representative accepts Buyer's proposed Final Closing Statement (either expressly in writing or by failing to deliver a Notice of Disagreement within the 30-day period), the proposed Final Closing Statement becomes the Final Closing Statement, and the Closing NWC set forth therein becomes the Final Closing NWC, final and binding on all parties.
2. Deliver a Notice of Disagreement. If the Sellers' Representative disagrees with any aspect of the proposed Final Closing Statement, the Sellers' Representative must deliver to Buyer, within the 30-day period, a written Notice of Disagreement (as defined in Section 2.5(c) of the SPA) that specifies in reasonable detail: (a) each item or amount on the proposed Final Closing Statement with which the Sellers' Representative disagrees (each, a "Disputed Item"); (b) the Sellers' Representative's proposed alternative amount for each Disputed Item; and (c) the basis for each such disagreement, including any supporting documentation.
If the Sellers' Representative fails to deliver a timely Notice of Disagreement within the 30-day period, the proposed Final Closing Statement becomes final and binding without further action by any party.
It is important to note that only items specifically identified in the Notice of Disagreement may be disputed. Any line item or amount on the proposed Final Closing Statement that is not specifically challenged in the Notice of Disagreement is deemed accepted by the Sellers' Representative and becomes part of the final and binding determination. This principle underscores the importance of precision and completeness in the preparation of the proposed Final Closing Statement, as well as in the identification and framing of any Disputed Items should a Notice of Disagreement be received.
During the 30-day review period, the SPA grants the Sellers' Representative and its advisors reasonable access to the books, records, work papers, and accounting personnel of the Company as reasonably necessary for the review of the proposed Final Closing Statement. We should anticipate that Dr. Ellsworth and his advisors will exercise these access rights and should coordinate with SBI's finance team accordingly to facilitate an orderly review process.
Assuming delivery of the proposed Final Closing Statement on or about January 29, 2025, the Sellers' Representative's 30-day review period would expire on or about February 28, 2025.
C. Negotiation Period
If the Sellers' Representative delivers a timely Notice of Disagreement, the parties enter a negotiation period during which they are required to attempt in good faith to resolve all Disputed Items identified in the Notice of Disagreement. Pursuant to Section 2.5(d) of the SPA, this negotiation period is thirty (30) calendar days following Buyer's receipt of the Notice of Disagreement.
During the negotiation period, we anticipate that the principals and advisors for each side will engage in discussions—whether in person, by telephone, or by video conference—to review the disputed line items, exchange supporting documentation and analyses, and attempt to reach agreement on some or all of the Disputed Items. To the extent the parties are able to resolve certain Disputed Items during this period, those resolved items become part of the final and binding determination. Any Disputed Items that remain unresolved at the expiration of the 30-day negotiation period are referred to the Independent Accounting Referee.
It is our recommendation that Calderwood & Harkness be closely involved in any negotiations arising from a Notice of Disagreement, both to ensure that Buyer's positions are well-supported and documented and to manage the process in a manner that preserves Buyer's rights and options, including the right to escalate unresolved items to the Independent Accounting Referee.
If a Notice of Disagreement is received on or about February 28, 2025, the 30-day negotiation period would expire on or about March 30, 2025.
D. Independent Accounting Referee — Escalation
If the parties are unable to resolve all Disputed Items within the 30-day negotiation period, any remaining Disputed Items are submitted to the Independent Accounting Referee for final determination. The SPA designates the following firm as the Independent Accounting Referee:
Hargrove Bennett LLP 1735 Market Street, Suite 2800 Philadelphia, PA 19103
Key Contact: Margaret Chen, CPA, Partner
Hargrove Bennett LLP was mutually pre-selected and designated in the SPA by both Buyer and the Sellers. The selection of the Independent Accounting Referee at the time of signing (rather than leaving it to post-dispute negotiation) is a common and beneficial feature of well-drafted stock purchase agreements, as it eliminates the delay and potential gamesmanship that can arise from post-dispute selection of a neutral.
The specific procedures and standards governing the Independent Accounting Referee's determination are discussed in detail in Section VI of this memorandum.
E. Summary Timeline Table
The following table summarizes the key milestones and deadlines in the post-closing NWC true-up process:
We note that the dates for Steps 3 through 7 are approximate and depend on when Buyer delivers the proposed Final Closing Statement and, if applicable, when the Sellers' Representative delivers a Notice of Disagreement. The only absolute deadline is January 29, 2025 for delivery of the proposed Final Closing Statement.
IV. Preparation of the Proposed Final Closing Statement
A. Buyer's Obligations and Access Rights
Under Section 2.5(a) of the SPA, the Buyer (SBI) has both the right and the obligation to prepare and deliver the proposed Final Closing Statement. The proposed Final Closing Statement must set forth Buyer's good-faith calculation of the actual Closing NWC as of the close of business on the Closing Date (October 31, 2024), together with reasonable supporting documentation and schedules. The proposed Final Closing Statement must be prepared in a format consistent with the Estimated Closing Statement and in accordance with the accounting standards, methodologies, and definitions specified in the SPA, including the NWC Calculation Schedule set forth on Schedule 1.1(a).
To facilitate the preparation of the proposed Final Closing Statement, Section 2.5(b) of the SPA grants the Buyer access to the Company's books, records, financial data, work papers, and accounting personnel as reasonably necessary. Following the closing, all of Meridian's books and records are now in the possession and control of SBI. In addition, David Hensley, Meridian's former Chief Financial Officer, has been integrated into the SBI organization and remains available as a primary accounting resource for the NWC true-up process. Mr. Hensley possesses detailed knowledge of Meridian's historical accounting policies, practices, and estimation methodologies, and his involvement in the preparation of the Final Closing Statement will be invaluable in ensuring consistency with the Estimated Closing Statement and with Meridian's historical financial statements.
We strongly recommend that Conor Muldoon's finance team engage closely with David Hensley and the Meridian accounting staff to commence the NWC calculation process immediately. Early engagement will allow time to identify any areas of complexity, to gather and organize supporting documentation, and to resolve internal questions well before the January 29, 2025 deadline.
B. Accounting Methodology and Consistency Requirements
The proposed Final Closing Statement must be prepared in accordance with the following standards, as specified in the SPA and Schedule 1.1(a):
1. GAAP as Applied by Meridian. The NWC calculation must be prepared in accordance with U.S. generally accepted accounting principles as applied by Meridian in the preparation of its historical financial statements for fiscal years 2021 through 2023, as audited by Dunfield & Associates, P.C. This means that the accounting policies, practices, and estimation techniques used in the proposed Final Closing Statement must be the same as those used in Meridian's audited financial statements, subject to the specific provisions of Schedule 1.1(a).
2. Consistency with the Estimated Closing Statement and the Target NWC. The same accounting policies, practices, methodologies, classification conventions, and estimation procedures used in the preparation of the Estimated Closing Statement and in the derivation of the Target NWC must be applied in the proposed Final Closing Statement. This consistency requirement is paramount: the purpose of the NWC adjustment is to compare "Apples to apples," and any deviation in methodology—even if such deviation might be more technically correct under current GAAP—is generally impermissible absent a clear contractual basis.
3. No Changes in Reserves, Accrual Methodologies, or Classification. The Buyer may not change reserves, accrual methodologies, or the classification of items on the Closing Date balance sheet unless such changes are required by GAAP to correct an identifiable error in the historical financial statements. This prohibition is designed to prevent the Buyer from manipulating the NWC calculation by, for example, increasing bad debt reserves, writing down inventory, or reclassifying items between current and non-current categories in ways that differ from Meridian's historical practice. Any such changes, if made without proper basis, would be vulnerable to challenge by the Sellers' Representative and potentially by the Independent Accounting Referee.
The following specific areas of the NWC calculation warrant particularly careful attention and review, given their potential for complexity or dispute:
• Accounts Receivable Reserves and Allowances. The allowance for doubtful accounts must be calculated using the same methodology and reserve percentages applied by Meridian historically. If there have been material changes in the aging profile of receivables between Meridian's most recent fiscal year-end and the Closing Date, those changes should be reflected in the reserve calculation consistent with the methodology historically applied—but the methodology itself should not be changed.
• Inventory Valuation and Obsolescence Reserves. Inventory must be valued at the lower of cost or net realizable value, consistent with Meridian's historical practice. Obsolescence reserves must be assessed using the same criteria and estimation techniques used by Meridian in prior periods. Particular attention should be paid to any pre-ArthroNav prototype components or other items that may have become obsolete or slow-moving in connection with the development of the ArthroNav platform.
• Accrued Liabilities. Accrued liabilities must include all obligations of the Company incurred on or before the Closing Date, whether or not invoiced as of the Closing Date. Warranty accruals for PrecisionBlade products and powered shaver systems should be reviewed for adequacy and consistency with Meridian's historical warranty experience and accrual methodology.
• Prepaid Expenses. Prepaid expenses should be confirmed as current assets properly includable in NWC, and their classification (current vs. non-current) should be consistent with Meridian's historical treatment.
• Deferred Revenue Classification. Deferred revenue items must be carefully reviewed against the specific enumeration on Schedule 1.1(a) to determine which items are excluded from NWC and which, if any, are included.
C. Specific Line Items to Review
In preparing the proposed Final Closing Statement, we recommend that the SBI finance team conduct a detailed review of the following line items, which are typically the most significant components of NWC and the most common sources of post-closing disputes:
Accounts Receivable. Meridian's fiscal year 2023 revenue was approximately $87 million, implying a substantial accounts receivable balance at any given time. The SBI finance team should perform a thorough aging analysis of all trade receivables as of October 31, 2024, confirm the collectability of all amounts, and review the reserve for doubtful accounts for consistency with Meridian's historical methodology. Any receivable that has become uncollectable or significantly aged since the Closing Date should be assessed to determine whether the deterioration was foreseeable as of the Closing Date and whether the reserve, as calculated using Meridian's historical methodology, was adequate. It is important to note that the relevant measurement date is October 31, 2024—post-closing events (such as customer bankruptcies or disputes arising after that date) are generally not relevant to the NWC calculation unless they provide evidence of conditions that existed as of the Closing Date.
Inventory. Inventory must be confirmed at the lower of cost or net realizable value, consistent with Meridian's historical practice. The SBI finance team should reconcile the physical inventory count data from the Exton manufacturing facility (located at 45 Forge Creek Road, Exton, PA 19341) for the period around the Closing Date, ensuring that all inventory on hand as of October 31, 2024 has been captured and properly valued. Obsolescence reserves should be reviewed with particular attention to pre-ArthroNav prototype components, any slow-moving or excess raw materials, and any finished goods inventory that may have experienced reduced demand. The inventory count reconciliation at the Exton facility is a critical workstream that should be completed by no later than the end of November 2024.
Accounts Payable. All liabilities incurred by the Company through October 31, 2024 must be captured in the accounts payable balance, whether or not invoices had been received or processed as of that date. Particular attention should be paid to invoices from Titanium Precision Components, Inc. ("TPC"), Meridian's exclusive supplier of titanium alloy components for the PrecisionBlade product line, under the exclusive supply agreement between Meridian and TPC (which provides for a minimum annual purchase commitment of $3,200,000). Any TPC invoices for goods delivered or services rendered on or before October 31, 2024 should be confirmed as properly accrued, even if the invoices were not received until after closing. The SBI finance team should also review the Company's purchase order log and receiving reports to identify any uninvoiced liabilities.
Accrued Expenses. Accrued expenses represent a broad category of liabilities that frequently requires careful analysis. Key sub-categories include:
• Accrued Compensation. As of the Closing Date, Meridian employed approximately 312 individuals. Accrued compensation should include all wages, salaries, bonuses, commissions, paid time off, and payroll-related liabilities (including employer payroll taxes) attributable to services rendered on or before October 31, 2024. If the Closing Date falls in the middle of a payroll period, appropriate proration should be applied.
• Accrued Warranty Costs. Meridian's PrecisionBlade products and powered shaver systems carry warranty obligations. The warranty accrual should be calculated using Meridian's historical warranty experience (typically expressed as a percentage of revenue or units shipped) and the same estimation methodology used in prior periods. Any known or anticipated warranty claims outstanding as of the Closing Date should also be reviewed.
• Accrued Professional Fees. Professional fees incurred by the Company in the ordinary course of business (e.g., audit fees, regulatory consulting fees) that are not treated as Sellers' Transaction Expenses should be accrued as of the Closing Date. It is important to distinguish between professional fees that are properly included in NWC (ordinary-course fees of the Company) and those that are excluded as Sellers' Transaction Expenses (fees incurred in connection with the sale transaction).
Excluded Items. The SBI finance team must confirm the proper exclusion of the following items from the NWC calculation, consistent with Schedule 1.1(a):
• Cash and cash equivalents (excluded from current assets);
• The Ironclad Capital Partners revolving credit facility balance of $7,341,822.16 (paid off at closing and excluded from current liabilities);
• Income tax receivables and income tax payables;
• Sellers' Transaction Expenses of $4,825,000 (paid at closing and excluded from current liabilities);
• Intercompany receivables and payables; and
• Any other items specifically listed as excluded on Schedule 1.1(a).
Improper inclusion or exclusion of these items is a common error in post-closing NWC calculations and could result in a material overstatement or understatement of the Final Closing NWC.
D. Practical Recommendations
Based on our experience with post-closing NWC true-up processes, we offer the following practical recommendations to the Solstice team:
1. Commence Work Immediately. The SBI finance team, under the direction of Conor Muldoon and with the assistance of David Hensley, should commence the NWC compilation process no later than November 15, 2024. This will allow approximately ten weeks for preparation, review, and finalization of the proposed Final Closing Statement before the January 29, 2025 deadline, providing an adequate buffer for unforeseen complexities or delays.
2. Coordinate with Calderwood & Harkness. Before delivery to the Sellers' Representative, the proposed Final Closing Statement should be reviewed by Calderwood & Harkness for legal compliance with the SPA's requirements, including proper application of the defined terms, inclusion and exclusion of the specified line items, and compliance with the accounting methodology and consistency requirements. We recommend that a draft be circulated to us for review by no later than January 6, 2025, with final legal sign-off targeted for January 20, 2025.
3. Retain All Supporting Documentation. All work papers, schedules, analyses, reconciliations, and backup documentation prepared in connection with the NWC calculation should be carefully organized and retained. If a dispute arises, the Buyer will be required to provide supporting documentation to the Sellers' Representative during the review period and, if the matter is escalated, to the Independent Accounting Referee. A well-organized and thoroughly documented work paper file will significantly strengthen Buyer's position in any dispute.
4. Consider Independent Accounting Review. Given the significance of the NWC determination and the potential for dispute, the Solstice team should consider whether an independent review of the proposed Final Closing Statement by Solstice's own external accounting advisors would be prudent before delivery. Brindoval & Albright LLP, Solstice's tax advisor, may be available for this purpose, subject to conflict review; alternatively, another qualified accounting firm could be engaged. An independent review can serve as a "dry run" of the types of challenges the Sellers' Representative might raise and can help identify and address any vulnerabilities in Buyer's NWC calculation before the statement is delivered.
5. Maintain Privilege and Confidentiality. All internal analyses, draft calculations, memoranda, and communications relating to the NWC true-up process should be treated as privileged and confidential. Internal drafts and analytical work product should be clearly marked as attorney-client privileged and work product to the extent they are prepared at the direction of counsel.
V. Potential Adjustment Scenarios
The following scenarios illustrate the potential financial outcomes of the NWC true-up process, depending on the final determination of Closing NWC. These scenarios are intended to provide the Solstice team with a practical understanding of the adjustment mechanics and their impact on the effective purchase price.
A. Scenario 1: Final Closing NWC Equals Estimated Closing NWC
If the actual Closing NWC is confirmed at $12,175,000—the same amount set forth in the Estimated Closing Statement—the estimated adjustment of +$675,000 paid to the Sellers at closing stands as the final NWC adjustment. No additional payment is owed by either party, and the NWC adjustment process is complete upon the Final Closing NWC determination becoming final and binding.
In this scenario, the effective NWC surplus remains at $675,000, and the total Estimated Closing Cash Consideration of $182,108,177.84 is confirmed as the final closing cash consideration (subject to any other adjustments under the SPA).
B. Scenario 2: Final Closing NWC Exceeds Estimated Closing NWC (Additional Payment to Sellers)
If the actual Closing NWC exceeds $12,175,000, the Buyer owes the Sellers the positive difference between the Final Closing NWC and the Estimated Closing NWC. This scenario would arise if, for example, the SBI finance team determines that the Estimated Closing Statement understated certain current assets or overstated certain current liabilities.
Illustrative Example: If the Final Closing NWC is determined to be $12,500,000, the additional payment to the Sellers would be calculated as follows:
Final Closing NWC: $12,500,000 Less: Estimated Closing NWC: ($12,175,000) Additional Payment to Sellers: $325,000
In this scenario, the effective NWC surplus increases from $675,000 to $1,000,000 ($12,500,000 minus $11,500,000), and the aggregate effective purchase price increases by $325,000. The additional payment is directed to the Sellers' Representative (Dr. Marcus Ellsworth) for distribution to the Sellers on a pro rata basis in accordance with their respective ownership percentages.
C. Scenario 3: Final Closing NWC Is Below Estimated Closing NWC but Above Target NWC (Partial Clawback from Sellers)
If the actual Closing NWC is less than the Estimated Closing NWC of $12,175,000 but greater than the Target NWC of $11,500,000, the Sellers must refund to the Buyer the difference between the Estimated Closing NWC and the actual Final Closing NWC. In this scenario, the Sellers received more at closing than the NWC adjustment warranted, but the actual NWC still exceeds the Target, so the Sellers retain a portion of the surplus.
Illustrative Example: If the Final Closing NWC is determined to be $11,800,000, the refund from the Sellers to the Buyer would be calculated as follows:
Estimated Closing NWC: $12,175,000 Less: Final Closing NWC: ($11,800,000) Refund from Sellers to Buyer: $375,000
In this scenario, the effective NWC surplus is reduced from $675,000 to $300,000 ($11,800,000 minus $11,500,000). The Sellers retain $300,000 of the $675,000 surplus paid at closing and refund $375,000 to the Buyer.
D. Scenario 4: Final Closing NWC Falls Below Target NWC (Full Clawback of Surplus Plus Additional Refund)
If the actual Closing NWC is below the Target NWC of $11,500,000, the Sellers must refund to the Buyer the full $675,000 estimated surplus paid at closing, plus the additional shortfall below Target NWC. In this scenario, the NWC adjustment swings from a surplus to a deficit, and the Sellers owe the Buyer more than the amount of the original surplus.
Illustrative Example: If the Final Closing NWC is determined to be $11,000,000, the refund from the Sellers to the Buyer would be calculated as follows:
Estimated Closing NWC: $12,175,000 Less: Final Closing NWC: ($11,000,000) Refund from Sellers to Buyer: $1,175,000
This refund can be understood as comprising two components: (i) the full $675,000 surplus paid at closing, which is returned in its entirety; and (ii) an additional $500,000, representing the shortfall of the actual Closing NWC below the Target NWC ($11,500,000 minus $11,000,000 = $500,000). In this scenario, the aggregate effective purchase price is reduced by $1,175,000 relative to the amount paid at closing.
E. Payment Mechanics
Regardless of which scenario applies, the following payment mechanics govern the settlement of any NWC true-up payment:
1. Timing. Any true-up payment owed by either party is due and payable within five (5) business days after the date on which the Final Closing NWC determination becomes final and binding on all parties. A determination becomes final and binding upon: (a) the expiration of the Sellers' Representative's 30-day review period without delivery of a Notice of Disagreement; (b) written agreement of the parties resolving all Disputed Items; or (c) the issuance of the Independent Accounting Referee's written determination.
2. Payments by Sellers. Any payment owed by the Sellers to the Buyer is made by the Sellers' Representative from the Sellers' Representative Payment Account, established at Founders National Bank, N.A., Account No. 6654-1029-8871. The Sellers' Representative has been funded by the Sellers to make payments on their behalf, including NWC true-up payments.
3. Payments by Buyer. Any payment owed by the Buyer to the Sellers is made by SBI from its account at Tidewater Atlantic Bank, N.A., Account No. 8801-4437-2290, and is directed to the Sellers' Representative for distribution to the Sellers pro rata.
4. Interest. Any NWC adjustment payment that is not timely made bears interest from the Closing Date (October 31, 2024) through the date of actual payment at the prime rate as published in The Wall Street Journal on the Closing Date. This interest provision creates an incentive for both parties to make timely payments once the Final Closing NWC determination becomes binding.
5. Independence from the Indemnity Escrow. The NWC adjustment is separate from, and independent of, the Indemnity Escrow of $26,400,000 held by Keystone Escrow Services, Inc. NWC true-up payments are not made from, and do not affect the balance of, the Indemnity Escrow. The Indemnity Escrow is reserved exclusively for the satisfaction of indemnification claims under Article IX of the SPA. Similarly, the NWC true-up is unrelated to the Earnout Escrow Reserve of $2,500,000 held at Keystone Escrow Services, Inc.
VI. Dispute Resolution — Hargrove Bennett LLP as Independent Accounting Referee
A. Scope of Authority
If the parties are unable to resolve all Disputed Items during the 30-day negotiation period following delivery of a Notice of Disagreement, the remaining unresolved Disputed Items are submitted to the Independent Accounting Referee for final determination. As noted above, the SPA designates Hargrove Bennett LLP as the Independent Accounting Referee, with Margaret Chen, CPA, Partner, serving as the primary contact and lead engagement partner.
The authority of the Independent Accounting Referee is carefully circumscribed by the SPA:
• Limited to Disputed Items. The Independent Accounting Referee's authority is strictly limited to the specific Disputed Items submitted to it by the parties. Hargrove Bennett may not review, revise, or opine on any item or amount that is not the subject of a Disputed Item. Items that were accepted by the Sellers' Representative (either expressly or by failure to include them in the Notice of Disagreement) or that were resolved by the parties during the negotiation period are outside the scope of the Independent Accounting Referee's authority and form part of the final and binding determination regardless of Hargrove Bennett's findings on the remaining Disputed Items.
• "Baseball" Resolution. For each Disputed Item, the Independent Accounting Referee must determine a value that is no higher than the highest value proposed by either party and no lower than the lowest value proposed by either party. This "baseball" or "bounded" resolution mechanism prevents the Independent Accounting Referee from adopting a value that falls entirely outside the range defined by the parties' respective positions. It also creates a strong incentive for both parties to submit reasonable, well-supported positions, as extreme or unsupported positions are unlikely to be adopted by the referee.
• No Authority Beyond the SPA. The Independent Accounting Referee acts solely to determine the proper application of the accounting principles, methodologies, and definitions set forth in the SPA and Schedule 1.1(a). The referee has no authority to resolve legal disputes, interpret ambiguous contractual provisions (other than accounting methodology provisions), award damages, or modify the terms of the SPA.
B. Procedures Before the Independent Accounting Referee
The procedures before the Independent Accounting Referee are set forth in Section 2.5(e) of the SPA and are generally as follows:
1. Submission of Written Briefs. Each party submits to the Independent Accounting Referee a written brief—typically ranging from ten to twenty pages, with supporting schedules, work papers, and backup documentation—setting forth its position on each Disputed Item. The brief should articulate the accounting basis for the party's position, explain why the applicable accounting standards, methodologies, and SPA definitions support the party's proposed value, and address the opposing party's position with specificity. The quality and persuasiveness of these submissions are often determinative of the outcome.
2. Information Requests. The Independent Accounting Referee may, in its discretion, request additional information, documents, or clarifications from either party. Both parties are required to cooperate fully and in good faith with any such requests.
3. Hearing or Conference Call. The Independent Accounting Referee may, but is not required to, conduct a hearing, conference call, or in-person meeting with the parties and their advisors to discuss the Disputed Items, ask questions, and hear oral presentations. The SPA does not prescribe formal rules of procedure for any such hearing; the process is informal and at the discretion of the referee.
4. Written Determination. The Independent Accounting Referee must render its determination in writing within thirty (30) days of the date the Disputed Items are submitted, subject to extension for complex items up to a maximum of forty-five (45) days as provided in the SPA. The written determination must set forth the Independent Accounting Referee's conclusions on each Disputed Item, including the final value determined for each item and, ideally, the basis for each conclusion.
5. Final and Binding. The determination of the Independent Accounting Referee is final and binding on all parties, absent manifest error. The determination is not subject to appeal, judicial review (except for manifest error or fraud), or reconsideration. This finality provision is a critical feature of the dispute resolution mechanism, as it provides certainty and closure to the NWC true-up process.
C. Governing Standards
The Independent Accounting Referee is required to apply the same accounting principles, methodologies, policies, practices, and definitions as are set forth in the SPA, including Schedule 1.1(a), and GAAP as consistently applied by Meridian in its historical financial statements (as audited by Dunfield & Associates, P.C.). The referee may not apply alternative accounting methodologies, deviate from the SPA's defined terms, or exercise subjective judgment inconsistent with the contractual framework established by the parties.
It is also important to note that the Independent Accounting Referee acts in the capacity of an expert, not as an arbitrator. The process before the Independent Accounting Referee is not subject to the rules of the American Arbitration Association ("AAA"), the Federal Arbitration Act, or any analogous state arbitration statute. This distinction is significant: it means that the procedures are more flexible and less formal than a traditional arbitration, and that the standards of judicial review applicable to arbitration awards do not necessarily apply. This distinction is particularly noteworthy in the context of the Meridian acquisition, as the SPA's earnout dispute mechanism (Section 2.7) does involve AAA arbitration procedures, and the parties should not conflate the two processes.
D. Costs and Fees
The fees and expenses of Hargrove Bennett LLP in connection with the Independent Accounting Referee engagement are allocated between the Buyer and the Sellers in inverse proportion to the degree to which each party's position ultimately prevails.
The allocation methodology is as follows:
• The "aggregate amount of Disputed Items" is determined by calculating the total dollar amount in dispute across all Disputed Items (i.e., the sum of the absolute differences between the parties' respective positions on each Disputed Item).
• The Independent Accounting Referee's final determination is then compared to each party's position to determine the degree to which each party's position prevailed.
• The party whose position prevailed to a lesser degree bears a proportionally greater share of the Independent Accounting Referee's fees.
Illustrative Example: If the aggregate amount of Disputed Items (measured as the total spread between the parties' respective positions) is $500,000, and the Independent Accounting Referee's final determination results in a value that is $350,000 closer to Buyer's position and $150,000 closer to the Sellers' position, then the Sellers would bear 70% (i.e., $350,000 / $500,000) and the Buyer would bear 30% (i.e., $150,000 / $500,000) of Hargrove Bennett's fees and expenses.
Each party bears its own legal fees, accounting advisory fees, and other professional costs incurred in connection with the dispute resolution process. This is consistent with standard practice in NWC disputes and should be factored into any cost-benefit analysis undertaken by the Solstice team in deciding whether and how aggressively to dispute items raised by the Sellers' Representative.
VII. Interaction with Other Post-Closing Provisions
A. NWC Adjustment vs. Indemnification
The NWC adjustment mechanism is a distinct post-closing mechanism from the indemnification provisions set forth in Article IX of the SPA, and the two should not be conflated. The following key distinctions should be kept in mind:
• Indemnity Escrow. The Indemnity Escrow of $26,400,000 is held by Keystone Escrow Services, Inc. and is available solely to satisfy indemnification claims asserted by the Buyer against the Sellers under Article IX of the SPA. The Indemnity Escrow is not available to fund or satisfy NWC adjustment payments. NWC true-up payments are made directly by the owing party (Buyer or Sellers, as applicable) from the accounts specified in Section V.E above.
• Indemnification Thresholds and Limitations. The Sellers' indemnification obligations under Article IX of the SPA are subject to a $1,650,000 "tipping basket" (i.e., the Buyer may not recover any indemnification payments until aggregate Losses exceed $1,650,000, at which point the Buyer may recover from the first dollar), a $75,000 de minimis threshold (i.e., individual claims below $75,000 do not count toward the tipping basket), and a $61,600,000 aggregate cap on the Sellers' indemnification liability. None of these thresholds or limitations apply to the NWC adjustment, which operates on a dollar-for-dollar basis without any deductible, threshold, or cap.
• No Double Counting. Items that are properly reflected in the Final Closing NWC calculation (e.g., accrued liabilities, reserves, and other current liabilities included in the NWC determination) should not also be the subject of duplicative indemnification claims under Article IX. For example, if a warranty liability is properly accrued in the Final Closing NWC (and thereby reduces the NWC, resulting in a true-up payment to the Buyer), the Buyer should not seek additional indemnification under Article IX for the same liability. Conversely, if a liability is discovered post-closing that was not and should not have been reflected in the NWC calculation (e.g., a pre-closing breach of a representation that gives rise to Losses), the appropriate remedy is an indemnification claim, not an NWC adjustment.
The distinction between NWC adjustments and indemnification claims is a frequent source of post-closing disputes, and the Solstice team should be careful to analyze any identified issues through the appropriate contractual lens. We are available to advise on the proper categorization of specific items as they are identified during the NWC preparation process.
B. NWC Adjustment vs. Earnout
The NWC adjustment process has no bearing on, and is entirely independent of, the earnout milestones established under Section 2.7 of the SPA. The earnout provides for two potential milestone payments:
• Milestone 1: $20,000,000, payable if certain FDA 510(k) clearance milestones for the ArthroNav platform are achieved on or before December 31, 2026.
• Milestone 2: $15,000,000, payable if certain additional FDA 510(k) clearance milestones for the ArthroNav platform are achieved on or before June 30, 2027.
These milestone payments are contingent on regulatory outcomes and are unrelated to the balance sheet condition of the Company at closing. The Earnout Escrow Reserve of $2,500,000, held at Keystone Escrow Services, Inc., is also separate from and unaffected by the NWC true-up process.
The parties should ensure that the NWC true-up process and any related disputes do not interfere with or distract from the ongoing management of the ArthroNav development program or the Buyer's obligations under the earnout provisions of the SPA, including the covenant to operate the Company's business in a manner consistent with the achievement of the earnout milestones.
C. Tax Implications
The NWC adjustment may have implications for the allocation of the purchase price for U.S. federal income tax purposes, given that the Buyer and the Sellers have jointly made an election under Section 338(h)(10) of the Internal Revenue Code in connection with the acquisition.
Under a Section 338(h)(10) election, the acquisition of Meridian's stock is treated for tax purposes as a deemed asset acquisition, and the total consideration paid by the Buyer (including the effective purchase price, as adjusted by the NWC true-up) must be allocated among the assets of the Company in accordance with Section 1060 of the Internal Revenue Code and Treasury Regulation § 1.338-6. Any increase in the effective purchase price resulting from an additional payment to the Sellers (Scenario 2 above) increases the aggregate deemed asset acquisition consideration and may require adjustments to the allocation among the various asset classes. Conversely, any decrease in the effective purchase price resulting from a refund to the Buyer (Scenarios 3 and 4 above) reduces the aggregate deemed asset acquisition consideration and may similarly require reallocation.
We recommend that the Solstice team coordinate with Leonard Cross of Calderwood & Harkness (our tax specialist) and Eleanor Voss of Brindoval & Albright LLP (Solstice's external tax advisor) as soon as the Final Closing NWC is determined, to evaluate whether any adjustments to the purchase price allocation are necessary and to ensure timely and accurate preparation of IRS Form 8023 (Elections Under Section 338 for Corporations Making Qualified Stock Purchases) and any related filings. The filing deadline for Form 8023 is the 15th day of the ninth month following the month in which the acquisition date occurs, which in this case is July 15, 2025.
VIII. Sellers' Representative — Coordination and Communications
All communications regarding the NWC true-up process must be directed to and through the Sellers' Representative, Dr. Marcus Ellsworth, who was duly appointed as the Sellers' Representative by the holders of at least sixty-five percent (65%) of the outstanding shares of Meridian pursuant to Section 11.1 of the SPA. The appointment of the Sellers' Representative is irrevocable and binding on all Sellers, and Dr. Ellsworth has exclusive authority on behalf of all Sellers to take the following actions in connection with the NWC true-up:
• Receive and review the proposed Final Closing Statement delivered by Buyer;
• Accept the proposed Final Closing Statement or deliver a Notice of Disagreement specifying Disputed Items;
• Negotiate the resolution of Disputed Items on behalf of all Sellers during the 30-day negotiation period;