PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP Attorneys at Law
One World Financial Center 200 Liberty Street, 40th Floor New York, New York 10281
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MEMORANDUM
PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
Matter No.: 2024-M&A-0142
TO: Beatrice Holloway, Partner, M&A Practice, Calderwood & Harkness LLP Derek Okonkwo, Associate, M&A Practice, Calderwood & Harkness LLP
FROM: Sylvia Hartwell, Partner, Tax Practice, Calderwood & Harkness LLP (with assistance from Ashford & Creighton LLP, Transaction Advisory Services — Gregory Nolan, CPA)
DATE: February 8, 2024
RE: Tax Structure Analysis — Proposed Asset Purchase of Cardinal Peak Industries, Inc. by Ardent Healthcare Acquisition Corp. (Project Cardinal)
CLIENT: Ardent Capital Partners III LP (through its general partner, Ardent Capital Management LLC)
CONFIDENTIALITY NOTICE: This memorandum is subject to the attorney-client privilege and the work product doctrine. It has been prepared at the direction of counsel in connection with the provision of legal advice and in anticipation of litigation or transactional proceedings. This memorandum and its contents should not be disclosed, distributed, or disseminated to any person or entity without the prior written approval of Sylvia Hartwell, Partner, Tax Practice, Calderwood & Harkness LLP, or Beatrice Holloway, Partner, M&A Practice, Calderwood & Harkness LLP. Any unauthorized disclosure may constitute a waiver of applicable privileges.
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I. Executive Summary
This memorandum has been prepared at the request of the Calderwood & Harkness M&A practice group, on behalf of our client Ardent Capital Partners III LP ("Ardent Capital" or the "Sponsor"), to analyze the federal and state tax implications of the proposed acquisition by Ardent Healthcare Acquisition Corp. (the "Purchaser" or "Acquisition Sub"), a newly formed Delaware corporation wholly owned by Ardent Capital Partners III LP, of substantially all of the assets of Cardinal Peak Industries, Inc. ("CPI" or the "Seller"), a Delaware corporation qualified to do business in Tennessee, Georgia, North Carolina, South Carolina, Alabama, Virginia, and Kentucky (collectively, the "Operating States").
The proposed transaction is structured as a direct asset purchase, with a base purchase price of $620,000,000, plus contingent earnout consideration of up to $45,000,000 in the aggregate, payable in two tranches tied to post-closing Adjusted EBITDA targets. The aggregate maximum consideration, before working capital adjustments and assumed liabilities, is therefore $665,000,000.
Set forth below is a summary of our key tax conclusions, each of which is discussed in detail in the body of this memorandum:
1. Step-Up in Basis. The asset purchase structure provides Purchaser with a full stepped-up tax basis in all acquired assets under IRC § 1060. This stepped-up basis will enable Purchaser to claim depreciation and amortization deductions on the full purchase price allocated to depreciable and amortizable assets, including tangible personal property, leasehold improvements, IRC § 197 intangible assets, goodwill, and going-concern value. The resulting depreciation and amortization tax shield is the primary structural advantage of the asset purchase for Ardent Capital and constitutes the core economic rationale for selecting this transaction form.
2. Purchase Price Allocation. The total consideration for the acquisition (including the base purchase price, assumed liabilities, contingent earnout consideration, and any working capital adjustments) must be allocated among seven asset classes (Classes I through VII) under IRC § 1060, utilizing the residual method prescribed by Treasury Regulations §§ 1.338-6 and 1.338-7. Both Buyer and Seller are required to file IRS Form 8594 (Asset Acquisition Statement Under Section 1060) with their respective federal income tax returns for the taxable year in which the closing occurs. The Asset Purchase Agreement ("APA") should include a binding allocation schedule and require the parties to file consistent Forms 8594.
3. Treatment of Earnout. The contingent earnout payments, when paid, will be treated as additional purchase price and allocated among the acquired assets under the § 1060 residual method. Amended Forms 8594 will be required upon payment of each earnout tranche (or upon expiration of the earnout without payment). The fair market value of the contingent right should be estimated and included in the initial § 1060 allocation at the time of closing.
4. Double Taxation of Seller. CPI, as a C-corporation, will recognize gain on the deemed sale of its assets at the corporate level, subject to federal corporate income tax at the current rate of 21%, plus applicable state income and franchise taxes. Upon liquidation and distribution of the after-tax proceeds to CPI's shareholders, each shareholder will recognize additional gain at the shareholder level — long-term capital gain at rates up to 20% for individuals (plus the 3.8% net investment income tax, if applicable). This double tax consequence is the principal disadvantage of the asset purchase structure from CPI's perspective. However, the step-up in basis and the controlled liability assumption are the corresponding advantages that justify the structure from Buyer's perspective, and the purchase price was negotiated with this tax cost differential in view.
5. Unavailability of § 338(h)(10) Election. Because CPI is a standalone C-corporation (not a member of a consolidated group and not an S corporation), a joint election under IRC § 338(h)(10) is not available. A "regular" § 338 election would be economically inferior to a direct asset purchase. The asset purchase structure is therefore confirmed as the preferred and optimal approach.
6. State Tax Implications. The asset sale will give rise to state income and franchise tax obligations for CPI in each of the seven Operating States, subject to each state's applicable tax rates and apportionment rules. In addition, the transfer of tangible personal property may be subject to state sales and use tax in certain states, although bulk sale, occasional sale, or isolated sale exemptions should be available in most or all of the Operating States. A detailed state-by-state analysis is warranted and is being coordinated with Ashford & Creighton LLP.
7. Recommendation. We recommend that the Ardent Capital deal team proceed with the asset purchase structure as proposed. The M&A practice group should coordinate with us on the drafting of tax-related provisions of the APA, including the purchase price allocation schedule, tax representations and warranties, pre-closing tax covenants, straddle period allocation methodology, tax indemnification, and cooperation provisions. We are coordinating with Ashford & Creighton LLP (Gregory Nolan, CPA) on finalization of the purchase price allocation schedule and preparation of a draft IRS Form 8594, with a target completion date for the detailed Asset Allocation Memorandum of March 18, 2024.
II. Transaction Overview
This Section provides a detailed description of the parties, structure, and economic terms of the proposed acquisition, as relevant to the tax analysis set forth in this memorandum. The factual summary is based on the draft Letter of Intent dated January 8, 2024, the confidential information memorandum prepared by Graystone Partners LLC (the Seller's financial advisor), and discussions with the Ardent Capital deal team (Marcus Ainsworth, Priya Mehta-Sullivan, and Connor Briggs).
A. The Buyer
The Purchaser is Ardent Healthcare Acquisition Corp., a Delaware corporation formed on January 22, 2024, for the sole purpose of effecting this acquisition. The Purchaser's Employer Identification Number is 93-2184720 and its Delaware file number is 7129384. Its registered agent in Delaware is National Registered Services, Inc., located at 1209 Orange Street, Wilmington, Delaware 19801.
The Purchaser is wholly owned by Ardent Capital Partners III LP, a Delaware limited partnership (the "Fund" or the "Sponsor"). The general partner of the Fund is Ardent Capital Management LLC, a Delaware limited liability company. The Purchaser was formed as a wholly owned acquisition subsidiary of the Fund and will serve as the operating entity for the acquired business following the closing. The Purchaser has no prior operating history, no assets other than the equity contribution from the Fund, and no liabilities other than those incurred in connection with the formation and the proposed acquisition.
B. The Seller
The Seller is Cardinal Peak Industries, Inc., a Delaware corporation. CPI's Employer Identification Number is 82-3947561 and its Delaware file number is 5487231. CPI is headquartered at 8400 Crescent Ridge Parkway, Suite 200, Nashville, Tennessee 37215, and is qualified to do business in Tennessee, Georgia, North Carolina, South Carolina, Alabama, Virginia, and Kentucky.
CPI was founded in 2011 and operates 37 outpatient rehabilitation and behavioral health clinics across the seven Operating States. CPI's workforce consists of approximately 2,100 employees, including approximately 1,450 licensed clinicians (physical therapists, occupational therapists, speech-language pathologists, and licensed behavioral health counselors) and approximately 650 administrative and support staff. All 37 clinic locations are leased under triple-net lease arrangements. CPI's key intellectual property includes the PeakConnect patient-engagement software platform, which is registered with the United States Patent and Trademark Office (U.S. Reg. No. 5,412,887).
CPI has a single dormant subsidiary, Cardinal Peak Labs, Inc., a Delaware corporation, which has no operations, assets, or liabilities of consequence. The equity interests in Cardinal Peak Labs, Inc. are an excluded asset and will not be acquired by Purchaser.
C. Seller's Shareholders
The equity ownership of CPI is as follows:
Dr. Whitfield is the founder and Chief Executive Officer of CPI. Elaine Whitfield-Torres is Dr. Whitfield's sister and serves as CPI's Chief Operating Officer. Ridgeline Growth Equity Fund II LP is a private equity fund that made a minority growth equity investment in CPI in 2017. The remaining 8% is held by various members of CPI's senior management team under equity incentive arrangements.
D. Transaction Structure
The transaction is structured as a direct asset purchase. Purchaser will acquire substantially all of the assets of CPI and will assume certain specified liabilities of CPI, in exchange for the cash consideration described below. The acquisition is not structured as a stock purchase, merger, or reorganization.
Acquired Assets. Purchaser will acquire all of CPI's assets used in or related to the operation of the business, including but not limited to tangible personal property (medical and clinic equipment, furniture, fixtures, computer hardware, and vehicles), accounts receivable, inventory (medical supplies), intellectual property (the PeakConnect software platform, the associated trademark, trade secrets, and proprietary technology), real property leases (by assignment), contracts, permits, licenses, patient records (to the extent transferable under applicable law), goodwill, and going-concern value.
Excluded Assets. The following assets will be retained by CPI and not transferred to Purchaser: (i) cash and cash equivalents; (ii) pre-closing tax refunds and credits; (iii) certain personal property of Dr. Whitfield identified on an exhibit to the APA; (iv) the CPI corporate name "Cardinal Peak Industries," which will be licensed back to Purchaser for a period of 12 months post-closing; and (v) all equity interests in Cardinal Peak Labs, Inc.
Assumed Liabilities. Purchaser will assume only those liabilities specifically enumerated in the APA, which are expected to include trade payables arising in the ordinary course of business, accrued paid time off ("PTO") obligations for transferred employees, and post-closing obligations under the assigned leases and contracts.
Excluded Liabilities. All other liabilities, including pre-closing tax liabilities, indebtedness to Velthorn Merchant Bank, N.A., liabilities related to the pending Dawson litigation, and any undisclosed or contingent liabilities arising from pre-closing operations, will be retained by CPI and will not be assumed by Purchaser.
E. Consideration
Base Purchase Price. The base purchase price is $620,000,000, payable in cash at closing, subject to the escrow holdback and working capital adjustment described below.
Cash at Closing (Net of Escrow). $558,000,000 will be payable in cash to CPI at the closing (or, as directed by CPI, applied to discharge CPI's existing indebtedness).
Escrow Holdback. $62,000,000 (representing 10% of the base purchase price) will be deposited with Commonwealth Trust & Escrow Company as escrow agent, to secure Seller's indemnification obligations under the APA. The escrow will be released in two tranches: Tranche 1 of $31,000,000 on June 30, 2025, and Tranche 2 of $31,000,000 on December 30, 2025, in each case net of any amounts subject to pending indemnification claims.
Contingent Earnout Consideration. In addition to the base purchase price, Purchaser will pay contingent earnout consideration of up to $45,000,000 in the aggregate, payable in two tranches as follows:
Tranche 1: Up to $22,500,000 if the Adjusted EBITDA of the acquired business equals or exceeds $85,000,000 for the twelve-month period ending June 30, 2025 (the "First Earnout Period"). Payment is calculated on a linear ramp basis, at $4.50 per $1.00 of Adjusted EBITDA above the $80,000,000 threshold, with a maximum payment of $22,500,000.
Tranche 2: Up to $22,500,000 if the Adjusted EBITDA of the acquired business equals or exceeds $95,000,000 for the twelve-month period ending June 30, 2026 (the "Second Earnout Period"). Payment is calculated on a linear ramp basis, at $4.50 per $1.00 of Adjusted EBITDA above the $90,000,000 threshold, with a maximum payment of $22,500,000.
Change of Control Acceleration: If a change of control of the acquired business or of Ardent Healthcare Acquisition Corp. occurs prior to the end of an Earnout Period, 100% of the maximum remaining unpaid earnout becomes immediately due and payable.
Working Capital Adjustment. The APA will include a customary working capital adjustment provision. The parties have agreed to a net working capital ("NWC") target of $28,000,000. Based on preliminary estimates, closing NWC is expected to be approximately $29,200,000. The working capital adjustment is calculated on a dollar-for-dollar basis, subject to a de minimis collar of $500,000 (i.e., no adjustment is made unless the difference between actual closing NWC and the NWC target exceeds $500,000 in either direction). The final NWC determination is expected to be completed within 90 days following the closing date (i.e., by approximately September 28, 2024, based on an anticipated closing date of June 30, 2024).
F. Seller's Existing Indebtedness
CPI has outstanding indebtedness of approximately $87,400,000 under a Credit Agreement dated March 15, 2018, as amended, with Velthorn Merchant Bank, N.A. as administrative agent and lender. This indebtedness will be repaid in full at or prior to the closing from a portion of the cash proceeds of the sale. The payoff of existing indebtedness is a condition to closing.
G. Acquisition Financing
The acquisition will be financed with a combination of debt and equity:
• Term Loan A: $310,000,000 from a syndicate of lenders led by Pinnacle National Bank, N.A. (Lead Arranger and Administrative Agent), with Horizon Commercial Lending Corp., Tidewater Savings Bank, N.A., and Great Plains Capital Partners LLC as syndicate participants.
• Revolving Credit Facility: $90,000,000 (expected to be undrawn at closing) from the same syndicate.
• Equity Contribution: $220,000,000 from Ardent Capital Partners III LP.
H. Key Financial Metrics
I. Anticipated Timeline
The parties anticipate executing the Asset Purchase Agreement on or about April 2, 2024. Closing is expected to occur on or about June 30, 2024, subject to satisfaction of customary closing conditions, including HSR Act clearance (if applicable), third-party consents, and regulatory approvals.
III. Federal Income Tax Analysis — Asset Purchase Structure
A. Characterization of the Transaction
The proposed transaction is structured as a direct asset purchase, in which Purchaser acquires specified assets of CPI and assumes specified liabilities of CPI, in exchange for cash consideration. The transaction is not structured as a stock acquisition, a statutory merger, or a reorganization within the meaning of IRC § 368. There is no election being made under IRC § 338 (discussed in Section V below).
For federal income tax purposes, the transaction will be treated as a taxable sale by CPI of its assets to Purchaser. CPI will be treated as having sold each acquired asset in a taxable transaction, and Purchaser will be treated as having purchased each acquired asset for an amount equal to the portion of the aggregate consideration allocated to that asset under the rules of IRC § 1060. This treatment follows directly from the form of the transaction and is consistent with the substance of the economic arrangement between the parties.
Because the transaction involves the acquisition of assets constituting a trade or business, it constitutes an "applicable asset acquisition" within the meaning of IRC § 1060(c) and Treas. Reg. § 1.1060-1(b)(1). An applicable asset acquisition exists where the transferee's basis in the transferred assets is determined wholly by reference to the consideration paid for the assets — which is the case in a direct asset purchase for cash. Accordingly, the special purchase price allocation rules of IRC § 1060 apply to this transaction, as discussed in detail in Section III.D below.
B. Step-Up in Basis — Buyer's Perspective
The primary tax benefit of the asset purchase structure for Purchaser (and, by extension, for the Sponsor) is that Purchaser obtains a full cost basis (i.e., a stepped-up tax basis) in each acquired asset, equal to the portion of the total consideration allocated to that asset under IRC § 1060. This is in contrast to a stock purchase (without a § 338 election), in which the purchaser would inherit the target's historical (carryover) tax basis in its assets, which in CPI's case is substantially below the fair market value reflected in the purchase price.
The stepped-up basis enables Purchaser to claim depreciation and amortization deductions over the applicable recovery periods on the full purchase price allocated to depreciable and amortizable assets. The resulting depreciation and amortization tax shield — that is, the present value of the future tax savings attributable to these deductions — is the core economic benefit of the asset purchase structure and constitutes the single most significant tax advantage of the transaction from Ardent Capital's perspective.
The following categories of assets are relevant to the depreciation and amortization analysis:
Tangible Personal Property. Medical equipment, clinic equipment, furniture, fixtures, computer hardware, and other tangible personal property acquired in the transaction will be depreciable by Purchaser under the Modified Accelerated Cost Recovery System ("MACRS") of IRC § 168. The applicable recovery periods for tangible personal property are generally 5 years (for certain computer equipment, medical devices, and similar assets) or 7 years (for furniture, fixtures, and general-purpose equipment), depending on the specific asset class as determined under Revenue Procedure 87-56 (as updated). Purchaser will be entitled to elect the applicable depreciation method (200% declining balance, 150% declining balance, or straight-line) and applicable convention (half-year or mid-quarter). Additionally, Purchaser should evaluate the availability of bonus depreciation under IRC § 168(k) and first-year expensing under IRC § 179, subject to applicable phase-down rules and limitations in effect for property placed in service after 2023.
Real Property Improvements (Leasehold Improvements). CPI's 37 clinic locations are all leased under triple-net lease arrangements; CPI does not own any real property. However, to the extent that Purchaser acquires leasehold improvements (tenant build-outs, specialized clinic finishes, HVAC modifications, and similar improvements made by CPI to leased premises), such improvements will be depreciable by Purchaser. The applicable recovery period for qualified leasehold improvement property is 15 years under IRC § 168(e)(6) for improvements that satisfy the definitional requirements of that section, or 39 years for general nonresidential real property improvements. The characterization of specific improvements must be analyzed on a lease-by-lease basis, taking into account the nature of the improvement, the remaining lease term, and applicable renewal options. We will coordinate with Ashford & Creighton LLP on this analysis as part of the detailed asset allocation.
IRC § 197 Intangible Assets. A significant portion of the purchase price — potentially the largest single component — will be allocated to IRC § 197 intangible assets, which are amortizable on a straight-line basis over a 15-year period beginning in the month of acquisition. The following categories of § 197 intangible assets are expected to be present in this transaction:
(a) Goodwill and going-concern value. Given CPI's implied purchase price multiple of approximately 8.36x Adjusted EBITDA and the service-business nature of CPI's operations (where the principal value lies in the established referral relationships, reputation, workforce, and operational platform rather than in hard assets), the residual allocation to goodwill and going-concern value is expected to be the largest single component of the purchase price allocation. All amounts allocated to goodwill and going-concern value are amortizable over 15 years under § 197.
(b) PeakConnect software platform and trademark. CPI's proprietary PeakConnect patient-engagement software platform and the associated registered trademark (U.S. Reg. No. 5,412,887) are § 197 intangible assets, amortizable over 15 years. To the extent the software is also categorized as a § 197 intangible, the 15-year amortization period applies notwithstanding any shorter useful life, because § 197 generally requires a 15-year straight-line amortization for all covered intangibles regardless of actual useful life.
(c) Patient lists and relationships. CPI's established patient relationships and referral networks, including relationships with referring physicians, health systems, and managed care organizations, constitute customer-based intangibles within the meaning of § 197(d)(2). These are amortizable over 15 years.
(d) Workforce in place. CPI's assembled workforce of approximately 2,100 employees — including approximately 1,450 licensed clinicians — represents a significant intangible asset. Workforce in place is a § 197 intangible, amortizable over 15 years.
(e) Covenants not to compete. Dr. Whitfield and Elaine Whitfield-Torres will each enter into three-year non-competition and non-solicitation agreements. The value allocated to these covenants is a § 197 intangible, amortizable by Purchaser over 15 years (not over the three-year covenant period). See Section IX.A below for further discussion of the allocation dynamics associated with non-compete covenants.
Quantitative Illustration. A detailed quantification of the annual depreciation and amortization deductions and the resulting tax shield will be set forth in the separate Section 338 / Asset Allocation Memorandum, which we anticipate completing by March 18, 2024. As a preliminary directional matter, however, if the aggregate allocation to § 197 intangible assets (including goodwill) is in the range of $500,000,000 to $590,000,000 (as suggested by the preliminary allocation ranges set forth in Section III.D below), the annual § 197 amortization deduction would be in the range of approximately $33,300,000 to $39,300,000 per year. At a blended federal-state effective tax rate of approximately 25% to 27%, this would produce annual tax savings of approximately $8,300,000 to $10,600,000, sustained over the full 15-year amortization period. Additional deductions from MACRS depreciation of tangible assets would further increase the tax shield. These figures are preliminary and subject to refinement.
C. Tax Consequences to Seller (CPI and Its Shareholders)
1. Corporate-Level Tax (CPI)
As a C-corporation, CPI will recognize taxable gain on the sale of each acquired asset in an amount equal to the excess of the portion of the total consideration allocated to that asset (under IRC § 1060) over CPI's adjusted tax basis in the asset. The character of the gain — ordinary income or capital gain — will depend on the nature of the asset sold. Gain on the sale of depreciable property may be subject to ordinary income recapture under IRC §§ 1245 and 1250. Gain on the sale of § 197 intangible assets (to the extent CPI has basis in self-created intangibles) would be treated as gain from the sale of property used in a trade or business under § 1231 (and potentially as ordinary income to the extent of prior amortization deductions under § 1245). Gain on the sale of capital assets would be capital gain.
CPI will owe federal corporate income tax at the current statutory rate of 21% on its aggregate taxable gain from the asset sale, plus applicable state income and franchise taxes as discussed in Section VI below. The aggregate tax liability will depend on the final purchase price allocation and CPI's adjusted tax basis in its assets, both of which are not yet finalized.
2. Shareholder-Level Tax
After CPI pays its corporate-level income tax liabilities and distributes the remaining after-tax proceeds to its shareholders in connection with its wind-down and dissolution, each shareholder will recognize gain or loss at the shareholder level on the liquidating distribution. The amount of gain recognized by each shareholder will equal the excess of the liquidating distribution received (plus any other property distributed) over the shareholder's adjusted tax basis in his, her, or its CPI stock.
For individual shareholders (Dr. Whitfield and Whitfield-Torres), the gain on the liquidating distribution will generally be treated as long-term capital gain (assuming their CPI stock has been held for more than one year), subject to federal tax at rates of up to 20%. In addition, the 3.8% net investment income tax under IRC § 1411 may apply to the extent their modified adjusted gross incomes exceed the applicable threshold ($250,000 for married filing jointly).
For Ridgeline Growth Equity Fund II LP (22% shareholder), the gain on the liquidating distribution will be treated as a pass-through item to the Fund's partners. Ridgeline is a limited partnership and is not itself subject to entity-level federal income tax. Each limited partner of Ridgeline will include its allocable share of the gain on its own federal income tax return, with the character of the gain (long-term capital gain) preserved at the partner level.
For the management shareholders (8% collectively), the tax treatment will depend on the individual circumstances of each shareholder, including their respective holding periods and tax rates.
3. Double Taxation
The asset purchase structure results in a double layer of federal (and state) income tax on the sale proceeds: first at the corporate level (CPI pays corporate income tax on the gain from the asset sale) and then at the shareholder level (the shareholders pay capital gains tax on the liquidating distribution). This double taxation is the principal disadvantage of the asset purchase structure from the Seller's perspective and is an inherent consequence of CPI's status as a C-corporation. If CPI were instead an S corporation, the double taxation would generally not apply (subject to built-in gains tax considerations under IRC § 1374, if applicable).
The double tax consequence was a known negotiating dynamic throughout the price discussions. The base purchase price of $620,000,000 and the contingent earnout of up to $45,000,000 were negotiated by the parties with this tax cost differential in view. According to feedback from the Ardent Capital deal team and from Graystone Partners LLC (CPI's financial advisor), the purchase price compensates Seller to some degree for the incremental tax burden of an asset sale relative to a stock sale. We should expect that Seller's counsel (Barrow, Kensington & Pratt LLP) and Seller's tax advisors may continue to advocate for APA provisions that address the tax cost — such as a purchase price gross-up, a tax adjustment payment, or other protective provisions — but we understand from the Ardent Capital deal team that no gross-up obligation has been agreed upon and that this was addressed through the overall purchase price negotiation.
D. IRC § 1060 Purchase Price Allocation — Residual Method
1. Statutory Framework
Under IRC § 1060, in an "applicable asset acquisition" — defined as any transfer (whether direct or indirect) of assets that constitute a trade or business and in which the transferee's basis in the transferred assets is determined wholly by reference to the consideration paid — both the Buyer and the Seller are required to allocate the total consideration among the acquired assets using the "residual method" prescribed in Treasury Regulations §§ 1.338-6 and 1.338-7.
The residual method requires the total consideration to be allocated first to the lowest-priority asset classes (beginning with Class I) up to the fair market value of the assets in each class, with any remaining consideration allocated to the next higher class, and so on. The final residual — the amount of consideration remaining after allocation to all other asset classes — is allocated to Class VII (goodwill and going-concern value). This methodology ensures that goodwill and going-concern value are treated as the residual component, which is consistent with the economic reality that, in most acquisitions, the premium above the aggregate fair market value of identifiable assets represents the value of goodwill and going-concern value.
2. Determination of Total Consideration
For purposes of the § 1060 allocation, the "total consideration" includes the following components:
(a) The base purchase price of $620,000,000;
(b) Assumed liabilities — the aggregate amount of liabilities assumed by Purchaser, including trade payables, accrued PTO obligations for transferred employees, and post-closing obligations under assigned leases and contracts (to be determined based on the closing balance sheet);
(c) Contingent earnout consideration — the fair market value of the contingent right to receive up to $45,000,000 in earnout payments, as of the closing date (discussed in Section IV below); and
(d) Working capital adjustment — to the extent the final NWC determination results in an upward or downward adjustment to the purchase price in excess of the $500,000 de minimis collar, the adjustment increases or decreases the total consideration. Based on preliminary estimates (closing NWC of $29,200,000 vs. target of $28,000,000), the adjustment may be approximately $1,200,000 upward, subject to the collar, but the final determination will not occur until approximately September 28, 2024.
3. Seven Asset Classes
The total consideration is allocated among the following seven asset classes, in order of priority:
Class I: Cash and Cash Equivalents. Cash and cash equivalents are an excluded asset in this transaction. CPI will retain all cash and cash equivalents. Accordingly, no consideration is allocated to Class I.
Class II: Actively Traded Personal Property, Certificates of Deposit, and Similar Items. This class includes actively traded personal property (within the meaning of IRC § 1092(d)(1)), certificates of deposit, and foreign currency. Based on our preliminary understanding of CPI's asset base, there are likely minimal or no Class II assets. This will be confirmed by Ashford & Creighton LLP during the financial due diligence process.
Class III: Accounts Receivable, Mortgages, and Credit Card Receivables. This class includes CPI's outstanding patient receivables and third-party payor receivables. The allocated value should approximate the fair market value of these receivables, which in turn approximates their net realizable value (i.e., book value less appropriate reserves for bad debts and contractual adjustments). CPI's major third-party payor is SummitCare Health Plans, Inc., which accounts for approximately 22% of CPI's net revenue. Medicare and Medicaid combined account for approximately 31% of net revenue. The balance of receivables is attributable to other commercial payors and, to a lesser extent, self-pay patients. Valuation of Class III assets will be a key deliverable of the Ashford & Creighton financial due diligence workstream.
Class IV: Inventory. This class includes CPI's medical supplies and clinic inventory. Given CPI's outpatient service model, inventory is a relatively small component of total assets. The fair market value of inventory is expected to be in the low single-digit millions of dollars.
Class V: All Other Assets Not in Classes I–IV, VI, or VII. This is a broad residual class that includes all tangible personal property (medical equipment, furniture, fixtures, computer hardware, and leasehold improvements across 37 clinic locations) and intangible assets that are not classified as § 197 intangibles (Class VI) or goodwill/going-concern value (Class VII). The aggregate value of Class V assets will reflect the fair market value of CPI's tangible asset base and any non-§ 197 intangibles.
Class VI: IRC § 197 Intangibles Other Than Goodwill and Going-Concern Value. This class includes all § 197 intangible assets other than goodwill and going-concern value. In this transaction, the relevant Class VI intangibles include:
(i) The PeakConnect patient-engagement software platform and associated trademark (U.S. Reg. No. 5,412,887);
(ii) Patient lists, patient relationships, and referral networks;
(iii) Workforce in place (the assembled workforce of approximately 2,100 employees); and
(iv) The covenants not to compete entered into by Dr. Whitfield and Elaine Whitfield-Torres.
Each of these intangibles is amortizable by Purchaser over 15 years under IRC § 197.
Class VII: Goodwill and Going-Concern Value. This class receives the residual allocation — i.e., the amount of total consideration remaining after all allocations to Classes I through VI. Given the implied 8.36x EBITDA multiple and the service-business nature of CPI's operations (where the premium above tangible and identified intangible asset values principally reflects the established market position, reputation, referral relationships, and earnings capacity of the business), the allocation to Class VII goodwill and going-concern value is expected to be the largest single component of the purchase price allocation. All amounts allocated to Class VII are amortizable over 15 years under § 197.
4. Buyer-Seller Agreement on Allocation
We strongly recommend that the APA include a provision requiring Buyer and Seller to (i) agree on the allocation of the total consideration among the seven asset classes, (ii) memorialize the agreed allocation in a binding schedule attached as an exhibit to the APA, and (iii) file consistent IRS Forms 8594 reflecting the agreed allocation with their respective federal income tax returns for the taxable year in which the closing occurs. Consistency in the allocation between Buyer and Seller is not strictly required under the Code, but inconsistent allocations invite IRS scrutiny and create potential for disputes. A binding allocation agreement protects both parties and is standard market practice in asset acquisitions of this size.
The allocation schedule should be finalized within 90 days post-closing, which aligns with the anticipated NWC true-up deadline of approximately September 28, 2024 (90 days after the anticipated closing date). To the extent the parties are unable to agree on the allocation, the APA should specify a dispute resolution mechanism — typically a referral to an independent accounting firm acceptable to both parties, whose determination would be final and binding.
5. Preliminary Allocation Ranges
A detailed purchase price allocation will be set forth in a separate Section 338 / Asset Allocation Memorandum, which we anticipate completing by March 18, 2024. Pending finalization of the independent appraisal and completion of the Ashford & Creighton financial due diligence workstream, we provide the following preliminary directional estimates:
These are preliminary ranges only, based on our initial review of CPI's financial statements and comparable transaction data. The final allocation will be refined based on the results of the independent appraisal (to be engaged by Ardent Capital), the financial due diligence conducted by Ashford & Creighton LLP (Gregory Nolan, CPA), and negotiations with Seller's counsel and auditor. We note that the allocation to Class VI (§ 197 intangibles excluding goodwill) and Class VII (goodwill and going-concern value) will be the most significant components of the allocation and will have the most direct impact on Purchaser's future amortization deductions. Valuation of the PeakConnect platform, patient relationships, and workforce in place will be key drivers of the Class VI allocation.
E. IRS Form 8594 Filing Requirement
Both Buyer (Ardent Healthcare Acquisition Corp., EIN 93-2184720) and Seller (Cardinal Peak Industries, Inc., EIN 82-3947561) are required to file IRS Form 8594 (Asset Acquisition Statement Under Section 1060) with their respective federal income tax returns for the taxable year in which the closing of the acquisition occurs. The Form 8594 must report the total consideration paid for the assets, the allocation of the consideration among the seven asset classes, and other information required by the form and its instructions.
If the total consideration is subsequently adjusted — for example, due to earnout payments, working capital true-up adjustments, or indemnification payments — amended Forms 8594 must be filed by both Buyer and Seller to reflect the revised consideration and updated allocation. We anticipate that at least one amended Form 8594 will be required in connection with the working capital true-up (expected September 2024), and additional amendments will be required if and when earnout payments are made (Tranche 1 potentially in the second half of 2025; Tranche 2 potentially in the second half of 2026).
A draft IRS Form 8594 will be prepared by Calderwood & Harkness (Tax) in coordination with Ashford & Creighton LLP following finalization of the purchase price allocation schedule and completion of the NWC true-up.
IV. Treatment of Contingent Earnout Consideration
A. General Principles
The earnout of up to $45,000,000 in the aggregate ($22,500,000 for Tranche 1 and $22,500,000 for Tranche 2) constitutes contingent consideration — that is, consideration that is not fixed at the time of closing but is contingent upon the occurrence of specified future events (the achievement of Adjusted EBITDA targets during the respective Earnout Periods).
The tax treatment of contingent consideration in an asset acquisition is governed by the general recognition and realization principles of IRC § 1001 and the regulations thereunder, as well as the allocation rules of IRC § 1060. Under Treas. Reg. § 1.1001-1(a), the amount realized by a seller in a taxable exchange includes the fair market value of property (other than money) received, including contingent rights to receive future payments. Accordingly, if the contingent earnout right is capable of valuation — i.e., if its fair market value can be reasonably ascertained at the time of the sale — the fair market value of the right is included in the seller's amount realized at the time of the sale, and must be included in the initial § 1060 allocation.
The alternative "open transaction" doctrine, under which recognition of gain would be deferred until the contingency is resolved and the actual consideration received, is available only in the rare circumstance where the contingent right has no ascertainable fair market value. This standard has been strictly construed by the courts and the IRS, and it is generally accepted that most earnout arrangements — particularly those with defined caps, defined performance periods, and objective metrics — are capable of valuation. See Burnet v. Logan, 283 U.S. 404 (1931); Commissioner v. Estate of Calhoun, 44 T.C. 329 (1965). The earnout in this transaction has a defined maximum ($45,000,000), defined performance periods (twelve-month periods ending June 30, 2025 and June 30, 2026), and objective performance metrics (Adjusted EBITDA). Accordingly, the open transaction doctrine should not apply.
Recommended Approach. We recommend treating the earnout as having a determinable fair market value at closing. The estimated fair market value of the contingent earnout right should be included in the total consideration for purposes of the initial § 1060 allocation. When actual earnout payments are made (or when the earnout expires unpaid), the total consideration is adjusted to reflect the actual amounts paid, and the § 1060 allocation is updated accordingly. Amended Forms 8594 are filed by both Buyer and Seller to reflect the adjustments.
The fair market value of the earnout right at closing should be determined by Ashford & Creighton LLP in coordination with us, using an appropriate valuation methodology (such as a probability-weighted expected value approach or a Monte Carlo simulation). We note that the financial projections underlying the earnout thresholds suggest that achievement of the EBITDA targets is within a reasonable range of CPI's recent performance trajectory (LTM Adjusted EBITDA of $74,160,000 in FY2023 against a Tranche 1 threshold of $85,000,000 for the twelve months ending June 30, 2025 — representing required EBITDA growth of approximately 14.6% over the initial earnout period).
B. Buyer's Perspective
From Purchaser's perspective, earnout payments, when and if made, constitute additional purchase price. Under IRC § 1060 and the residual method, the additional consideration must be allocated among the acquired assets. In practice, the additional consideration is allocated to the asset classes in order of priority (Classes I through VII), with any incremental consideration above the fair market value of identifiable assets allocated to goodwill and going-concern value (Class VII).
The additional basis allocated to amortizable or depreciable assets generates additional tax deductions for Purchaser. For § 197 intangible assets (including goodwill), additional basis arising from earnout payments is amortizable over the remaining portion of the original 15-year amortization period beginning in the month of the original acquisition (not a new 15-year period beginning in the month of the earnout payment). Accordingly, to the extent earnout payments are made and allocated to § 197 intangibles, the incremental amortization deductions will be "catch-up" deductions that accelerate the amortization to reflect the higher total basis, with the remaining basis amortized ratably over the remaining amortization period.
Based on the anticipated timing of the earnout payments, Tranche 1 (if any) would be payable no earlier than the second half of calendar year 2025, following the conclusion of the First Earnout Period on June 30, 2025 and the completion of the earnout computation and any applicable dispute resolution process. Tranche 2 (if any) would be payable no earlier than the second half of calendar year 2026, following the conclusion of the Second Earnout Period on June 30, 2026.
C. Seller's Perspective
From CPI's perspective, earnout payments received constitute additional amounts realized on the asset sale. CPI will recognize additional gain upon receipt of each earnout payment, allocated among the assets consistent with the updated § 1060 allocation. The character of the additional gain (ordinary income or capital gain) depends on the asset classes to which the additional consideration is allocated.
CPI may be entitled to use the installment method under IRC § 453 for the contingent earnout component of the consideration, provided the requirements of § 453 are satisfied. The installment method would permit CPI to recognize gain on the contingent component proportionately as earnout payments are actually received, rather than recognizing the full gain at closing based on the estimated fair market value of the contingent right. CPI is a C-corporation; the installment method is generally available to C-corporations, subject to the exception for "dealer" dispositions under § 453(b)(2) (which does not apply here, as CPI is not a dealer in the type of property being sold) and the exception for certain recapture income under § 453(i) (which requires recognition of ordinary income from depreciation recapture in the year of sale regardless of the installment method). Additionally, § 453A imposes an interest charge on the deferred tax liability for certain large installment obligations (over $5,000,000 in aggregate face amount), which would apply here if CPI elects the installment method.
We note that the decision to elect or decline the installment method is CPI's decision as the Seller, and is beyond the scope of this memorandum. However, we mention it here because the Seller's installment method election (or lack thereof) may affect the allocation and Form 8594 reporting.
D. Change of Control Acceleration
The earnout contains a change of control acceleration provision: if a "change of control" of the acquired business or of Ardent Healthcare Acquisition Corp. occurs prior to the end of an Earnout Period, 100% of the maximum remaining unpaid earnout becomes immediately due and payable.
An accelerated earnout payment would constitute additional purchase price in the year paid, requiring (i) a recalculation of the § 1060 allocation to reflect the accelerated payment (allocated in the same manner as any other additional consideration — i.e., using the residual method), and (ii) filing of amended Forms 8594 by both Buyer and Seller.
For Ardent Capital's planning purposes, this acceleration provision has significant economic implications. If the Sponsor pursues a secondary exit, recapitalization, dividend recapitalization, or other change of control event during the earnout period (prior to June 30, 2026, in the case of Tranche 2), the full $45,000,000 maximum earnout (or the remaining unpaid portion) would accelerate, increasing the all-in acquisition cost. This increased cost would generate additional stepped-up basis in the acquired assets and additional amortization deductions, but would also represent a cash outflow that should be factored into any exit or recapitalization analysis. The Ardent Capital deal team should be aware of this dynamic in planning the fund's hold period and exit strategy.
V. Comparison to Alternative Structures
A. Stock Purchase (Without § 338(h)(10) Election)
As an alternative to the asset purchase, the transaction could have been structured as a stock purchase, in which Purchaser (or the Fund) would acquire the shares of CPI directly from CPI's shareholders (Dr. Whitfield, Whitfield-Torres, Ridgeline Growth Equity Fund II LP, and the management shareholders).
No Step-Up in Basis. In a stock purchase, Purchaser acquires the outstanding stock of CPI and, as a result, acquires CPI as a legal entity with its existing assets and liabilities. Importantly, the tax basis of CPI's assets does not change — CPI retains its historical (carryover) adjusted tax basis in each asset. Because CPI's historical tax basis in its assets is substantially below the purchase price (the premium represents goodwill, going-concern value, and appreciation in asset values), Purchaser would not receive the benefit of a stepped-up basis and would not be able to claim depreciation or amortization deductions on the premium above book value. This is the principal and decisive disadvantage of a stock purchase structure from Buyer's perspective.
Single Layer of Tax for Seller. In a stock purchase, the selling shareholders would recognize capital gain on the sale of their CPI stock — but CPI itself would not recognize any gain at the corporate level, because CPI is not selling its assets. This results in a single layer of tax at the shareholder level, which is substantially more favorable for Seller than the double taxation that results from an asset purchase. Dr. Whitfield and Whitfield-Torres would recognize long-term capital gain (assuming their CPI stock has been held for more than one year), subject to rates of up to 20% plus the 3.8% net investment income tax. Ridgeline would pass through its share of the gain to its limited partners. This single-layer tax treatment was the structure preferred by Seller's advisors; however, Buyer's overriding need for the stepped-up basis dictated the asset purchase structure.
Assumption of All Liabilities. In a stock purchase, Purchaser acquires CPI as a going entity, including all of its liabilities — both known and unknown, disclosed and undisclosed, fixed and contingent. This would include, among other things: (i) the pending Dawson litigation (Case No. 3:23-cv-01847, United States District Court for the Middle District of Tennessee, with estimated exposure of $2,800,000 to $5,100,000); (ii) CPI's 401(k) plan liabilities; (iii) all pre-closing tax liabilities (including any tax deficiencies or assessments arising from audits of prior periods); and (iv) any undisclosed or unknown liabilities. This broad assumption of liabilities significantly increases the risk profile for Buyer and was an additional factor weighing against the stock purchase structure.
Conclusion. A stock purchase without a § 338 election is tax-disadvantaged for Buyer and carries greater liability risk. This structure was not pursued by the Ardent Capital deal team.
B. Stock Purchase with § 338(h)(10) Election
An alternative structure that would combine the benefits of a stock purchase (simplified acquisition mechanics) with the tax benefits of an asset purchase (stepped-up basis) is a stock purchase accompanied by a joint election under IRC § 338(h)(10).
Mechanics. Under IRC § 338(h)(10), if the parties to a "qualified stock purchase" jointly elect § 338(h)(10) treatment, the target (CPI) is treated as if it sold all of its assets in a single transaction at fair market value and then liquidated — all within the framework of the old corporation. This deemed asset sale generates a stepped-up tax basis in CPI's assets for purposes of the acquiring corporation (or the new target), producing the same basis step-up that would be achieved in a direct asset purchase. At the same time, the election eliminates the shareholder-level tax that would otherwise apply in a stock sale — the old shareholders are treated as if they received a liquidating distribution from CPI in exchange for their stock, but the § 338(h)(10) regulations coordinate the corporate-level and shareholder-level tax consequences so that only a single level of tax is imposed (at the corporate level).
Requirements. A § 338(h)(10) election is available only if the target is either (i) a member of a selling consolidated group (i.e., a subsidiary of another corporation that is included in a consolidated federal income tax return and that can join in the election as the common parent), or (ii) an S corporation. See IRC § 338(h)(10); Treas. Reg. § 1.338(h)(10)-1(c).
CPI's Status. CPI is a standalone C-corporation. It is not a subsidiary of another corporation and is not a member of any consolidated group. CPI is also not an S corporation. Accordingly, a § 338(h)(10) election is not available for this transaction.
Regular § 338 Election. We also considered the possibility of a "regular" § 338 election (without the (h)(10) component), which may be made unilaterally by the acquiring corporation in connection with a qualified stock purchase. Under a regular § 338 election, the target is treated as if it sold all its assets and then purchased them back as a "new" corporation, generating a stepped-up basis. However, unlike a § 338(h)(10) election, a regular § 338 election does not coordinate the corporate-level and shareholder-level tax consequences. The result is that: (i) the deemed asset sale triggers corporate-level tax (just as in an actual asset sale); (ii) the old shareholders still recognize gain on the stock sale (they are not treated as receiving a liquidating distribution — they sold stock, and they report stock sale gain); and (iii) the acquirer effectively bears the cost of the corporate-level tax through either an inflated stock purchase price (to compensate Seller for the "extra" corporate-level tax) or a reduced net benefit from the basis step-up. This combination of outcomes is economically worse than a direct asset purchase, because the direct asset purchase achieves the same basis step-up without the added complexity, without the uncertainty of the election mechanics, and without the risk of a botched election.
Conclusion. The § 338(h)(10) election is unavailable due to CPI's corporate status as a standalone C-corporation. Even if it were available, the direct asset purchase achieves the same stepped-up basis result without the added complexity and risk. A regular § 338 election is economically inferior to a direct asset purchase. The asset purchase structure is confirmed as the preferred and optimal approach.
C. Summary Comparison Table
The following table summarizes the key differences among the three structural alternatives:
Based on this analysis, the asset purchase structure provides the optimal combination of tax efficiency (stepped-up basis), liability management (controlled assumption), and structural simplicity for Ardent Capital.
VI. State Tax Considerations
A. Overview
CPI conducts business through 37 outpatient rehabilitation and behavioral health clinics located in seven states: Tennessee (14 clinics), Georgia (8 clinics), North Carolina (5 clinics), South Carolina (4 clinics), Alabama (3 clinics), Virginia (2 clinics), and Kentucky (1 clinic). CPI has nexus for state income and franchise tax purposes in each of these states and is qualified to do business in each state.
The asset purchase transaction gives rise to several categories of state tax issues: (i) state income and franchise tax on the gain recognized by CPI from the asset sale; (ii) state sales and use tax on the transfer of tangible personal property; (iii) potential real estate transfer tax (not applicable here, as CPI owns no real property); and (iv) state withholding requirements on sale proceeds. Each of these categories is discussed below.
The state tax analysis set forth in this memorandum is preliminary. A detailed state-by-state analysis is being coordinated with Ashford & Creighton LLP (Gregory Nolan, CPA), which will address state-specific apportionment computations, sales/use tax exemption analysis, and bulk sale notice requirements. We expect to have the detailed state tax analysis completed by late March 2024.
B. State Income and Franchise Tax — Seller
CPI will owe state-level income or franchise tax on the gain recognized from the asset sale in each state where it has nexus and to which gain is apportioned or allocated under that state's apportionment rules. Because CPI is qualified to do business in all seven Operating States and maintains clinics (with employees, patients, and leases) in each state, CPI has nexus for income tax purposes in all seven states. The aggregate gain from the asset sale will be subject to apportionment among these states based on each state's applicable apportionment formula (typically weighted toward the revenue factor or using a single-sales-factor formula, depending on the state and the applicable industry classification).
The applicable state tax rates are as follows:
The apportionment of CPI's gain from the asset sale among these seven states will be determined by CPI's apportionment factors for the tax year in which the closing occurs. The specific computation is dependent on (i) the applicable apportionment formula in each state (single sales factor vs. multi-factor), (ii) the sourcing rules applicable to gains from asset sales (market-based vs. cost-of-performance), and (iii) the nature of the assets sold (real property and tangible personal property gains may be sourced to the location of the property, while intangible property gains may be sourced based on market-based or commercial domicile rules). Detailed state-by-state computations will be performed by Ashford & Creighton LLP.
We note that these are Seller's tax obligations, not Buyer's. However, Buyer should ensure that the APA clearly allocates responsibility for all pre-closing tax liabilities — including state income and franchise taxes arising from the asset sale — to Seller. Pre-closing tax liabilities should be treated as excluded liabilities under the APA, and CPI should indemnify Purchaser for any pre-closing tax liabilities that are assessed or imposed on the acquired business or the acquired assets after the closing.
C. Sales and Use Tax on Asset Transfers
The transfer of tangible personal property (medical equipment, furniture, fixtures, computer hardware, supplies, and other tangible assets) in the asset purchase may be subject to state sales or use tax in each state where such property is located at the time of transfer. Sales tax is generally imposed on the retail sale of tangible personal property; use tax is imposed on the use, storage, or consumption of tangible personal property on which sales tax has not been paid.
However, most states provide an exemption from sales tax for "bulk sales," "occasional sales," or "isolated sales" by sellers who are not regularly engaged in the business of selling the type of property being transferred. CPI is a healthcare services provider — it is not a dealer in medical equipment, furniture, or similar property. The asset sale constitutes a one-time bulk transfer of substantially all of CPI's tangible assets in connection with the sale of a going business. Accordingly, the bulk sale, occasional sale, or isolated sale exemption should be available in most or all of the Operating States, provided the applicable requirements are satisfied.
The following is a state-by-state summary of the applicable exemptions:
Tennessee. A bulk sale exemption is available under Tennessee Code Annotated § 67-6-328, which provides an exemption from sales tax for certain bulk sales of substantially all of the assets of a business. The exemption requires compliance with notice and procedural requirements, including potential notice to the Tennessee Department of Revenue. Further analysis is needed to confirm that all applicable conditions are satisfied. Additionally, Tennessee taxes pre-written computer software as tangible personal property; to the extent the PeakConnect platform is transferred via delivery of tangible media or is classified as pre-written software (as opposed to custom software), the transfer may be subject to Tennessee sales tax unless an exemption applies. This issue warrants particular attention and is being analyzed by Ashford & Creighton LLP.
Georgia.