Gladstone Investment Corporation
GLADSTONE INVESTMENT CORPORATION\DE (Form: POS 8C, Received: 07/28/2017 16:05:46)
Table of Contents

As filed with the Securities and Exchange Commission on July 28, 2017

1933 Act File No. 333-204996

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form N-2

 

  

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 
   PRE-EFFECTIVE AMENDMENT NO.  
   POST-EFFECTIVE AMENDMENT NO. 5  

 

 

GLADSTONE INVESTMENT CORPORATION

(Exact name of registrant as specified in charter)

 

 

1521 Westbranch Drive, Suite 100

McLean, VA 22102

Address of principal executive offices (Number, Street, City, State, Zip Code)

Registrant’s telephone number, including area code: (703) 287-5800

David Gladstone

Chairman and Chief Executive Officer

Gladstone Investment Corporation

1521 Westbranch Drive, Suite 100

McLean, Virginia 22102

Name and address (Number, Street, City, State, Zip Code) of agent for service

 

 

Copies to:

Lori B. Morgan

Sehrish Siddiqui

Bass, Berry & Sims PLC

150 Third Avenue South

Suite 2800

Nashville, TN 37201

Tel: (615) 742-6200

Fax: (615) 742-6293

 

 

Approximate date of proposed public offering: From time to time after the effective date of this registration statement.

If any securities being registered on this form will be offered on a delayed or continuous basis in reliance on Rule 415 under the Securities Act of 1933, other than securities offered in connection with a dividend reinvestment plan, check the following box.    ☒

It is proposed that this filing will become effective (check appropriate box)

 

  when declared effective pursuant to section 8(c).

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(c) of the Securities Act of 1933, as amended, or until this Registration Statement shall become effective on such date as the Commission, acting pursuant to Section 8(c), may determine.

 

 

 


Table of Contents

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the SEC is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED July 28, 2017

Preliminary Prospectus

 

LOGO

$300,000,000

COMMON STOCK

PREFERRED STOCK

SUBSCRIPTION RIGHTS

WARRANTS

DEBT SECURITIES

 

 

We may offer, from time to time, up to $300,000,000 aggregate primary offering price of our common stock, $0.001 par value per share, preferred stock, $0.001 par value per share, subscription rights, warrants representing rights to purchase our common stock, preferred stock or debt securities, or debt securities, or concurrent, separate offerings of these securities, which we refer to in this prospectus collectively as our Securities, in one or more offerings. The Securities may be offered at prices and on terms to be disclosed in one or more supplements to this prospectus. In the case of our common stock and warrants or rights to acquire such common stock hereunder, the offering price per share of our common stock by us, less any underwriting commissions or discounts, will not be less than the net asset value per share of our common stock at the time of the offering except (i) in connection with a rights offering to our existing stockholders, (ii) with the consent of the holders of the majority of our outstanding stock, or (iii) under such other circumstances as the U.S. Securities and Exchange Commission may permit. You should read this prospectus and the applicable prospectus supplement carefully before you invest in our Securities.

We operate as an externally managed, closed-end, non-diversified management investment company and have elected to be treated as a business development company under the Investment Company Act of 1940, as amended. For federal income tax purposes, we have elected to be treated as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended. Our investment objectives are to: (i) achieve and grow current income by investing in debt securities of established businesses that we believe will provide stable earnings and cash flow to pay expenses, make principal and interest payments on our outstanding indebtedness and make distributions to stockholders that grow over time; and (ii) provide our stockholders with long-term capital appreciation in the value of our assets by investing in equity securities, generally in combination with the aforementioned debt securities, of established businesses that we believe can grow over time to permit us to sell our equity investments for capital gains.

Our Securities may be offered directly to one or more purchasers, including existing stockholders in a rights offering, through agents designated from time to time by us, or to or through underwriters or dealers. The prospectus supplement relating to the offering will identify any agents or underwriters involved in the sale of our Securities and will disclose any applicable stabilizing transaction, purchase price, fee, commission or discount arrangement between us and our agents or underwriters or among our underwriters or the basis upon which such amount may be calculated. See “ Plan of Distribution .” We may not sell any of our Securities through agents, underwriters or dealers without delivery of a prospectus supplement describing the method and terms of the offering of such Securities. Our common stock is traded on The NASDAQ Global Select Market under the symbol “GAIN.” As of July 27, 2017, the last reported sales price of our common stock was $9.51, and the net asset value per share of our common stock on March 31, 2017 (the last date prior to the date of this prospectus as of which we determined our net asset value per share) was $9.95. Our 6.75% Series B Cumulative Term Preferred Stock, our 6.50% Series C Cumulative Term Preferred Stock and our 6.25% Series D Cumulative Term Preferred Stock trade on The NASDAQ Global Select Market under the symbol “GAINO,” “GAINN,” and “GAINM,” respectively. As of July 27, 2017, the last reported sales price of our 6.75% Series B Cumulative Term Preferred Stock, 6.50% Series C Cumulative Term Preferred Stock and 6.25% Series D Cumulative Term Preferred Stock was $25.55, $25.73, and $25.70, respectively.

The securities in which we invest generally would be rated below investment grade if they were rated by rating agencies. Below investment grade securities, which are often referred to as “junk,” have predominantly speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal. They may also be difficult to value and are illiquid.

 

 

An investment in our Securities involves certain risks, including, among other things, the risk of leverage and risks relating to investments in securities of small, private and developing businesses. We describe some of these risks in the section entitled “ Risk Factors ,” beginning on page 13. Common shares of closed-end investment companies, including business development companies, frequently trade at a discount to their net asset value per share. If our shares trade at a discount to their net asset value, this will likely increase the risk of loss to purchasers of our Securities. You should carefully consider these risks together with all of the other information contained in this prospectus and any prospectus supplement before making a decision to purchase our Securities.

This prospectus contains important information you should know before investing in our securities, including information about risks. Please read it before you invest and retain it for future reference. Additional information about us, including our annual, quarterly and current reports, has been filed with U.S. Securities and Exchange Commission and can be accessed at its website at www.sec.gov. This information is also available free of charge by calling us collect at (703) 287-5893, on our corporate website located at http://www.gladstoneinvestment.com or by writing us at 1521 Westbranch Drive, Suite 100, McLean, Virginia 22012. You may also call us collect at this number to make stockholder inquiries or request other information. See “ Additional Information ”.

The U.S. Securities and Exchange Commission has not approved or disapproved these securities or passed upon the adequacy of this prospectus. Any representation to the contrary is a criminal offense.

This prospectus may not be used to consummate sales of the Securities unless accompanied by a prospectus supplement.

 

 

The date of this prospectus is             , 2017


Table of Contents

TABLE OF CONTENTS

 

     Page  

Prospectus Summary

     1  

The Offering

     6  

Fees and Expenses

     9  

Risk Factors

     13  

Special Note Regarding Forward-Looking Statements

     37  

Use of Proceeds

     38  

Price Range of Common Stock and Distributions

     39  

Ratio of Earnings to Combined Fixed Charges and Preferred Dividends

     40  

Consolidated Selected Financial and Other Data

     41  

Selected Quarterly Financial Data

     43  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     44  

Sales of Common Stock Below Net Asset Value

     70  

Senior Securities

     77  

Business

     79  

Portfolio Companies

     93  

Management

     100  

Control Persons and Principal Stockholders

     116  

Dividend Reinvestment Plan

     119  

Material U.S. Federal Income Tax Considerations

     120  

Regulation as a Business Development Company

     123  

Description of Our Securities

     126  

Certain Provisions of Delaware Law and of Our Certificate of Incorporation and Bylaws

     132  

Share Repurchases

     136  

Plan of Distribution

     137  

Brokerage Allocation and Other Practices

     139  

Proxy Voting Policies and Procedures

     139  

Custodian, Transfer and Dividend Paying Agent and Registrar

     140  

Legal Matters

     140  

Experts

     140  

Additional Information

     141  

Index to Consolidated Financial Statements

     F-1  

You should rely only on the information contained in this prospectus. We have not authorized any dealer, salesman or other person to give any information or to make any representation other than those contained in this prospectus or any accompanying supplement to this prospectus. You must not rely upon any information or representation not contained or incorporated by reference in this prospectus or any accompanying prospectus supplement as if we had authorized it. This prospectus and any prospectus supplement do not constitute an offer to sell or a solicitation of any offer to buy any security other than the registered securities to which they relate, nor do they constitute an offer to sell or a solicitation of an offer to buy any securities in any jurisdiction to any person to whom it is unlawful to make such an offer or solicitation in such jurisdiction. The information contained in this prospectus and any prospectus supplement is accurate as of the dates on their respective covers only. Our business, financial condition, results of operations and prospects may have changed since such dates. We will update these documents to reflect material changes only as required by law.

This prospectus is part of a registration statement that we have filed with the U.S. Securities and Exchange Commission (“SEC”) using the “shelf” registration process. Under the shelf registration process, we may offer, from time to time, up to $300,000,000 of our Securities on terms to be determined at the time of the offering. This prospectus provides you with a general description of the Securities that we may offer. Each time we use this prospectus to offer Securities, we will provide a prospectus supplement that will contain specific information about the terms of that offering. We may sell the Securities through underwriters or dealers, “at-the-market” to or


Table of Contents

through a market maker, into an existing trading market or otherwise directly to one or more purchasers or through agents or through a combination of methods of sale. The identities of such underwriters, dealers, market makers or agents, as the case may be, will be described in one or more supplements to this prospectus. The prospectus supplement may also add, update or change information contained in this prospectus. To the extent required by law, we will amend or supplement the information contained in this prospectus and any accompanying prospectus supplement to reflect any material changes to such information subsequent to the date of the prospectus and any accompanying prospectus supplement and prior to the completion of any offering pursuant to the prospectus and any accompanying prospectus supplement. Please carefully read this prospectus and any accompanying prospectus supplement together with any exhibits, the additional information described under “ Additional Information ” and “ Risk Factors ” before you make an investment decision.


Table of Contents

PROSPECTUS SUMMARY

The following summary highlights some of the information in this prospectus. It is not complete and may not contain all the information that you may want to consider. You should read the entire prospectus and any prospectus supplement carefully, including the section entitled “Risk Factors.” Except where the context suggests otherwise, the terms “we,” “us,” “our,” the “Company,” and “Gladstone Investment” refer to Gladstone Investment Corporation; “Adviser” refers to Gladstone Management Corporation; “Administrator” refers to Gladstone Administration, LLC; “Gladstone Commercial” refers to Gladstone Commercial Corporation; “Gladstone Capital” refers to Gladstone Capital Corporation; “Gladstone Land” refers to Gladstone Land Corporation; “Gladstone Securities” refers to Gladstone Securities, LLC; and “Gladstone Companies” refers to our Adviser and its affiliated companies.

GLADSTONE INVESTMENT CORPORATION

General

We were incorporated under the General Corporation Law of the State of Delaware on February 18, 2005. On June 22, 2005, we completed our initial public offering and commenced operations. We operate as an externally managed closed-end, non-diversified management company and have elected to be treated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). For federal income tax purposes, we have elected to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). To continue to qualify as a RIC for federal income tax purposes and obtain favorable RIC tax treatment, we must meet certain requirements, including certain minimum distribution requirements. From our initial public offering in June 2005 through July 27, 2017, we have made 144 consecutive monthly distributions to common stockholders.

Our shares of common stock, 6.75% Series B Cumulative Term Preferred Stock, par value $0.001 per share (the “Series B Term Preferred Stock”), 6.50% Series C Cumulative Term Preferred Stock due 2022, par value $0.001 per share (the “Series C Term Preferred Stock”), and 6.25% Series D Cumulative Term Preferred Stock due 2023, par value $0.001 per share ( the “Series D Term Preferred Stock” and together with the Series B Term Preferred Stock and the Series C Term Preferred Stock, the “Term Preferred Stock”) trade on the NASDAQ Global Select Market (“NASDAQ”) under the trading symbols “GAIN,” “GAINO,” “GAINN,” and “GAINM,” respectively.

Investment Adviser and Administrator

We are externally managed by the Adviser, an affiliate of ours, under an investment advisory and management agreement (the “Advisory Agreement”) and the Administrator, another of our affiliates, provides administrative services to us pursuant to a contractual agreement (the “Administration Agreement”). Each of the Adviser and the Administrator are privately-held companies that are indirectly owned and controlled by David Gladstone, our chairman and chief executive officer. Mr. Gladstone and Terry Brubaker, our vice chairman and chief operating officer, also serve on the board of directors of the Adviser, the board of managers of the Administrator, and serve as executive officers of both the Adviser and the Administrator. The Administrator employs, among others, our chief financial officer and treasurer, chief valuation officer, chief compliance officer, general counsel and secretary (who also serves as the president of the Administrator) and their respective staffs. The Adviser and the Administrator each has extensive experience in our lines of business and also provide investment advisory and administrative services, respectively, to our affiliates, including Gladstone Commercial, a publicly-traded real estate investment trust; Gladstone Capital, a publicly-traded BDC and RIC; and Gladstone Land, a publicly-traded real estate investment trust (collectively, the “Affiliated Public

 



 

1


Table of Contents

Funds”). In the future, the Adviser and the Administrator may provide investment advisory and administrative services, respectively, to other funds and companies, both public and private.

The Adviser was organized as a corporation under the laws of the State of Delaware on July 2, 2002, and is a registered investment adviser under the Investment Advisers Act of 1940, as amended (the “Advisers Act”). The Administrator was organized as a limited liability company under the laws of the State of Delaware on March 18, 2005. The Adviser and Administrator are headquartered in McLean, Virginia, a suburb of Washington, D.C. The Adviser also has offices in several other states.

Investment Objectives and Strategy

We were established for the purpose of investing in debt and equity securities of established private businesses operating in the United States (“U.S.”). Our investment objectives are to: (i) achieve and grow current income by investing in debt securities of established businesses that we believe will provide stable earnings and cash flow to pay expenses, make principal and interest payments on our outstanding indebtedness and make distributions to stockholders that grow over time; and (ii) provide our stockholders with long-term capital appreciation in the value of our assets by investing in equity securities, generally in combination with the aforementioned debt securities, of established businesses that we believe can grow over time to permit us to sell our equity investments for capital gains. To achieve our objectives, our investment strategy is to invest in several categories of debt and equity securities, with individual investments generally totaling up to $30 million, although investment size may vary, depending upon our total assets or available capital at the time of investment. We intend that our investment portfolio over time will consist of approximately 75% in debt securities and 25% in equity securities, at cost. As of March 31, 2017, our investment portfolio was made up of 72.0% in debt securities and 28.0% in equity securities, at cost.

We focus on investing in lower middle market private businesses (which we generally define as private companies with annual earnings before interest, taxes, depreciation and amortization (“EBITDA”) of $3 million to $20 million) (“Lower Middle Market”) in the United States that meet certain criteria, including the following: the sustainability of the business’ free cash flow and its ability to grow it over time, adequate assets for loan collateral, experienced management teams with a significant ownership interest in the portfolio company, reasonable capitalization of the portfolio company, including an ample equity contribution or cushion based on prevailing enterprise valuation multiples, and the potential to realize appreciation and gain liquidity in our equity position, if any. We anticipate that liquidity in our equity position will be achieved through a merger or acquisition of the portfolio company, a public offering of the portfolio company’s stock or, to a lesser extent, by exercising our right to require the portfolio company to repurchase our warrants, as applicable, though there can be no assurance that we will always have these rights. We invest in portfolio companies that need funds for growth capital or to finance acquisitions or recapitalize or, to a lesser extent, refinance their existing debt facilities. We seek to avoid investing in high-risk, early-stage enterprises.

We invest by ourselves or jointly with other funds and/or management of the portfolio company, depending on the opportunity. In July 2012, the SEC granted us an exemptive order (the “Co-Investment Order”) that expanded our ability to co-invest, under certain circumstances, with certain of our affiliates, including Gladstone Capital and any future business development company or closed-end management investment company that is advised (or sub-advised if it controls the fund) by the Adviser, or any combination of the foregoing, subject to the conditions in the Co-Investment Order. Since 2012, we have opportunistically made several co-investments with Gladstone Capital pursuant to the Co-Investment Order. We believe the Co-Investment Order has enhanced and will continue to enhance our ability to further our investment objectives and strategies. If we are participating in an investment with one or more co-investors, whether or not an affiliate of ours, our investment is likely to be smaller than if we were investing alone.

 



 

2


Table of Contents

In general, our investments in debt securities have a term of five years, accrue interest at variable rates (based on the one-month London InterBank Offered Rate (“LIBOR”)) or, to a lesser extent, at fixed rates. As of March 31, 2017, our loan portfolio consisted of 92.9% variable rate loans with floors and 7.1% fixed rate loans based on the total principal balance of all outstanding debt investments. We seek debt instruments that pay interest monthly or, at a minimum, quarterly, and which may include a yield enhancement such as a success fee or, to a lesser extent, deferred interest provision and are primarily interest only, with all principal and any accrued but unpaid interest due at maturity. Generally, success fees accrue at a set rate and are contractually due upon a change of control of the business. Some debt securities may have deferred interest whereby some portion of the interest payment is added to the principal balance so that the interest is paid, together with the principal, at maturity. This form of deferred interest is often called “paid-in-kind” (“PIK”) interest. As of March 31, 2017, we did not have any securities with a PIK feature.

Typically, our investments in equity securities take the form of common stock, preferred stock, limited liability company interests, or warrants or options to purchase any of the foregoing. Often, these equity investments occur in connection with our original investment, buyouts and recapitalizations of a business, or refinancing existing debt. Since our initial public offering in 2005 and through March 31, 2017, we have made investments in 45 companies, excluding investments in syndicated loans.

We expect that our investment portfolio will continue to primarily include the following three categories of investments in private companies in the United States:

 

    First Lien Secured Debt Securities : We seek to invest a portion of our assets in first lien secured debt securities also known as senior loans, senior term loans, lines of credit and senior notes. Using its assets as collateral, the borrower typically uses first lien secured debt to cover a substantial portion of the funding needs of the business. These debt securities usually take the form of first priority liens on all, or substantially all, of the assets of the business.

 

    Second Lien Secured Debt Securities : We seek to invest a portion of our assets in second lien secured debt securities, which may also be referred to as subordinated loans, subordinated notes and mezzanine loans. These second lien secured debt securities rank junior to the borrower’s first lien secured debt securities and may be secured by second priority liens on all or a portion of the assets of the business. Additionally, we may receive other yield enhancements, such as warrants to buy common and preferred stock or limited liability interests, in connection with these second lien secured debt securities.

 

    Preferred and Common Equity/Equivalents : We seek to invest a portion of our assets in equity securities, which consist of preferred and common equity, limited liability company interests, warrants or options to acquire such securities, and are generally in combination with our debt investment in a business. Additionally, we may receive equity investments derived from restructurings on some of our existing debt investments. In many cases, we will own a significant portion of the equity of the businesses in which we invest.

Pursuant to the 1940 Act, we must maintain at least 70% of our total assets in qualifying assets, which generally include each of the investment types listed above. Therefore, the 1940 Act permits us to invest up to 30% of our assets in other non-qualifying assets. See “ Regulation as a Business Development Company—Qualifying Assets ” for a discussion of the types of qualifying assets in which we are permitted to invest pursuant to Section 55(a) of the 1940 Act.

Because the majority of the loans in our portfolio consist of term debt in private companies that typically cannot or will not expend the resources to have their debt securities rated by a credit rating agency, we expect that most, if not all, of the debt securities we acquire will be unrated. Investors should assume that these loans would be rated below what is today considered “investment grade” quality. Investments rated below investment

 



 

3


Table of Contents

grade are often referred to as high yield securities or junk bonds and may be considered higher risk as compared to investment-grade debt instruments. With the exception of our policy to conduct our business as a BDC, these investment policies are not fundamental and may be changed without stockholder approval.

Risk Factors

Investing in our securities involves a high degree of risk. You should consider carefully the information found in the section entitled “ Risk Factors ” on page 13 of this prospectus, including the following risks:

 

    general volatility of the capital markets and the market price of our common and preferred stock;

 

    the availability of additional capital on attractive terms or at all;

 

    uncertainty regarding the valuation of our portfolio investments;

 

    lack of liquidity of our portfolio investments;

 

    lack of control over our portfolio companies and the timing, form and amount of distributions from our portfolio companies;

 

    the size and concentration of our portfolio;

 

    our use of leverage;

 

    the impact of a decline in liquidity of credit markets and changes in interests rates on our business and portfolio of investments;

 

    our ability to maintain our status as a RIC and BDC;

 

    dilution risks related to issuance of shares at or below the then-current net asset value (“NAV”) per share;

 

    our ability to pay distributions on our common stock upon issuance of additional preferred stock or debt securities ranking senior to our common stock

 

    our Adviser’s ability to attract and retain highly qualified personnel, and particularly its ability to retain our key officers, including Mr. Gladstone, our chairman and chief executive officer; Mr. Brubaker, our vice chairman and chief operating officer; or Mr. David Dullum, our president;

 

    competition for investment opportunities;

 

    our Adviser’s ability to identify and invest in companies that meet our investment criteria; and

 

    actual and potential conflicts of interest with our Adviser.

Recent Developments

Common Stock Offering

In May 2017, we completed a public offering of 2.1 million shares of our common stock at a public offering price of $9.38 per share, which was below our then current estimated NAV of $9.95 per share. Gross proceeds totaled $19.7 million, and net proceeds, after deducting underwriting discounts and commissions and estimated offering costs borne by us, were $18.7 million, which was used to repay borrowings under our Fifth Amended and Restated Credit Agreement, as further amended (the “Credit Facility”), and for other general corporate purposes. On June 2, 2017, we issued an additional 155,265 shares of our common stock at a public offering price of $9.38 per share in connection with the partial exercise of the underwriters’ option to purchase additional shares of common stock on the same terms and conditions solely to cover over-allotments, which resulted in gross proceeds of approximately $1.5 million, and net proceeds, after deducting underwriting discounts and

 



 

4


Table of Contents

commissions and estimated offering costs borne by us, of approximately $1.4 million, which were used to repay borrowings under the Credit Facility and for other general corporate purposes.

Distributions and Dividends

In April 2017, our Board of Directors declared the following monthly and supplemental distributions to common stockholders and monthly dividends to holders of our Series B Term Preferred Stock, Series C Term Preferred Stock and Series D Term Preferred Stock:

 

Record Date

   Payment Date      Distribution per
Common Share
    Dividend per
Series B Term
Preferred Share
     Dividend per
Series C Term
Preferred Share
     Dividend per
Series D Term
Preferred Share
 

April 21, 2017

     April 28, 2017      $ 0.064     $ 0.140625      $ 0.135417      $ 0.13020833  

May 19, 2017

     May 31, 2017        0.064       0.140625        0.135417        0.13020833  

June 5, 2017

     June 15, 2017        0.060 (A)       —          —          —    

June 21, 2017

     June 30, 2017        0.064       0.140625        0.135417        0.13020833  
     

 

 

   

 

 

    

 

 

    

 

 

 

Total for the Quarter:

 

   $ 0.252     $ 0.421875      $ 0.406251      $ 0.39062499  
     

 

 

   

 

 

    

 

 

    

 

 

 

 

(A)   Denotes supplemental distribution to common stockholders.

In July 2017, our Board of Directors declared the following monthly distributions to common stockholders and monthly dividends to holders of our Series B Term Preferred Stock, Series C Term Preferred Stock and Series D Term Preferred Stock:

 

Record Date

  Payment Date     Distribution per
Common Share
    Dividend per
Series B Term
Preferred Share
    Dividend per
Series C Term
Preferred Share
    Dividend per
Series D Term
Preferred Share
 
July 21, 2017     July 31, 2017     $ 0.064     $ 0.140625     $ 0.135417     $ 0.13020833  
August 21, 2017     August 31, 2017       0.064       0.140625       0.135417       0.13020833  
September 20, 2017     September 29, 2017       0.064       0.140625       0.135417       0.13020833  
   

 

 

   

 

 

   

 

 

   

 

 

 

Total for the Quarter:

    $ 0.192     $ 0.421875     $ 0.406251     $ 0.39062499  
   

 

 

   

 

 

   

 

 

   

 

 

 

Investment Activity

 

    In May and June 2017, we sold a portion of our common stock investment in AquaVenture Holdings Limited resulting in net cash proceeds of $2.0 million, which represented a return of capital.

 

    In June 2017, one of our portfolio companies, Mathey Investments, Inc. (“Mathey”) was merged with and into another of our portfolio companies, SBS Industries, LLC (“SBS”). As a result of this transaction, we received success fee income of $0.3 million from Mathey. Our debt investments in Mathey, which totaled $8.6 million at principal and cost, were assumed by SBS and combined with our existing debt investment in SBS, which totaled $11.4 million at principal and cost, into a new secured first lien term loan totaling $20.0 million. Our common equity investment in Mathey, with a cost basis of $0.8 million, was converted into a preferred equity investment in SBS with the same cost basis. In connection with the merger, we also extended a secured first lien revolving line of credit to SBS with a total facility amount of $1.5 million, which was undrawn at the time of the transaction.

 



 

5


Table of Contents

THE OFFERING

We may offer, from time to time, up to $300,000,000 of our Securities, at prices and on terms to be determined at the time of the offering to be disclosed in one or more prospectus supplements. In the case of our common stock and warrants or rights to acquire such common stock hereunder in any offering, the offering price per share, exclusive of any distribution commission or discount, will not be less than NAV per share of our common stock at the time of the offering except (i) in connection with a rights offering to our existing stockholders, (ii) with the consent of the majority of our common stockholders or (iii) under such other circumstances as the SEC may permit. If we were to sell shares of our common stock below our then-current NAV per share, as we did in October 2012, March 2015 and May 2017, such sales would result in an immediate dilution to the NAV per share. Such a share issuance would also cause a proportionately greater decrease in a stockholder’s interest in our earnings and assets than the increase in our assets resulting from such issuance.

Our Securities may be offered directly to one or more purchasers, including existing stockholders in a rights offering, by us or through agents designated from time to time by us, or to or through underwriters or dealers. The prospectus supplement relating to the offering will disclose the terms of the offering, including the name or names of any agents or underwriters involved in the sale of our Securities by us, the purchase price, and any fee, commission or discount arrangement between us and our agents or underwriters or among our underwriters or the basis upon which such amount may be calculated. See “ Plan of Distribution .” We may not sell any of our Securities through agents, underwriters or dealers without delivery of a prospectus supplement describing the method and terms of the offering of our Securities.

Set forth below is additional information regarding the offering of our Securities:

 

Common stock trading symbol (NASDAQ)    GAIN
Series B Term Preferred Stock trading symbol (NASDAQ)    GAINO
Series C Term Preferred Stock trading symbol (NASDAQ)    GAINN
Series D Term Preferred Stock trading symbol (NASDAQ)    GAINM
Use of proceeds    Unless otherwise specified in a prospectus supplement, we intend to use the net proceeds from the sale of our Securities first to pay down outstanding debt, if any, then to make investments in accordance with our investment objectives and strategy, with any remaining proceeds to be used for other general corporate purposes. See “ Use of Proceeds .”
Dividends and distributions    We have paid monthly distributions to the holders of our common stock since July 2005 and intend to continue to do so. We have paid monthly dividends on each series of our Term Preferred Stock since the date of issuance of the respective series of such Term Preferred Stock. The amount of the monthly distribution on our common stock is determined by our board of directors (“Board of Directors”) on a quarterly basis and is based on our estimate of annual

 



 

6


Table of Contents
   taxable ordinary income plus the excess of our net short-term capital gains over net long-term capital losses (“Investment Company Taxable Income”), if any. See “ Price Range of Common Stock and Distributions .” Certain additional amounts may be deemed as distributed to stockholders for income tax purposes or may be paid as supplemental distributions, as applicable. We expect other types of Securities to pay distributions in accordance with their terms.
Taxation    We have elected to be treated, and intend to maintain qualification as a RIC under Subchapter M of the Code and we generally do not expect to be subject to U.S. federal income taxes. To maintain our RIC status, we must maintain our status as a BDC, meet specified source-of-income and asset diversification requirements, and distribute annually at least 90% of our Investment Company Taxable Income, if any, out of assets legally available for distribution. See “ Material U.S. Federal Income Tax Considerations .”
Trading at a discount    Common shares of closed-end investment companies, including BDCs, frequently trade at a discount to their NAV per share. The possibility that our shares of common stock may trade at a discount to our NAV per share is separate and distinct from the risk that our NAV per share may decline. We cannot predict whether our shares will trade above, at or below NAV per share, although during the past three years, our common stock has consistently traded, and at times significantly, below NAV per share.
Certain anti-takeover provisions    Our Board of Directors is divided into three classes of directors serving staggered three-year terms. This structure is intended to provide us with a greater likelihood of continuity of management, which may be necessary for us to realize the full value of our investments. A staggered board of directors also may serve to deter hostile takeovers or proxy contests, as may certain provisions of Delaware law and other measures we have adopted. See “ Certain Provisions of Delaware Law and of Our Certificate of Incorporation and Bylaws .”
Dividend reinvestment plan    Our transfer agent, Computershare Inc. (“Computershare”), offers a dividend reinvestment plan for our common stockholders. This is an “opt in” dividend reinvestment plan, meaning that stockholders may elect to have their cash dividends automatically reinvested in additional shares of our common stock. Stockholders who do not so elect will receive their dividends in cash. Stockholders who

 



 

7


Table of Contents
   receive distributions in the form of stock will be subject to the same federal, state and local tax consequences as stockholders who elect to receive their distributions in cash. See “ Dividend Reinvestment Plan .”
Management arrangements    Gladstone Management Corporation serves as our investment adviser, and Gladstone Administration, LLC serves as our administrator. For a description of our Adviser, our Administrator, the Gladstone Companies and our contractual arrangements with these companies, see “ Business—Transactions with Related Parties—Investment Advisory and Management Agreement ” and “ Management—Certain Transactions—Investment Advisor and Administrator.

 



 

8


Table of Contents


FEES AND EXPENSES

The following table is intended to assist you in understanding the costs and expenses that an investor in this offering will bear directly or indirectly. We caution you that some of the percentages indicated in the table below are estimates and may vary. Except where the context suggests otherwise, whenever this prospectus contains a reference to fees or expenses paid by “us” or “Gladstone Investment,” or that “we” will pay fees or expenses, stockholders will indirectly bear such fees or expenses as investors in Gladstone Investment. The following annualized percentages were calculated based on actual expenses incurred in the quarter ended March 31, 2017, and average net assets for the quarter ended March 31, 2017. The table and examples below include all fees and expenses of our consolidated subsidiaries.

 

Stockholder Transaction Expenses:

  

Sales load (as a percentage of offering price) (1)

     —  

Offering expenses (as a percentage of offering price) (1)

     —  

Dividend reinvestment plan expenses (per sales transaction fee) (2)

    

Up to $25.00

Transaction

Fee

 

 

 

Total stockholder transaction expenses (1)

     —  

Annual expenses (as a percentage of net assets attributable to common stock) (3) :

  

Base Management fee (4)

     3.33 %

Loan servicing fee (5)

     2.04 %

Incentive fees payable under investment advisory and management agreement (20% of net realized capital gains in excess of unrealized depreciation and 20% of pre-incentive fee net investment income) (6)

     1.77 %

Interest payments on borrowed funds (7)

     1.29 %

Dividend expense on mandatorily redeemable preferred stock (8)

     3.27 %

Other expenses (9)

     1.16 %
  

 

 

 

Total annual expenses (10)

     12.86 %

 

(1) The amounts set forth in the table above do not reflect the impact of any sales load or other offering expenses borne by Gladstone Investment and its stockholders. The prospectus supplement relating to an offering of securities pursuant to this prospectus will disclose the offering price and the estimated offering expenses and total stockholder transaction expenses borne by Gladstone Investment and its stockholders as a percentage of the offering price. In the event that securities to which this prospectus relates are sold to or through underwriters, the prospectus supplement will also disclose the applicable sales load.
(2) The expenses of the dividend reinvestment plan, if any, are included in stock record expenses, a component of “Other expenses.” If a participant elects by written notice to the plan agent prior to termination of his or her account to have the plan agent sell part or all of the shares held by the plan agent in the participant’s account and remit the proceeds to the participant, the plan agent is authorized to deduct a transaction fee, plus per share brokerage commissions, from the proceeds. The participants in the dividend reinvestment plan will also bear a transaction fee, plus per share brokerage commissions, incurred with respect to open market purchases. See “ Dividend Reinvestment Plan ” for information on the dividend reinvestment plan.
(3) The percentages presented in this table are gross of credits to any fees.
(4)

In accordance with the Advisory Agreement between us and our Adviser, our annual base management fee is 2.00% (0.50% quarterly) of our average gross assets, which are defined as total assets, including investments made with proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings, and adjusted appropriately for any share issuances or repurchases. In accordance with the

 



 

9


Table of Contents
  requirements of the SEC, the table above shows our base management fee as a percentage of average net assets attributable to common stockholders. For purposes of the table, the annualized base management fee has been converted to 3.33% of the average net assets for the quarter ended March 31, 2017 by dividing the total annualized amount of the base management fee by our average net assets. The base management fee for the quarter ended March 31, 2017 before application of any credits was $2.5 million.

Pursuant to the requirements of the 1940 Act, the Adviser makes available significant managerial assistance to our portfolio companies. The Adviser may also provide other services to our portfolio companies under certain agreements and may receive fees for services other than managerial assistance. Such services may include (i) assistance obtaining, sourcing or structuring credit facilities, long term loans or additional equity from unaffiliated third parties; (ii) negotiating important contractual financial relationships; (iii) consulting services regarding restructuring of the portfolio company and financial modeling as it relates to raising additional debt and equity capital from unaffiliated third parties; and (iv) primary role in interviewing, vetting and negotiating employment contracts with candidates in connection with adding and retaining key portfolio company management team members. The Adviser non-contractually, unconditionally, and irrevocably credits 100% of these fees against the base management fee that we would otherwise be required to pay to the Adviser; however, pursuant to the terms of the Advisory Agreement, a small percentage of certain of such fees, is retained by the Adviser in the form of reimbursement, at cost, for tasks completed by personnel of the Adviser and primarily for the valuation of portfolio companies. For the quarter ended March 31, 2017, $1.0 million of these fees were non-contractually, unconditionally and irrevocably credited against the base management fee. See “ Business—Transactions with Related Parties—Investment Advisory and Management Agreement” and “Management—Certain Transactions—Investment Advisor and Administrator

(5) Our Adviser services, administers and collects on the loans held by Gladstone Business Investment, LLC, our wholly-owned subsidiary (“Business Investment”), in return for which our Adviser receives a 2.0% annual loan servicing fee payable monthly by Business Investment based on the monthly aggregate balance of loans held by Business Investment in accordance with the Credit Facility. Since Business Investment is a consolidated subsidiary of ours, coupled with the fact that the total base management fee paid to the Adviser pursuant to the Advisory Agreement cannot exceed 2.0% of total assets (as reduced by cash and cash equivalents pledged to creditors) during any given calendar year, we treat payment of the loan servicing fee pursuant to our Credit Facility as a pre-payment of the base management fee under the Advisory Agreement. Accordingly, these loan servicing fees are 100% non-contractually, unconditionally and irrevocably credited back to us by the Adviser. The loan servicing fee for the quarter ended March 31, 2017 was $1.5 million. See “ Business—Transactions with Related Parties—Loan Servicing Fee Pursuant to Credit Facility ” and “ Management—Certain Transactions—Loan Servicing Fee Pursuant to Credit Facility ” and footnote 6 below.
(6)

The incentive fee payable to the Adviser under the Advisory Agreement consists of two parts: an income-based fee and a capital gains-based fee. The income-based incentive fee is payable quarterly in arrears, and equals 20% of the excess, if any, of our pre-incentive fee net investment income that exceeds a 1.75% quarterly (7% annualized) hurdle rate of our net assets, adjusted appropriately for any share issuances or repurchases, subject to a “catch-up” provision measured as of the end of each calendar quarter. The “catch-up” provision requires us to pay 100% of our pre-incentive fee net investment income with respect to that portion of such income, if any, that exceeds the hurdle rate but is less than 125% of the quarterly hurdle rate (or 2.1875%) in any calendar quarter (8.75% annualized). The catch-up provision is meant to provide our Adviser with 20% of our pre-incentive fee net investment income as if a hurdle rate did not apply when our pre-incentive fee net investment income exceeds 125% of the quarterly hurdle rate in any calendar quarter (8.75% annualized). The capital gains-based incentive fee equals 20% of our net realized capital gains in excess of unrealized depreciation since our inception, if any, computed as all realized capital gains net of all realized capital losses and unrealized capital depreciation since our inception, less any prior payments, and is payable at the end of each fiscal year. We have not recorded a capital gains-based incentive fee from our inception through March 31, 2017. The income-based incentive fee for the quarter ended March 31, 2017

 



 

10


Table of Contents
  was $1.3 million. No credits were applied to the incentive fee for the quarter ended March 31, 2017; however, the Adviser may credit such fee in the future.

Examples of how the incentive fee would be calculated are as follows:

 

    Assuming pre-incentive fee net investment income of 0.55%, there would be no income-based incentive fee because such income would not exceed the hurdle rate of 1.75%.

 

    Assuming pre-incentive fee net investment income of 2.00%, the income-based incentive fee would be as follows:

= 100% × (2.00% – 1.75%)

= 0.25%

 

    Assuming pre-incentive fee net investment income of 2.30%, the income-based incentive fee would be as follows:

= (100% × (“catch-up”: 2.1875% – 1.75%)) + (20% × (2.30% – 2.1875%))

= (100% × 0.4375%) + (20% × 0.1125%)

= 0.4375% + 0.0225%

= 0.46%

 

    Assuming realized capital gains of 6% and realized capital losses and unrealized capital depreciation of 1%, the capital gains-based incentive fee would be as follows:

= 20% × (6% – 1%)

= 20% × 5%

= 1%

For a more detailed discussion of the calculation of the two-part incentive fee, see “ Business—Transactions with Related Parties—Investment Advisory and Management Agreement .”

 

(7) Includes amortization of deferred financing costs. As of March 31, 2017, we had $69.7 million in borrowings outstanding under our Credit Facility.
(8) Includes dividends paid on our Series B Term Preferred Stock, Series C Term Preferred Stock and Series D Term Preferred Stock and amortization of deferred financing costs. See “ Description of Our Securities—Preferred Stock—Term Preferred Stock ” for additional information.
(9) Includes our overhead expenses, including payments under the Administration Agreement based on our projected allocable portion of overhead and other expenses incurred by our Administrator in performing its obligations under the administration agreement. See “ Business—Transactions with Related Parties—Administration Agreement ” and “ Management—Certain Transactions—Investment Advisor and Administrator.”
(10) Total annualized gross expenses, based on actual amounts incurred for the quarter ended March 31, 2017, would be $38.5 million. After all non-contractual, unconditional, and irrevocable credits described in footnote 4 and footnote 5 above are applied to the base management fee and the loan servicing fee, total annualized expenses after fee credits, based on actual amounts incurred for the quarter ended March 31, 2017, would be $28.3 million, or 9.46% as a percentage of average net assets.

 



 

11


Table of Contents

Example

The following examples demonstrate the projected dollar amount of total cumulative expenses that would be incurred over various periods with respect to a hypothetical investment in our common stock. In calculating the following expense amounts, we have assumed that our annual operating expenses would remain at the levels set forth in the table above. The amounts set forth below do not reflect the impact of any sales load or offering expenses to be borne by Gladstone Investment and its stockholders. In the prospectus supplement relating to an offering of securities pursuant to this prospectus, the examples below will be restated to reflect the impact of the estimated offering expenses borne by Gladstone Investment and its stockholders and, in the event that securities to which this prospectus relates are sold to or through underwriters, the impact of the applicable sales load. The examples below and the expenses in the table above should not be considered a representation of our future expenses, and actual expenses may be greater or less than those shown. While the example assumes, as required by the SEC, a 5% annual return, our performance will vary and may result in a return greater or less than 5%.

 

     1 Year      3 Years      5 Years      10 Years  

You would pay the following expenses on a $1,000 investment:

           

assuming a 5% annual return consisting entirely of ordinary income (1)(2)

   $ 116      $ 327      $ 510      $ 871  

assuming a 5% annual return consisting entirely of capital gains (2)(3)

   $ 125      $ 348      $ 539      $ 904  

 

(1) For purposes of this example, we have assumed that the entire amount of the assumed 5% annual return would constitute ordinary income as we have not historically realized positive capital gains (computed net of all realized capital losses) in excess of unrealized depreciation on our investments through March 31, 2017. Because the assumed 5% annual return is significantly below the hurdle rate of 7% (annualized) that we must achieve under the Advisory Agreement to trigger the payment of an income-based incentive fee, we have assumed, for purposes of this example, that no income-based incentive fee would be payable if we realized a 5% annual return on our investments.
(2) While the example assumes reinvestment of all distributions at NAV per share, participants in the dividend reinvestment plan will receive a number of shares of our common stock determined by dividing the total dollar amount of the distribution payable to a participant by the market price per share of our common stock at the close of trading on the valuation date for the distribution, and this price per share may differ from NAV per share. See “ Dividend Reinvestment Plan ” for additional information regarding the dividend reinvestment plan.
(3) For purposes of this example, we have assumed that the entire amount of the assume 5% annual return would constitute capital gains and that no accumulated capital losses or unrealized depreciation exist that would have to be overcome first before a capital gains-based incentive fee is payable.

 



 

12


Table of Contents

RISK FACTORS

You should carefully consider the risks described below and all other information provided in this prospectus (and any prospectus supplement) before making a decision to purchase our Securities. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties not presently known to us, or not presently deemed material by us, may also impair our operations and performance.

If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected. If that happens, the trading price of our Securities could decline, and you may lose all or part of your investment.

Risks Related to Our Investments

We operate in a highly competitive market for investment opportunities.

A large number of entities compete with us to make the types of investments we seek to make in Lower Middle Market companies. We compete with public and private buyout funds, commercial and investment banks, commercial financing companies, and, to the extent that they provide an alternative form of financing, hedge funds, mutual funds, and private equity. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which would allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC. The competitive pressures we face could have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time and we can offer no assurance that we will be able to identify and make investments that are consistent with our investment objective. We do not seek to compete based on the interest rates we offer and we believe that some of our competitors may make loans with interest rates that will be comparable to or lower than the rates we offer. We may lose investment opportunities if we do not match our competitors’ pricing, terms, and structure. However, if we match our competitors’ pricing, terms, and structure, we may experience decreased net interest income and increased risk of credit loss.

Our investments in Lower Middle Market portfolio companies are extremely risky and could cause you to lose all or a part of your investment.

Investments in Lower Middle Market portfolio companies are subject to a number of significant risks including the following:

 

    Lower Middle Market businesses are likely to be more significantly impacted in economic downturns than larger businesses . Our portfolio companies may have fewer resources than larger businesses, and any economic downturns or recessions, are more likely to have a material adverse effect on them. If one of our portfolio companies is adversely impacted by a recession, its ability to repay our loan or engage in a liquidity event, such as a sale, recapitalization or initial public offering would be diminished.

 

   

Lower Middle Market businesses may have limited financial resources and may not be able to repay the loans we make to them.  Our strategy includes providing financing to portfolio companies that typically do not have readily available access to financing. While we believe that this provides an attractive opportunity for us to generate profits, this may make it difficult for the portfolio companies to repay their loans to us upon maturity. A borrower’s ability to repay its loan may be adversely affected by numerous factors, including the failure to meet its business plan, a downturn in its industry or negative economic conditions. Deterioration in a borrower’s financial condition and prospects

 

13


Table of Contents
 

usually will be accompanied by deterioration in the value of any collateral and a reduction in the likelihood of realizing on any guaranties we may have obtained from the borrower’s management. As of March 31, 2017, certain loans to two portfolio companies were on non-accrual status with an aggregate debt cost basis of $15.6 million, or 4.1%, of the cost basis of all debt investments in our portfolio. While we are working with the portfolio companies to improve their profitability and cash flows, there can be no assurance that our efforts will prove successful. Although we will generally seek to be the secured first lien lender to a borrower, in some of our loans we expect to be subordinated to a senior lender and our security interest in any collateral would, accordingly, likely be second lien and subordinate to another lender’s security interest.

 

    Lower Middle Market businesses typically have narrower product lines and smaller market shares than large businesses.  Our target portfolio companies tend to be more vulnerable to competitors’ actions and market conditions, as well as general economic downturns. In addition, our portfolio companies may face intense competition, including competition from companies with greater financial resources, more extensive development, manufacturing, marketing and other capabilities and a larger number of qualified managerial and technical personnel.

 

    There is generally little or no publicly available information about these businesses.  Because we seek to invest in privately owned businesses, there is generally little or no publicly available operating and financial information about our potential portfolio companies. As a result, we rely on our officers, the Adviser and its employees, Gladstone Securities and consultants to perform due diligence investigations of these portfolio companies, their operations, and their prospects. We may not learn all of the material information we need to know regarding these businesses through our investigations to make a well informed investment decision.

 

    Lower Middle Market businesses generally have less predictable operating results.  We expect that our portfolio companies may have significant variations in their operating results, may from time to time be exposed to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, may require substantial additional capital to support their operations, to finance expansion or to maintain their competitive position, may otherwise have a weak financial position or may be adversely affected by changes in the business cycle. Our portfolio companies may not meet net income, cash flow and other coverage tests typically imposed by their senior lenders. A borrower’s failure to satisfy financial or operating covenants imposed by senior lenders could lead to defaults and, potentially, foreclosure on its senior credit facility, which could additionally trigger cross-defaults in other agreements. If this were to occur, it is possible that the borrower’s ability to repay our loan would be jeopardized.

 

    Lower Middle Market businesses are more likely to be dependent on one or two persons.  Typically, the success of a Lower Middle Market business also depends on the management talents and efforts of one or two persons or a small group of persons. The death, disability or resignation of one or more of these persons could have a material adverse impact on our borrower and, in turn, on us.

 

    Lower Middle Market businesses may have limited operating histories.  While we intend to continue to target stable companies with proven track records, we may make loans to new companies that meet our other investment criteria. Portfolio companies with limited operating histories will be exposed to all of the operating risks that new businesses face and may be particularly susceptible to, among other risks, market downturns, competitive pressures and the departure of key executive officers.

 

    Debt securities of Lower Middle Market companies typically are not rated by a credit rating agency . Typically, a Lower Middle Market business cannot or will not expend the resources to have their debt securities rated by a credit rating agency. We expect that most, if not all, of the debt securities we acquire will be unrated. Investors should assume that these loans would be at rates below what is today considered “investment grade” quality. Investments rated below investment grade are often referred to as high yield securities or junk bonds and may be considered high risk as compared to investment-grade debt instruments.

 

14


Table of Contents

Because the loans we make and equity securities we receive when we make loans are not publicly traded, there is uncertainty regarding the value of our privately held securities that could adversely affect our determination of our NAV.

Substantially all of our portfolio investments are, and we expect will continue to be, in the form of securities that are not publicly traded. The fair value of securities and other investments that are not publicly traded may not be readily determinable. Our Board of Directors has ultimate responsibility for reviewing and approving, in good faith, the fair value of our investments, based on our investment valuation policy (the “Policy”). Our Board of Directors reviews valuation recommendations that are provided by professionals of the Adviser and Administrator with oversight and direction from the chief valuation officer, employed by the Administrator (the “Valuation Team”). In valuing our investment portfolio, several techniques are used, including a total enterprise value approach, a yield analysis, and market quotes. Currently, Standard & Poor’s Securities Evaluation, Inc. provides estimates of fair value on generally all of our debt investments and we use another independent valuation firm to provide valuation inputs for our significant equity investments, including earnings multiple ranges, as well as other information. In addition to these techniques, inputs and information, other factors are considered when determining fair value of our investments, including the nature and realizable value of the collateral, including external parties’ guaranties; any relevant offers or letters of intent to acquire the portfolio company; timing of expected loan repayments; and the markets in which the portfolio company operates. If applicable, new and follow-on debt and equity investments made during the current three month reporting period are generally valued at original cost basis. For additional information on our valuation policies, procedures and processes, see “ Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policy — Investment Valuation .”

Fair value measurements of our investments may involve subjective judgments and estimates and, due to the uncertainty inherent in valuing these securities, the Adviser’s determination of fair value may fluctuate from period to period and may differ materially from the values that could be obtained if a ready market for these securities existed. Additionally, changes in the market environment and other events that may occur over the life of the investment may cause the gains or losses ultimately realized on these investments to be different than the valuations currently assigned.

The valuation process for certain of our portfolio holdings creates a conflict of interest.

A substantial portion of our portfolio investments are made in the form of securities that are not publicly traded. As a result, our Board of Directors determines the fair value of these securities in good faith pursuant the Policy. In connection with that determination, our Valuation Team prepares portfolio company valuations based upon the most recent portfolio company financial statements available and projected financial results of each portfolio company. The participation of our Adviser’s investment professionals in our valuation process and Mr. Gladstone’s pecuniary interest in our Adviser may result in a conflict of interest, as the management fees that we pay our Adviser are based on our gross assets, less uninvested cash or cash equivalents from borrowings.

The lack of liquidity of our privately held investments may adversely affect our business.

We will generally make investments in private companies whose securities are not traded in any public market. Substantially all of the investments we presently hold and the investments we expect to acquire in the future are, and will be, subject to legal and other restrictions on resale and will otherwise be less liquid than publicly-traded securities. The illiquidity of our investments may make it difficult for us to quickly obtain cash equal to the value at which we record our investments if the need arises. This could cause us to miss important investment opportunities. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may record substantial realized losses upon liquidation. We may also face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we, the Adviser, the Administrator, or our respective officers, or affiliates have material non-public information regarding such portfolio company.

 

15


Table of Contents

Due to the uncertainty inherent in valuing these securities, the Adviser’s determinations of fair value may differ materially from the values that could be obtained if a ready market for these securities existed. Our NAV could be materially affected if the Adviser’s determinations regarding the fair value of our investments are materially different from the values that we ultimately realize upon our disposal of such securities.

Our financial results could be negatively affected if a significant portfolio investment fails to perform as expected.

Our total investment in one or more companies may be significant individually or in the aggregate. As a result, if a significant investment in one or more companies fails to perform as expected, our financial results could be more negatively affected and the magnitude of the loss could be more significant than if we had made smaller investments in more companies. Our five largest investments represented 27.4% of the fair value of our total portfolio as of March 31, 2017, compared to 30.5% as of March 31, 2016. Any disposition of a significant investment in one or more companies may negatively impact our net investment income and limit our ability to pay distributions.

The tightening of the U.S. monetary policy through the increase in the Federal Reserve System (“Fed”) interest rate has resulted in three interest rate raises by 25 basis points, respectively. The increase in the Fed rate can have a negative effect on our investments by making it harder and more expensive to refinance capital structures or even obtain financing.

In December 2015, December 2016 and March 2017, the Fed raised the fed funds rate by 0.25%, respectively, raising the target range for the federal funds rate to 0.75% to 1%, with additional gradual increases expected to come over the next year. As interest rates increase, generally, the cost of borrowing increases, affecting our ability to make new investments on favorable terms or at all. More generally, interest rate fluctuations and changes in credit spreads on floating rate loans may have a negative impact on our investments and investment opportunities and, accordingly, may have a material adverse effect on our rate of return on invested capital, our net investment income, our net asset value and the market price of our securities. A substantial portion of our debt investments have variable interest rates that reset periodically and are generally based on LIBOR, so an increase in interest rates from the current interest rate may make it more difficult for our portfolio companies to service their obligations under the debt investments that we hold. To the extent that interest rates increase, this may negatively impact the operating performance of our portfolio companies due to increasing debt service obligations and, therefore, may affect our results of operations. In addition, to the extent that an increase in interest rates makes it difficult or impossible to make payments on outstanding indebtedness to us or other financial sponsors or refinance debt that is maturing in the near term, some of our portfolio companies may be unable to repay such debt at maturity and may be forced to sell assets, undergo a recapitalization or seek bankruptcy protection. There can be no guaranty the Fed will raise rates at the gradual pace they originally proposed, nor can there be any assurance that the Fed will make sound decisions as to when to raise rates. The increase in interest rates could have a negative effect on our investments.

We generally will not be involved in the day-to-day operations and decision making of our portfolio companies.

We generally are not, and do not expect to be, involved in the day-to-day operations and decision making of our portfolio companies, even though we may have board representation or board observation rights and our debt agreements may contain certain restrictive covenants. As a result, we are subject to the risk that a portfolio company in which we invest may make business decisions with which we disagree and the management of such company, as representatives of the holders of their common stock, may take risks or otherwise act in ways that do not serve our interests of maximizing our investment value.

 

16


Table of Contents

We typically invest in transactions involving acquisitions, buyouts and recapitalizations of companies, which will subject us to the risks associated with change in control transactions.

Our strategy, in part, includes making debt and equity investments in companies in connection with acquisitions, buyouts and recapitalizations, which subjects us to the risks associated with change in control transactions. Change in control transactions often present a number of uncertainties. Companies undergoing change in control transactions often face challenges retaining key employees and maintaining relationships with customers and suppliers. While we hope to avoid many of these difficulties by participating in transactions where the management team is retained and by conducting thorough due diligence in advance of our decision to invest, if our portfolio companies experience one or more of these problems, we may not realize the value that we expect in connection with our investments, which would likely harm our operating results and financial condition.

Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.

We primarily invest in secured first and second lien debt securities issued by our portfolio companies. In some cases, portfolio companies will be permitted to have other debt that ranks equally with, or senior to, the debt securities in which we invest. By their terms, such debt securities may provide that the holders thereof are entitled to receive payment of interest and principal on or before the dates on which we are entitled to receive payments in respect of the debt securities in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization, or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying such senior creditors, such portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with debt securities in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization, or bankruptcy of a portfolio company.

Prepayments of our investments by our portfolio companies could adversely impact our results of operations and reduce our return on investment.

In addition to risks associated with delays in investing our capital, we are also subject to the risk that investments we make in our portfolio companies may be repaid prior to maturity. During the fiscal year 2017, we experienced prepayments of term debt investments of $30.5 million. We intend to first use any proceeds from prepayments to repay any borrowings outstanding on the Credit Facility. In the event that funds remain after repayment of our outstanding borrowings, then we may reinvest these proceeds in government securities, pending their future investment in new debt and/or equity securities. These government securities will typically have substantially lower yields than the debt securities being prepaid and we could experience significant delays in reinvesting these amounts. As a result, our results of operations could be materially adversely affected if one or more of our portfolio companies elect to prepay amounts owed to us. While we generally do not provide for prepayments of our debt investments where we also own a significant equity investment in a portfolio company, prepayments allowable under pure debt investments could negatively impact our return on those investments, which could result in a decline in the market price of our common stock.

Our portfolio is concentrated in a limited number of companies and industries, which subjects us to an increased risk of significant loss if any one of these companies does not repay us or if the industries experience downturns.

As of March 31, 2017, we had investments in 35 portfolio companies, the five largest of which included JR Hobbs Co. – Atlanta LLC (“JR Hobbs”), Counsel Press, Inc. (“Counsel Press”) Cambridge Sound Management, Inc. (“Cambridge”), Nth Degree, Inc. and Drew Foam Companies, Inc., and comprised $137.5 million, or 27.4% of our total investment portfolio, at fair value. A consequence of a limited number of investments is that the aggregate returns we realize may be substantially adversely affected by the unfavorable performance of a small number of such loans or a substantial write-down of any one investment. Beyond our

 

17


Table of Contents

regulatory and income tax diversification requirements, as well as the Credit Facility requirements, we do not have fixed guidelines for industry concentration and our investments could potentially be concentrated in relatively few industries. In addition, while we do not intend to invest 25% or more of our total assets in a particular industry or group of industries at the time of investment, it is possible that as the values of our portfolio companies change, one industry or a group of industries may comprise in excess of 25% of the value of our total assets. A downturn in a particular industry in which we have invested a significant portion of our total assets could have a materially adverse effect on us. As of March 31, 2017, our largest industry concentration was in Home and Office Furnishings, Housewares, and Durable Consumer Products, representing 18.6% of our total investments, at fair value.

Our investments are typically long term and will require several years to realize liquidation events.

Since we generally make five to seven year term loans and hold our loans and related equity positions until the loans mature, investors should not expect realization events, if any, to occur over the near term. In addition, we expect that any equity investments may require several years to appreciate in value and we cannot give any assurance that such appreciation will occur.

The disposition of our investments may result in contingent liabilities.

Currently, all but one of our investments involve private securities. In connection with the disposition of an investment in private securities, we may be required to make representations about the business and financial affairs of the underlying portfolio company typical of those made in connection with the sale of a business. We may also be required to indemnify the purchasers of such investment to the extent that any such representations turn out to be inaccurate or with respect to certain potential liabilities. These arrangements may result in contingent liabilities that ultimately yield funding obligations that must be satisfied through our return of certain distributions previously made to us.

There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to lender liability claims.

Even though we have structured a majority of our investments as secured first and second lien loans, if one of our portfolio companies were to go bankrupt, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might re-characterize our debt investments and subordinate all, or a portion, of our claims to that of other creditors. In such an event, holders of debt instruments ranking senior to our investments typically would be entitled to receive payment in full before we receive any payments. After repaying such senior creditors, such portfolio company may not have any remaining assets to use to repay its obligation to us. We may also be subject to lender liability claims for actions taken by us with respect to a borrower’s business or in instances in which we exercised control over the borrower. It is possible that we could become subject to a lender liability claim, including as a result of actions taken in rendering significant managerial assistance.

Portfolio company-related litigation could result in costs, including defense costs or damages, and the diversion of management time and resources.

In the course of investing in and often providing significant managerial assistance to certain of our portfolio companies, certain persons employed by the Adviser sometimes serve as directors on the boards of such companies. To the extent that litigation arises out of our investments in these companies, even if meritless, we or such employees may be named as defendants in such litigation, which could result in additional costs, including defense costs, and the diversion of management time and resources. We may be unable to accurately estimate our exposure to litigation risk if we record balance sheet reserves for probable loss contingencies. As a result, any reserves we establish to cover any settlements or judgments may not be sufficient to cover our actual financial exposure, which may have a material impact on our results of operations, financial condition, or cash flows.

 

18


Table of Contents

In view of the inherent difficulty of predicting the outcome of legal actions and regulatory matters, we cannot provide assurance as to the outcome of any threatened or pending matter or, if resolved adversely, the costs associated with any such matter, particularly where the claimant seeks very large or indeterminate damages or where the matter presents novel legal theories, involves a large number of parties or is at a preliminary stage. The resolution of any such matters may be time consuming, expensive, and may distract management from the conduct of our business. The resolution of certain threatened or pending legal actions or regulatory matters, if unfavorable, whether in settlement or a judgment, could have a material adverse effect on our financial condition, results of operations, or cash flows for the quarter in which such actions or matters are resolved or a reserve is established.

For example, a former portfolio company, Noble Logistics, Inc. (“Noble”) is a defendant in employment law wage and hour and independent contractor misclassification claims in a purported class action seeking monetary damages, Maximo v. Aspen Contracting California LLC d/b/a/ Noble Logistics, et al. (“Maximo”). Noble is a debtor in a bankruptcy case under Chapter 11 of the federal bankruptcy code, pending in federal bankruptcy court in Delaware. The claims against Noble asserted in the Maximo case have been stayed by the filing of Noble’s bankruptcy case. A lawsuit brought by plaintiffs Clarence and Sheila Walder against a customer of Noble is also pending in California based on similar facts relating to Noble and claims under California law. The Maximo and Walder plaintiffs have attempted to bring claims against us and other former investors in Noble based primarily on allegations that we and such other investors controlled Noble and were responsible for the misclassification of Noble’s workforce. To date, claims against us have been struck by a court or voluntarily dismissed by the plaintiffs in connection with the automatic stay arising in connection with the Noble bankruptcy. While neither we nor any of our portfolio companies (other than Noble) are currently defendants in these cases, we or our portfolio companies may in the future be subject to claims by these plaintiffs or other persons alleging similar claims or may expend funds on behalf of Noble to defend claims.

While we believe we would have valid defenses to potential claims brought due to our investment in any portfolio company, and will defend any such claims vigorously, we may nevertheless expend significant amounts of money in defense costs and expenses. Further, if we enter into settlements or suffers an adverse outcome in any litigation, we could be required to pay significant amounts. In addition, if any of our portfolio companies become subject to direct or indirect claims or other obligations, such as defense costs or damages in litigation or settlement, our investment in such companies could diminish in value and we could suffer indirect losses. Further, these matters could cause us to expend significant management time and effort in connection with assessment and defense of any claims. No range of potential expenses, costs or damages in connection with these matters can be estimated at this time.

We may not realize gains from our equity investments and other yield enhancements.

We generally make equity investments in combination with secured debt investments. We may also receive other equity interests to purchase stock issued by the portfolio company, such as warrants, and generally receive other yield enhancements, such as success fees. Our goal is to ultimately dispose of these equity interests and realize gains and collect the yield enhancements. We expect that, over time, the realized gains from the disposition of equity interests and the yield enhancements we collect will offset any losses we may experience on potential loan defaults. However, equity interests may not appreciate in value and, in fact, may decline in value and any other yield enhancements, such as success fees, may not be collected. Accordingly, we may not be able to realize gains from our equity interests or collect other yield enhancements and any gains we do recognize and yield enhancements we collect may not be sufficient to offset losses we experience on other debt and equity investments.

During the fiscal year ended March 31, 2017, we recorded a net realized gain on investments of $15.6 million. During the fiscal years ended 2016 and 2015, we recorded net realized losses on investments of $4.6 million and $0.1 million, respectively. There can be no guarantee that net realized gains can be achieved in future periods and the impact of sales on our results of operations in prior periods should not be relied upon as

 

19


Table of Contents

being indicative of performance in future periods. For the years ended March 31, 2017, 2016 and 2015, success fee income totaled $2.4 million, $1.6 million and $1.4 million, respectively.

Any cumulative unrealized depreciation we experience on our investment portfolio may be an indication of future realized losses, which could reduce any gains available for distribution.

As a BDC we are required to carry our investments at market value or, if no market value is ascertainable, at fair value as determined in good faith by or under the direction of our Board of Directors. We will record decreases in the market values or fair values of our investments as unrealized depreciation. Since our inception, we have, at times, incurred a cumulative net unrealized depreciation of our portfolio. Any unrealized depreciation in our investment portfolio could result in realized losses in the future and ultimately in reductions of any gains available for distribution to stockholders in future periods.

The recent volatility of oil and natural gas prices could impair certain of our portfolio companies’ operations and ability to satisfy obligations to their respective lenders and investors, including us, which could negatively impact our financial condition.

Certain of our portfolio companies’ businesses may be impacted by the prices of, and demand for, oil and natural gas, which have exhibited significantly volatility in recent years and such volatility could continue or increase in the future. A substantial or extended decline in oil and natural gas demand or prices may adversely affect the business, financial condition, cash flow, liquidity or results of operations of these portfolio companies and might impair their ability to meet capital expenditure obligations and financial commitments. A prolonged or continued decline in oil prices could therefore have an adverse effect on our business, financial condition and results of operations.

Risks Related to Our External Financing

In addition to regulatory limitations on our ability to raise capital, the Credit Facility contains various covenants which, if not complied with, could accelerate our repayment obligations under the facility, thereby materially and adversely affecting our liquidity, financial condition, results of operations and ability to pay distributions.

We will have a continuing need for capital to finance our investments. As of March 31, 2017, we, through our wholly-owned subsidiary, Business Investment, had $69.7 million in borrowings, at cost, outstanding under the Credit Facility, which provides for maximum borrowings of $165.0 million, with a revolving period end date of November 15, 2019 (the “Revolving Period End Date”). The Credit Facility permits us to fund additional loans and investments as long as we are within the conditions and covenants set forth in the credit agreement. Among other things, the Credit Facility contains covenants that require Business Investment to maintain its status as a separate legal entity, prohibit certain significant corporate transactions (such as mergers, consolidations, liquidations or dissolutions) and restrict certain material changes to our credit and collection policy without the lenders’ consent. The Credit Facility also generally seeks to restrict distributions to stockholders to the sum of (i) our net investment income, (ii) net capital gains and (iii) amounts deemed by the Company to be considered as having been paid during the prior fiscal year in accordance with Section 855(a) of the Code. Loans eligible to be pledged as collateral are subject to certain limitations, including, among other things, restrictions on geographic concentrations, industry concentrations, loan size, payment frequency and status, average life, portfolio company leverage, and lien property. The Credit Facility also requires Business Investment to comply with other financial and operational covenants, which obligate Business Investment to, among other things, maintain certain financial ratios, including asset and interest coverage and a minimum number of obligors required in the borrowing base. Additionally, the Credit Facility contains a performance guaranty that requires the Company to maintain (i) a minimum net worth (defined in the Credit Facility to include our mandatory redeemable term preferred stock) of the greater of (a) $210.0 million or (b) $210.0 million plus 50% of all equity and subordinated debt raised minus 50% of any equity or subordinated debt redeemed or retired after November 16, 2016, which equated to $210.0 million as of March 31, 2017, (ii) asset coverage with respect to senior securities representing

 

20


Table of Contents

indebtedness of at least 200%, in accordance with Sections 18 and 61 of the 1940 Act and (iii) our status as a BDC under the 1940 Act and as a RIC under the Code. As of March 31, 2017, and as defined in the performance guaranty of the Credit Facility, we had a net worth of $434.3 million, an asset coverage ratio on our senior securities representing indebtedness of 661.3%, calculated in compliance with the requirements of Sections 18 and 61 of the 1940 Act, and an active status as a BDC and RIC. As of March 31, 2017, we were in compliance with all covenants under the Credit Facility; however, our continued compliance depends on many factors, some of which are beyond our control.

Given the continued uncertainty in the capital markets, the cumulative net unrealized depreciation in our portfolio may increase in future periods and threaten our ability to comply with the minimum net worth covenant and other covenants under the Credit Facility. Our failure to satisfy these covenants could result in foreclosure by our lenders, which would accelerate our repayment obligations under the facility and thereby have a material adverse effect on our business, liquidity, financial condition, results of operations and ability to pay distributions to our stockholders.

Any inability to renew, extend or replace the Credit Facility on terms favorable to us, or at all, could adversely impact our liquidity and ability to fund new investments or maintain distributions to our stockholders.

If the Credit Facility is not renewed or extended by the Revolving Period End Date, all principal and interest will be due and payable on or before November 15, 2021 (two years after the Revolving Period End Date). Subject to certain terms and conditions, the Credit Facility may be expanded to a total of $250 million through additional commitments of existing or new lenders. However, if such lenders are unwilling to provide additional commitments under the terms of the Credit Facility, we will be unable to expand the Credit Facility and our ability to finance new investments may be limited. There can be no guarantee that we will be able to renew, extend or replace the Credit Facility prior to the Revolving Period End Date on terms that are favorable to us, if at all. Our ability to expand the Credit Facility, and to obtain replacement financing at or before the time of its Revolving Period End Date, will be constrained by then-current economic conditions affecting the credit markets. In the event that we are not able to expand the Credit Facility, or to renew, extend or refinance the Credit Facility by the Revolving Period End Date, this could have a material adverse effect on our liquidity and ability to fund new investments, our ability to make distributions to our stockholders and our ability to qualify as a RIC under the Code.

If we are unable to secure replacement financing, we may be forced to sell certain assets on disadvantageous terms, which may result in realized losses, and such realized losses could materially exceed the amount of any unrealized depreciation on these assets as of our most recent balance sheet date, which would have a material adverse effect on our results of operations. Such circumstances would also increase the likelihood that we would be required to redeem some or all of our outstanding mandatorily redeemable preferred stock, which could potentially require us to sell more assets. In addition to selling assets, or as an alternative, we may issue common equity in order to repay amounts outstanding under the Credit Facility. Based on the recent trading prices of our common stock, such an equity offering may have a substantial dilutive impact on our existing stockholders’ interest in our earnings, assets and voting interest in us. If we are able to renew, extend or refinance the Credit Facility prior to maturity, renewal, extension or refinancing, it could potentially result in significantly higher interest rates and related charges and may impose significant restrictions on the use of borrowed funds to fund investments or to make distributions to common and preferred stockholders.

Because we expect to distribute substantially all of our Investment Company Taxable Income on an annual basis, our business plan is dependent upon external financing, which is constrained by the limitations of the 1940 Act.

We completed recent offerings of our common stock in March 2015 and May 2017 and of our Series B Term Preferred Stock, Series C Preferred Stock and Series D Term Preferred Stock in November 2014, May 2015 and September 2016, respectively. However, there can be no assurance that we will be able to raise capital

 

21


Table of Contents

through issuing equity in the future. Our business requires a substantial amount of cash to operate and grow. We may acquire such additional capital from the following sources:

 

    Senior Securities : We may issue senior securities representing indebtedness (including additional borrowings under the Credit Facility) and senior securities that are stock (including additional series of preferred stock), up to the maximum amount permitted by the 1940 Act. The 1940 Act currently permits us, as a BDC, to issue senior securities representing indebtedness and senior securities which are stock, in amounts such that our asset coverage, as defined in Section 18(h) of the 1940 Act, is at least 200% on each such senior security immediately after each issuance of each such senior security. As a result of incurring indebtedness (in whatever form), we will be exposed to the risks associated with leverage. Although borrowing money for investments increases the potential for gain, it also increases the risk of a loss. A decrease in the value of our investments will have a greater impact on the value of our common stock to the extent that we have borrowed money to make investments. There is a possibility that the costs of borrowing could exceed the income we receive on the investments we make with such borrowed funds. In addition, our ability to pay distributions, issue senior securities or repurchase shares of our common stock would be restricted if the asset coverage on each of our senior securities is not at least 200%. If the aggregate fair value of our assets declines, we might be unable to satisfy that 200% requirement. To satisfy the 200% asset coverage requirement in the event that we are seeking to pay a distribution, we might either have to (i) liquidate a portion of our loan portfolio to repay a portion of our indebtedness or (ii) issue common stock. This may occur at a time when a sale of a portfolio asset may be disadvantageous, or when we have limited access to capital markets on agreeable terms. In addition, any amounts that we use to service our indebtedness or for offering costs will not be available for distributions to stockholders. Furthermore, if we have to issue common stock below NAV per common share, any non-participating stockholders will be subject to dilution, as described below. Pursuant to Section 61(a)(2) of the 1940 Act, we are permitted, under specified conditions, to issue multiple classes of senior securities representing indebtedness. However, pursuant to Section 18(c) of the 1940 Act, we are permitted to issue only one class of senior securities that are stock (i.e., preferred stock).

 

    Common and Convertible Preferred Stock : Because we are constrained in our ability to issue debt or senior securities for the reasons given above, we are dependent on the issuance of equity as a financing source. If we raise additional funds by issuing more common stock, the percentage ownership of our common stockholders at the time of the issuance would decrease and, if such an issuance is at a price below our then current NAV per share, our existing common stockholders may experience dilution. In addition, under the 1940 Act, we will generally not be able to issue additional shares of our common stock at a price below NAV per common share to purchasers, other than to our existing common stockholders through a rights offering, without first obtaining the approval of our stockholders and our independent directors. If we were to sell shares of our common stock below our then current NAV per common share, as we did in October 2012, March 2015 and May 2017, such sales would result in an immediate dilution to the NAV per common share. This dilution would occur as a result of the sale of common shares at a price below the then current NAV per share of our common stock and a proportionately greater decrease in a common stockholder’s interest in our earnings and assets and voting percentage than the increase in our assets resulting from such issuance. For example, if we issue and sell an additional 10% of our common stock at a 5% discount from NAV, a common stockholder who does not participate in that offering for its proportionate interest will suffer NAV dilution of up to 0.5%, or $5 per $1,000 of NAV. This imposes constraints on our ability to raise capital when our common stock is trading below NAV per common share, as it generally has for the last several years. As noted above, the 1940 Act prohibits the issuance of multiple classes of senior securities that are stock. As a result, we would be prohibited from issuing convertible preferred stock to the extent that such a security was deemed to be a separate class of stock from our outstanding mandatorily redeemable preferred stock.

 

22


Table of Contents

We financed certain of our investments with borrowed money and capital from the issuance of senior securities, which will magnify the potential for gain or loss on amounts invested and may increase the risk of investing in us.

The following table illustrates the effect of leverage on returns from an investment in our common stock assuming various annual returns on our portfolio, net of expenses. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing in the table below.

 

    

Assumed Return on Our Portfolio

(Net of Expenses)

 
     (10 )%      (5 )%      0     5     10

Corresponding return to common stockholder (A)

     (21.2 )%      (12.6 )%      (4.1 )%      4.5     13.0

 

(A) The hypothetical return to common stockholders is calculated by multiplying our total assets as of March 31, 2017, by the assumed rates of return and subtracting all interest on our debt and dividends on our mandatorily redeemable preferred stock expected to be paid or declared during the twelve months following March 31, 2017; and then dividing the resulting difference by our total net assets attributable to common stock as of March 31, 2017. Based on $515.2 million in total assets, $69.7 million in borrowings outstanding on the Credit Facility, $5.1 million in a secured borrowing, $41.4 million in aggregate liquidation preference of Series B Term Preferred Stock, $40.3 million in aggregate liquidation preference of Series C Term Preferred Stock, $57.5 million in aggregate liquidation preference of Series D Term Preferred Stock and $301.1 million in net assets as of March 31, 2017.

Based on an aggregate outstanding indebtedness of $74.8 million at principal as of March 31, 2017, the effective annual interest rate of 4.3% as of that date, and aggregate liquidation preference of our mandatorily redeemable preferred stock of $139.2 million, our investment portfolio at fair value would have to produce an annual return of at least 2.4% to cover annual interest payments on the outstanding debt and dividends on our mandatorily redeemable preferred stock.

A change in interest rates may adversely affect our profitability and hedging arrangements may expose us to additional risks.

We anticipate using a combination of equity and long-term and short-term borrowings to finance our investment activities. As a result, a portion of our income will depend upon the spread between the rate at which we borrow funds and the rate at which we loan these funds. An increase or decrease in interest rates could reduce the spread between the rate at which we invest and the rate at which we borrow, and thus, adversely affect our profitability, if we have not appropriately hedged against such event. Alternatively, interest rate hedging arrangements may limit our ability to participate in the benefits of lower interest rates with respect to the hedged portfolio.

Ultimately, we expect approximately 90.0% of the loans in our portfolio to be at variable rates determined on the basis of the LIBOR and approximately 10.0% to be at fixed rates. As of March 31, 2017, based on the total principal balance of debt investments outstanding, our portfolio consisted of 92.9% of loans at variable rates with floors and 7.1% at fixed rates.

As of March 31, 2017, we did not have any hedging arrangement, such as interest rate hedges. While hedging arrangements may insulate us against adverse fluctuations in interest rates, they may also limit our ability to participate in the benefits of lower interest rates with respect to the hedged portfolio. Adverse developments resulting from changes in interest rates or any future hedging transactions could have a material adverse effect on our business, financial condition, results of operations, and cash flows. Our ability to receive payments pursuant to a hedging arrangement is linked to the ability of the counter-party to that hedging arrangement to make the required payments. To the extent that the counter-party to the hedging arrangement is unable to pay pursuant to the terms of the agreement, we may lose the hedging protection of the arrangement.

 

23


Table of Contents

Also, the fair value of certain of our debt investments is based, in part, on the current market yields or interest rates of similar securities. A change in interest rates could have a significant impact on our determination of the fair value of these debt investments. In addition, a change in interest rates could also have an impact on the fair value of any hedging arrangements then in effect that could result in the recording of unrealized appreciation or depreciation in future periods. Therefore, adverse developments resulting from changes in interest rates could have a material adverse effect on our business, financial condition, results of operations, and cash flows. For additional information on interest rate fluctuations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Quantitative and Qualitative Disclosures About Market Risk .”

Risks Related to Our Regulation and Structure

We will be subject to corporate-level tax if we are unable to satisfy Code requirements for RIC qualification.

To maintain our qualification as a RIC, we must maintain our status as a BDC and meet annual distribution, income source, and asset diversification requirements. The annual distribution requirement is satisfied if we distribute at least 90% of Investment Company Taxable Income to our stockholders on an annual basis. Because we use leverage, we are subject to certain asset coverage ratio requirements under the 1940 Act and could, under certain circumstances, be restricted from making distributions necessary to qualify as a RIC. Warrants we may receive with respect to debt investments will create original issue discount (“OID”), which we must recognize as ordinary income over the term of the debt investment. Similarly, PIK interest which is accrued generally over the term of the debt investment but not paid in cash, is recognized as ordinary income. Both OID and PIK interest will increase the amounts we are required to distribute to maintain our RIC status. Because such OIDs and PIK interest will not produce distributable cash for us at the same time as we are required to make distributions, we will need to use cash from other sources to satisfy such distribution requirements. As of March 31, 2017, we did not have investments with OID or a PIK feature. Additionally, we must meet asset diversification and income source requirements at the end of each calendar quarter. If we fail to meet these tests, we may need to quickly dispose of certain investments to prevent the loss of RIC status. Since most of our investments will be illiquid, such dispositions, if even possible, may not be made at prices advantageous to us and, in fact, may result in substantial losses. If we fail to qualify as a RIC as of a calendar quarter or annually for any reason and become fully subject to corporate income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution, and the actual amount distributed. Such a failure would have a material adverse effect on us and our common stock. For additional information regarding asset coverage ratio and RIC requirements, see “Material U.S. Federal Income Tax Considerations — RIC Status.”

Some of our debt investments may include success fees that would generally generate payments to us upon a change of control. Because the satisfaction of these success fees, and the ultimate payment of these fees, is uncertain and highly contingent, we generally only recognize them as income when the payment is received. Success fee amounts are characterized as ordinary income for tax purposes and, as a result, we are required to distribute such amounts to our stockholders in order to maintain our RIC status.

If we do not invest a sufficient portion of our assets in “qualifying assets,” we could fail to qualify as a BDC under the 1940 Act or be precluded from investing according to our current business strategy.

As a BDC, we may not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets are qualifying assets, as defined in Section 55(a) of the 1940 Act.

We believe that most of the investments that we may acquire in the future will constitute qualifying assets. However, we may be precluded from investing in what we believe to be attractive investments if such investments are not qualifying assets for purposes of the 1940 Act. If we do not invest a sufficient portion of our assets in qualifying assets, we could violate the 1940 Act provisions applicable to BDCs. As a result of such violation, specific rules under the 1940 Act could prevent us, for example, from making follow-on investments in

 

24


Table of Contents

existing portfolio companies (which could result in the dilution of our position) or could require us to dispose of investments at inappropriate times in order to come into compliance with the 1940 Act. If we need to dispose of such investments quickly, it could be difficult to dispose of such investments on favorable terms. We may not be able to find a buyer for such investments and, even if we do find a buyer, we may have to sell the investments at a substantial loss. Any such outcomes would have a material adverse effect on our business, financial condition, results of operations and cash flows.

If we do not maintain our status as a BDC, we would be subject to regulation as a registered closed-end investment company under the 1940 Act. As a registered closed-end investment company, we would be subject to substantially more regulatory restrictions under the 1940 Act, which would significantly decrease our operating flexibility. For additional information regarding qualifying assets, see “Regulation as a Business Development Company — Qualifying Assets.”

Changes in laws or regulations governing our operations, or changes in the interpretation thereof, and any failure by us to comply with laws or regulations governing our operations may adversely affect our business.

We, and our portfolio companies, are subject to regulation by laws at the local, state and federal levels. These laws and regulations, as well as their interpretation, may be changed from time to time. Accordingly, any change in these laws or regulations, or their interpretation, or any failure by us or our portfolio companies to comply with these laws or regulations may adversely affect our business. For additional information regarding the regulations to which we are subject, see “ Material U.S. Federal Income Tax Considerations — RIC Status” and “Regulation as a Business Development Company.

Provisions of the Delaware General Corporation Law and of our certificate of incorporation and bylaws could restrict a change in control and have an adverse impact on the price of our common stock.

We are subject to provisions of the Delaware General Corporation Law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for three years unless the holder’s acquisition of our stock was either approved in advance by our Board of Directors or ratified by our Board of Directors and stockholders owning two-thirds of our outstanding stock not owned by the acquiring holder. Although we believe these provisions collectively provide for an opportunity to receive higher bids by requiring potential acquirers to negotiate with our Board of Directors, they would apply even if the offer may be considered beneficial by some stockholders.

We have also adopted other measures that may make it difficult for a third party to obtain control of us, including provisions of our certificate of incorporation classifying our Board of Directors in three classes serving staggered three-year terms, and provisions of our certificate of incorporation authorizing our Board of Directors to induce the issuance of additional shares of our stock. These provisions, as well as other provisions of our certificate of incorporation and bylaws, may delay, defer, or prevent a transaction or a change in control that might otherwise be in the best interests of our stockholders.

We may not be permitted to declare a dividend or make any distribution to stockholders or repurchase shares until such time as we satisfy the asset coverage tests under the provisions of the 1940 Act that apply to BDCs. As a BDC, we have the ability to issue senior securities only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after each issuance of senior securities. If the value of our assets declines, we may be unable to satisfy this test. If that happens, we may be required to sell a portion of our investments and, depending on the nature of our leverage, repay a portion of our debt at a time when such sales and/or repayments may be disadvantageous.

Regulations governing our operation as a BDC and RIC will affect our ability to raise, and the way in which we raise, additional capital or borrow for investment purposes, which may have a negative effect on our growth. As a result of the annual distribution requirement to qualify as a RIC, we may need to periodically access the

 

25


Table of Contents

capital markets to raise cash to fund new investments. We may issue senior securities representing indebtedness, including borrowing money from banks or other financial institutions, or senior securities that are stock, such as our Series B Term Preferred Stock, our Series C Term Preferred Stock, and our Series D Term Preferred Stock, only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after each such incurrence or issuance. Further, we may not be permitted to declare a dividend or make any distribution to our outstanding stockholders or repurchase shares until such time as we satisfy this test. Our ability to issue different types of securities is also limited. Compliance with these requirements may unfavorably limit our investment opportunities and reduce our ability in comparison to other companies to profit from favorable spreads between the rates at which we can borrow and the rates at which we can lend. As a BDC, therefore, we intend to continuously issue equity at a rate more frequent than our privately owned competitors, which may lead to greater stockholder dilution. We have incurred leverage to generate capital to make additional investments. If the value of our assets declines, we may be unable to satisfy the asset coverage test under the 1940 Act, which could prohibit us from paying distributions and could prevent us from qualifying as a RIC. If we cannot satisfy the asset coverage test, we may be required to sell a portion of our investments and, depending on the nature of our debt financing, repay a portion of our indebtedness at a time when such sales and repayments may be disadvantageous.

The current U.S. presidential administration (the “Administration”) may make substantial changes to certain regulations that may adversely affect our business.

The Administration has called for substantial change to fiscal and tax policies, which may include comprehensive tax reform, including significant changes to taxation of business entities and the deductibility of interest expense. On February 3, 2017, President Trump signed an executive order calling for the Administration to review U.S. financial laws and regulations in order to determine their consistency with a set of core principles identified in the order. Some areas identified as subject to potential change, amendment or repeal include the Dodd-Frank Act, the Consumer Protection Act, the Volcker Rule, credit risk retention requirements and the authorities of the Fed and the Financial Stability Oversight Council. We cannot predict which, if any, of these or other actions will be taken or, if taken, their effect on the financial stability of the credit market in which we operate. Such actions could have a significant adverse effect on our business, financial condition, results of operations, and cash flows.

Risks Related to Our External Management

We are dependent upon our key management personnel and the key management personnel of the Adviser, particularly David Gladstone, Terry Lee Brubaker and David Dullum, and on the continued operations of the Adviser, for our future success.

We have no employees. Our chief executive officer, chief operating officer, chief financial officer and treasurer, chief valuation officer, and the employees of the Adviser do not spend all of their time managing our activities and our investment portfolio. We are particularly dependent upon David Gladstone, Terry Lee Brubaker and David Dullum for their experience, skills, and networks. Our executive officers and the employees of the Adviser allocate some, and in some cases a material portion, of their time to businesses and activities that are not related to our business. We have no separate facilities and are completely reliant on the Adviser, which has significant discretion as to the implementation and execution of our business strategies and risk management practices. We are subject to the risk of discontinuation of the Adviser’s operations or termination of the Advisory Agreement and the risk that, upon such event, no suitable replacement will be found. We believe that our success depends to a significant extent upon the Adviser and that discontinuation of its operations or the loss of its key management personnel could have a material adverse effect on our ability to achieve our investment objectives.

 

26


Table of Contents

Our success depends on the Adviser’s ability to attract and retain qualified personnel in a competitive environment.

The Adviser experiences competition in attracting and retaining qualified personnel, particularly investment professionals and senior executives, and we may be unable to maintain or grow our business if we cannot attract and retain such personnel. The Adviser’s ability to attract and retain personnel with the requisite credentials, experience and skills depends on several factors including its ability to offer competitive wages, benefits and professional growth opportunities. The Adviser competes with investment funds (such as private equity funds and mezzanine funds) and traditional financial services companies for qualified personnel, many of which have greater resources than us. Searches for qualified personnel may divert management’s time from the operation of our business. Strain on the existing personnel resources of the Adviser, in the event that it is unable to attract experienced investment professionals and senior executives, could have a material adverse effect on our business.

We are dependent upon the contacts and relationships of the Adviser to provide us with potential investment opportunities.

We depend upon the Adviser to maintain its relationships with private equity sponsors, placement agents, investment banks, management groups and other financial institutions, and we expect to rely to a significant extent upon these relationships to provide us with potential investment opportunities. If the Adviser or members of our investment team fail to maintain such relationships, or to develop new relationships with other sources of investment opportunities, we will not be able to grow our investment portfolio. In addition, individuals with whom the Adviser has relationships are not obligated to provide us with investment opportunities, and we can offer no assurance that these relationships will generate investment opportunities for us in the future. Failure of the Adviser to maintain such relationships or enter into new relationships that would generate additional investment opportunities, could have a material adverse effect on our business.

The Adviser can resign on 60 days’ notice, and we may not be able to find a suitable replacement within that time, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations.

The Adviser has the right to resign under the Advisory Agreement at any time upon not less than 60 days’ written notice, whether we have found a replacement or not. If the Adviser resigns, we may not be able to find a new investment adviser or hire internal management with similar expertise and ability to provide the same or equivalent services on acceptable terms within 60 days, or at all. If we are unable to do so quickly, our operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions are likely to be adversely affected and the market price of our common stock may decline. In addition, the coordination of our internal management and investment activities is likely to suffer if we are unable to identify and reach an agreement with a single institution or group of executives having the expertise possessed by the Adviser and its affiliates. Even if we are able to retain comparable management, whether internal or external, the integration of such management and their lack of familiarity with our investment objective may result in additional costs and time delays that may adversely affect our business, financial condition, results of operations and cash flows.

Our incentive fee may induce the Adviser to make certain investments, including speculative investments.

The management compensation structure that has been implemented under the Advisory Agreement may cause the Adviser to invest in high-risk investments or take other investment risks. In addition to its management fee, the Adviser is entitled under the Advisory Agreement to receive incentive compensation based in part upon our achievement of specified levels of income. In evaluating investments and other management strategies, the opportunity to earn incentive compensation based on net investment income may lead the Adviser to place undue emphasis on the maximization of net investment income at the expense of other criteria, such as preservation of capital, maintaining sufficient liquidity, or management of credit risk or market risk, in order to achieve higher

 

27


Table of Contents

incentive compensation. Investments with higher yield potential are generally riskier or more speculative. This could result in increased risk to the value of our investment portfolio.

We may be obligated to pay the Adviser incentive compensation even if we incur a net decrease in net assets.

The Advisory Agreement entitles the Adviser to incentive compensation for each fiscal quarter in an amount equal to a percentage of the excess of our net investment income for that quarter (before deducting the incentive fee) above a threshold return of 1.75% of our net assets, as adjusted, for that quarter. When calculating our incentive fee, our pre-incentive fee net investment income excludes realized losses and unrealized depreciation that we may incur in the fiscal quarter, even if such losses or depreciation result in a net decrease in net assets on our statement of operations for that quarter. Thus, we may be required to pay the Adviser incentive compensation for a fiscal quarter even if there is a decline in the value of our portfolio or we incur a net realized or unrealized loss for that quarter. For additional information on incentive compensation under the Advisory Agreement with the Adviser, see “ Business — Transactions with Related Parties — Investment Advisory and Management Agreement .”

We may be required to pay the Adviser incentive compensation on income accrued, but not yet received in cash.

The part of the incentive fee payable by us that relates to our net investment income is computed and paid on income that may include income that has been accrued but not yet received in cash, such as debt instruments with PIK interest. If a portfolio company defaults on a loan, it is possible that such accrued interest previously used in the calculation of the incentive fee will become uncollectible. Consequently, we may make incentive fee payments on income accruals that we may not collect in the future and with respect to which we do not have a clawback right against the Adviser. PIK income and any other non-cash income represented less than 1% of total investment income during the years ended March 31, 2017, 2016 and 2015.

The Adviser’s failure to identify and invest in securities that meet our investment criteria or perform its responsibilities under the Advisory Agreement would likely adversely affect our ability for future growth.

Our ability to achieve our investment objectives will depend on our ability to grow, which in turn will depend on the Adviser’s ability to identify and invest in securities that meet our investment criteria. Accomplishing this result on a cost-effective basis will be largely a function of the Adviser’s structuring of the investment process, its ability to provide competent and efficient services to us, and our access to financing on acceptable terms. The senior management team of the Adviser has substantial responsibilities under the Advisory Agreement. In order to grow, the Adviser will need to hire, train, supervise, and manage new employees successfully. Any failure to manage our future growth effectively would likely have a material adverse effect on our business, financial condition, and results of operations and cash flows.

There are significant potential conflicts of interest, including with the Adviser, which could impact our investment returns.

Our executive officers and directors, and the officers and directors of the Adviser, serve or may serve as officers, directors, or principals of entities that operate in the same or a related line of business as we do or of investment funds managed by our affiliates. Accordingly, they may have obligations to investors in those entities, the fulfillment of which might not be in the best interests of us or our stockholders. For example, Mr. Gladstone, our chairman and chief executive officer, is the chairman of the board and chief executive officer of the Adviser and Administrator, and the Affiliated Public Funds. In addition, Mr. Brubaker, our vice chairman and chief operating officer, is the vice chairman and chief operating officer of the Adviser and Administrator, and the Affiliated Public Funds. Mr. Dullum, our president, is an executive managing director of the Adviser. Moreover, the Adviser may establish or sponsor other investment vehicles which from time to time may have potentially overlapping investment objectives with ours and accordingly may invest in, whether principally or secondarily, asset classes we target. While the Adviser generally has broad authority to make investments on behalf of the

 

28


Table of Contents

investment vehicles that it advises, the Adviser has adopted investment allocation procedures to address these potential conflicts and intends to direct investment opportunities to the Company or the Affiliated Public Fund with the investment strategy that most closely fits the investment opportunity. Nevertheless, the management of the Adviser may face conflicts in the allocation of investment opportunities to other entities managed by the Adviser. As a result, it is possible that we may not be given the opportunity to participate in certain investments made by other funds managed by the Adviser. Our Board of Directors approved a revision of our investment objectives and strategies that became effective on January 1, 2013, which may enhance the potential for conflicts in the allocation of investment opportunities to us and other entities managed by the Adviser.

In certain circumstances, we may make investments in a portfolio company in which one of our affiliates has or will have an investment, subject to satisfaction of any regulatory restrictions and, where required, the prior approval of our Board of Directors. As of March 31, 2017, our Board of Directors has approved the following types of transactions:

 

    Our affiliate, Gladstone Commercial, may, under certain circumstances, lease property to portfolio companies that we do not control. We may pursue such transactions only if (i) the portfolio company is not controlled by us or any of our affiliates, (ii) the portfolio company satisfies the tenant underwriting criteria of Gladstone Commercial, and (iii) the transaction is approved by a majority of our independent directors and a majority of the independent directors of Gladstone Commercial. We expect that any such negotiations between Gladstone Commercial and our portfolio companies would result in lease terms consistent with the terms that the portfolio companies would be likely to receive were they not portfolio companies of ours.

 

    We may invest simultaneously with our affiliate Gladstone Capital in senior loans in the broadly syndicated market whereby neither we nor any affiliate has the ability to dictate the terms of the loans.

 

    Pursuant to the Co-Investment Order, under certain circumstances, we may co-invest with Gladstone Capital and any future BDC or closed-end management investment company that is advised by the Adviser (or sub-advised by the Adviser if it controls the fund) or any combination of the foregoing subject to the conditions included therein.

Certain of our officers, who are also officers of the Adviser, may from time to time serve as directors of certain of our portfolio companies. If an officer serves in such capacity with one of our portfolio companies, such officer will owe fiduciary duties to stockholders of the portfolio company, which duties may from time to time conflict with the interests of our stockholders.

In the course of our investing activities, we will pay management and incentive fees to the Adviser and will reimburse the Administrator for certain expenses it incurs. As a result, investors in our common stock will invest on a “gross” basis and receive distributions on a “net” basis after expenses, resulting in, among other things, a lower rate of return than one might achieve through our investors themselves making direct investments. As a result of this arrangement, there may be times when the management team of the Adviser has interests that differ from those of our stockholders, giving rise to a conflict. In addition, as a BDC, we make available significant managerial assistance to our portfolio companies and provide other services to such portfolio companies. While neither we nor the Adviser currently receive fees in connection with managerial assistance, the Adviser and Gladstone Securities have, at various times, provided other services to certain of our portfolio companies and received fees for services other than managerial assistance as discussed in “ Business — Ongoing Management of Investment Portfolio Company Relationships — Managerial Assistance and Services.”

Our business model is dependent upon developing and sustaining strong referral relationships with investment bankers, business brokers and other intermediaries and any change in our referral relationships may impact our business plan.

We are dependent upon informal relationships with investment bankers, business brokers and traditional lending institutions to provide us with deal flow. If we fail to maintain our relationship with such funds or

 

29


Table of Contents

institutions, or if we fail to establish strong referral relationships with other funds, we will not be able to grow our portfolio of investments and fully execute our business plan.

The Adviser is not obligated to provide credits of the base management fee or incentive fees, which could negatively impact our earnings and our ability to maintain our current level of distributions to our stockholders.

The Advisory Agreement provides for a base management fee, based on our gross assets, and an incentive fee, that is based on our income and capital gains. Our Board of Directors has accepted in the past and may accept in the future non-contractual, unconditional, and irrevocable credits to reduce the annual 2.0% base management fee or the incentive fee, on a quarterly or annual basis. Any fees credited may not be recouped by the Adviser in the future. However, the Adviser is not required to issue these or other credits of fees under the Advisory Agreement. If the Adviser does not issue these credits in the future, it could negatively impact our earnings and may compromise our ability to maintain our current level of distributions to our stockholders, which could have a material adverse impact on our common stock price.

Our base management fee may induce the Adviser to incur leverage.

The fact that our base management fee is payable based upon our gross assets, which would include any investments made with proceeds of borrowings, may encourage the Adviser to use leverage to make additional investments. Under certain circumstances, the use of increased leverage may increase the likelihood of default, which would disfavor holders of our securities. Given the subjective nature of the investment decisions made by the Adviser on our behalf, we will not be able to monitor this potential conflict of interest.

Risks Related to an Investment in Our Securities

We may experience fluctuations in our quarterly and annual operating results.

We may experience fluctuations in our quarterly and annual operating results due to a number of factors, including, among others, variations in our investment income, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, placing and removing investments on non-accrual status, the degree to which we encounter competition in our markets, the ability to sell investments at attractive terms, the ability to fund and close suitable investments, the degree to which we encounter competition in our markets, and general economic conditions, including the impacts of inflation. The majority of our portfolio companies are in industries that are directly impacted by inflation, such as manufacturing and consumer goods and services. Our portfolio companies may not be able to pass on to customers increases in their costs of production which could greatly affect their operating results, impacting their ability to service and repay our loans. In addition, any projected future decreases in our portfolio companies’ operating results due to inflation could adversely impact the fair value of those investments. Any decreases in the fair value of our investments could result in future realized and unrealized losses and therefore reduce our net assets. As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods.

There is a risk that you may not receive distributions or that distributions may not grow over time.

Our current intention is to distribute at least 90% of our Investment Company Taxable Income to our stockholders by paying monthly distributions. We may retain some or all realized long-term capital gains by first offsetting them with realized capital losses, and, secondly, through a “deemed distribution” to supplement our equity capital and support the growth of our portfolio, although our Board of Directors may determine to distribute these net long-term capital gains to our stockholders in cash. In addition, the Credit Facility restricts the amount of distributions we are permitted to make annually. We cannot assure investors that we will achieve investment results or maintain a tax status that will allow or require any specified level of cash distributions.

 

30


Table of Contents

Investing in our securities may involve an above average degree of risk.

The investments we make in accordance with our investment objective may result in a higher amount of risk than alternative investment options and a higher risk of volatility or loss of principal. Our investments in portfolio companies may be highly speculative, and therefore, an investment in our common stock may not be suitable for someone with lower risk tolerance.

Distributions to our common stockholders have included and may in the future include a return of capital.

Our Board of Directors declares monthly common distributions each quarter based on estimates of Investment Company Taxable Income for each fiscal year, which may differ, and in the past have differed, from actual results. Because our common distributions are based on estimates of Investment Company Taxable Income that may differ from actual results, future common distributions payable to our common stockholders may include a return of capital. Moreover, to the extent that we distribute amounts that exceed our accumulated earnings and profits, these distributions constitute a return of capital. A return of capital represents a return of a common stockholder’s original investment in common shares of our stock and should not be confused with a distribution from earnings and profits. Although return of capital distributions may not be taxable, such distributions may increase an investor’s tax liability for capital gains upon the sale of our common stock by reducing the investor’s tax basis for such common stock. Such returns of capital reduce our asset base and also adversely impact our ability to raise debt capital as a result of the leverage restrictions under the 1940 Act, which could have a material adverse impact on our ability to make new investments.

The market price of our shares may fluctuate significantly.

The trading price of our common stock and our preferred stock may fluctuate substantially. Due to the volatility and disruptions that have affected the capital and credit markets over the past few years, our stock has experienced greater than usual price volatility.

The market price and marketability of our shares may from time to time be significantly affected by numerous factors, including many over which we have no control and that may not be directly related to us. These factors include the following:

 

    General economic trends and other external factors, such as inflation, oil and gas prices, and gross domestic product growth;

 

    Price and volume fluctuations in the stock market from time to time, which are often unrelated to the operating performance of particular companies;

 

    Significant volatility in the market price and trading volume of shares of RICs, BDCs or other companies in our sector, which is not necessarily related to the operating performance of these companies;

 

    Changes in stock index definitions or policies, which may impact an investor’s desire to hold shares of BDCs;

 

    Changes in regulatory policies or tax guidelines, particularly with respect to RICs or BDCs;

 

    Loss of BDC status;

 

    Loss of RIC status;

 

    Changes in our earnings or variations in our operating results;

 

    Changes and perceived projected changes in prevailing interest rates;

 

    Changes in the value of our portfolio of investments;

 

31


Table of Contents
    Any shortfall in our revenue or net income or any increase in losses from levels expected by securities analysts;

 

    Departure of key personnel;

 

    Operating performance of companies comparable to us;

 

    Short-selling pressure with respect to our shares or BDCs generally;

 

    The announcement of proposed, or completed, offerings of our securities, including a rights offering; and

 

    Loss of a major funding source.

Fluctuations in the trading prices of our shares may adversely affect the liquidity of the trading market for our shares and, if we seek to raise capital through future equity financings, our ability to raise such equity capital.

Common shares of closed-end investment companies frequently trade at a discount from NAV.

Shares of closed-end investment companies frequently trade at a discount from NAV per common share. Since our inception, our common stock has at times traded above NAV and at times below NAV. During the past year, our common stock has at times traded significantly below NAV. Subsequent to March 31, 2017, and through July 27, 2017, our common stock has traded at discounts of up to 10.6% of our NAV per share, which was $9.95 as of March 31, 2017. This characteristic of shares of closed-end investment companies is separate and distinct from the risk that our NAV per share will decline. As with any stock, the price of our common shares will fluctuate with market conditions and other factors. If common shares are sold, the price received may be more or less than the original investment. Whether investors will realize gains or losses upon the sale of our shares will not depend directly upon our NAV, but will depend upon the market price of the shares at the time of sale. Since the market price of our common shares will be affected by such factors as the relative demand for and supply of the shares in the market, general market and economic conditions and other factors beyond our control, we cannot predict whether the common shares will trade at, below or above our NAV. Under the 1940 Act, we are generally not able to issue additional shares of our common stock at a price below NAV per share to purchasers other than our existing common stockholders through a rights offering without first obtaining the approval of our stockholders and our independent directors. Additionally, at times when our common stock is trading below its NAV per share, our dividend yield may exceed the weighted average returns that we would expect to realize on new investments that would be made with the proceeds from the sale of such stock, making it unlikely that we would determine to issue additional common shares in such circumstances. Thus, for as long as our common stock may trade below NAV, we generally will be subject to significant constraints on our ability to raise capital through the issuance of common stock. Additionally, an extended period of time in which we are unable to raise capital may restrict our ability to grow and adversely impact our ability to increase or maintain our distributions.

Common stockholders may incur dilution if we sell shares of our common stock in one or more offerings at prices below the then current NAV per share.

During the past year, our common stock has traded consistently, and at times significantly, below NAV. At our most recent annual meeting of stockholders on August 4, 2016, our stockholders authorized us, with subsequent Board approval, to sell shares of our common stock at prices below the then-current NAV per share in one or more offerings for a period of one year from the date of such authorization, subject to certain conditions (including that the number of common shares issued and sold pursuant to such authority does not exceed 25% of our then outstanding common stock immediately prior to each such sale). At the upcoming annual meeting of stockholders scheduled for August 3, 2017, we intend to ask our stockholders to vote in favor of renewing this authorization for another year. Any decision to sell shares of our common stock below the then current NAV per share of our common stock would be subject to the determination by our Board of Directors that such issuance is in our and our stockholders’ best interests.

 

32


Table of Contents

With previous approval from our stockholders, we exercised this right, with our Board of Director’s approval, in May 2017, when we completed a public offering of 2.1 million shares of our common stock at a public offering price of $9.38 per share, which was below our then-current estimated NAV of $9.95 per share. Gross proceeds totaled $19.7 million and net proceeds, after deducting underwriting discounts and commissions and estimated offering costs borne by us, were $18.7 million. On June 2, 2017, we issued an additional 155,265 shares of our common stock at a public offering price of $9.38 per share in connection with the partial exercise of the underwriters’ option to purchase additional shares of common stock on the same terms and conditions solely to cover over-allotments, which resulted in gross proceeds of approximately $1.5 million, and net proceeds, after deducting underwriting discounts and commissions and estimated offering costs borne by us, of approximately $1.4 million. The net dilutive effect of the issuance of common stock, net of estimated expenses, below NAV was $0.07 per share of common stock. Prior to the May 2017 offering, in March 2015, with previous approval from our stockholders, we exercised this right with our Board of Director’s approval, when we completed a public offering of 3.3 million shares of our common stock at a public offering price of $7.40 per share, which was below our then-current NAV of $8.55 per share. Gross proceeds totaled $24.4 million and net proceeds, after deducting underwriting discounts and offering costs borne by us, were $23.0 million. In April 2015, the underwriters exercised their option to purchase an additional 495,000 shares at the public offering price of $7.40 per share to cover over-allotments, which resulted in gross proceeds of $3.7 million and net proceeds, after deducting underwriting discounts and offering costs borne by us, of $3.4 million. The net dilutive effect of the issuance of common stock, net of expenses, below NAV was $0.25 per share of common stock. Additionally and with previous approval from our stockholders, we also exercised this right with our Board of Director’s approval in October 2012, when we completed a public offering of 4.4 million shares of our common stock at a public offering price of $7.50 per share, which was below our then-current NAV of $8.65 per share. Gross proceeds totaled $33.0 million and net proceeds, after deducting underwriting discounts and offering costs borne by us, were $31.0 million. The net dilutive effect of the issuance of common stock, net of expenses, below NAV was $0.31 per share of common stock.

If we were to sell shares of our common stock below NAV per share, such sales would result in an immediate dilution to the NAV per share. This dilution would occur as a result of the sale of shares at a price below the then current NAV per share of our common stock and a proportionately greater decrease in a common stockholder’s interest in our earnings and assets and voting interest in us than the increase in our assets resulting from such issuance. The greater the difference between the sale price and the NAV per share at the time of the offering, the more significant the dilutive impact would be. Because the number of shares of common stock that could be so issued and the timing of any issuance is not currently known, the actual dilutive effect, if any, cannot be currently predicted. However, if, for example, we sold an additional 10% of our common stock at a 5% discount from NAV, an existing common stockholder who did not participate in that offering for its proportionate interest would suffer NAV dilution of up to 0.5% or $5 per $1,000 of NAV.

If we fail to pay dividends on our mandatorily redeemable preferred stock for two years, the holders of our preferred stock will be entitled to elect a majority of our directors.

The terms of our three series of mandatorily redeemable preferred stock provide for annual dividends of $1.6875, $1.6250 and $1.5625 per outstanding share of our Series B Term Preferred Stock, Series C Term Preferred Stock and Series D Term Preferred Stock, respectively. In accordance with the terms of each of our three series of mandatorily redeemable term preferred stock, if dividends thereon are unpaid in an amount equal to at least two years of dividends, the holders of such series of stock will be entitled to elect a majority of our Board of Directors.

Holders of our debt or Term Preferred Stock have liquidation and other rights that are senior to the rights of the holders of our common stock. Any future issuance of debt or preferred stock could adversely affect the market price of our common stock.

We may in the future raise additional capital through the issuance of debt or additional shares of preferred stock. Our Board of Directors is authorized to issue one or more classes or series of preferred stock from time to

 

33


Table of Contents

time without any action on the part of the stockholders, as it has done with respect to the outstanding Term Preferred Stock. Our Board of Directors also has the power, without stockholder approval, to set the terms of any such classes or series of preferred stock that may be issued, including voting rights, dividend rights and preferences over our common stock with respect to dividends or upon our dissolution, winding-up or liquidation, and other terms. Holders of our outstanding Term Preferred Stock have, and holders of any future debt securities will have, preference over our common stock with respect to the payment of dividends and upon our liquidation, dissolution or winding-up. This will reduce the amount of our assets, if any, available for distribution to holders of our common stock. The decision to issue debt or preferred stock is dependent on market conditions and other factors that may be beyond our control. As a result, we cannot predict or estimate the amount, timing or nature of our future issuances. Any such future issuance could reduce the market price of our common stock.

Additionally, if we issue additional preferred stock with voting rights that dilute the voting power of our common stock, the rights of holders of our common stock or the market price of our common stock could be adversely affected.

An active trading market for the Term Preferred Stock may not exist or continue, which could adversely affect the market price of the Term Preferred Stock or a holder’s ability to sell its shares.

The Series B Term Preferred Stock, Series C Term Preferred Stock and Series D Term Preferred Stock are listed on NASDAQ under the symbols “GAINO”, “GAINN” and “GAINM”, respectively. However, we cannot provide any assurances that an active trading market for the Term Preferred Stock will exist in the future or that you will be able to sell your shares of Term Preferred Stock. Even if an active trading market does exist, shares of the Term Preferred Stock may trade at a discount from the liquidation preference for such shares depending on prevailing interest rates, the market for similar securities, general economic conditions, our issuance of debt or preferred equity securities and our financial condition, results of operation and prospects. To the extent an active trading market does not exist, the liquidity and trading price for shares of the Term Preferred Stock may be harmed. Accordingly, holders may be required to bear the financial risk of an investment in the Term Preferred Stock for an indefinite period of time.

An investment in preferred stock with a fixed interest rate bears interest rate risk.

Our Term Preferred Stock pays dividends at a fixed dividend rate. Prices of fixed income investments vary inversely with changes in market yields. The market yields on securities comparable to our Term Preferred Stock may increase, which would likely result in a decline in the secondary market price of Term Preferred Stock prior to the mandatory redemption date for that series of Term Preferred Stock. This risk may be even more significant in light of low currently prevailing market interest rates.

The Term Preferred Stock is not rated.

The Term Preferred Stock is not rated by any rating agency. Unrated securities usually trade at a discount to similar, rated securities. As a result, the Term Preferred Stock may trade at a price that is lower than it might otherwise trade if rated by a rating agency.

The Term Preferred Stock bears a risk of early redemption by us.

We may voluntarily redeem some or all of the Series B Term Preferred Stock on or after December 31, 2017, the Series C Term Preferred Stock on or after May 31, 2018 and the Series D Term Preferred Stock on or after September 30, 2018. We also may be forced to redeem some or all of the outstanding shares of Term Preferred Stock to meet regulatory requirements or the asset coverage requirements of such shares. We are also required to redeem all of the Term Preferred Stock upon certain change of control transactions. Any such redemption may occur at a time that is unfavorable to holders of the affected series of Term Preferred Stock. We

 

34


Table of Contents

may have an incentive to redeem a series of Term Preferred Stock voluntarily before the mandatory redemption date for such series if market conditions allow us to issue other preferred stock or debt securities at a rate that is lower than the dividend rate on such series of Term Preferred Stock or for other reasons. If we redeem shares of the Term Preferred Stock before the mandatory redemption date for such series of Term Preferred Stock, the holders of such redeemed shares face the risk that the return on an investment purchased with proceeds from such redemption may be lower than the return previously obtained from the investment in the Term Preferred Stock.

Claims of holders of the Term Preferred Stock will be subject to a risk of subordination relative to holders of our debt instruments.

While holders of the Term Preferred Stock will have equal liquidation rights to the holder of any other outstanding series of our preferred stock, such holders will be subordinated to the rights of holders of our current and any future indebtedness, including the Credit Facility. Even though the Term Preferred Stock is classified as a liability for purposes of accounting principles generally accepted in the United States (“GAAP”) and considered senior securities under the 1940 Act, the Term Preferred Stock are not debt instruments. Therefore, dividends, distributions and other payments to holders of Term Preferred Stock in liquidation or otherwise may be subject to prior payments due to the holders of our indebtedness. In addition, under some circumstances the 1940 Act may provide debt holders with voting rights that are superior to the voting rights of holders of the Term Preferred Stock.

Holders of the Term Preferred Stock will bear dividend risk.

We may be unable to pay dividends on the Term Preferred Stock under some circumstances. The terms of our indebtedness, including the Credit Facility, preclude the payment of dividends in respect of equity securities, including the Term Preferred Stock, under certain conditions.

There is a risk of delay in our redemption of the Term Preferred Stock, and we may fail to redeem such securities as required by their terms.

We generally make investments in private companies whose securities are not traded in any public market. Substantially all of the investments we presently hold and the investments we expect to acquire in the future are, and will be, subject to legal and other restrictions on resale and will otherwise be less liquid than publicly traded securities. The illiquidity of our investments may make it difficult for us to obtain cash equal to the value at which we record our investments quickly if a need arises. If we are unable to obtain sufficient liquidity prior to the mandatory redemption date or any other date on which we are required by law or the terms of a series of Term Preferred Stock to redeem shares of such series, we may be forced to engage in a partial redemption or to delay a required redemption. If such a partial redemption or delay were to occur, the market price of the Term Preferred Stock might be adversely affected.

Other Risks

Uncertainty in the current global market and the condition of the U.S. debt and equity capital markets could negatively impact our financial condition and stock price.

In the recent past, the global capital markets experienced periods of disruption resulting from a lack of liquidity in parts of the debt capital markets, significant write-offs in the financial services sector, and other factors. These events led to a general decline in U.S. economic conditions and the overall confidence in the debt and equity markets. While the market has since improved and investors have regained confidence, the macroeconomic environment and recovery from the downturn has been challenging and inconsistent and remains uncertain given the global economic effects of recent events, including the United Kingdom’s exit from the European Union and proposed amendments to certain regulations from the new Administration. Instability in the credit markets, the impact of periodic uncertainty regarding the U.S. federal budget, tapering of bond purchases

 

35


Table of Contents

by the Fed and debt ceiling, the instability in the geopolitical environment in many parts of the world, sovereign debt conditions in Europe and other disruptions may continue to put pressure on economic conditions in the U.S. and abroad, all of which can have an adverse effect on our business. We do not know how long the financial markets will continue to be affected by these events or how severely such effect may be and cannot predict the effects of these or similar events in the future on the U.S. economy and securities markets or on our investments. We monitor developments and seek to manage our investments in a manner consistent with achieving our investment objective, but there can be no assurance that we will be successful in doing so.

Economic recessions or downturns could impair our portfolio companies and harm our operating results.

Many of our portfolio companies may be susceptible to economic downturns or recessions and may be unable to repay our loans during these periods. Therefore, during these periods, our non-performing assets may increase and the value of these assets may decrease. Adverse economic conditions may also decrease the value of collateral securing some of our loans and the value of our equity investments. Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in investment income, net investment income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing investments and harm our operating results. We experienced to some extent such effects as a result of the economic downturn that occurred from 2008 through 2009 and may experience such effects again in any future downturn or recession.

We could face losses and potential liability if intrusion, viruses or similar disruptions to our technology and communications systems.

We depend on the technology and communications systems of the Adviser, the Administrator and their affiliates as well as certain third-party service providers. Any failure or interruption in these systems could disrupt our activities. In addition, these systems are subject to potential attacks, which may disrupt our operations, corrupt our financial or other data and/or result in a third party gaining access to confidential information about us or our portfolio companies. Although we have implemented, and will continue to implement and upgrade, security measures, our technology and communications systems are and will continue to be vulnerable to intrusion, computer viruses or similar disruptive problems. Any such attack could result in misstated or unreliable financial data, liability for stolen assets or information, increased cybersecurity protection and insurance costs, litigation and damage to our business relationships, any of which could have a material adverse effect on our business, financial condition and results of operations.

Terrorist attacks, acts of war, or national disasters may affect any market for our stock, impact the businesses in which we invest, and harm our business, operating results, and financial conditions.

Terrorist acts, acts of war, or national disasters have created, and continue to create, economic and political uncertainties and have contributed to global economic instability. Future terrorist activities, military or security operations, or national disasters could further weaken the domestic/global economies and create additional uncertainties, which may negatively impact the businesses in which we invest directly or indirectly and, in turn, could have a material adverse impact on our business, operating results, and financial condition. Losses from terrorist attacks and national disasters are generally uninsurable.

 

36


Table of Contents

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

All statements contained or incorporated by reference in this prospectus or any accompanying prospectus supplement, other than historical facts, may constitute “forward-looking statements.” These statements may relate to, among other things, future events or our future performance or financial condition of us and our portfolio companies. In some cases, you can identify forward-looking statements by terminology such as “estimate,” “may,” “might,” “believe,” “will,” “provided,” “anticipate,” “future,” “could,” “growth,” “plan,” “project,” “intend,” “expect,” “should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” or the negative or other variations of such terms or comparable terminology. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Such factors include:

 

    further adverse changes in the economy and the capital markets;

 

    risks associated with negotiation and consummation of pending and future transactions;

 

    the loss of one or more of our executive officers, in particular David Gladstone, David Dullum or Terry Lee Brubaker;

 

    changes in our investment objectives and strategy;

 

    availability, terms (including the possibility of interest rate volatility) and deployment of capital;

 

    changes in our industry, interest rates, exchange rates, regulation or the general economy;

 

    our business prospects and the prospects of our portfolio companies;

 

    the degree and nature of our competition;

 

    our ability to maintain our qualification as a RIC and as a BDC; and

 

    those factors described in the “ Risk Factors ” section of this prospectus and any accompanying prospectus supplement.

We caution readers not to place undue reliance on any such forward-looking statement, which speak only as of the date made. Actual results could differ materially from those anticipated in our forward-looking statements and future results could differ materially from historical performance. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this prospectus. The forward-looking statements contained or incorporated by reference in this prospectus or any accompanying prospectus supplement are excluded from the safe harbor protection provided by the Private Securities Litigation Reform Act of 1995 and Section 27A of the Securities Act.

 

37


Table of Contents

USE OF PROCEEDS

Unless otherwise specified in any prospectus supplement accompanying this prospectus, we intend to use the net proceeds from the sale of the Securities first to pay down outstanding debt (which may include borrowings under the Credit Facility), if any, then to make investments in accordance with our investment objectives and strategy, with any remaining proceeds to be used for other general corporate purposes. Indebtedness outstanding under our Credit Facility as of March 31, 2017 was $69.7 million and advances under the Credit Facility generally bear interest at 30-day LIBOR plus 3.15% per annum until November 15, 2019, with the margin then increasing to 3.40% for the period from November 15, 2019 to November 15, 2020, and increasing further to 3.65% thereafter through maturity. If not renewed or extended by November 15, 2019, all principal and interest will be due and payable on or before November 15, 2021. We anticipate that substantially all of the net proceeds of any offering of Securities will be utilized in the manner described above within three months of the completion of such offering. Pending such utilization, we intend to invest the net proceeds of any offering of Securities primarily in cash, cash equivalents, U.S. government securities, and other high-quality debt investments that mature in one year or less from the date of investment, consistent with the requirements for continued qualification as a RIC for federal income tax purposes. These temporary investments may have lower yields than our other investments and, accordingly, may result in lower distributions, if any, during such period. Our ability to achieve our investment objective may be limited to the extent that the net proceeds from an offering, pending full investment, are held in lower yielding interest-bearing deposits or other short-term instruments.

 

38


Table of Contents

PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS

We currently intend to distribute in the form of cash distributions, a minimum of 90% of our Investment Company Taxable Income, if any, to our stockholders in the form of monthly distributions. We may retain net long-term capital gains in excess of net short-term capital losses and treat them as deemed distributions for tax purposes or may distribute such amounts as supplemental distributions. The tax characteristics of distributions are reported annually to each stockholder on IRS Form 1099-DIV. There is no assurance that we will achieve investment results or maintain a tax status that will permit any specified level of cash distributions or year-to-year increases in cash distributions. At the option of a holder of record of common stock, all cash distributions with respect to shares of our common stock can be reinvested automatically under the dividend reinvestment plan. A stockholder whose shares of our common stock are held in the name of a broker or other nominee should contact the broker or nominee regarding participation in the dividend reinvestment plan on the stockholder’s behalf. See “ Risk Factors—Risks Related to Our Regulation and Structure—We will be subject to corporate-level tax if we are unable to satisfy Code requirements for RIC qualification ,” “ Dividend Reinvestment Plan ” and “ Material U.S. Federal Income Tax Considerations .”

Our common stock is traded on NASDAQ under the symbol “GAIN.” The following table reflects, by quarter, the high and low intraday sales prices per share of our common stock on NASDAQ, the intraday sales prices as a percentage of NAV and distributions declared per share of our common stock for each fiscal quarter during the last two completed fiscal years and the current fiscal year through July 27, 2017.

 

     Net Asset
Value Per

Share (1)
     Sales Price      Distribution
Declared
    Discount of
High Sales Price
to Net Asset
Value (2)
    Discount of Low
Sales Price to Net

Asset  Value (2)
 
        High      Low         

Fiscal Year ended March 31, 2016

               

First Quarter

   $ 9.24      $ 8.10      $ 7.35      $ 0.1875       12 %     20 %

Second Quarter

     9.05        8.25        6.66        0.1875       9       26  

Third Quarter

     8.66        8.00        6.96        0.1875       8       20  

Fourth Quarter

     9.22        7.96        6.40        0.1875       14       31  

Fiscal Year ended March 31, 2017

               

First Quarter

     9.84        7.24        6.65        0.1875       26       32  

Second Quarter

     9.65        9.30        7.16        0.1875       4       26  

Third Quarter

     9.82        9.15        7.16        0.1875       7       27  

Fourth Quarter

     9.95        9.36        8.45        0.1875       6       15  

Fiscal Year ending March 31, 2018

               

First Quarter

     *        9.84        8.90        0.2520 (3)       *       *  

Second Quarter (through July 27, 2017)

     *        9.55        9.25        0.1920       *       *  

 

(1) NAV per share is determined as of the last day in the relevant quarter and therefore may not reflect the NAV per common share on the date of the high and low intra-day sales prices. The NAVs per share shown are based on outstanding common shares at the end of each period.
(2) The discounts set forth in these columns represent the high or low, as applicable, intra-day sale prices per share for the relevant quarter minus the NAV per share as of the end of such quarter, and therefore may not reflect the discount to NAV per share on the date of the high and low intra-day sales prices.
(3) Includes a supplemental distribution of $0.06 per share of common stock.
* Not yet available, as the NAV per share as of the end of this quarter has not yet been finalized.

Common shares of closed-end investment companies, including BDCs, frequently trade at a discount to their NAV per share. The possibility that our common shares may trade at such discount to our NAV per share is separate and distinct from the risk that our NAV per share may decline. We cannot predict whether our common shares will trade at prices above, at or below our NAV per share, although during the past two years, our common stock has consistently traded, and at times significantly, below NAV

As of July 24, 2017, there were 21 record owners of our common stock.

 

39


Table of Contents

RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED DIVIDENDS

For the years ended March 31, 2017, 2016, 2015, 2014 and 2013, the ratio of earnings to combined fixed charges and preferred dividends of the Company, computed as set forth below, was as follows:

 

     Year Ended March 31,  
     2017      2016      2015      2014      2013  

Ratio of earnings to combined fixed charges and preferred dividends

     2.6x      2.5x      3.3x      4.2x      4.5x

For purposes of computing the ratio, “earnings” consist of net investment income before fixed charges and preferred dividends. “Fixed charges and preferred dividends” consist of interest expense, amortization of deferred financing costs and discounts, preferred dividends on our outstanding series of mandatorily redeemable preferred stock, and the portion of operating lease expense that represents interest. The portion of operating lease expense that represents interest is calculated by dividing the amount of rent expense, allocated to us by our Administrator as part of the administration fee payable under the Administration Agreement, by three. You should read these ratios of earnings to combined fixed charges and preferred dividends in connection with our consolidated financial statements, including the notes to those statements, included elsewhere in this prospectus.

 

40


Table of Contents

CONSOLIDATED SELECTED FINANCIAL AND OTHER DATA

The following consolidated selected financial data as of and for the fiscal years ended March 31, 2017, 2016, 2015, 2014 and 2013, are derived from our audited Consolidated Financial Statements found elsewhere in this prospectus. The other data included in the second table below is unaudited. The data should be read in conjunction with our audited Consolidated Financial Statements and notes thereto and “ Management’s Discussion and Analysis of Financial Condition and Results of Operations ” included elsewhere in this prospectus.

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)

 

    Year Ended March 31,  
    2017     2016     2015     2014     2013  

Statement of Operations Data:

         

Total investment income

  $ 51,875     $ 50,955     $ 41,643     $ 36,264     $ 30,538  

Total expenses, net of credits from Adviser

    29,542       30,239       21,746       16,957       14,050  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

    22,422       20,716       19,897       19,307       16,488  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net realized and unrealized gain (loss)

    22,341       4,138       30,317       (20,636 )     791  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in net assets resulting from operations

  $ 44,763     $ 24,854     $ 50,214     $ (1,329 )   $ 17,279  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Per Common Share Data:

         

Net increase (decrease) in net assets resulting from operations per common share—basic and diluted (A)

  $ 1.48     $ 0.82     $ 1.88     $ (0.05 )   $ 0.71  

Net investment income before net gain (loss) on investments per common share—basic and diluted (A)

    0.74       0.68       0.75       0.73       0.68  

Cash distributions declared per common share (B)

    0.75       0.75       0.77       0.71       0.60  

Statement of Assets and Liabilities Data:

         

Total assets

  $ 515,195     $ 506,260     $ 483,521     $ 330,694     $ 379,803  

Net assets

    301,082       279,022       273,429       220,837       240,963  

Net asset value per common share

    9.95       9.22       9.18       8.34       9.10  

Common shares outstanding

    30,270,958       30,270,958       29,775,958       26,475,958       26,475,958  

Weighted common shares outstanding—basic and diluted

    30,270,958       30,268,253       26,665,821       26,475,958       24,189,148  

Senior Securities Data:

         

Total borrowings, at cost (C)

  $ 74,796     $ 100,096     $ 123,896     $ 66,250     $ 94,016  

Mandatorily redeemable preferred stock (D)

    139,150       121,650       81,400       40,000       40,000  

 

(A)   Per share data is based on the weighted average common stock outstanding for both basic and diluted.
(B)   The tax character of distributions is determined on an annual basis. For further information on the estimated character of our distributions to common stockholders, please refer to Note 9— Distributions to Common Stockholders to our consolidated financial statements included elsewhere in this prospectus.
(C)  

Includes borrowings under our Credit Facility, other secured borrowings, and short-term loans, as applicable.

 

41


Table of Contents
(D)   Represents the total liquidation preference of our mandatorily redeemable preferred stock.

 

     Year Ended March 31,  
     2017     2016     2015     2014     2013  

Other Unaudited Data:

          

Number of portfolio companies

     35       36       34       29       21  

Average size of portfolio company investment at cost

   $ 15,005     $ 14,392     $ 14,861     $ 13,225     $ 15,544  

Principal amount of new investments

     54,370       69,380       108,197       132,291       87,607  

Proceeds from loan repayments and investments sold

     68,825       44,582       11,260       83,415       28,424  

Weighted average yield on investments, excluding loans on non-accrual status (A)

     12.65       12.62 %     12.60 %     12.61 %     12.51 %

Weighted average yield on investments, including loans on non-accrual status (B)

     12.44 %       12.33     12.12     11.65     11.34

Total return (C)

     41.58       4.82       11.96       24.26       4.73  

 

(A)   Weighted average yield on investments, excluding loans on non-accrual status, equals interest income earned on investments divided by the weighted average interest-bearing principal balance throughout the fiscal year.
(B)   Weighted average yield on investments, including loans on non-accrual status, equals interest income earned on investments divided by the weighted average total principal balance throughout the fiscal year.
(C)   Total return equals the change in the ending market value of our common stock from the beginning of the fiscal year, taking into account common dividends reinvested in accordance with the terms of the dividend reinvestment plan. Total return does not take into account common distributions that may be characterized as a return of capital. For further information on the estimated character of our distributions to common stockholders, please refer to Note 9— Distributions to Common Stockholders to our consolidated financial statements included elsewhere in this prospectus.

 

42


Table of Contents

SELECTED QUARTERLY FINANCIAL DATA

The following tables set forth certain quarterly financial information for each of the eight quarters in the two years ended March 31, 2017. The information was derived from our unaudited consolidated financial statements. Results for any quarter are not necessarily indicative of results for the past fiscal year or for any future quarter.

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)

 

     Quarter Ended  

Year ended March 31, 2017

   June 30, 2016      September 30, 2016      December 31, 2016      March 31, 2017  

Total investment income

   $ 14,393      $ 11,744      $ 13,374      $ 12,364  

Net investment income

     6,812        5,112        5,204        5,294  

Net increase (decrease) in net assets resulting from operations

     24,534        (102      10,955        9,376  

Net increase (decrease) in net assets resulting from operations per weighted average common share – basic & diluted

   $ 0.81      $ —        $ 0.36      $ 0.31  
     Quarter Ended  

Year ended March 31, 2016

   June 30, 2015      September 30, 2015      December 31, 2015      March 31, 2016  

Total investment income

   $ 12,706      $ 13,740      $ 12,068      $ 12,441  

Net investment income

     5,163        6,023        4,631        4,899  

Net increase (decrease) in net assets resulting from operations

     8,559        (110      (6,213      22,618  

Net increase (decrease) in net assets resulting from operations per weighted average common share – basic & diluted

   $ 0.29      $ —        $ (0.21    $ 0.74  

 

43


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(dollar amounts in thousands, except per share data and as otherwise indicated)

The following analysis of our financial condition and results of operations should be read in conjunction with our accompanying Consolidated Financial Statements and the notes thereto contained elsewhere in this prospectus. Historical financial condition and results of operations and percentage relationships among any amounts in the financial statements are not necessarily indicative of financial condition, results of operations or percentage relationships for any future periods.

OVERVIEW

General

We were incorporated under the General Corporation Laws of the State of Delaware on February 18, 2005. On June 22, 2005, we completed our initial public offering and commenced operations. We operate as an externally managed, closed-end, non-diversified management investment company and have elected to be treated as a BDC under the 1940 Act. For federal income tax purposes, we have elected to be treated as a RIC under Subchapter M of the Code. In order to continue to qualify as a RIC for federal income tax purposes and obtain favorable RIC tax treatment, we must meet certain requirements, including certain minimum distribution requirements.

We were established for the purpose of investing in debt and equity securities of established private businesses operating in the United States. Our investment objectives are to: (i) achieve and grow current income by investing in debt securities of established businesses that we believe will provide stable earnings and cash flow to pay expenses, make principal and interest payments on our outstanding indebtedness and make distributions to stockholders that grow over time; and (ii) provide our stockholders with long-term capital appreciation in the value of our assets by investing in equity securities, generally in combination with the aforementioned debt securities, of established businesses that we believe can grow over time to permit us to sell our equity investments for capital gains. To achieve our objectives, our investment strategy is to invest in several categories of debt and equity securities, with individual investments generally totaling up to $30 million, although investment size may vary, depending upon our total assets or available capital at the time of investment. We intend that our investment portfolio over time will consist of approximately 75% in debt securities and 25% in equity securities, at cost. As of March 31, 2017, our investment portfolio was made up of 72.0% in debt securities and 28.0% in equity securities, at cost.

We focus on investing in Lower Middle Market private businesses in the United States that meet certain criteria, including the following: the sustainability of the business’ free cash flow and its ability to grow it over time, adequate assets for loan collateral, experienced management teams with a significant ownership interest in the borrower, reasonable capitalization of the borrower, including an ample equity contribution or cushion based on prevailing enterprise valuation multiples, and the potential to realize appreciation and gain liquidity in our equity position, if any. We anticipate that liquidity in our equity position will be achieved through a merger or acquisition of the borrower, a public offering of the borrower’s stock or by exercising our right to require the borrower to repurchase our warrants, though there can be no assurance that we will always have these rights. We lend to borrowers that need funds for growth capital or to finance acquisitions or recapitalize or refinance their existing debt facilities. We seek to avoid investing in high-risk, early-stage enterprises.

We invest by ourselves or jointly with other funds and/or management of the portfolio company, depending on the opportunity, and have opportunistically made several co-investments with our affiliate Gladstone Capital pursuant to the Co-Investment Order. We believe the Co-Investment Order has enhanced and will continue to enhance our ability to further our investment objectives and strategies. If we are participating in an investment with one or more co-investors, whether or not an affiliate of ours, our investment is likely to be smaller than if we were investing alone.

 

44


Table of Contents

Business

Portfolio Activity

While the business environment remains competitive, we continue to see new investment opportunities consistent with our investment strategy of providing a combination of debt and equity in support of management and sponsor-led buyouts of Lower Middle Market companies in the United States. For the fiscal year ended March 31, 2017, we invested a total of $54.4 million in two new portfolio companies and exited three existing portfolio companies with a combined fair value prior to their sales of $70.8 million resulting in a net reduction of one company from our portfolio, which was comprised of 35 companies as of March 31, 2017. From our initial public offering in June 2005 through March 31, 2017, we have made investments in 45 companies, excluding investments in syndicated loans, for a total of approximately $914 million, before giving effect to principal repayments and divestures.

The majority of the debt securities in our portfolio have a success fee component, which enhances the yield on our debt investments. Unlike PIK income, we generally do not recognize success fees as income until they are received in cash. Due to the contingent nature of success fees, there are no guarantees that we will be able to collect any or all of these success fees or know the timing of any such collections. As a result, as of March 31, 2017, we had unrecognized, contractual success fees of $24.2 million, or $0.80 per common share. Consistent with GAAP, we generally have not recognized our success fee receivable and related income in our Consolidated Financial Statements until earned.

From inception through March 31, 2017, we have completed ten buyout liquidity events, which, in the aggregate, have generated $84.3 million in net realized gains and $20.3 million in other income upon exit, for a total increase to our net assets of $104.6 million. We believe each of these transactions was an equity-oriented investment success and exemplifies our investment strategy of striving to achieve returns through current income on the debt portion of our investments and capital gains from the equity portion. The ten liquidity events have offset our cumulative realized losses since inception, which were primarily incurred during the recession in connection with the sale of performing syndicated loans at a realized loss to pay off a former lender. These successful exits, in part, enabled us to increase the monthly distribution by 56.3% from March 2011 through March 31, 2017, and allowed us to declare and pay a $0.03 per common share special distribution in fiscal year 2012, a $0.05 per common share special distribution in November 2013 and a $0.05 per common share special distribution in December 2014.

Capital Raising Efforts

We have been able to meet our capital needs through extensions of and increases to the Credit Facility and by accessing the capital markets in the form of public offerings of common and preferred stock. We have successfully extended the Credit Facility’s revolving period multiple times, most recently to November 2019, and currently have a total commitment amount of $165.0 million (with a potential total commitment of $250.0 million through additional commitments of new or existing lenders). Additionally, we issued approximately 2.3 million shares of common stock for gross process of $21.2 million in May and June 2017, 3.8 million shares of common stock for gross proceeds of $28.1 million in March 2015, inclusive of the April 2015 overallotment, approximately 1.7 million shares of our Series B Term Preferred Stock for gross proceeds of $41.4 million in November 2014, approximately 1.6 million shares of our Series C Term Preferred Stock for gross proceeds of $40.3 million in May 2015 and 2.3 million shares of our Series D Term Preferred Stock for gross proceeds of $57.5 million in September 2016. Refer to “ Liquidity and Capital Resources — Equity — Common Stock ” and “ Liquidity and Capital Resources — Equity — Term Preferred Stock ” for further discussion of our common stock and mandatorily redeemable preferred stock and “ Liquidity and Capital Resources — Revolving Line of Credit ” for further discussion of the Credit Facility.

Although we were able to access the capital markets historically, we believe market conditions continue to affect the trading price of our common stock and thus our ability to finance new investments through the issuance

 

45


Table of Contents

of common equity. On July 27, 2017, the closing market price of our common stock was $9.51 per share, which represented a 4.4% discount to our March 31, 2017 NAV per share of $9.95. When our common stock trades below NAV, our ability to issue additional equity is constrained by provisions of the 1940 Act, which generally prohibits the issuance and sale of our common stock at an issuance price below the then current NAV per share without stockholder approval, other than through sales to our then-existing stockholders pursuant to a rights offering.

At our 2016 Annual Meeting of Stockholders held on August 4, 2016, our stockholders approved a proposal authorizing us to issue and sell shares of our common stock at a price below our then current NAV per share, subject to certain limitations, including that the number of common shares issued and sold pursuant to such authority does not exceed 25.0% of our then outstanding common stock immediately prior to each such sale, provided that our Board of Directors makes certain determinations prior to any such sale. This August 2016 stockholder authorization is in effect for one year from the date of stockholder approval. We sought and obtained stockholder approval concerning similar proposals at each Annual Meeting of Stockholders since 2008, and with our Board of Directors’ subsequent approval, we issued shares of our common stock in three offerings (including offerings of additional shares of common stock to cover overallotments) at a price below the then current NAV per share, once in May and June 2017, once in March and April 2015, and once in October and November 2012. The resulting proceeds, in part, have allowed us to grow the portfolio by making new investments, generate additional income through these new investments, provide us additional equity capital to help ensure continued compliance with regulatory tests and increase our debt capital while still complying with our applicable debt-to-equity ratios. Refer to “ Liquidity and Capital Resources — Equity — Common Stock ” for further discussion of our common stock.

Regulatory Compliance

Our ability to seek external debt financing, to the extent that it is available under current market conditions, is further subject to the asset coverage limitations of the 1940 Act, which require us to have asset coverage (as defined in Sections 18 and 61 of the 1940 Act) of at least 200.0% on each of our senior securities representing indebtedness and our senior securities that are stock (such as our three series of Term Preferred Stock). As of March 31, 2017, our asset coverage on our senior securities representing indebtedness was 661.3% and our asset coverage on our senior securities that are stock was 235.6%.

Investment Highlights

For the fiscal year ended March 31, 2017, we received $78.8 million in proceeds from repayments and sales, invested $54.4 million in two new portfolio companies, and extended $16.8 million of follow-on investments to existing portfolio companies through revolver draws, term loans, preferred equity, and common equity. From our initial public offering in June 2005 through March 31, 2017, we have made investments in 45 companies, excluding investments in syndicated loans, for a total of approximately $914 million before giving effect to principal repayments and divestitures.

Investment Activity

During the fiscal year ended March 31, 2017, the following significant transactions occurred:

 

    In April 2016, we sold our investment in Acme Cryogenics, Inc. (“Acme”), which resulted in dividend income of $2.8 million and a net realized gain of $18.8 million. In connection with the sale, we received net cash proceeds of $44.6 million, including the repayment of our debt investment of $14.5 million at par and net receivables of $0.6 million, which were recorded within Other assets, net .

 

    In May 2016, we invested $25.5 million in The Mountain Corporation (“The Mountain”) through a combination of secured second lien debt and preferred equity. The Mountain, headquartered in Keene, New Hampshire, is a designer and manufacturer of premium quality, bold artwear apparel serving a diverse global customer base.

 

   

In October 2016, we restructured our investment in D.P.M.S., Inc. (“Danco”). As a result of the restructure, we exchanged existing debt with a cost basis of $16.5 million for a new $8.8 million

 

46


Table of Contents
 

secured first lien term loan, relinquished our preferred equity with a cost basis of $2.5 million, and relinquished a portion of our common equity with a total cost basis of $3. The transaction resulted in a realized loss of $10.2 million.

 

    In December 2016, we sold our investment in Behrens Manufacturing, LLC (“Behrens”), which resulted in success fee income of $0.9 million and a net realized gain of $5.8 million. In connection with the sale, we received net cash proceeds of $19.2 million, including the repayment of our debt investment of $10.0 million at par.

 

    In February 2017, our $5.0 million investment in Auto Safety House, LLC was repaid at par plus $0.5 million of success fee income.

 

    In February 2017, we invested $28.9 million in JR Hobbs through a combination of secured first lien debt and preferred equity. JR Hobbs, headquartered in Lawrenceville, Georgia, is an HVAC installation subcontractor focused on the multifamily and light commercial construction market in the Southeast United States.

The following significant investment activity occurred subsequent to March 31, 2017. Also refer to Note 15 —Subsequent Events in our accompanying Consolidated Financial Statements included elsewhere in this prospectus.

 

    In April 2017, we sold our investment in Mitchell Rubber Products, Inc. (“Mitchell”), which had a cost basis and fair value of $16.4 million and $19.2 million, respectively, as of March 31, 2017. In connection with the sale, we received net cash proceeds of $19.0 million, including the repayment of our debt investment of $13.6 million at par.

Recent Developments

Common Stock Offering

In May 2017, we completed a public offering of 2.1 million shares of our common stock at a public offering price of $9.38 per share, which was below our then current estimated NAV of $9.95 per share. Gross proceeds totaled $19.7 million, and net proceeds, after deducting underwriting discounts and commissions and estimated offering costs borne by us, were $18.7 million, which was used to repay borrowings under the Credit Facility and for other general corporate purposes. On June 2, 2017, we issued an additional 155,265 shares of our common stock at a public offering price of $9.38 per share in connection with the partial exercise of the underwriters’ option to purchase additional shares of common stock on the same terms and conditions solely to cover over-allotments, which resulted in gross proceeds of approximately $1.5 million, and net proceeds, after deducting underwriting discounts and commissions and estimated offering costs borne by us, of approximately $1.4 million, which we intend to use to repay borrowings under the Credit Facility and for other general corporate purposes.

Distributions and Dividends

In April 2017, our Board of Directors declared the following monthly and supplemental distributions to common stockholders and monthly dividends to holders of our Series B Term Preferred Stock, Series C Term Preferred Stock and Series D Term Preferred Stock:

 

Record Date

   Payment Date    Distribution per
Common Share
    Dividend per Series B
Term Preferred Share
     Dividend per Series C
Term Preferred Share
     Dividend per Series D
Term Preferred Share
 

April 21, 2017

   April 28, 2017    $ 0.064     $ 0.140625      $ 0.135417      $ 0.13020833  

May 19, 2017

   May 31, 2017      0.064       0.140625        0.135417        0.13020833  

June 5, 2017

   June 15, 2017      0.060 (A)       —          —          —    

June 21, 2017

   June 30, 2017      0.064       0.140625        0.135417        0.13020833  
     

 

 

   

 

 

    

 

 

    

 

 

 

Total for the Quarter:

   $ 0.252     $ 0.421875      $ 0.406251      $ 0.39062499  
     

 

 

   

 

 

    

 

 

    

 

 

 

 

(A)   Denotes supplemental distribution to common stockholders.

 

47


Table of Contents

In July 2017, our Board of Directors declared the following monthly distributions to common stockholders and monthly dividends to holders of our Series B Term Preferred Stock, Series C Term Preferred Stock and Series D Term Preferred Stock:

 

Record Date

  Payment Date     Distribution per
Common Share
    Dividend per Series B
Term Preferred Share
    Dividend per Series C
Term Preferred Share
    Dividend per Series D
Term Preferred Share
 
July 21, 2017     July 31, 2017     $ 0.064     $ 0.140625     $ 0.135417     $ 0.13020833  
August 21, 2017     August 31, 2017       0.064       0.140625       0.135417       0.13020833  
September 20, 2017     September 29, 2017       0.064       0.140625       0.135417       0.13020833  
   

 

 

   

 

 

   

 

 

   

 

 

 

Total for the Quarter:

    $ 0.192     $ 0.421875     $ 0.406251     $ 0.39062499  
   

 

 

   

 

 

   

 

 

   

 

 

 

Investment Activity

 

    In May and June 2017, we sold a portion of our common stock investment in AquaVenture Holdings Limited resulting in net cash proceeds of $2.0 million, which represented a return of capital.

 

    In June 2017, one of our portfolio companies, Mathey Investments, Inc. (“Mathey”) was merged with and into another of our portfolio companies, SBS Industries, LLC (“SBS”). As a result of this transaction, we received success fee income of $0.3 million from Mathey. Our debt investments in Mathey, which totaled $8.6 million at principal and cost, were assumed by SBS and combined with our existing debt investment in SBS, which totaled $11.4 million at principal and cost, into a new secured first lien term loan totaling $20.0 million. Our common equity investment in Mathey, with a cost basis of $0.8 million, was converted into a preferred equity investment in SBS with the same cost basis. In connection with the merger, we also extended a secured first lien revolving line of credit to SBS with a total facility amount of $1.5 million, which was undrawn at the time of the transaction.

RESULTS OF OPERATIONS

Comparison of the Fiscal Year Ended March 31, 2017, to the Fiscal Year Ended March 31, 2016

 

     For the Fiscal Years Ended March 31,  
     2017      2016      $ Change      % Change  

INVESTMENT INCOME

           

Interest income

   $ 46,147      $ 46,397      $ (250      (0.5 )% 

Other income

     5,728        4,558        1,170        25.7  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment income

     51,875        50,955        920        1.8  
  

 

 

    

 

 

    

 

 

    

 

 

 

EXPENSES

           

Base management fee

     9,925        9,925        —          —    

Loan servicing fee

     6,606        6,697        (91      (1.4

Incentive fee

     4,750        5,179        (429      (8.3

Administration fee

     1,120        1,190        (70      (5.9

Interest and dividend expense

     12,223        12,117        106        0.9  

Amortization of deferred financing costs and discounts

     1,875        1,908        (33      (1.7

Other

     3,066        3,046        20        0.7  
  

 

 

    

 

 

    

 

 

    

 

 

 

Expenses before credits from Adviser

     39,565        40,062        (497      (1.2

Credits to fees from Adviser

     (10,112      (9,823      (289      2.9  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses, net of credits to fees

     29,453        30,239        (786      (2.6
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INVESTMENT INCOME

     22,422        20,716        1,706        8.2  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

48


Table of Contents
     For the Fiscal Years Ended March 31,  
     2017      2016      $ Change      % Change  

REALIZED AND UNREALIZED GAIN (LOSS)

           

Net realized gain (loss) on investments

   $ 15,641      $ (4,599    $ 20,240        NM  

Net realized loss on other

     (254      —          (254      NM  

Net unrealized appreciation of investments

     6,879        8,737        (1,858      (21.3 )% 

Net unrealized appreciation of other

     75        —          75        NM  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net realized and unrealized gain

     22,341        4,138        18,203        439.9  
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS

   $ 44,763      $ 24,854      $ 19,909        80.1  
  

 

 

    

 

 

    

 

 

    

 

 

 

BASIC AND DILUTED PER COMMON SHARE:

           

Net investment income

   $ 0.74      $ 0.68      $ 0.06        8.8
  

 

 

    

 

 

    

 

 

    

 

 

 

Net increase in net assets resulting from operations

     1.48        0.82        0.66        80.5  
  

 

 

    

 

 

    

 

 

    

 

 

 

NM = Not Meaningful

Investment Income

Total investment income increased by 1.8% for the year ended March 31, 2017, as compared to the prior year. This increase was due to an increase in other income, partially offset by a slight decline in interest income for the same period, which resulted primarily from a small decrease in the size of our interest-bearing portfolio during the year ended March 31, 2017.

Other income for the year ended March 31, 2017 increased 25.7% from the prior year. During the year ended March 31, 2017, other income primarily consisted of $3.3 million of dividend income and $2.4 million of success fee income. During the year ended March 31, 2016, other income primarily consisted of $2.9 million of dividend income and $1.6 million of success fee income.

Interest income from our investments in debt securities remained relatively flat for the year ended March 31, 2017, as compared to the prior year. The level of interest income from investments is directly related to the principal balance of our interest-bearing investment portfolio outstanding during the period multiplied by the weighted average yield. The weighted average principal balance of our interest-bearing investment portfolio during the year ended March 31, 2017, was $364.7 million, compared to $367.6 million for the prior year. This slight decrease was primarily due to the pay-off or restructure of $48.4 million of debt investments principally related to the exit or restructure of portfolio companies, and to $41.6 million in new debt investments and $15.5 million in follow-on debt investments to existing portfolio companies originated after March 31, 2016, and their respective impact on the weighted average principal balance when considering timing of new investments, pay-offs, and restructures, as applicable. The weighted average yield on our interest-bearing investments, excluding cash and cash equivalents and receipts recorded as other income, was 12.7% and 12.6% for the year ended March 31, 2017 and 2016, respectively. The weighted average yield may vary from period to period, based on the current stated interest rate on interest-bearing investments.

At March 31, 2017 and 2016, certain of our loans to two portfolio companies, Alloy Die Casting Co. and Tread Corporation (“Tread”), were on non-accrual status, with an aggregate debt cost basis of $15.6 million. At March 31, 2016, our loan to Tread was on non-accrual status, with an aggregate debt cost basis of $1.4 million.

 

49


Table of Contents

The following table lists the investment income for our five largest portfolio company investments, at fair value, during the respective fiscal years:

 

     As of March 31, 2017     Year Ended March 31, 2017  

Company

   Fair Value      % of
Portfolio
    Investment
Income
     % of Total
Investment
Income
 

J.R. Hobbs Co. – Atlanta, LLC (A)

   $ 29,870        6.0   $ 359        0.7

Counsel Press, Inc.

     29,617        5.9       3,118        6.0  

Cambridge Sound Management, Inc.

     27,046        5.4       2,065        4.0  

Nth Degree, Inc.

     25,761        5.1       1,684        3.2  

Drew Foam Companies, Inc.

     25,242        5.0       1,666        3.2  
  

 

 

    

 

 

   

 

 

    

 

 

 

Subtotal—five largest investments

     137,536        27.4       8,892        17.1  

Other portfolio companies

     364,043        72.6       42,983        82.9  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total investment portfolio

   $ 501,579        100.0   $ 51,875        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

     As of March 31, 2016     Year Ended March 31, 2016  

Company

   Fair Value      % of
Portfolio
    Investment
Income
     % of Total
Investment
Income
 

Acme Cryogenics, Inc. (B)

   $ 44,894        9.2   $ 1,695        3.3

Counsel Press, Inc.

     28,899        5.9       3,183        6.3  

Cambridge Sound Management, Inc.

     27,835        5.7       1,983        3.9  

SOG Specialty Knives & Tools, LLC

     26,147        5.4       2,665        5.2  

Nth Degree, Inc. (A)

     21,002        4.3       503        1.0  
  

 

 

    

 

 

   

 

 

    

 

 

 

Subtotal—five largest investments

     148,777        30.5       10,029        19.7  

Other portfolio companies

     338,879        69.5       40,926        80.3  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total investment portfolio

   $ 487,656        100.0   $ 50,955        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(A )   New investment during the applicable year.
(B )   Investment exited subsequent to March 31, 2016.

Expenses

Total expenses, net of any non-contractual, unconditional, and irrevocable credits from the Adviser, decreased 2.6% for the year ended March 31, 2017, as compared to the prior year, primarily due to a decrease in the incentive fee. The incentive fee decreased as a result of an increase in net assets, which drives the hurdle rate, period over period.

The base management fee, loan servicing fee, incentive fee, and their related non-contractual, unconditional, and irrevocable credits are computed quarterly, as described under “ Transactions with the Adviser ” in Note 4 – Related Party Transactions of the notes to our accompanying Consolidated Financial Statements included elsewhere in this prospectus, and are summarized in the following table:

 

     Year Ended March 31,  
     2017     2016  

Average total assets subject to base management fee (A)

   $ 496,250     $ 496,250  

Multiplied by annual base management fee of 2.0%

     2.0     2.0
  

 

 

   

 

 

 

Base management fee (B)

     9,925       9,925  

Credits to fees from Adviser—other (B)

     (3,506     (3,126
  

 

 

   

 

 

 

Net base management fee

   $ 6,419     $ 6,799  
  

 

 

   

 

 

 

 

50


Table of Contents
     Year Ended March 31,  
     2017      2016  

Loan servicing fee (B)

   $ 6,606      $ 6,697  

Credits to base management fee—loan servicing fee (B)

     (6,606      (6,697
  

 

 

    

 

 

 

Net loan servicing fee

   $ —        $ —    
  

 

 

    

 

 

 

Incentive fee (B)

     4,750        5,179  

Credits to fees from Adviser—other (B)

     —          —    
  

 

 

    

 

 

 

Net incentive fee

   $ 4,750      $ 5,179  
  

 

 

    

 

 

 

 

(A)   Average total assets subject to the base management fee is defined as total assets, including investments made with proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings, valued at the end of the applicable quarters within the respective periods and adjusted appropriately for any share issuances or repurchases during the periods.
(B)   Reflected as a line item on our accompanying Consolidated Statement of Operations included elsewhere in this prospectus.

Realized and Unrealized Gain (Loss)

Net Realized Gain (Loss) on Investments

During the year ended March 31, 2017, we recorded a net realized gain on investments of $15.6 million, primarily related to a $18.9 million realized gain from the exit of Acme, a $5.9 million realized gain from the exit of Behrens, and a $1.3 million realized gain related to an additional earn-out from Funko, LLC (“Funko”), which was exited in the prior year, partially offset by a $10.2 million realized loss from the restructure of Danco. During the year ended March 31, 2016, we recorded a net realized loss of $4.6 million, primarily related to realized losses of $10.5 million, $2.8 million, and $8.6 million related to the restructuring of our investments in Galaxy Tool Holding Corporation (“Galaxy”), NDLI, Inc. (“NDLI”), and Tread, respectively, partially offset by a realized gain of $17.0 million related to the sale of our investments in Funko and $0.3 million of other gains.

Net Realized Loss on Other

During the year ended March 31, 2017, we recorded a net realized loss on other of $0.3 million, of which $0.2 million related to the redemption of our Series A Term Preferred Stock in September 2016 and $0.1 million related to the expiration of our interest rate cap agreement in April 2016. There were no realized gains or losses on other during the year ended March 31, 2016.

Net Unrealized Appreciation of Investments

During the year ended March 31, 2017, we recorded net unrealized appreciation of investments of $6.9 million. The realized gains (losses) and unrealized appreciation (depreciation) across our investments for the year ended March 31, 2017, were as follows:

 

     Year Ended March 31, 2017  

Portfolio Company

   Realized
Gain

(Loss)
     Unrealized
Appreciation
(Depreciation)
     Reversal of
Unrealized
(Appreciation)
Depreciation
     Net Gain
(Loss)
 

Mitchell Rubber Products, Inc.

   $ —        $ 14,079      $ —        $ 14,079  

Logo Sportswear, Inc.

     —          8,375        —          8,375  

Galaxy Tool Holding Corporation

     —          6,242        —          6,242  

Brunswick Bowling Products, Inc.

     —          6,062        —          6,062  

Head Country, Inc.

     —          5,752        —          5,752  

Drew Foam Companies, Inc.

     —          5,287        —          5,287  

 

51


Table of Contents
     Year Ended March 31, 2017  

Portfolio Company

   Realized
Gain

(Loss)
     Unrealized
Appreciation
(Depreciation)
     Reversal of
Unrealized
(Appreciation)
Depreciation
     Net Gain
(Loss)
 

Nth Degree, Inc.

   $ —        $ 4,760      $ —        $ 4,760  

Old World Christmas, Inc.

     —          2,975        —          2,975  

Ginsey Home Solutions, Inc.

     —          2,362        —          2,362  

Meridian Rack & Pinion, Inc.

     —          1,757        —          1,757  

Edge Adhesives Holdings, Inc.

     —          1,628        —          1,628  

Funko Acquisition Holdings, LLC

     1,087        36        —          1,123  

Diligent Delivery Systems

     —          907        —          907  

Counsel Press, Inc.

     —          717        —          717  

Behrens Manufacturing, LLC

     5,935        1,820        (7,491      264  

Auto Safety House, LLC

     —          146        (457      (311

SBS Industries, LLC

     —          (794      —          (794

Frontier Packaging, Inc.

     —          (843      —          (843

AquaVenture Holdings Limited

     —          (925      —          (925

B-Dry, LLC

     —          (987      —          (987

D.P.M.S., Inc.

     (10,226      (3,848      12,601        (1,473

Tread Corporation

     —          (1,737      —          (1,737

Cambridge Sound Management, Inc.

     —          (1,789      —          (1,789

Mathey Investments, Inc.

     —          (1,934      —          (1,934

Jackrabbit, Inc.

     —          (1,984      —          (1,984

Acme Cryogenics, Inc.

     18,904        —          (21,216      (2,312

Alloy Die Casting Co.

     —          (3,283      —          (3,283

Schylling, Inc.

     —          (3,842      —          (3,842

Precision Southeast, Inc.

     —          (3,922      —          (3,922

The Mountain Corporation

     —          (6,747      —          (6,747

SOG Specialty Knives & Tools, LLC

     —          (7,036      —          (7,036

Other, net (<$250 Net)

     (59      208        —          149  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 15,641      $ 23,442      $ (16,563    $ 22,520  
  

 

 

    

 

 

    

 

 

    

 

 

 

The primary drivers of net unrealized appreciation of investments of $6.9 million for the year ended March 31, 2017, was the reversal of previously recorded unrealized depreciation related to our investment in Danco upon its restructure, an increase in the fair value of our investment in Mitchell based on its sale in April 2017, and increased performance and comparable multiples used to estimate the fair value of certain of our investments, which was partially offset by unrealized depreciation resulting from the reversal of previously recorded unrealized appreciation related to the exit of our investments in Acme and Behrens and a decrease in performance of certain of our portfolio companies.

During the year ended March 31, 2016, we recorded net unrealized appreciation of investments of $8.7 million. The realized gains (losses) and unrealized appreciation (depreciation) across our investments for the year ended March 31, 2016 were as follows:

 

     Year Ended March 31, 2016  

Portfolio Company

   Realized
Gain
(Loss)
     Unrealized
Appreciation
(Depreciation)
     Reversal of
Unrealized
(Appreciation)
Depreciation
     Net Gain
(Loss)
 

Acme Cryogenics, Inc.

   $ —        $ 21,875      $ —        $ 21,875  

Cambridge Sound Management, Inc.

     —          5,636        —          5,636  

D.P.M.S., Inc.

     —          5,503        —          5,503  

Frontier Packaging, Inc.

     —          5,426        —          5,426  

Behrens Manufacturing, LLC

     —          5,147        —          5,147  

Schylling, Inc.

     —          4,103        —          4,103  

 

52


Table of Contents
     Year Ended March 31, 2016  

Portfolio Company

   Realized
Gain
(Loss)
     Unrealized
Appreciation
(Depreciation)
     Reversal of
Unrealized
(Appreciation)
Depreciation
     Net Gain
(Loss)
 

Drew Foam Companies, Inc.

   $ —        $ 3,697      $ —        $ 3,697  

Funko, LLC

     17,039        1,861        (16,009      2,891  

Country Club Enterprises, LLC

     —          2,450        —          2,450  

Precision Southeast, Inc.

     —          2,092        —          2,092  

Nth Degree, Inc.

     —          2,052        —          2,052  

Diligent Delivery Systems

     —          1,484        —          1,484  

Logo Sportswear, Inc.

     —          1,245        —          1,245  

Tread Corporation

     (8,628      3,603        6,086        1,061  

NDLI, Inc.

     (2,795      (50      3,480        635  

GI Plastek, Inc.

     —          522        —          522  

Auto Safety House, LLC

     —          373        —          373  

Brunswick Bowling Products, Inc.

     —          324        —          324  

Star Seed, Inc.

     —          (300      —          (300

Quench Holdings Corp.

     —          (1,072      —          (1,072

Jackrabbit, Inc.

     —          (1,133      —          (1,133

Channel Technologies Group, LLC

     —          (1,401      —          (1,401

Cavert II Holding Corp.

     (1      63        (1,483      (1,421

Counsel Press Inc.

     —          (1,596      —          (1,596

B-Dry, LLC

     —          (2,069      —          (2,069

Ginsey Home Solutions, Inc.

     —          (2,362      —          (2,362

Mitchell Rubber Products, Inc.

     —          (3,154      700        (2,454

Old World Christmas, Inc.

     —          (2,498      —          (2,498

SBS Industries, LLC

     —          (2,810      —          (2,810

Meridian Rack & Pinion, Inc.

     —          (2,950      —          (2,950

Head Country Food Products, Inc.

     —          (3,931      —          (3,931

Edge Adhesives Holdings, Inc.

     —          (3,971      9        (3,962

Alloy Die Casting Co.

     —          (4,274      —          (4,274

B+T Group Acquisition, Inc.

     —          (4,541      —          (4,541

SOG Specialty Knives & Tools, LLC

     —          (5,704      —          (5,704

Mathey Investments, Inc.

     —          (7,576      —          (7,576

Galaxy Tool Holding Corporation

     (10,545      (2,762      2,762        (10,545

Other, net (<$250 Net)

     331        —          (110      221  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ (4,599    $ 13,302      $ (4,565    $ 4,138  
  

 

 

    

 

 

    

 

 

    

 

 

 

The primary drivers of net unrealized appreciation of investments of $8.7 million for the year ended March 31, 2016, was an increase in the equity valuation of Acme due to an increase in performance and comparable multiples used to estimate the fair value of our investment, as well as an increase in performance and, to a lesser extent, multiples used to estimate the fair value of certain of our other investments and the reversal of previously recorded unrealized depreciation on our investments in Galaxy, NDLI, and Tread upon their restructures. These increases were partially offset by the reversal of previously recorded unrealized appreciation on our investments in Cavert II Holding Corp. (“Cavert”) and Funko upon their exits as well as a decline in the performance of certain portfolio companies.

Across our entire investment portfolio, we recorded $10.0 million of net unrealized appreciation on our debt positions and $3.1 million of net unrealized depreciation on our equity holdings for the year ended March 31, 2017. At March 31, 2017, the fair value of our investment portfolio was less than our cost basis by $23.6 million, as compared to $30.5 million at March 31, 2016, representing net unrealized appreciation of $6.9 million for the year ended March 31, 2017. Our entire portfolio was fair valued at 95.5% of cost as of March 31, 2017.

 

53


Table of Contents

Net Unrealized Appreciation on Other

For the year ended March 31, 2017, we recorded net unrealized appreciation on other of $75 due to the reversal of previously recorded depreciation upon the expiration of our interest rate cap agreement in April 2016. For the year ended March 31, 2016, no such amounts were incurred.

Comparison of the Fiscal Year Ended March 31, 2016, to the Fiscal Year Ended March 31, 2015

 

     For the Fiscal Years Ended March 31,  
     2016      2015      $ Change      % Change  

INVESTMENT INCOME

           

Interest income

   $ 46,397      $ 36,685      $ 9,712        26.5

Other income

     4,558        4,958        (400      (8.1
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment income

     50,955        41,643        9,312        22.4  
  

 

 

    

 

 

    

 

 

    

 

 

 

EXPENSES

           

Base management fee

     9,925        7,569        2,356        31.1  

Loan servicing fee

     6,697        4,994        1,703        34.1  

Incentive fee

     5,179        4,975        204        4.1  

Administration fee

     1,190        932        258        27.7  

Interest and dividend expense

     12,117        7,460        4,657        62.4  

Amortization of deferred financing costs

     1,908        1,329        579        43.6  

Other

     3,046        2,329        717        30.8  
  

 

 

    

 

 

    

 

 

    

 

 

 

Expenses before credits from Adviser

     40,062        29,588        10,474        35.4  

Credits to fees from Adviser

     (9,823      (7,842      (1,981      25.3  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses, net of credits to fees

     30,239        21,746        8,493        39.1  
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INVESTMENT INCOME

     20,716        19,897        819        4.1  
  

 

 

    

 

 

    

 

 

    

 

 

 

REALIZED AND UNREALIZED GAIN (LOSS)

           

Net realized loss on investments

     (4,599      (73      (4,526      NM  

Net unrealized appreciation of investments

     8,737        29,940        (21,203      (70.8

Net unrealized depreciation of other

     —          450        (450      (100.0
  

 

 

    

 

 

    

 

 

    

 

 

 

Net realized and unrealized gain

     4,138        30,317        (26,179      (86.4
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS

   $ 24,854      $ 50,214      $ (25,360      (50.5
  

 

 

    

 

 

    

 

 

    

 

 

 

BASIC AND DILUTED PER COMMON SHARE:

           

Net investment income

   $ 0.68      $ 0.75      $ (0.07      (9.3 )% 
  

 

 

    

 

 

    

 

 

    

 

 

 

Net increase in net assets resulting from operations

     0.82        1.88        (1.06      (56.4
  

 

 

    

 

 

    

 

 

    

 

 

 

NM = Not Meaningful

Investment Income

Total investment income increased by 22.4% for the year ended March 31, 2016, as compared to the prior year. This increase was due to an increase in interest income, which resulted primarily from an increase in the size of our interest-bearing portfolio during the year ended March 31, 2016, partially offset by a decline in other income for the same period.

Interest income from our investments in debt securities increased 26.5% for the year ended March 31, 2016, as compared to the prior year. The level of interest income from investments is directly related to the principal balance of our interest-bearing investment portfolio outstanding during the period multiplied by the weighted average yield. The weighted average principal balance of our interest-bearing investment portfolio during the

 

54


Table of Contents

year ended March 31, 2016, was $367.6 million, compared to $292.2 million for the prior year. This increase was primarily due to $53.4 million in new debt investments originated after March 31, 2015. The weighted average yield on our interest-bearing investments, excluding cash and cash equivalents and receipts recorded as other income, was 12.6% for both years ended March 31, 2016 and 2015. The weighted average yield may vary from period to period, based on the current stated interest rate on interest-bearing investments.

Our loans to one portfolio company, Tread, were on non-accrual status as of March 31, 2016 and 2015, with an aggregate debt cost basis of $1.4 million and $11.7 million, respectively.

Other income for the year ended March 31, 2016 decreased 8.1% from the prior year. During the year ended March 31, 2016, other income primarily consisted of $2.9 million of dividend income and $1.6 million of success fee income. During the year ended March 31, 2015, other income primarily consisted of $3.5 million of dividend income and $1.4 million of success fee income.

The following table lists the investment income for our five largest portfolio company investments, at fair value, during the respective fiscal years:

 

     As of March 31, 2016     Year Ended
March 31, 2016
 

Company

   Fair Value      % of
Portfolio
    Investment
Income
     % of Total
Investment
Income
 

Acme Cryogenics, Inc. (A)

   $ 44,894        9.2   $ 1,695        3.3

Counsel Press, Inc.

     28,899        5.9       3,183        6.3  

Cambridge Sound Management, Inc.

     27,835        5.7       1,983        3.9  

SOG Specialty Knives & Tools, LLC

     26,147        5.4       2,665        5.2  

Nth Degree, Inc. (B)

     21,002        4.3       503        1.0  
  

 

 

    

 

 

   

 

 

    

 

 

 

Subtotal — five largest investments

     148,777        30.5       10,029        19.7  

Other portfolio companies

     338,879        69.5       40,926        80.3  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total investment portfolio

   $ 487,656        100.0   $ 50,955        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

     As of March 31, 2015     Year Ended
March 31, 2015
 

Company

   Fair Value      % of
Portfolio
    Investment
Income
     % of Total
Investment
Income
 

Counsel Press, Inc. (B)

   $ 31,995        6.9   $ 9        0.0

SOG Specialty Knives & Tools, LLC

     31,851        6.8       2,657        6.4  

Funko, LLC

     25,008        5.4       991        2.4  

Acme Cryogenics, Inc.

     23,019        4.9       1,691        4.1  

Old World Christmas, Inc. (B)

     22,427        4.8       1,060        2.5  
  

 

 

    

 

 

   

 

 

    

 

 

 

Subtotal — five largest investments

     134,300        28.8       6,408        15.4  

Other portfolio companies

     331,753        71.2       35,235        84.6  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total investment portfolio

   $ 466,053        100.0   $ 41,643        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(A)   Investment exited subsequent to March 31, 2016.
(B)   New investment during the applicable year.

Expenses

Total expenses, net of any non-contractual, unconditional, and irrevocable credits from the Adviser, increased 39.1% for the year ended March 31, 2016, as compared to the prior year period, primarily due to an increase in interest and dividend expense and in the net base management fee.

 

55


Table of Contents

The net base management fee increased for the fiscal year ended March 31, 2016, as compared to the prior year, as a result of the increased size of our portfolio over the respective periods. The base management fee, loan servicing fee, incentive fee, and their related non-contractual, unconditional, and irrevocable credits are computed quarterly, as described under “ Transactions with the Adviser ” in Note 4 — Related Party Transactions of the notes to our accompanying Consolidated Financial Statements included elsewhere in this prospectus and are summarized in the following table:

 

     Year Ended March 31,  
     2016     2015  

Average total assets subject to base management fee (A)

   $ 496,250     $ 378,450  

Multiplied by annual base management fee of 2.0%

     2.0     2.0
  

 

 

   

 

 

 

Base management fee (B)

     9,925       7,569  

Credits to fees from Adviser — other (B)

     (3,126     (2,848
  

 

 

   

 

 

 

Net base management fee

   $ 6,799     $ 4,721  
  

 

 

   

 

 

 

Loan servicing fee (B)

     6,697       4,994  

Credits to base management fee — loan servicing fee (B)

     (6,697     (4,994
  

 

 

   

 

 

 

Net loan servicing fee

   $ —       $ —    
  

 

 

   

 

 

 

Incentive fee (B)

     5,179       4,975  

Credits to fees from Adviser — other (B)

     —         —    
  

 

 

   

 

 

 

Net incentive fee

   $ 5,179     $ 4,975  
  

 

 

   

 

 

 

 

(A)   Average total assets subject to the base management fee is defined as total assets, including investments made with proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings, valued at the end of the applicable quarters within the respective periods and adjusted appropriately for any share issuances or repurchases during the periods.
(B)   Reflected as a line item on our accompanying Consolidated Statement of Operations .

Interest and dividend expense increased 62.4% for the year ended March 31, 2016, as compared to the prior year , primarily due to increased average borrowings under the Credit Facility and the issuance of our Series B Term Preferred Stock in November 2014 and our Series C Term Preferred Stock in May 2015. The weighted average balance outstanding on the Credit Facility during the fiscal year ended March 31, 2016 was $94.6 million, as compared to $79.2 million in the prior year. Dividends on mandatorily redeemable preferred stock increased as a result of the issuance of $41.4 million of our Series B Term Preferred Stock in November 2014 and the issuance of $40.3 million of our Series C Term Preferred Stock in May 2015.

Realized and Unrealized Gain (Loss)

Net Realized Loss on Investments

During the year ended March 31, 2016, we recorded a net realized loss of $4.6 million, primarily consisting of realized losses of $10.5 million, $2.8 million, and $8.6 million related to the restructuring of our investments in Galaxy, NDLI, and Tread, respectively, partially offset by a realized gain of $17.0 million related to the sale of our investments in Funko and $0.3 million of other gains. During the fiscal year ended March 31, 2015, we recorded a net realized loss of $0.1 million related to reversal of escrows from previous investment exits.

 

56


Table of Contents

Net Unrealized Appreciation of Investments

During the year ended March 31, 2016, we recorded net unrealized appreciation of investments of $8.7 million. The realized gains (losses) and unrealized appreciation (depreciation) across our investments for the year ended March 31, 2016, were as follows:

 

     Year Ended March 31, 2016  

Portfolio Company

   Realized
Gain
(Loss)
     Unrealized
Appreciation
(Depreciation)
     Reversal of
Unrealized
(Appreciation)
Depreciation
     Net Gain
(Loss)
 

Acme Cryogenics, Inc.

   $ —        $ 21,875      $ —        $ 21,875  

Cambridge Sound Management, Inc.

     —          5,636        —          5,636  

D.P.M.S., Inc.

     —          5,503        —          5,503  

Frontier Packaging, Inc.

     —          5,426        —          5,426  

Behrens Manufacturing, LLC

     —          5,147        —          5,147  

Schylling, Inc.

     —          4,103        —          4,103  

Drew Foam Companies, Inc.

     —          3,697        —          3,697  

Funko, LLC

     17,039        1,861        (16,009      2,891  

Country Club Enterprises, LLC

     —          2,450        —          2,450  

Precision Southeast, Inc.

     —          2,092        —          2,092  

Nth Degree, Inc.

     —          2,052        —          2,052  

Diligent Delivery Systems

     —          1,484        —          1,484  

Logo Sportswear, Inc.

     —          1,245        —          1,245  

Tread Corporation

     (8,628      3,603        6,086        1,061  

NDLI, Inc.

     (2,795      (50      3,480        635  

GI Plastek, Inc.

     —          522        —          522  

Auto Safety House, LLC

     —          373        —          373  

Brunswick Bowling Products, Inc.

     —          324        —          324  

Star Seed, Inc.

     —          (300      —          (300

Quench Holdings Corp.

     —          (1,072      —          (1,072

Jackrabbit, Inc.

     —          (1,133      —          (1,133

Channel Technologies Group, LLC

     —          (1,401      —          (1,401

Cavert II Holding Corp.

     (1      63        (1,483      (1,421

Counsel Press Inc.

     —          (1,596      —          (1,596

B-Dry, LLC

     —          (2,069      —          (2,069

Ginsey Home Solutions, Inc.

     —          (2,362      —          (2,362

Mitchell Rubber Products, Inc.

     —          (3,154      700        (2,454

Old World Christmas, Inc.

     —          (2,498      —          (2,498

SBS Industries, LLC

     —          (2,810      —          (2,810

Meridian Rack & Pinion, Inc.

     —          (2,950      —          (2,950

Head Country Food Products, Inc.

     —          (3,931      —          (3,931

Edge Adhesives Holdings, Inc.

     —          (3,971      9        (3,962

Alloy Die Casting Co.

     —          (4,274      —          (4,274

B+T Group Acquisition, Inc.

     —          (4,541      —          (4,541

SOG Specialty Knives & Tools, LLC

     —          (5,704      —          (5,704

Mathey Investments, Inc.

     —          (7,576      —          (7,576

Galaxy Tool Holding Corporation

     (10,545      (2,762      2,762        (10,545

Other, net (<$250 Net)

     331        —          (110      221  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ (4,599    $ 13,302      $ (4,565    $ 4,138  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

57


Table of Contents

The primary drivers of net unrealized appreciation of investments of $8.7 million for the year ended March 31, 2016, was an increase in the equity valuation of Acme due to an increase in performance and comparable multiples used to estimate the fair value of our investment, as well as an increase in performance and, to a lesser extent, multiples used to estimate the fair value of certain of our other investments and the reversal of previously recorded unrealized depreciation on our investments in Galaxy, NDLI, and Tread upon their restructures. These increases were partially offset by the reversal of previously recorded unrealized appreciation on our investments in Cavert and Funko upon their exits as well as a decline in the performance of certain portfolio companies.

During the year ended March 31, 2015, we recorded net unrealized appreciation of investments of $29.9 million. The realized gains (losses) and unrealized appreciation (depreciation) across our investments for the year ended March 31, 2015, were as follows:

 

     Year Ended March 31, 2015  

Portfolio Company

   Realized
Loss
     Unrealized
Appreciation
(Depreciation)
     Reversal of
Unrealized
(Appreciation)
Depreciation
     Net Gain
(Loss)
 

Funko, LLC

   $ —        $ 13,090      $ —        $ 13,090  

SOG Specialty Knives & Tools, LLC

     —          5,211        —          5,211  

Drew Foam Companies, Inc.

     —          4,994        —          4,994  

Jackrabbit, Inc.

     —          4,575        —          4,575  

NDLI, Inc.

     —          4,397        —          4,397  

Ginsey Home Solutions, Inc.

     —          3,904        —          3,904  

Mathey Investments, Inc.

     —          2,735        —          2,735  

Cambridge Sound Management, Inc.

     —          2,698        —          2,698  

Alloy Die Casting Co.

     —          2,068        —          2,068  

Tread Corporation

     —          1,896        —          1,896  

Frontier Packaging, Inc.

     —          1,816        —          1,816  

SBS Industries, LLC

     —          1,746        —          1,746  

Behrens Manufacturing, LLC

     —          692        —          692  

Old World Christmas, Inc.

     —          477        —          477  

Quench Holdings Corp.

     —          375        —          375  

B+T Group Acquisition, Inc.

     —          344        —          344  

Edge Adhesives Holdings, Inc.

     —          (274      —          (274

Meridian Rack & Pinion, Inc.

     —          (411      —          (411

D.P.M.S., Inc.

     —          (605      —          (605

Country Club Enterprises, LLC

     —          (806      —          (806

Channel Technologies Group, LLC

     —          (807      —          (807

Galaxy Tool Holding Corporation

     —          (2,992      —          (2,992

Acme Cryogenics, Inc.

     —          (3,881      —          (3,881

B-Dry, LLC

     —          (4,081      —          (4,081

Mitchell Rubber Products, Inc.

     —          (7,178      —          (7,178

Other, net (<$250 Net)

     (73      (43      —          (116
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ (73    $ 29,940      $ —        $ 29,867  
  

 

 

    

 

 

    

 

 

    

 

 

 

The primary drivers of net unrealized appreciation of investments of $29.9 million for the year ended March 31, 2015, was an increase in the equity valuations of Funko, SOG Specialty Knives & Tools, LLC (“SOG”), Drew Foam Companies, Inc., Jackrabbit, Inc. and NDLI, due to an increase in the portfolio companies’ performance and an increase in certain comparable multiples used to estimate the fair value of our investments. This was partially offset by a decline in performance of certain portfolio companies.

 

58


Table of Contents

Across our entire investment portfolio, we recorded $15.2 million of net unrealized appreciation on our debt positions and $6.5 million of net unrealized depreciation on our equity holdings for the year ended March 31, 2016. At March 31, 2016, the fair value of our investment portfolio was less than our cost basis by $30.5 million, as compared to $39.2 million at March 31, 2015, representing net unrealized appreciation of $8.7 million for the year ended March 31, 2016. Our entire portfolio was fair valued at 94.1% of cost as of March 31, 2016.

Net Unrealized Depreciation on Other

For the year ended March 31, 2015, we recorded $0.5 million of net unrealized depreciation on the Credit Facility recorded at fair value. For the year ended March 31, 2016, no such amounts were incurred.

LIQUIDITY AND CAPITAL RESOURCES

Operating Activities

Cash inflows from operating activities are primarily generated from cash collections of interest and other income from our portfolio companies, as well as cash proceeds received from repayments of debt investments and sales of equity investments. These cash collections are principally used to fund new investments, pay distributions to our common stockholders, make interest payments on the Credit Facility, make dividend payments on our mandatorily redeemable preferred stock, pay management and incentive fees to the Adviser, and for other operating expenses. We may also use cash collections from operations to repay outstanding borrowing under the Credit Facility.

Net cash provided by operating activities for the year ended March 31, 2017 was $32.5 million, as compared to $4.1 million for the year ended March 31, 2016. This change was primarily due to an increase in repayments and proceeds from the sale of investments year over year. Repayments and proceeds from the sale of investments totaled $68.8 million during the year ended March 31, 2017 compared to $44.6 million during the year ended March 31, 2016.

Net cash provided by operating activities for the year ended March 31, 2016 was $4.1 million, as compared to net cash used in operating activities of $97.6 million for the year ended March 31, 2015. This change was primarily due to a decrease in the purchase of investments and an increase in repayments and proceeds from the sale of investments year over year. Purchases of investments were $61.9 million during the year ended March 31, 2016 compared to $132.9 million during the year ended March 31, 2015. Repayments and proceeds from the sale of investments totaled $44.6 million during the year ended March 31, 2016 compared to $11.3 million during the year ended March 31, 2015.

As of March 31, 2017, we had equity investments in, or loans to, 35 companies with an aggregate cost basis of $525.2 million. As of March 31, 2016, we had equity investments in, or loans to, 36 companies with an aggregate cost basis of $518.1 million. The following table summarizes our total portfolio investment activity for the years ended March 31, 2017 and 2016:

 

     Years Ended March 31,  
     2017      2016  

Beginning investment portfolio, at fair value

   $ 487,656      $ 466,053  

New investments

     54,370        55,436  

Disbursements to existing portfolio companies

     8,076        6,460  

Scheduled principal repayments

     —          (4,141

Unscheduled principal repayments

     (31,886      (20,064

Net proceeds from sales of investments

     (36,939      (20,377

Net realized gain (loss) on investments

     13,423        (4,448

Net unrealized appreciation of investments

     23,442        13,302  

Reversal of net unrealized appreciation of investments

     (16,563      (4,565
  

 

 

    

 

 

 

Ending investment portfolio, at fair value

   $ 501,579      $ 487,656  
  

 

 

    

 

 

 

 

59


Table of Contents

The following table summarizes the contractual principal repayment and maturity of our investment portfolio by fiscal year, assuming no voluntary prepayments, as of March 31, 2017:

 

         Amount (A)  

For the fiscal years ending March 31:

  2018    $ 60,640  
  2019      76,941  
  2020      100,408  
  2021      75,515  
  2022      64,397  
  Thereafter      —    
    

 

 

 
 

Total contractual repayments

   $ 377,901  
  Investments in equity securities      147,268  
    

 

 

 
 

Total cost basis of investments held as of March 31, 2017:

   $ 525,169  
    

 

 

 

 

(A)   Subsequent to March 31, 2017, one debt investment with a principal balance of $13.6 million maturing during the fiscal year ending March 31, 2018 was repaid at par and debt investments in two portfolio companies with principal balances of $4.0 million and $18.4 million, which previously had maturity dates during the fiscal year ending March 31, 2018, were extended to mature during the fiscal year ending March 31, 2019 and March 31, 2021, respectively.

Financing Activities

Net cash used in financing activities for the year ended March 31, 2017 was $34.1 million, which consisted primarily of $25.3 million of net repayments on the Credit Facility, $22.7 million in distributions to common stockholders, and the redemption of our Series A Term Preferred Stock in September 2016 of $40.0 million, partially offset by net proceeds from the issuance of our Series D Term Preferred Stock of $55.4 million in September 2016. Net cash used in financing activities for the year ended March 31, 2016 was $4.5 million, which consisted primarily of $23.8 million of net repayments on the Credit Facility and $22.7 million of distributions to common stockholders, partially offset by $38.6 million of net proceeds from the issuance of our Series C Term Preferred Stock and $3.4 million of net proceeds from the issuance of additional shares of our common stock. Net cash provided by financing activities for the year ended March 31, 2015, was $97.9 million, which consisted primarily of $39.7 million of net proceeds from the issuance of our Series B Term Preferred Stock, $23.0 million of net proceeds from the issuance of additional shares of our common stock, and $57.5 million of net borrowings on the Credit Facility, partially offset by $20.6 million in distributions to common stockholders.

Distributions and Dividends to Stockholders

Common Stock Distributions

To qualify to be taxed as a RIC and thus avoid corporate level federal income tax on the income we distribute to our stockholders, we are required to distribute to our stockholders on an annual basis at least 90% of our Investment Company Taxable Income. Additionally, the Credit Facility generally restricts the amount of distributions to stockholders that we can pay out to be no greater than the sum of certain amounts, including, but not limited to, our net investment income, plus net capital gains, plus amounts elected by the Company to be considered as having been paid during the prior fiscal year in accordance with Section 855(a) of the Code. In accordance with these requirements, our Board of Directors declared, and we paid, monthly cash distributions of $0.0625 per common share for each month during the year ended March 31, 2017. In April 2017, our Board of Directors declared a monthly distribution of $0.064 per common share for each of April, May, and June 2017 and

 

60


Table of Contents

a supplemental distribution of $0.06 per common share for June 2017. Our Board of Directors declared these distributions based on estimates of taxable income for the fiscal year ending March 31, 2018.

For federal income tax purposes, we determine the tax characterization of our common distributions as of the end of our fiscal year based upon our taxable income for the full fiscal year and distributions paid during the full fiscal year. The characterization of the common stockholder distributions declared and paid for the year ending March 31, 2018 will be determined after the 2018 fiscal year end based upon our taxable income for the full year and distributions paid during the full year. Such a characterization made on an interim, quarterly basis may not be representative of the actual full year characterization.

For the year ended March 31, 2017, distributions to common stockholders totaled $22.7 million and were less than our taxable income for the same year, when also considering prior spillover amounts under Section 855(a) of the Code. At March 31, 2017, we elected to treat $8.2 million of the first distributions paid after fiscal year-end as having been paid in the prior fiscal year, in accordance with Section 855(a) of the Code. In addition, we recorded a $1.3 million adjustment for estimated book-tax differences, which decreased Capital in excess of par value and increased Accumulated net realized gain (loss) and Net investment income in excess of distributions. For the year ended March 31, 2016, distributions to common stockholders totaled $22.7 million and were less than our taxable income for the same year, when also considering prior year spillover amounts under Section 855(a) of the Code. In addition, we recorded a $1.7 million adjustment for estimated book-tax differences, which decreased Capital in excess of par value and Accumulated net realized loss and increased Net investment income in excess of distributions. At March 31, 2016, we elected to treat $6.9 million of the first distributions paid after fiscal year-end as having been paid in the prior fiscal year, in accordance with Section 855(a) of the Code.

Preferred Stock Dividends

Our Board of Directors declared and we paid monthly cash dividends of (i) $0.1484375 per share to holders of our Series A Term Preferred Stock for each of the six months from April 2016 through September 2016 (after which we voluntarily redeemed in full our Series A Term Preferred Stock); (ii) $0.140625 per share to holders of our Series B Term Preferred Stock; and (iii) $0.135417 per share to holders of our Series C Term Preferred Stock for each month during the year ended March 31, 2017. Our Board of Directors also declared and we paid a combined dividend for the pro-rated period from and including the issuance date, September 26, 2016, to and including September 30, 2016 and the full month of October 2016, which totaled $0.15190972 per share, to the holders of our Series D Term Preferred Stock and monthly cash dividends of $0.13020833 per share to holders of our Series D Term Preferred Stock for each of the five months from November 2016 through March 2017.

In accordance with GAAP, we treat these monthly dividends as an operating expense. For federal income tax purposes, the dividends paid by us to preferred stockholders generally constitute ordinary income to the extent of our current and accumulated earnings and profits.

Dividend Reinvestment Plan

Our common stockholders who hold their shares through our transfer agent, Computershare, have the option to participate in a dividend reinvestment plan offered by Computershare. This is an “opt in” dividend reinvestment plan, meaning that common stockholders may elect to have their cash distributions automatically reinvested in additional shares of our common stock. Common stockholders who do not so elect will receive their distributions in cash. Common stockholders who receive distributions in the form of stock will be subject to the same federal, state and local tax consequences as stockholders who elect to receive their distributions in cash. The common stockholder will have an adjusted basis in the additional common shares purchased through the plan equal to the amount of the reinvested distribution. The additional shares will have a new holding period commencing on the day following the date on which the shares are credited to the common stockholder’s account. Our plan agent purchases shares in the open market in connection with the obligations under the plan. The Computershare dividend reinvestment plan is not open to holders of our preferred stock.

 

61


Table of Contents

Equity

Registration Statement

On June 16, 2015, we filed a registration statement on Form N-2 (File No. 333-204996) with the SEC and subsequently filed a Pre-Effective Amendment No. 1 thereto on July 28, 2015, which the SEC declared effective on July 29, 2015. On June 8, 2016, we filed Post-Effective Amendment No. 1 to the registration statement, which the SEC declared effective on July 28, 2016. The registration statement permits us to issue, through one or more transactions, up to an aggregate of $300.0 million in securities, consisting of common stock, preferred stock, subscription rights, debt securities and warrants to purchase common stock, preferred stock or debt securities, including through concurrent, separate offerings of such securities. After the Series D Term Preferred Stock offering in September 2016 and the common stock offering in May 2017 (including shares issued to cover overallotments in June 2017), we currently have the ability to issue up to $221.3 million in securities under the registration statement.

Common Stock

Pursuant to our current registration statement on Form N-2 (File No. 333-204996), in May 2017, we completed a public offering of 2.1 million shares of our common stock at a public offering price of $9.38 per share, which was below our then current estimated NAV of $9.95 per share. Gross proceeds totaled $19.7 million and net proceeds, after deducting underwriting discounts and commissions and estimated offering costs borne by us, were $18.7 million, which was used to repay borrowings under the Credit Facility and other general corporate purposes. On June 2, 2017, we issued an additional 155,265 shares of our common stock at a public offering price of $9.38 per share in connection with the partial exercise of the underwriters’ option to purchase additional shares of common stock on the same terms and conditions solely to cover over-allotments, which resulted in gross proceeds of approximately $1.5 million, and net proceeds, after deducting underwriting discounts and commissions and estimated offering costs borne by us, of approximately $1.4 million, which we intend to use to repay borrowings under the Credit Facility and for other general corporate purposes.

Pursuant to our prior registration statement on Form N-2 (Registration No. 333-181879), on March 13, 2015, we completed a public offering of 3.3 million shares of our common stock at a public offering price of $7.40 per share, which was below then current NAV of $8.55 per share. Gross proceeds totaled $24.4 million and net proceeds, after deducting underwriting discounts and offering costs borne by us, were $23.0 million, which were primarily used to repay borrowings under the Credit Facility. In connection with the offering, on April 2, 2015, the underwriters exercised their option to purchase an additional 495,000 shares at the public offering price to cover over-allotments, which resulted in gross proceeds of $3.7 million and net proceeds, after deducting underwriting discounts and offering costs borne by us, of $3.4 million.

We anticipate issuing equity securities to obtain additional capital in the future. However, we cannot determine the terms of any future equity issuances or whether we will be able to issue equity on terms favorable to us, or at all. When our common stock is trading at a price below NAV per share, as it has predominantly since September 30, 2008, the 1940 Act places regulatory constraints on our ability to obtain additional capital by issuing common stock. Generally, the 1940 Act provides that we may not issue and sell our common stock at a price below our NAV per common share, other than to our then existing common stockholders pursuant to a rights offering, without first obtaining approval from our stockholders and our independent directors and meeting other stated requirements. On July 27, 2017, the closing market price of our common stock was $9.51 per share, representing a 4.4% discount to our NAV of $9.95 as of March 31, 2017. To the extent that our common stock continues to trade at a market price below our NAV per common share, we will generally be precluded from raising equity capital through public offerings of our common stock, other than pursuant to stockholder approval or through a rights offering to existing common stockholders. At our 2016 Annual Meeting of Stockholders held on August 4, 2016, our stockholders approved a proposal authorizing us to issue and sell shares of our common stock at a price below our then current NAV per common share for a period of one year from the date of such approval, provided that our Board of Directors makes certain determinations prior to any such sale. At our 2017 Annual Meeting of Stockholders, scheduled to take place in August 2017, we intend to again ask our stockholders to vote in favor of a similar proposal so that it may be in effect for another year.

 

62


Table of Contents

Term Preferred Stock

Pursuant to an earlier registration statement on Form N-2 (File No. 333-160720), in March 2012, we completed an offering of 1,600,000 shares of our Series A Term Preferred Stock at a public offering price of $25.00 per share. Gross proceeds totaled $40.0 million, and net proceeds, after deducting underwriting discounts and offering costs borne by us, were $38.0 million, a portion of which was used to repay borrowings under the Credit Facility, with the remaining proceeds being held to make additional investments and for general corporate purposes. Total underwriting discounts and offering costs related to this offering were $2.0 million, which have been recorded as discounts to the liquidation value on our Consolidated Statements of Assets and Liabilities which are included elsewhere in this prospectus and which, prior to the redemption in September 2016, were amortized over the period ending February 28, 2017, the mandatory redemption date.

In September 2016, we used a portion of the proceeds from the issuance of our Series D Term Preferred Stock, discussed below, to voluntarily redeem all 1.6 million outstanding shares of our Series A Term Preferred Stock, which had a liquidation preference of $25.00 per share. In connection with this voluntary redemption, we incurred a loss on extinguishment of debt of $0.2 million, which has been recorded in Realized loss on other in our Consolidated Statements of Operations which are included elsewhere in this prospectus and which was primarily comprised of unamortized deferred issuance costs at the time of redemption.

Prior to its redemption in September 2016, our Series A Term Preferred Stock provided for a fixed dividend equal to 7.125% per year, payable monthly (which equated to $2.9 million per year). We were required to redeem all of the outstanding Series A Term Preferred Stock on February 28, 2017, for cash at a redemption price equal to $25.00 per share plus an amount equal to accumulated but unpaid dividends, if any, to the date of redemption. Our Series A Term Preferred Stock was not convertible into our common stock or any other security.

Pursuant to our prior registration statement on Form N-2 (Registration No. 333-181879), in November 2014, we completed a public offering of 1,656,000 shares of our Series B Term Preferred Stock at a public offering price of $25.00 per share. Gross proceeds totaled $41.4 million and net proceeds, after deducting underwriting discounts and offering costs borne by us, were $39.7 million. Total underwriting discounts and offering costs related to this offering were $1.7 million, which have been recorded as discounts to the liquidation value on our Consolidated Statements of Assets and Liabilities which are included elsewhere in this prospectus and are being amortized over the period ending December 31, 2021, the mandatory redemption date.

Our Series B Term Preferred Stock is not convertible into our common stock or any other security. Our Series B Term Preferred Stock provides for a fixed dividend equal to 6.75% per year, payable monthly (which equates to $2.8 million per year). We are required to redeem all shares of our outstanding Series B Term Preferred Stock on December 31, 2021, for cash at a redemption price equal to $25.00 per share, plus an amount equal to accumulated but unpaid dividends, if any, to, but excluding, the date of redemption. In addition, two other potential mandatory redemption triggers are as follows: (1) upon the occurrence of certain events that would constitute a change in control of us, we would be required to redeem all of our outstanding Series B Term Preferred Stock, and (2) if we fail to maintain an asset coverage of at least 200%, we are required to redeem a portion of our outstanding Series B Term Preferred Stock or otherwise cure the asset coverage redemption trigger (and we may also redeem additional securities to cause the asset coverage to be 215%). We may also voluntarily redeem all or a portion of our Series B Term Preferred Stock at our sole option at the redemption price at any time on or after December 31, 2017.

Also, pursuant to our prior registration statement on Form N-2 (Registration No. 333-181879), in May 2015, we completed a public offering of 1,610,000 shares of our Series C Term Preferred Stock at a public offering price of $25.00 per share. Gross proceeds totaled $40.3 million and net proceeds, after deducting underwriting discounts and offering costs borne by us, were $38.6 million. Total underwriting discounts and offering costs related to this offering were $1.6 million, which have been recorded as discounts to the liquidation value on our Consolidated Statements of Assets and Liabilities which are included elsewhere in this prospectus and are being amortized over the period ending May 31, 2022, the mandatory redemption date.

 

63


Table of Contents

Our Series C Term Preferred Stock is not convertible into our common stock or any other security. Our Series C Term Preferred Stock provides for a fixed dividend equal to 6.50% per year, payable monthly (which equates to $2.6 million per year). We are required to redeem all shares of our outstanding Series C Term Preferred Stock on May 31, 2022, for cash at a redemption price equal to $25.00 per share, plus an amount equal to accumulated but unpaid dividends, if any, to, but excluding, the date of redemption. In addition, two other potential mandatory redemption triggers are as follows: (1) upon the occurrence of certain events that would constitute a change in control of us, we would be required to redeem all of our outstanding Series C Term Preferred Stock, and (2) if we fail to maintain an asset coverage of at least 200%, we are required to redeem a portion of our outstanding Series C Term Preferred Stock or otherwise cure the asset coverage redemption trigger (and we may also redeem additional securities to cause the asset coverage to be 215%). We may also voluntarily redeem all or a portion of our Series C Term Preferred Stock at our sole option at the redemption price at any time on or after May 31, 2018.

Pursuant to our current registration statement on Form N-2 (Registration No. 333-204996), in September 2016, we completed a public offering of 2,300,000 shares of our Series D Term Preferred Stock at a public offering price of $25.00 per share. Gross proceeds totaled $57.5 million and net proceeds, after deducting underwriting discounts and offering costs borne by us, were $55.4 million. Total underwriting discounts and offering costs related to this offering were $2.1 million, which have been recorded as discounts to the liquidation value on our Consolidated Statements of Assets and Liabilities which are included elsewhere in this prospectus and are being amortized over the period ending September 30, 2023, the mandatory redemption date.

Our Series D Term Preferred Stock is not convertible into our common stock or any other security. Our Series D Term Preferred Stock provides for a fixed dividend equal to 6.25% per year, payable monthly (which equates to $3.6 million per year). We are required to redeem all shares of our outstanding Series D Term Preferred Stock on September 30, 2023, for cash at a redemption price equal to $25.00 per share, plus an amount equal to accumulated but unpaid dividends, if any, to, but excluding, the date of redemption. In addition, two other potential mandatory redemption triggers are as follows: (1) upon the occurrence of certain events that would constitute a change in control of us, we would be required to redeem all of our outstanding Series D Term Preferred Stock, and (2) if we fail to maintain an asset coverage of at least 200% and are unable to correct such failure within a specific amount of time, we are required to redeem a portion of our outstanding Series D Term Preferred Stock or otherwise cure the asset coverage redemption trigger (and we may also redeem additional securities to cause the asset coverage to be 240%). We may also voluntarily redeem all or a portion of our Series D Term Preferred Stock at our sole option at the redemption price at any time on or after September 30, 2018.

Each series of our Term Preferred Stock has a preference over our common stock with respect to dividends, whereby no distributions are payable on our common stock unless the stated dividends, including any accrued and unpaid dividends, on the Term Preferred Stock have been paid in full. The Series B Term Preferred Stock, Series C Term Preferred Stock, and Series D Term Preferred Stock are considered liabilities in accordance with GAAP and, as such, affect our asset coverage, exposing us to additional leverage risks. The asset coverage on our senior securities that are stock (our Series B Term Preferred Stock, Series C Term Preferred Stock, and Series D Term Preferred Stock) as of March 31, 2017 was 235.6%, calculated pursuant to Sections 18 and 61 of the 1940 Act.

Revolving Line of Credit

On November 16, 2016, we, through our wholly-owned subsidiary, Business Investment, entered into Amendment No. 2 to the Fifth Amended and Restated Credit Agreement, originally entered into on April 30, 2013 and as previously amended on June 26, 2014, with KeyBank National Association (“KeyBank”), as administrative agent, lead arranger, managing agent and lender, the Adviser, as servicer, and certain other lenders party thereto which governs the Credit Facility. The revolving period was extended to November 15, 2019, and if not renewed or extended by such date, all principal and interest will be due and payable on or before November 15, 2021 (two years after the revolving period end date). The amended Credit Facility provides two one-year extension options that may be exercised on or before the first and second anniversary of the

 

64


Table of Contents

November 16, 2016 amendment date, subject to approval by all lenders. Additionally, the Credit Facility commitment amount was changed from $185.0 million to $165.0 million and, subject to certain terms and conditions, can be expanded to a total facility amount of $250.0 million through additional commitments of existing or new lenders. Advances under the Credit Facility generally bear interest at 30-day LIBOR plus 3.15% per annum until November 15, 2019, with the margin then increasing to 3.40% for the period from November 15, 2019 to November 15, 2020, and increasing further to 3.65% thereafter. The Credit Facility has an unused commitment fee of 0.50% per annum on the portion of the total unused commitment amount that is less than or equal to 45.0% of the total commitment amount and 0.80% per annum on the total unused commitment amount that is greater than 45.0%. We incurred fees of approximately $1.4 million in connection with this amendment.

On January 20, 2017, we entered into Amendment No. 3 to the Credit Facility, which clarified a definition in the Company’s performance guaranty under the Credit Facility.

Interest is payable monthly during the term of the Credit Facility. Available borrowings are subject to various constraints and applicable advance rates, which are generally based on the size, characteristics, and quality of the collateral pledged by Business Investment. The Credit Facility also requires that any interest and principal payments on pledged loans be remitted directly by the borrower into a lockbox account with KeyBank. KeyBank is also the trustee of the account and generally remits the collected funds to us once a month.

Among other things, the Credit Facility contains covenants that require Business Investment to maintain its status as a separate legal entity, prohibit certain significant corporate transactions (such as mergers, consolidations, liquidations or dissolutions) and restrict certain material changes to our credit and collection policies without the lenders’ consent. The Credit Facility also generally seeks to restrict distributions to shareholders to the sum of (i) our net investment income, (ii) net capital gains, and (iii) amounts deemed by the Company to be considered as having been paid during the prior fiscal year in accordance with Section 855(a) of the Code. Loans eligible to be pledged as collateral are subject to certain limitations, including, among other things, restrictions on geographic concentrations, industry concentrations, loan size, payment frequency and status, average life, portfolio company leverage, and lien property. The Credit Facility also requires Business Investment to comply with other financial and operational covenants, which obligate Business Investment to, among other things, maintain certain financial ratios, including asset and interest coverage and a minimum number of obligors required in the borrowing base. Additionally, the Credit Facility contains a performance guaranty that requires the Company to maintain (i) a minimum net worth (defined in the Credit Facility to include our mandatory redeemable term preferred stock) of the greater of (a) $210.0 million or (b) $210.0 million plus 50% of all equity and subordinated debt raised minus 50% of any equity or subordinated debt redeemed or retired after November 16, 2016, which equated to $210.0 million as of March 31, 2017, (ii) asset coverage with respect to senior securities representing indebtedness of at least 200%, in accordance with Sections 18 and 61 of the 1940 Act and (iii) our status as a BDC under the 1940 Act and as a RIC under the Code. As of March 31, 2017, and as defined in the performance guaranty of the Credit Facility, we had a net worth of $434.3 million, asset coverage on our senior securities representing indebtedness of 661.3%, calculated in compliance with the requirements of Sections 18 and 61 of the 1940 Act, and an active status as a BDC and RIC. As of March 31, 2017, we had availability, after adjustments for various constraints based on collateral quality, of $93.4 million under the Credit Facility and were in compliance with all covenants under the Credit Facility. As of July 27, 2017, we had availability, before adjustments for various constraints based on collateral quality, of $135.2 million under the Credit Facility.

In July 2013, pursuant to the terms of the then effective revolving line of credit, we entered into an interest rate cap agreement with KeyBank effective October 2013 for a notional amount of $45.0 million. The interest rate cap agreement expired in April 2016. Prior to its expiration in April 2016, the agreement effectively limited the interest rate on a portion of our borrowings under the then effective revolving line of credit. We incurred a premium fee of $75 in conjunction with this agreement, which was recorded in Net realized loss on other on our accompanying Consolidated Statements of Operations during the year ended March 31, 2017.

 

65


Table of Contents

OFF-BALANCE SHEET ARRANGEMENTS

Unlike PIK income, we generally recognize success fees as income when the payment has been received. As a result, as of March 31, 2017 and 2016, we had unrecognized, contractual off-balance sheet success fee receivables of $24.2 million and $27.8 million (or approximately $0.80 and $0.92 per common share), respectively, on our debt investments. Consistent with GAAP, we generally have not recognized success fee receivables and related income in our Consolidated Financial Statements until earned. Due to the contingent nature of our success fees, there are no guarantees that we will be able to collect any or all of these success fees or know the timing of such collections.

CONTRACTUAL OBLIGATIONS

We have lines of credit and other uncalled capital commitments to certain of our portfolio companies that have not been fully drawn. Since these lines of credit and uncalled capital commitments have expiration dates and we expect many will never be fully drawn, the total line of credit and other uncalled capital commitment amounts do not necessarily represent future cash requirements. We estimate the fair value of the combined unused line of credit and other uncalled capital commitments as of March 31, 2017 to be immaterial.

In addition to the lines of credit and other uncalled capital commitments to our portfolio companies, we have also extended a guaranty on behalf of one of our portfolio companies, whereby we have guaranteed $2.0 million of obligations of Country Club Enterprises, LLC. The guaranty expires in February 2018, unless renewed. As of March 31, 2017, we have not been required to make payments on this or any previous guaranties, and we consider the credit risks to be remote and the fair value of this guaranty to be immaterial.

The following table shows our contractual obligations as of March 31, 2017, at cost:

 

     Payments Due by Period  
     Total      Less
than

1 Year
     1-3 Years      3-5 Years      More
than
5 Years
 

Contractual Obligations (A)

              

Credit Facility (B)

   $ 69,700      $ —        $ —        $ 69,700      $ —    

Mandatorily redeemable preferred stock

     139,150        —          —          41,400        97,750  

Secured borrowing

     5,096        —          —          5,096        —    

Interest payments on obligations (C)

     67,268        12,834        25,678        23,229        5,527  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 281,214      $ 12,834      $ 25,678      $ 139,425      $ 103,277  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(A)   Excludes unused line of credit commitments, uncalled capital commitments and guaranties to our portfolio companies in the aggregate principal amount of $4.9 million.
(B)   Principal balance of borrowings outstanding under the Credit Facility, based on the maturity date following the current contractual revolving period end date.
(C)   Includes interest payments due on the Credit Facility and secured borrowing, and dividend obligations on each series of our mandatorily redeemable preferred stock. The amount of interest expense calculated for purposes of this table was based upon rates and outstanding balances as of March 31, 2017. Dividend obligations on our mandatorily redeemable preferred stock assume quarterly declarations and monthly dividend payments through the date of mandatory redemption of each series.

Litigation

From time to time, we may become involved in various investigations, claims and legal proceedings that arise in the ordinary course of our business. Furthermore, third parties may try to seek to impose liability on us in connection with the activities of our portfolio companies. While we do not expect that the resolution of these matters if they arise would materially affect our business, financial condition, results of operations or cash flows, resolution will be subject to various uncertainties and could result in the expenditure of significant financial and managerial resources.

 

66


Table of Contents

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the reported consolidated amounts of assets and liabilities, including disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the period reported. Actual results could differ materially from those estimates under different assumptions or conditions. We have identified our investment valuation policy (which has been approved by our Board of Directors) as our most critical accounting policy, which is described in Note 2 — Summary of Significant Accounting Policies in the accompanying notes to our Consolidated Financial Statements included elsewhere in this prospectus. Additionally, refer to Note 3 —  Investments in the accompanying notes to our Consolidated Financial Statements included elsewhere in this prospectus for additional information regarding fair value measurements and our application of Financial Accounting Standards Board Accounting Standards Codification Topic 820, “ Fair Value Measurements and Disclosures. ” We have also identified our revenue recognition policy as a critical accounting policy, which is described in Note 2 — Summary of Significant Accounting Policies in the accompanying notes to our Consolidated Financial Statements included elsewhere in this prospectus.

Investment Valuation

Credit Monitoring and Risk Rating

The Adviser monitors a wide variety of key credit statistics that provide information regarding our portfolio companies to help us assess credit quality and portfolio performance and, in some instances, are used as inputs in our valuation techniques. Generally, we, through the Adviser, participate in periodic board meetings of our portfolio companies in which we hold board seats and also require them to provide annual audited and monthly unaudited financial statements. Using these statements or comparable information and board discussions, the Adviser calculates and evaluates certain credit statistics.

The Adviser risk rates all of our investments in debt securities. The Adviser does not risk rate our equity securities. For loans that have been rated by a SEC registered Nationally Recognized Statistical Rating Organization (“NRSRO”), the Adviser generally uses the average of two corporate level NRSRO’s risk ratings for such security. For all other debt securities, the Adviser uses a proprietary risk rating system. While the Adviser seeks to mirror the NRSRO systems, we cannot provide any assurance that the Adviser’s risk rating system will provide the same risk rating as an NRSRO for these securities. The Adviser’s risk rating system is used to estimate the probability of default on debt securities and the expected loss if there is a default. The Adviser’s risk rating system uses a scale of 0 to >10, with >10 being the lowest probability of default. It is the Adviser’s understanding that most debt securities of Lower Middle Market companies do not exceed the grade of BBB on an NRSRO scale, so there would be no debt securities in the Lower Middle Market that would meet the definition of AAA, AA or A. Therefore, the Adviser’s scale begins with the designation >10 as the best risk rating which may be equivalent to a BBB from an NRSRO; however, no assurance can be given that a >10 on the Adviser’s scale is equal to a BBB or Baa2 on an NRSRO scale. The Adviser’s risk rating system covers both qualitative and quantitative aspects of the business and the securities we hold.

The following table reflects risk ratings for all loans in our portfolio as of March 31, 2017 and 2016:

 

     As of
March 31,
 

Rating

   2017      2016  

Highest

     10.0        10.0  

Average

     6.1        6.0  

Weighted Average

     6.5        6.2  

Lowest

     3.0        3.0  

 

67


Table of Contents

Tax Status

We intend to continue to maintain our qualification as a RIC under Subchapter M of the Code for federal income tax purposes. As a RIC, we generally are not subject to federal income tax on the portion of our taxable income and gains distributed to our stockholders. To maintain our qualification as a RIC, we must maintain our status as a BDC and meet certain source-of-income and asset diversification requirements. In addition, in order to qualify to be taxed as a RIC, we must distribute to stockholders at least 90% of our Investment Company Taxable Income. Our policy generally is to make distributions to our stockholders in an amount up to 100% of our Investment Company Taxable Income.

In an effort to limit certain federal excise taxes imposed on RICs, we generally intend to distribute to our stockholders, during each calendar year, an amount close to the sum of: (1) 98% of our ordinary income for the calendar year, (2) 98.2% of our capital gains in excess of capital losses for the one-year period ending on October 31 of the calendar year, and (3) any ordinary income and capital gains in excess of capital losses from preceding years that were not distributed during such years. Under the RIC Modernization Act, we are permitted to carryforward capital losses incurred in taxable years beginning after March 31, 2011, for an unlimited period. Additionally, post-enactment capital loss carryforwards will retain their character as either short-term or long-term capital losses rather than being considered all short-term as permitted under the Treasury regulations applicable to pre-enactment capital loss carryforwards. Our capital loss carryforward balance was $0 and $13.6 million as of March 31, 2017 and 2016, respectively.

Recent Accounting Pronouncements

See Note 2 — Summary of Significant Accounting Policies in the accompanying notes to our Consolidated Financial Statements included elsewhere in this prospectus for a description of recent accounting pronouncements.

Quantitative and Qualitative Disclosures About Market Risk

Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments. The prices of securities held by us may decline in response to certain events, including those directly involving the companies whose securities are owned by us; conditions affecting the general economy; overall market changes; local, regional or global political, social or economic instability; and interest rate fluctuations.

The primary risk we believe we are exposed to is interest rate risk. Because we borrow money to make investments, our net investment income is dependent upon the difference between the rates at which we borrow funds, such as under the Credit Facility (which is variable) and our mandatorily redeemable preferred stock (which are fixed), and the rates at which we invest those funds. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income. We use a combination of debt and equity capital to finance our investing activities. We may use interest rate risk management techniques to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act.

We target to have approximately 10% of the loans in our portfolio at fixed rates, with approximately 90% at variable rates or variables rates with a floor mechanism. Currently, all of our variable-rate loans have rates associated with the current 30-day LIBOR rate. As of March 31, 2017, our portfolio consisted of the following breakdown based on the total principal balance of all outstanding debt investments:

 

Variable rates with a floor

     92.9

Fixed rates

     7.1  
  

 

 

 

Total

     100.0
  

 

 

 

 

68


Table of Contents

Advances under the Credit Facility generally bear interest at 30-day LIBOR, plus 3.15% per annum, and the Credit Facility includes an unused fee of 0.50% per annum on the portion of the total unused commitment amount that is less than or equal to 45.0% of the total commitment amount and 0.80% per annum on the total unused commitment amount that is greater than 45.0%. Once the revolving period ends, the interest rate margin increases to 3.40% for the period from November 15, 2019 to November 15, 2020, and further increases to 3.65% through maturity.

To illustrate the potential impact of changes in interest rates, we have performed the following hypothetical analysis, which assumes that our balance sheet and interest rates remain constant as of March 31, 2017 and no further actions are taken to alter our existing interest rate sensitivity.

 

Basis Point Change (A)

   Increase in
Interest Income
     Increase (Decrease)
in

Interest Expense
     Net (Decrease) Increase
in Net Assets Resulting
from Operations
 

Up 300 basis points

   $ 6,645      $ 2,091      $ 4,554  

Up 200 basis points

     3,572        1,394        2,178  

Up 100 basis points

     766        697        69  

Down 98 basis points

     (31      (685      654  

 

(A)   As of March 31, 2017, our effective average LIBOR was 0.98%, therefore the largest decrease in basis points that could occur was 98 basis points.

Although management believes that this analysis is indicative of our existing interest rate sensitivity, it does not adjust for potential changes in credit quality, size and composition of our loan portfolio on the balance sheet and other business developments that could affect net increase (decrease) in net assets resulting from operations. Accordingly, actual results could differ significantly from those in the hypothetical analysis in the table above.

We may also experience risk associated with investing in securities of companies with foreign operations. Some of our portfolio companies have operations located outside the United States. These risks include fluctuations in foreign currency exchange rates, imposition of foreign taxes, changes in exportation regulations and political and social instability.

 

69


Table of Contents

SALES OF COMMON STOCK BELOW NET ASSET VALUE

At our 2016 annual stockholders meeting, our stockholders approved our ability to sell or otherwise issue shares of our common stock at a price below the then current NAV per common share during a period beginning on August 5, 2016 and expiring on the first anniversary of such date (the “Stockholder Approval”). We intend to seek a similar approval at our 2017 annual meeting of stockholders in August 2017. To sell shares of common stock at a price below NAV per share pursuant to the Stockholder Approval, the 1940 Act mandates that a majority of our directors who have no financial interest in the sale and a majority of our independent directors must have determined (i) that such sale and issuance is in our best interests and in the best interests of our stockholders and (ii) in consultation with any underwriter or underwriters of the offering, make a good faith determination as of a time either immediately prior to the first solicitation by us or on our behalf of firm commitments to purchase such shares of common stock or immediately prior to the issuance of such common stock that the price at which such shares of common stock are to be sold is not less than a price which closely approximates the market value of those shares of common stock, less any distributing commission or discount.

In addition to the mandates of the 1940 Act pertaining to issuances and sales of common stock at a price below NAV per share, our Stockholder Approval requires that any offering of common stock at a price below NAV per share satisfy the following the total number of shares issued and sold pursuant to such Stockholder Approval may not exceed 25% of our currently outstanding common stock immediately prior to each such sale.

Any offering of common stock below its NAV per share will be designed to raise capital for investment in accordance with our investment objectives.

In making a determination that an offering of common stock below its NAV per share is in our and our stockholders’ best interests, our Board of Directors will consider a variety of factors including, but not limited to:

 

    the effect that an offering below NAV per share would have on our stockholders, including the potential dilution they would experience as a result of the offering;

 

    the amount per share by which the offering price per share and the net proceeds per share are less than our most recently determined NAV per share;

 

    the relationship of recent market prices of our common stock to NAV per share and the potential impact of the offering on the market price per share of our common stock;

 

    whether the estimated offering price would closely approximate the market value of shares of our common stock;

 

    the nature of any new investors anticipated to acquire shares of our common stock in the offering;

 

    the anticipated rate of return on and quality, type and availability of investments; and

 

    the leverage available to us.

Our Board of Directors will also consider the fact that sales of shares of common stock at a discount will benefit the Adviser as the Adviser will ultimately earn additional investment management fees on the proceeds of such offerings, as it would from the offering of any other securities of the Company or from the offering of common stock at a premium to NAV per share.

We will not sell shares of our common stock under this prospectus or an accompanying prospectus supplement pursuant to the Stockholder Approval without first filing a post-effective amendment to the registration statement if the cumulative dilution to the Company’s NAV per share from offerings under the registration statement exceeds 15%. This would be measured separately for each offering pursuant to the registration statement by calculating the percentage dilution or accretion to aggregate NAV from that offering and then summing the percentage from each offering. For example, if our most recently determined NAV per share at the time of the first offering is $10.00 and we have 140 million shares outstanding, the sale of 35 million

 

70


Table of Contents

shares at net proceeds to us (after discounts, commissions and offering expenses) of $5.00 per share (a 50% discount) would produce dilution of 10%. If we subsequently determined that our NAV per share increased to $11.00 on the then 175 million shares outstanding and then made an additional offering, we could, for example, sell approximately an additional 43.75 million shares at net proceeds to us (after discounts, commissions and offering expenses) of $8.25 per share, which would produce dilution of 5%, before we would reach the aggregate 15% limit. If we file a new post-effective amendment, the threshold would reset.

Sales by us of our common stock at a discount from NAV per share pose potential risks for our existing stockholders whether or not they participate in the offering, as well as for new investors who participate in the offering. Any sale of common stock at a price below NAV per share would result in an immediate dilution to existing common stockholders who do not participate in such sale on at least a pro-rata basis. See “ Risk Factors—Risks Related to an Investment in Our Securities ” in this prospectus.

The following three headings and accompanying tables explain and provide hypothetical examples on the impact of an offering of our common stock at a price less than NAV per share on three different types of investors:

 

    existing stockholders who do not purchase any shares in the offering;

 

    existing stockholders who purchase a relative small amount of shares in the offering or a relatively large amount of shares in the offering; and

 

    new investors who become stockholders by purchasing shares in the offering.

Impact on Existing Stockholders Who Do Not Participate in an Offering

Our existing common stockholders who do not participate in an offering below NAV per share or who do not buy additional shares in the secondary market at the same or lower price we obtain in the offering (after discounts, commissions and offering expenses) face the greatest potential risks. These stockholders will experience an immediate decrease (often called dilution) in the NAV of the common shares they hold and their NAV per common share. These common stockholders will also experience a disproportionately greater decrease in their participation in our earnings and assets and their voting power than the increase we will experience in our assets, potential earning power and voting interests due to the offering. These stockholders may also experience a decline in the market price of their shares, which often reflects to some degree announced or potential increases and decreases in NAV per common share. This decrease could be more pronounced as the size of the offering and level of discounts increase. Further, if current common stockholders do not purchase any shares to maintain their percentage interest, regardless of whether such offering is above or below the then current NAV, their voting power will be diluted.

 

71


Table of Contents

The following table illustrates the level of NAV dilution that would be experienced by a nonparticipating common stockholder in three different hypothetical offerings of different sizes and levels of discount from NAV per common share, although it is not possible to predict the level of market price decline that may occur. Actual sales prices and discounts may differ from the presentation below.

The examples assume that we have 1,000,000 common shares outstanding, $15,000,000 in total assets and $5,000,000 in total liabilities. The current NAV and NAV per common share are thus $10,000,000 and $10.00. The table illustrates the dilutive effect on a nonparticipating common stockholder of (1) an offering of 50,000 shares of common stock (5% of the outstanding common shares) at $9.50 per share after discounts, commissions and offering expenses (a 5% discount from NAV), (2) an offering of 100,000 shares (10% of the outstanding common shares) at $9.00 per share after discounts, commissions and offering expenses (a 10% discount from NAV) and (3) an offering of 250,000 shares of common stock (25% of the outstanding common shares) at $7.50 per common share after discounts, commissions and offering expenses (a 25% discount from NAV). The prospectus supplement pursuant to which any discounted offering is made will include a chart based on the actual number of shares of common stock in such offering and the actual discount to the most recently determined NAV.

 

    Prior to Sale
Below NAV
    Example 1
5% Offering at 5% Discount
    Example 2
10% Offering at 10% Discount
    Example 3
25% Offering at 25% Discount
 
      Following
Sale
    % Change     Following
Sale
    % Change     Following
Sale
    % Change  

Offering Price

             

Price per Common Share to Public

    —     $ 10.00       —       $ 9.47       —       $ 7.90       —    

Net Proceeds per Common Share to Us

    —       $ 9.50       —       $ 9.00       —       $ 7.50       —    

Decrease to NAV

             

Total Common Shares Outstanding

    1,000,000       1,050,000       5.00     1,100,000       10.00     1,250,000       25.00

NAV per Common Share

  $ 10.00     $ 9.98       (0.20 )%   $ 9.91       (0.90 )%   $ 9.50       5.00

Dilution to Stockholder

             

Common Shares Held by Stockholder

    10,000       10,000       —         10,000       —         10,000       —    

Percentage Held by Common Stockholder

    1.0 %     0.95 %     (4.76 )%     0.91 %     (9.09 )%     0.83 %     (16.67 )%

Total Asset Values

             

Total NAV Held by Common Stockholder

  $ 100,000     $ 99,800       (0.20 )%   $ 99,100       (0.90 )%   $ 95,000       (5.00 )%

Total Investment by Common Stockholder (Assumed to be $10.00 per Common Share)

  $ 100,000     $ 100,000       —       $ 100,000       —       $ 100,000       —    

Total Dilution to Common Stockholder (Total NAV Less Total Investment)

    —       $ (200 )     —       $ (900 )     —       $ 5,000       —    

Per Share Amounts

             

NAV Per Share Held by Common Stockholder

    —       $ 9.98       —       $ 9.91       —       $ 9.50       —    

Investment per Share Held by Common Stockholder (Assumed to be $10.00 per Common Share on Common Shares Held prior to Sale)

  $ 10.00     $ 10.00       —       $ 10.00       —       $ 10.00       —    

Dilution per Common Share Held by Stockholder (NAV per Common Share Less Investment per Share)

    —       $ (0.02 )     —       $ (0.09 )     —       $ (0.50 )     —    

Percentage Dilution to Common Stockholder (Dilution per Common Share Divided by Investment per Common Share)

    —         —         (0.20 )%     —         (0.90 )%     —         (5.00 )%

 

72


Table of Contents

Impact on Existing Stockholders Who Do Participate in an Offering

Our existing common stockholders who participate in an offering below NAV per common share or who buy additional shares in the secondary market at the same or lower price as we obtain in the offering (after discounts, commissions and offering expenses) will experience the same types of NAV dilution as the nonparticipating common stockholders, albeit at a lower level, to the extent they purchase less than the same percentage of the discounted offering as their interest in our common shares immediately prior to the offering. The level of NAV dilution will decrease as the number of common shares such stockholders purchase increases. Existing common stockholders who buy more than such percentage will experience NAV dilution but will, in contrast to existing common stockholders who purchase less than their proportionate share of the offering, experience an increase (often called accretion) in NAV per common share over their investment per share and will also experience a disproportionately greater increase in their participation in our earnings and assets and their voting power than our increase in assets, potential earning power and voting interests due to the offering. The level of accretion will increase as the excess number of shares such common stockholder purchases increases. Even a common stockholder who over-participates will, however, be subject to the risk that we may make additional discounted offerings in which such common stockholder does not participate, in which case such a stockholder will experience NAV dilution as described above in such subsequent offerings. These stockholders may also experience a decline in the market price of their shares, which often reflects to some degree announced or potential increases and decreases in NAV per share. This decrease could be more pronounced as the size of the offering and level of discount to NAV increases.

 

73


Table of Contents

The following chart illustrates the level of dilution and accretion in the hypothetical 25% discount offering from the prior chart for a common stockholder that acquires shares equal to (1) 50% of its proportionate share of the offering (i.e., 1,250 shares, which is 0.50% of the offering 250,000 common shares rather than its 1% proportionate share) and (2) 150% of such percentage (i.e., 3,750 shares, which is 1.50% of an offering of 250,000 common shares rather than its 1% proportionate share). The prospectus supplement pursuant to which any discounted offering is made will include a chart for this example based on the actual number of shares in such offering and the actual discount from the most recently determined NAV per common share. It is not possible to predict the level of market price decline that may occur.

 

     Prior to Sale
Below NAV
    50% Participation     150% Participation  
       Following
Sale
    %
Change
    Following
Sale
    %
Change
 

Offering Price

          

Price per Common Share to Public

     —       $ 7.90       —       $ 7.90       —    

Net Proceeds per Common Share to Us

     —       $ 7.50       —       $ 7.50       —    

Increases in Shares and Decrease to NAV

          

Total Common Shares Outstanding

     1,000,000       1,250,000       25.00 %     1,250,000       25.00 %

NAV per Common Share

   $ 10.00     $ 9.50       5.00 %   $ 9.50       5.00 %

Dilution/Accretion to Common Stockholder

          

Common Shares Held by Stockholder

     10,000       11,250       12.50 %     13,750       37.50 %

Percentage Held by Common Stockholder

     1.0 %     0.90 %     10.00 %     1.10 %     10.00 %

Total Asset Values

          

Total NAV Held by Common Stockholder

   $ 100,000     $ 106,875       6.88 %   $ 130,625       30.63 %

Total Investment by Common Stockholder (Assumed to be $10.00 per Common Share on Common Shares Held prior to Sale)

   $ 100,000     $ 109,875       —       $ 129,625       —    

Total Dilution/Accretion to Common Stockholder (Total NAV Less Total Investment)

     —         3,000       —       $ 1,000       —    

Per Common Share Amounts

          

NAV Per Common Share Held by Stockholder

     —       $ 9.50       —       $ 9.50       —    

Investment per Common Share Held by Stockholder (Assumed to be $10.00 per Common Share on Common Shares Held prior to Sale)

   $ 10.00     $ 9.77       2.33 %   $ 9.43       5.73 %

Dilution/Accretion per Common Share Held by Stockholder (NAV per Common Share Less Investment per Common Share)

     —       $ 0.27       —       $ 0.07       —    

Percentage Dilution/Accretion to Stockholder (Dilution/Accretion per Common Share Divided by Investment per Common Share)

     —         —         2.73 %     —         0.77 %

 

74


Table of Contents

Impact on New Investors

Investors who are not currently stockholders, but who participate in an offering below NAV and whose investment per common share is greater than the resulting NAV per share (due to discounts, commissions and offering expenses paid by us) will experience an immediate decrease, albeit small, in the NAV of their shares and their NAV per share compared to the price they pay for their shares of common stock. Investors who are not currently stockholders and who participate in an offering below NAV per common share and whose investment per common share is also less than the resulting NAV per common share due to discounts, commissions and offering expenses paid by us being significantly less than the discount per common share will experience an immediate increase in the NAV of their shares and their NAV per share compared to the price they pay for their shares of common stock. These investors will experience a disproportionately greater participation in our earnings and assets and their voting power than our increase in assets, potential earning power and voting interests. These investors will, however, be subject to the risk that we may make additional discounted offerings in which such new common stockholder does not participate, in which case such new stockholder will experience dilution as described above in such subsequent offerings. These investors may also experience a decline in the market price of their shares of common stock, which often reflects to some degree announced or potential increases and decreases in NAV per share. This decrease could be more pronounced as the size of the offering and level of discounts increases.

 

75


Table of Contents

The following chart illustrates the level of dilution or accretion for new investors that would be experienced by a new investor in the same 5%, 10% and 25% discounted offerings as described in the first chart above. The illustration is for a new investor who purchases the same percentage (1%) of the common shares in the offering as the common stockholder in the prior examples held immediately prior to the offering, The prospectus supplement pursuant to which any discounted offering is made will include a chart for this example based on the actual number of common shares in such offering and the actual discount from the most recently determined NAV per common share. It is not possible to predict the level of market price decline that may occur.

 

    Prior to
Sale Below
NAV
    Example 1
5% Offering at 5% Discount
    Example 2
10% Offering at 10% Discount
    Example 3
25% Offering at 25% Discount
 
      Following
Sale
    %
Change
    Following
Sale
    %
Change
    Following
Sale
    %
Change
 

Offering Price

             

Price per Common Share to Public

    —       $ 10.00       —       $ 9.47       —       $ 7.90       —    

Net Proceeds per Common Share to Us

    —       $ 9.50       —       $ 9.00       —       $ 7.50       —    

Decrease to NAV

             

Total Common Shares Outstanding

    1,000,000       1,050,000       5.00     1,100,000       10.00     1,250,000       25.00 %

NAV per Common Share

  $ 10.00     $ 9.98       (0.20 )%    $ 9.91       (0.90 )%   $ 9.50       5.00 %

Dilution/Accretion to Common Stockholder

             

Common Shares Held by Stockholder

    —         500       —         1,000       —         2,500       —    

Percentage Held by Common Stockholder

    0.0 %     0.05 %     —         0.09 %     —         0.20 %     —    

Total Asset Values

             

Total NAV Held by Common Stockholder

    —       $ 4,990       —       $ 9,910       —       $ 23,750       —    

Total Investment by Common Stockholder

    —       $ 5,000       —       $ 9,470       —       $ 19,750       —    

Total Dilution/Accretion to Common Stockholder (Total NAV Less Total Investment)

    —       $ (10 )     —       $ 440       —       $ 4,000       —    

Per Common Share Amounts

             

NAV Per Common Share Held by Common Stockholder

    —       $ 9.98       —       $ 9.91       —       $ 9.50       —    

Investment per Share Held by Common Stockholder

    —       $ 10.00       —       $ 9.47       —       $ 7.90       —    

Dilution/Accretion per Common Share Held by Common Stockholder (NAV per Common Share Less Investment per Common Share)

    —       $ (0.02 )     —       $ 0.44       —       $ 1.60       —