Item
1. Business
Rand
Capital Corporation (“Rand”, “we”, “us” and “our”) was incorporated under the
laws of New York in February 1969. We completed our initial public offering in 1971 and operated as an internally managed, closed-end,
diversified, management investment company from that time until November 2019.
On
November 8, 2019, Rand completed a stock sale transaction (the “Closing”) with East Asset Management (“East”).
The transaction consisted of a $25 million investment in Rand by East, in exchange for approximately 8.3 million shares of Rand
common stock. The consideration paid by East for the shares of Rand common stock was comprised of approximately $15.5 million
of cash and a contribution of $9.5 million of portfolio assets (the “Contributed Assets”). Concurrent with the Closing,
Rand’s management and staff became employees of Rand Capital Management, LLC (“RCM”), a registered investment
adviser that has been retained by Rand as its external investment adviser. In connection with retaining RCM as our investment
adviser, Rand entered into an investment advisory and management agreement (the “Investment Management Agreement”)
and an administration agreement (the “Administration Agreement”) with RCM pursuant to which RCM will serve as Rand’s
investment adviser and administrator (the Closing and the retention of RCM as our investment adviser and administrator are collectively
referred to herein as the “Transactions”). Pursuant to the terms of the Investment Management Agreement, Rand will
pay RCM a base management fee and may pay an incentive fee.
In
connection with the Closing, we also entered into a shareholder agreement, dated November 8, 2019 by and between Rand and East
(the “Shareholder Agreement”). Pursuant to the terms of the Shareholder Agreement, East has the right to designate
two or three persons, depending upon the size of Rand’s Board of Directors (the “Board”), for nomination for
election to the Board. East will have the right to designate (i) up to two persons if the size of the Board is composed of fewer
than seven directors or (ii) up to three persons if the size of the Board is composed of seven or more directors. East’s
right to designate persons for nomination for election to the Board under the Shareholder Agreement is the exclusive means by
which East may designate or nominate persons for election to the Board. Given the Board currently consists of five directors,
East has the right to designate up to two persons for nomination for election to the Board. In connection with the annual meeting
of shareholders held in December 2019, Adam S. Gusky and Benjamin E. Godley were each designated for nomination for election to
the Board by East pursuant to the terms of the Shareholder Agreement.
After
the completion of the Transactions, we are an externally managed, closed-end, diversified management investment company that has
elected to be treated as a business development company, or “BDC”, under the Investment Company Act of 1940, or the
“1940 Act.” As a BDC we are required to comply with certain regulatory requirements as provided for in the 1940 Act
and the rules and regulations promulgated thereunder. For instance, we generally have to invest at least 70% of our total assets
in “qualifying assets” and provide managerial assistance to the portfolio companies in which we invest. See “Item
1. Business - Regulations, Business Development Company Regulations.”
In
2002, we established our small business investment company (“SBIC”), Rand Capital SBIC, Inc. (“Rand SBIC”),
whereby we utilized funds borrowed from the Small Business Administration (“SBA”) combined with our capital to invest
in portfolio companies. In this Annual Report on Form 10-K, (“Annual Report”), unless the context otherwise requires,
“we”, the “Corporation”, “us”, and “our” refer to Rand Capital Corporation and
Rand SBIC. Rand SBIC’s predecessor was organized as a Delaware limited partnership and was converted into a New York corporation
in 2008, at which time our operations as a licensed SBIC were continued. Although Rand SBIC had operated as if it were a BDC,
it was registered as an investment company under the 1940 Act. In 2012, the Securities and Exchange Commission (“SEC”)
granted an Order of Exemption for Rand with respect to the operations of Rand SBIC and Rand SBIC then filed an election to be
regulated as a BDC under the 1940 Act. Rand SBIC’s board of directors is comprised of the directors of Rand, a majority
of whom are not “interested persons” of Rand Capital Corporation or Rand SBIC.
With
the completion of the Transactions, we changed our investment objectives and strategy. With our plan to elect U.S. federal tax
treatment as a regulated investment company (“RIC”), our new investment objective is to maximize total return to our
shareholders with current income combined with capital appreciation. As a result, our future investments will be made primarily
in higher yielding debt investments that may include related equity options, such as warrants or preferred equity. As required
for the RIC election, we will pay a special dividend to shareholders to distribute all accumulated earnings and profits, and we
intend to adopt a dividend policy that may provide regular cash dividends to shareholders. On March 3, 2020, the Board of Directors
of the Corporation declared a special dividend of $1.62 per share of Common Stock, paid in a combination of cash and shares of
Common Stock to shareholders of record at the close of business on April 2, 2020. The total amount of cash to be distributed to
all shareholders will be limited to 20% of the total dividend to be paid, excluding any cash paid for fractional shares. The remaining
80% of the dividend will be paid in shares of Common Stock. The exact distribution of cash and stock to any given shareholder
will depend upon their election as well as elections of other shareholders, subject to the pro-rata limitation. We expect to complete
the distribution of the special dividend on or about May 11, 2020.
Our
corporate office is located in Buffalo, NY and our website address is www.randcapital.com. We make available on our website, free
of charge, our annual and periodic reports, proxy statements and other information as soon as reasonably practicable after such
material is filed with the SEC. Our shares are traded on the Nasdaq Capital Market under the ticker symbol “RAND.”
Our
Investment Objectives and Strategy
Effective
with the completion of the Transactions, our investment activities are managed by our external investment adviser, RCM. Concurrent
with the externalization of the management of our investments to RCM, we changed our investment objectives and strategy. Previously,
our principal investment objective was to achieve long-term capital appreciation on equity investments while maintaining a current
cash flow from our debenture and pass-through equity instruments to fund expenses. With our plan to elect U.S. federal tax treatment
as a RIC, our new investment objective is to maximize total return to our shareholders with current income combined with capital
appreciation. As a result, our recent and future investments are expected to be made primarily in yield generating investments
which may include related equity options, such as warrants or preferred equity.
We
expect to continue to co-invest in privately-held, lower middle market companies with committed and experienced managements in
a broad variety of industries. We seek to invest in early to later stage businesses that have sustainable, differentiated and
market-accepted products and have revenue of more than $2 million and a clear path to free cash flow or are already generating
up to $5 million in EBITDA. We provide funding to companies that need growth or expansion capital or are looking to finance an
ownership transition. Geographically, we focus in the eastern and southern United States. We typically are a minority investor
and work with other lenders, investment partners and sponsors to source and fund investment opportunities.
Our
typical investment going forward is expected to be in the range of $500 thousand to $2.5 million in any one company. The debt
we invest in is not expected to be rated by a rating agency and, if it were, would be below investment grade. We intend to target
investments that mature in five to seven years. Because of the higher risk nature of our investments, we require board observation
or informational rights and may require a board seat.
We
may engage in various investment strategies to achieve our investment objectives based on the types of opportunities we discover
and the competitive landscape. We expect to focus on current cash yields in order to achieve our income producing goals.
Our
Investment Process
The
investment process is comprised of the sourcing and qualifying of investment opportunities, evaluating and negotiating the investment
vehicle, due diligence of the business plan, operations and prospects of the prospective investee and follow through investment
monitoring, follow on investments and portfolio management.
RCM’s
investment team identifies investment opportunities through a network of investment referral relationships. Investment proposals
may come to us from other sources, including unsolicited proposals from companies and referrals from accountants, bankers, lawyers
and other members of the financial community. We believe that RCM’s and our reputation and experience in the investment
community provide a competitive advantage in originating quality investments.
In
a typical private financing, RCM’s investment team will review, analyze, and confirm, through due diligence, the business
plan and operations of the potential portfolio company. Additionally, they will familiarize themselves with the portfolio company’s
industry and competition and may conduct reference checks with its customers and suppliers. RCM’s investment committee will
then review the deal and if approved, the transaction will be funded by Rand.
Following
our initial investment, we may make follow-on investments to take advantage of warrants or other preferential rights granted to
us to increase or maintain our position in a promising portfolio company, or provide additional funds to allow a portfolio company
to fully implement its business plans, develop a new line of business or recover from unexpected business problems. Follow-on
investments in a portfolio company are evaluated individually and may be subject to SBA restrictions.
Disposition
of Investments
We
may exit investments through the maturation of a debt security or when a liquidity event takes place, such as the sale, recapitalization,
or initial public offering of a portfolio company. The method and timing of the disposition of our portfolio investments can be
critical to the realization of maximum total return. We generally expect to dispose of our equity securities through private sales
of securities to other investors or through the sale or merger of the portfolio company. We anticipate our debt investments will
be repaid with interest and may realize further appreciation from warrants or other equity type instruments received in connection
with an investment.
Current
Portfolio Companies
For
a description of our current portfolio company investments, see “Item 7. Management’s Discussion and Analysis of Financial
Conditions and Results of Operations – Composition of the Investment Portfolio.”
Competition
We
compete for quality investments with other venture capital firms, individual investors, business development companies, and investment
funds (including private equity funds and mezzanine funds), as well as traditional financial services companies such as commercial
banks. We believe we are able to compete with these entities primarily on the basis of RCM’s and our referral network, RCM’s
and our investing reputation and experience, RCM’s responsive, quick and efficient investment analysis and decision-making
process, the investment terms we offer, and our willingness to make smaller investments.
For
information concerning the competitive risks we face, see “Item 1A. Risk Factors.”
Employees
We
do not have any employees. Our operations are managed by RCM, our investment adviser and administrator, and each of our officers
is an employee of RCM. As of March 5, 2020, our investment adviser, RCM, employed a total of four employees. We reimburse our
administrator, RCM, for the allocable portion of overhead and other expenses incurred by it in performing its obligations under
the Administration Agreement. For a more detailed discussion of the administration agreement with RCM, see “Administration
Agreement.”
Investment
Advisory and Management Agreement
RCM
serves as our investment advisor (the “Adviser”) under the terms of the Investment Management Agreement. The Adviser
is a registered investment adviser under the Investment Advisers Act of 1940, as amended, and is owned by East and CB Advisor
LLC (an entity owned by Brian Collins). The Adviser manages the investment and reinvestment of our assets and, without limiting
the generality of the foregoing:
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(i)
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determines
the composition of the portfolio, the nature and timing of the changes therein and the manner of implementing such changes;
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(ii)
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identifies,
evaluates and negotiates the structure of the investments;
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(iii)
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executes,
closes, services and monitors the investments;
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(iv)
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determines
the securities and other assets that we will purchase, retain or sell;
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(v)
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performs
due diligence on prospective portfolio companies and investments; and
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(vi)
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provides
us with other investment advisory, research and related services that may, from time to time, be required for the investment
of our assets.
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(vii)
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valuation
of portfolio investments
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The
Adviser’s services under the Investment Management Agreement are not exclusive, and it may furnish similar services to other
entities. In addition, subject to compliance with the requirements of the 1940 Act, the Adviser is authorized to enter into one
or more sub-advisory agreements with other investment advisors (each a “Sub-Advisor”), including for purposes of recommending
specific securities or other investments based upon our investment objectives and policies, and working, along with the Adviser,
in structuring, negotiating, arranging or effecting the acquisition or disposition of our investments and monitoring our investments.
Under the terms of the Investment Management Agreement, the Adviser, and not us, will be responsible for any compensation that
is payable to any sub-adviser.
About
the Investment Process of the Adviser
The
Adviser’s principal investment portfolio managers are Allen F. Grum and Daniel P. Penberthy, who manage the Corporation’s
investment portfolio on a day-to-day basis. All decisions to acquire or dispose of assets on behalf of the Corporation are made
by the Adviser’s investment committee (the “Investment Committee”). Each such decision must be approved by a
majority of Investment Committee members.
The
Investment Committee is composed five individuals, including three individuals designated by East. The Investment Committee currently
consists of the following individuals:
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●
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Brian
Collins, an East designee;
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●
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Allen
F. Grum;
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●
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Adam
Gusky, an East designee;
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●
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Scott
Barfield, an East designee; and
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●
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Daniel
P. Penberthy.
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All
potential investment opportunities undergo an initial informal review by Messrs. Grum and Penberthy, as the Adviser’s investment
professionals. Each potential investment opportunity that an investment professional determines merits consideration is presented
and evaluated at meetings in which the members of the Investment Committee discuss the merits and risks of each potential investment
opportunity and the pricing and structure for the investment.
Fees
Paid to Adviser
Under
the Investment Management Agreement, we will pay the Adviser, as compensation for the investment advisory and management services,
fees consisting of two components: (i) the Base Management Fee and (ii) the Incentive Fee.
Base
Management Fee
The
“Base Management Fee” is calculated at an annual rate of 1.50% of our total assets (other than cash or cash equivalents
but including assets purchased with borrowed funds), determined according to procedures duly adopted by the Board.
For
services rendered during the period commencing from the effective date of the Investment Management Agreement, through and including
the end of our first calendar quarter of operations after this effective date, the Base Management Fee is payable monthly in arrears.
In addition, until our first calendar quarter of operations after the effective date of the Investment Management Agreement, the
Base Management Fee is calculated based on the initial value of our total assets (other than cash or cash equivalents but including
assets purchased with borrowed funds) after giving effect to the contribution of investment assets by East as part of the consideration
paid to Rand in the stock sale transaction that closed in November 2019. Subsequently, the Base Management Fee is calculated based
on the average value of our total assets (other than cash or cash equivalents but including assets purchased with borrowed funds)
at the end of the two most recently completed calendar quarters. Base Management Fees for any partial month or quarter will be
appropriately prorated.
Incentive
Fee
The
“Incentive Fee” is comprised of two parts: (1) the Income Based Fee and (2) the Capital Gains Fee.
Income
Based Fee
The
“Income Based Fee” is calculated and payable quarterly in arrears based on the Pre-Incentive Fee Net Investment Income
for the immediately preceding calendar quarter and is payable promptly following the filing of our financial statements for such
quarter.
For
purposes of the Investment Management Agreement, “Pre-Incentive Fee Net Investment Income” is defined as interest
income, dividend income and any other income (including any other fees (other than fees for providing managerial assistance),
such as commitment, origination, structuring, diligence and consulting fees or other fees that we receive from portfolio companies)
we accrue during the relevant calendar quarter, minus the operating expenses for such calendar quarter (including the Base Management
Fee, expenses payable under the Administration Agreement, and any interest expense and dividends paid on any issued and outstanding
preferred stock, but excluding any portion of Incentive Fee).
Pre-Incentive
Fee Net Investment Income includes any accretion of original issue discount, market discount, payment-in-kind interest, payment-in-kind
dividends or other types of deferred or accrued income, including in connection with zero coupon securities, that we have recognized
in accordance with United States generally accepted accounting principles,(“GAAP”), but have not yet received in cash
(collectively, “Accrued Unpaid Income”). Pre-Incentive Fee Net Investment Income does not include any realized capital
gains, realized and unrealized capital losses or unrealized capital appreciation or depreciation.
Pre-Incentive
Fee Net Investment Income, expressed as a rate of return on the value of our net assets (defined as total assets less indebtedness)
at the end of the immediately preceding calendar quarter, is compared to a “hurdle rate”, expressed as a rate of return
on the value of the our net assets at the end of the most recently completed calendar quarter, of 1.75% per quarter (7% annualized).
We pay the Adviser an Incentive Fee with respect to our Pre-Incentive Fee Net Investment Income in each calendar quarter as follows:
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(i)
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no
Income Based Fee in any quarter in which the Pre-Incentive Fee Net Investment Income for such quarter does not exceed the
hurdle rate of 1.75% (7.00% annualized);
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(ii)
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100%
of the Pre-Incentive Fee Net Investment Income for any calendar quarter with respect to that portion of the Pre-Incentive
Fee Net Investment Income for such calendar quarter, if any, that exceeds the hurdle rate of 1.75% (7.00% annualized) but
is less than 2.1875% (8.75% annualized); and
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(iii)
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20%
of the amount of the Pre-Incentive Fee Net Investment Income for any calendar quarter with respect to that portion of the
Pre-Incentive Fee Net Investment Income for such calendar quarter, if any, that exceeds 2.1875% (8.75% annualized).
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However,
the Income Based Fee paid to the Adviser for any calendar quarter that begins more than two years and three months after the effective
date of the Investment Management Agreement shall not be in excess of the Incentive Fee Cap. The “Incentive Fee Cap”
for any quarter is an amount equal to (1) 20.0% of the Cumulative Net Return (as defined below) during the relevant Income Based
Fee Calculation Period (as defined below) minus (2) the aggregate Income Based Fee that was paid in respect of the calendar quarters
included in the relevant Income Based Fee Calculation Period.
For
purposes of the calculation of the Income Based Fee, “Income Based Fee Calculation Period” is defined as, with reference
to a calendar quarter, the period of time consisting of such calendar quarter and the additional quarters that comprise the lesser
of (1) the number of quarters immediately preceding such calendar quarter that began more than two years after the effective date
of the Investment Management Agreement or (2) the eleven calendar quarters immediately preceding such calendar quarter.
For
purposes of the calculation of the Income Based Fee, “Cumulative Net Return” is defined as (1) the aggregate net investment
income in respect of the relevant Income Based Fee Calculation Period minus (2) any Net Capital Loss, if any, in respect of the
relevant Income Based Fee Calculation Period. If, in any quarter, the Incentive Fee Cap is zero or a negative value, we will pay
no Income Based Fee to the Adviser for such quarter. If, in any quarter, the Incentive Fee Cap for such quarter is a positive
value but is less than the Income Based Fee that is payable to the Adviser for such quarter (before giving effect to the Incentive
Fee Cap) calculated as described above, we will pay an Income Based Fee to the Adviser equal to the Incentive Fee Cap for such
quarter. If, in any quarter, the Incentive Fee Cap for such quarter is equal to or greater than the Income Based Fee that is payable
to the Adviser for such quarter (before giving effect to the Incentive Fee Cap) calculated as described above, we will pay an
Income Based Fee to the Adviser equal to the Income Based Fee calculated as described above for such quarter without regard to
the Incentive Fee Cap.
For
purposes of the calculation of the Income Based Fee, “Net Capital Loss,” in respect of a particular period, means
the difference, if positive, between (1) aggregate capital losses, whether realized or unrealized, in such period and (2) aggregate
capital gains, whether realized or unrealized, in such period.
Any
Income Based Fee otherwise payable under the Investment Management Agreement with respect to Accrued Unpaid Income (such fees
being the “Accrued Unpaid Income Based Fees”) shall be deferred, on a security by security basis, and shall become
payable to the Adviser only if, as, when and to the extent cash is received by us in respect of any Accrued Unpaid Income. Any
Accrued Unpaid Income that is subsequently reversed by us in connection with a write-down, write-off, impairment or similar treatment
of the investment giving rise to such Accrued Unpaid Income will, in the applicable period of reversal, (1) reduce Pre-Incentive
Fee Net Investment Income and (2) reduce the amount of Accrued Unpaid Income Based Fees. Subsequent payments of Accrued Unpaid
Income Based Fees deferred pursuant to this paragraph shall not reduce the amounts otherwise payable for any quarter as an Income
Based Fee.
Capital
Gains Fee
The
“Capital Gains Fee” is determined and payable in arrears as of the end of each calendar year (or upon termination
of the Investment Management Agreement), commencing with the calendar year ended December 31, 2019. Under the terms of the Investment
Management Agreement, the Capital Gains Fee is calculated at the end of each applicable year by subtracting (1) the sum of the
our cumulative aggregate realized capital losses and aggregate unrealized capital depreciation from (2) our cumulative aggregate
realized capital gains, in each case calculated from the effective date of the Investment Management Agreement. If this amount
is positive at the end of any calendar year, then the Capital Gains Fee for such year is equal to 20.0% of such amount, less the
cumulative aggregate amount of Capital Gains Fees paid in all prior years. If such amount is negative, then there is no Capital
Gains Fee payable for that calendar year. If the Investment Management Agreement is terminated as of a date that is not a calendar
year end, the termination date shall be treated as though it were a calendar year end for purposes of calculating and paying the
Capital Gains Fee.
For
purposes of the Capital Gains Fee:
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●
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The
cumulative aggregate realized capital gains are calculated as the sum of the differences, if positive, between (a)
the net sales price of each investment in our portfolio when sold and (b) the accreted or amortized cost basis of such investment.
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●
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The
cumulative aggregate realized capital losses are calculated as the sum of the amounts by which (a) the net sales price
of each investment in our portfolio when sold is less than (b) the accreted or amortized cost basis of such investment.
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●
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The
aggregate unrealized capital depreciation is calculated as the sum of the differences, if negative, between (a) the
valuation of each investment in our portfolio as of the applicable Capital Gains Fee calculation date and (b) the accreted
or amortized cost basis of such investment.
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The
accreted or amortized cost basis of an investment shall mean, with respect to an investment owned by us as of the effective date
of the Investment Management Agreement, the fair value of that investment as set forth in our Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 2019, as filed with the SEC on November 7, 2019, and, with respect to an investment acquired
by us subsequent to the effective date of the Investment Management Agreement, the accreted or amortized cost basis of such investment
as reflected in the our financial statements.
Example
1: Income Based Fee Calculations:*
Alternative
1
Assumptions:
Investment
income (including interest, dividends, fees, etc.) = 1.25%
Hurdle
rate(1) = 1.75%
Base
Management Fee(2) = 0.375%
Other
expenses (legal, accounting, transfer agent, etc.) = 0.20%
Pre-Incentive
Fee Net Investment Income (investment income – (Base Management Fee + other expenses)) = 0.675%
Pre-Incentive
Fee Net Investment Income does not exceed the hurdle rate, therefore there is no Income Based Fee is payable for the calendar
quarter.
Alternative
2
Assumptions:
Investment
income (including interest, dividends, fees, etc.) = 2.70%
Hurdle
rate(1) = 1.75%
Base
Management Fee(2) = 0.375%
Other
expenses (legal, accounting, transfer agent, etc.) = 0.20%
Pre-Incentive
Fee Net Investment Income (investment income – (Base Management Fee + other expenses)) = 2.125%
Income
Based Fee (subject to “catch up”)(3) = 100.00% × (2.125% – 1.75%) = 0.375%
Pre-Incentive
Fee Net Investment Income exceeds the hurdle rate, but does not fully satisfy the “catch-up” provision, therefore
the Income Based Fee payable for the calendar quarter is 0.375%.
Alternative
3
Assumptions:
Investment
income (including interest, dividends, fees, etc.) = 3.50%
Hurdle
rate(1) = 1.75%
Base
Management Fee(2) = 0.375%
Other
expenses (legal, accounting, transfer agent, etc.) = 0.20%
Pre-Incentive
Fee Net Investment Income (investment income – (Base Management Fee + other expenses)) = 2.925%
Income
Based Fee (subject to “catch up”)(3) = 100.00% × “catch-up” + (20.00% × (Pre-Incentive
Fee Net Investment Income above 2.1875%))
Catch-up
= 2.1875% – 1.75% = 0.4375%
Income
Based Fee = (100.00% × .4375%) + (20.00% × (2.925% – 2.1875%))
=
0.4375% + (20.00% × 0.7375%)
=
0.4375% + 0.1475%
=
0.585%
Pre-Incentive
Fee Net Investment Income exceeds the hurdle rate, and fully satisfies the “catch-up” provision, therefore the Income
Based Fee payable for the calendar quarter is 0.585%.
*
For ease of review, (i) the hypothetical amounts of Pre-Incentive Fee Net Investment Income, investment income, Base Management
Fee, other expenses, and Income Based Fee are each expressed as a percentage of total assets, though as described in greater detail
above, each of these amounts will be calculated as a numerical dollar amount as set forth in the Investment Management Agreement,
(ii) the hypothetical amount of the Base Management Fee is assumed to be consistent from quarter to quarter, and (iii) these examples
each assume that the Incentive Fee Cap is not yet in effect.
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(1)
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Represents
7.00% annualized hurdle rate.
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(2)
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Represents
1.50% annualized Base Management Fee.
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(3)
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The
“catch-up” provision is intended to provide the Adviser with an Income Based Fee of 20.00% on all Pre-Incentive
Fee Net Investment Income as if a hurdle rate did not apply when the Company’s Pre-Incentive Net Investment Income exceeds
1.75% in any calendar quarter.
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Example
2: Capital Gains Fee Calculations:
Alternative
1
Assumptions:
Year
1:
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$20.0
million investment made in Company A (“Investment A”), and $30.0 million investment made in Company B (“Investment
B”)
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Year
2:
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Investment
A sold for $50.0 million and fair market value (“FMV”) of Investment B determined to be $32.0 million
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Year
3:
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FMV
of Investment B determined to be $25.0 million
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Year
4:
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Investment
B sold for $31.0 million
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The
Capital Gains Fees, if any, would be calculated as follows:
Year
1:
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None
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Year
2:
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Capital
Gains Fee of $6.0 million — ($30.0 million realized capital gains on sale of Investment A multiplied by 20.0%)
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Year
3:
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None
— $5.0 million (20.0% multiplied by ($30.0 million cumulative capital gains less $5.0 million cumulative capital depreciation))
less $6.0 million (previous Capital Gains Fee paid in Year 2)
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Year
4:
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Capital
Gains Fee of $0.2 million — $6.2 million ($31.0 million cumulative realized capital gains multiplied by 20.0%) less
$6.0 million (Capital Gains Fee taken in Year 2)
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Alternative
2
Assumptions:
Year
1:
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$20.0
million investment made in Company A (“Investment A”), $30.0 million investment made in Company B (“Investment
B”) and $25.0 million investment made in Company C (“Investment C”)
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Year
2:
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Investment
A sold for $50.0 million, FMV of Investment B determined to be $25.0 million and FMV of Investment C determined to be $25.0
million
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Year
3:
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FMV
of Investment B determined to be $27.0 million and Investment C sold for $30.0 million
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Year
4:
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FMV
of Investment B determined to be $35.0 million
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Year
5:
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Investment
B sold for $20.0 million
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The
Capital Gains Fees, if any, would be calculated as follows:
Year
1:
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None
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Year
2:
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$5.0
million Capital Gains Fee - 20.0% multiplied by $25.0 million ($30.0 million realized capital gains on Investment A less $5.0
million unrealized capital depreciation on Investment B)
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Year
3:
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$1.4
million Capital Gains Fee - $6.4 million (20.0% multiplied by $32.0 million ($35.0 million cumulative realized capital gains
less $3.0 million unrealized capital depreciation)) less $5.0 million Capital Gains Fee received in Year 2
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Year
4:
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$0.6
million Capital Gains Fee - $7.0 million (20.0% multiplied by $35.0 million cumulative realized capital gains) less cumulative
$6.4 million Capital Gains Fee received in Year 2 and Year 3
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Year
5:
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None
— $5.0 million (20.0% multiplied by $25.0 million (cumulative realized capital gains of $35.0 million less realized
capital losses of $10.0 million)) less $7.0 million cumulative Capital Gains Fee paid in Year 2, Year 3 and Year 4
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Payment
of Expenses
Under
the terms of Investment Management Agreement, all investment professionals of the Adviser and its staff, when and to the extent
engaged in providing investment advisory services to us, and the compensation of such personnel and the general office and facilities
and overhead expenses incurred by the Adviser in maintaining its place of business allocable to these services, are provided and
paid for by the Adviser and not by us. We will bear all other costs and expenses of its operations and transactions, related to
the Corporation, including those relating to:
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(i)
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organization;
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(ii)
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calculating
our net asset value (including the cost and expenses of any independent valuation firm);
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|
(iii)
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expenses
incurred by the Adviser payable to third parties, including agents, consultants or other advisors, in monitoring financial
and legal affairs and in monitoring our investments and performing due diligence on prospective portfolio companies;
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(iv)
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interest
payable on debt, if any, incurred to finance our investments;
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(v)
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offerings
of our common stock and other securities;
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(vi)
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investment
advisory and management fees payable under the Investment Management Agreement, but excluding any fees payable to any Sub-Adviser;
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(vii)
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administration
fees payable under the Administration Agreement;
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(viii)
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transfer
agent and custodial fees;
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(ix)
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federal
and state registration fees;
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(x)
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all
costs of registration and listing our shares on any securities exchange;
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(xi)
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federal,
state and local taxes;
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(xii)
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independent
directors’ fees and expenses;
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(xiii)
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costs
of preparing and filing reports or other documents required by governmental bodies (including the SEC);
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(xiv)
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costs
of any reports, proxy statements or other notices to shareholders, including printing costs;
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(xv)
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our
allocable portion of the fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance
premiums;
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(xvi)
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direct
costs and expenses of administration, including independent auditors and outside legal costs; and
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(xvii)
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all
other expenses incurred by us or the Adviser in connection with administering our business (including payments under the Administration
Agreement based upon our allocable portion of the Advisor’s overhead in performing its obligations under the Administration
Agreement, including rent and the allocable portion of the cost of our chief financial officer and chief compliance officer
and their respective staffs (including travel expenses))
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Indemnification
under the Investment Management Agreement
The
Investment Management Agreement provides that, absent willful misfeasance, bad faith or gross negligence in the performance of
its duties or by reason of the reckless disregard of its duties and obligations, the Adviser, its members and their respective
officers, managers, partners, agents, employees, controlling persons, members and any other person affiliated with any of them
(collectively, the “Indemnified Parties”), are entitled to indemnification from us for any damages, liabilities,
costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) incurred by the Indemnified
Parties in or by reason of any pending, threatened or completed action, suit, investigation or other proceeding (including an
action or suit by or in the right of us or our security holders) arising out of or otherwise based upon the performance of any
of the Adviser’s duties or obligations under the Investment Management Agreement or otherwise as an investment adviser.
Duration
and Termination
The
Investment Management Agreement was executed on November 8, 2019 and will remain in effect for two years after this date. Our
Board approved the Investment Management Agreement on January 24, 2019 and it was approved by our shareholders at a special meeting
of shareholders held on May 16, 2019. Thereafter, it will continue to renew automatically for successive annual periods so long
as such continuance is specifically approved at least annually by:
(i)
the vote of our Board, or by the vote of Shareholders holding a majority of the outstanding voting securities of the Corporation;
and
(ii)
the vote of a majority of our independent directors, in either case, in accordance with the requirements of the 1940 Act.
The
Investment Management Agreement may be terminated at any time, without the payment of any penalty, upon sixty days’ written
notice, by: (a) by vote of a majority of the Board or by vote of a majority of the outstanding voting securities of the Corporation
(as defined in the 1940 Act); or (b) the Adviser. Furthermore, the Investment Management Agreement will automatically terminate
in the event of its “assignment” (as such term is defined for purposes of Section 15(a)(4) of the 1940 Act). See Part
I, Item 1A. “Risk Factors - Our investment adviser and administrator, RCM, has the right to resign on sixty 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.”
Notwithstanding
the termination or expiration of the Investment Management Agreement, the Adviser will be entitled to any amounts owed as payment
of the Base Management Fees and the Incentive Fees through the date of termination or expiration.
Administration
Agreement
In
connection with the Closing, we entered into an Administration Agreement with the Adviser. Under the terms of the Administration
Agreement, the Adviser agreed to perform (or oversee, or arrange for, the performance of) the administrative services necessary
for our operations, including, but not limited to, office facilities, equipment, clerical, bookkeeping, finance, accounting, compliance
and record keeping services at such office facilities and such other services as the Adviser, subject to review by the Board,
will from time to time determine to be necessary or useful to perform its obligations under the Administration Agreement. The
Adviser shall also, on our behalf, arrange for the services of, and oversee, custodians, depositories, transfer agents, dividend
disbursing agents, other shareholder servicing agents, accountants, attorneys, underwriters, brokers and dealers, corporate fiduciaries,
insurers, banks and such other persons in any such other capacity deemed to be necessary or desirable. The Adviser will make reports
to our Board regarding the performance of its obligations under the Administration Agreement and furnish advice and recommendations
with respect to such other aspects of our business and affairs as it will determine to be desirable.
The
Adviser is responsible for our financial and other records that are required to be maintained and prepares all reports and other
materials required to be filed with the SEC or any other regulatory authority, including reports to shareholders. In addition,
the Adviser assists us in determining and publishing our Net Asset Value (“NAV”), overseeing the preparation and filing
of our tax returns, and the printing and dissemination of reports to shareholders, and generally overseeing the payment of our
expenses and the performance of administrative and professional services rendered to us by others. The Administrator provides,
on our behalf, significant managerial assistance to those portfolio companies to which we are required to provide such assistance.
In
full consideration of the provision of the services of the Adviser, we reimburse the Adviser for the costs and expenses incurred
by the Adviser in performing its obligations and providing personnel and facilities thereunder. Costs and expenses to be borne
by us include those relating to: organization; calculating NAV (including the cost and expenses of any independent valuation firm);
expenses incurred by the Administrator payable to third parties, including agents, consultants or other advisors, in monitoring
our financial and legal affairs and in monitoring our investments and performing due diligence on its prospective portfolio companies;
interest payable on debt, if any, incurred to finance our investments; offerings of our common stock and other securities; investment
advisory and management fees (other than fees (if any) payable to a sub-advisor retained by the Adviser under the Investment Management
Agreement); administration fees; transfer agent and custodial fees; federal and state registration fees; all costs of registration
and listing our common stock on any securities exchange; federal, state, local and other taxes; independent directors’ fees
and expenses; costs of preparing and filing reports or other documents required by governmental bodies (including the SEC); costs
of any reports, proxy statements or other notices to shareholders, including printing costs; our allocable portion of the fidelity
bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums; direct costs and expenses
of administration, including independent auditors and outside legal costs; and all other expenses incurred by us or the Adviser
in connection with administering our business, including payments under the Administration Agreement based upon our allocable
portion of the Adviser’s overhead in performing its obligations under the Administration Agreement, including rent (if office
space is provided by the Adviser) and our allocable portion of the cost of the chief financial officer and chief compliance officer
and their respective staffs (including travel expenses).
The
Administration Agreement was executed on November 8, 2019, the same date as the Investment Management Agreement, and will remain
in effect for two years, and thereafter will continue automatically for successive annual periods so long as such continuance
is specifically approved at least annually by the Board, including a majority of the independent directors. The Administration
Agreement may be terminated at any time, without the payment of any penalty, by vote of our directors, or by the Adviser, upon
60 days’ written notice to the other party. The Administration Agreement may not be assigned by a party without the consent
of the other party.
Regulations
The
following discussion is a general summary of the material prohibitions and descriptions governing BDCs and SBA-licensed SBICs.
It does not purport to be a complete description of all of the laws and regulations affecting BDCs and SBICs.
Business
Development Company Regulations
We
have elected to be regulated as a BDC under the 1940 Act. Although the 1940 Act exempts a BDC from registration under the 1940
Act, the 1940 Act contains significant limitations on the operations of BDCs. Among other things, the 1940 Act contains prohibitions
and restrictions relating to transactions between a BDC and its affiliates, principal underwriters and affiliates of its affiliates
or underwriters. The 1940 Act also prohibits a BDC from changing the nature of its business so as to cease to be, or to withdraw
its election as, a BDC unless so authorized by a vote of the holders of a majority of its outstanding voting securities. BDCs
are not required to maintain fundamental investment policies relating to diversification and concentration of investments within
a single industry. More specifically, in order to qualify as a BDC, a company must:
(1)
be a domestic company;
(2)
have registered a class of its equity securities or have filed a registration statement with the SEC pursuant to Section 12 of
the Securities Exchange Act of 1934 (the “Exchange Act”);
(3)
operate for the purpose of investing in the securities of certain types of companies, namely immature or emerging companies and
businesses suffering or just recovering from financial distress. Generally, a BDC must be primarily engaged in the business of
furnishing capital and providing managerial expertise to companies that do not have ready access to capital through conventional
financial channels. Such companies are termed “eligible portfolio companies;”
(4)
extend significant managerial assistance to such portfolio companies; and
(5)
have a majority of “disinterested” directors (as defined in the 1940 Act).
Qualifying
Assets
Under
the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in Section 55(a) of the 1940 Act, which are
referred to as qualifying assets, unless, at the time the acquisition is made, qualifying assets represent at least 70% of their
total assets. The 1940 Act prohibits BDCs from investing in certain types of companies, such as brokerage firms, insurance companies,
investment banking firms and investment companies.
An
eligible portfolio company is, generally, a private domestic operating company, or a public domestic operating company whose securities
are not listed on a national securities exchange. In addition, any small business investment company that is licensed by the SBA
and is a wholly owned subsidiary of a BDC is an eligible portfolio company.
Qualifying
assets include:
(1)
securities of companies that were eligible portfolio companies at the time the BDC acquired their securities;
(2)
securities of bankrupt or insolvent companies that were eligible at the time of the BDC’s initial acquisition of their securities
but are no longer eligible, provided that the BDC has maintained a substantial portion of its initial investment in those companies;
(3)
securities received in exchange for or distributed on or with respect to any of the foregoing; and
(4)
cash items, government securities and high-quality short-term debt.
The
1940 Act also places restrictions on the nature of the transactions in which, and the persons from whom, securities can be purchased
in order for the securities to be considered qualifying assets.
A
BDC is permitted to invest in the securities of public companies and other investments that are not qualifying assets, but those
kinds of investments may not exceed 30% of the BDC’s total asset value at the time of the investment. At December 31, 2019,
we were in compliance with this rule.
Managerial
Assistance to Portfolio Companies
In
order to count portfolio securities as qualifying assets for the purpose of the 70% test discussed above, a BDC must either control
the issuer of the securities or must offer to make available significant managerial assistance; except that, where the BDC purchases
the securities in conjunction with one or more other persons acting together, one of the other persons in the group may make available
such managerial assistance. Making available significant managerial assistance means, among other things, any arrangement whereby
the BDC, through its directors, officers or employees, offers to provide and, if accepted, does so provide, significant guidance
and counsel concerning the management, operations or business objectives and policies of a portfolio company through monitoring
of portfolio company operations, selective participation in board and management meetings, consulting with and advising a portfolio
company’s officers or other organizational or financial guidance.
Small
Business Investment Company Regulations
SBA
Lending Restrictions
SBICs
are designed to stimulate the flow of private debt and/or equity capital to small businesses. The types and dollar amounts of
the loans and other investments we may make are limited by the 1940 Act, the Small Business Act (the “SBA Act”) and
SBA regulations. Rand SBIC uses funds borrowed from the SBA that can be combined with our own capital to provide loans to, and
make equity investments in, businesses that meet the following criteria:
(a)
have a tangible net worth not in excess of $19.5 million and average net income after U.S. federal income taxes for the preceding
two completed fiscal years not in excess of $6.5 million, or
(b)
meet size standards set by the SBA that are measured by either annual receipts or number of employees, depending on the industry
in which the businesses are primarily engaged.
In
addition, at the end of each fiscal year, an SBIC must have at least 20% (in total dollars) invested in “smaller enterprises.”
The SBA defines “smaller enterprises” as businesses that:
(a)
do not have a net worth in excess of $6 million and have average net income after U.S. federal income taxes for the preceding
two years no greater than $2 million, or
(b)
meet size standards set by the SBA that are measured by either annual receipts or number of employees, depending on the industry
in which the concerns are primarily engaged.
We
have complied with these requirements since the inception of Rand SBIC.
The
SBA prohibits an SBIC from providing funds to small businesses with specific characteristics, such as businesses with the majority
of their employees located outside the United States, or from investing in passive or non-operating businesses, real estate, project
financing, farmland, or financial lenders. Without prior SBA approval, an SBIC may not invest an amount equal to more than approximately
30% of the SBIC’s regulatory capital in any one company and its affiliates.
The
SBA places limitations on the financing terms of investments by SBICs in portfolio companies such as limiting the prepayment options,
the financing fees that can be charged to a portfolio company, the allowable interest rate on loan and debt securities that an
SBIC can charge a portfolio company, and the maximum term of such financing. An SBIC may exercise control over a small business
for a period of up to seven years from the date on which the SBIC initially acquires its control position.
The
SBA restricts the ability of an SBIC to lend money to any of its officers, directors and employees or to invest in associates.
The SBA also prohibits, without prior SBA approval, a “change of control” of an SBIC or transfers that would result
in any person, or a group of persons acting together, owning 10% or more of a class of capital stock of a licensed SBIC. A “change
of control” is any event which would result in the transfer of the power, direct or indirect, to direct the management and
policies of an SBIC, whether through ownership, contractual arrangements or otherwise. Rand SBIC received approval from the SBA
in October 2019 for purposes of completing the stock sale transaction between Rand Capital Corporation and East.
Rand
SBIC may invest directly in a portfolio company’s equity, but may not become a general partner of a non-incorporated entity
or otherwise become jointly or severally liable for the general obligations of a non-incorporated entity. Rand SBIC may acquire
options or warrants in portfolio companies, and the options or warrants may have redemption provisions, subject to certain restrictions.
Pursuant to SBA regulations, the maximum cash which may be invested in any one portfolio company by Rand SBIC is currently $4.8
million.
In
addition, the SBA regulations require an examination of a licensed SBIC by an SBA examiner to determine the SBIC’s compliance
with the relevant SBA regulations. Our annual report, submitted to the SBA, must be audited by an independent public accounting
firm.
SBA
Leverage
The
SBA raises capital to enable it to provide funds to SBICs by guaranteeing certificates or bonds that are pooled and sold to purchasers
of the government guaranteed securities. The amount of funds that the SBA may lend to SBICs is determined by annual Congressional
appropriations.
SBA
debentures are issued with ten year maturities. Interest only is payable semi-annually until maturity. All of our outstanding
SBA debentures may be prepaid without penalty. To reserve the approved SBA debenture leverage, we paid an upfront 1% commitment
fee to the SBA as a partial prepayment of the SBA’s nonrefundable 3% leverage fee. These fees are expensed over the life
of the corresponding SBA debenture instruments. The SBA, as a creditor, will have a superior claim to Rand SBIC’s assets
over our shareholders in the event we liquidate Rand SBIC or the SBA exercises its remedies under the SBA-guaranteed debentures
issued by Rand SBIC upon an event of default.
At
December 31, 2019, we had $11,000,000 in outstanding SBA debenture instruments.
Taxation
as a Regulated Investment Company
Contingent
upon meeting certain tax-related conditions, we expect to elect to be taxed as a Regulated Investment Company (“RIC”)
for U.S. tax purposes (the “RIC Election”). In order to qualify to make the RIC Election, we must, among other things,
distribute our previously undistributed “accumulated earnings and profits” to shareholders. RIC qualification also
requires meeting specified source-of-income and asset-diversification requirements. In addition, we must distribute to our shareholders,
with respect of each taxable year, dividends for U.S. federal income tax purposes in an amount generally at least equal to 90%
of our “investment company taxable income,” which is generally equal to the sum of our net ordinary income plus the
excess of our realized net short-term capital gains over our realized net long-term capital losses, determined without regard
to any deduction for distributions paid (the “Annual Distribution Requirement”). As a RIC, we generally will not have
to pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that we distribute to our shareholders.
Even if we qualify as a RIC, we generally will be subject to corporate-level U.S. federal income tax on our undistributed taxable
income and could be subject to U.S. federal excise, state, local and foreign taxes.
In
connection with making the RIC Election, we expect that Rand SBIC will also make an election to be taxed as a RIC for U.S. federal
tax purposes. In order to be eligible to be taxed as a RIC, Rand SBIC must satisfy the source-of-income, asset-diversification,
and minimum distribution requirements discussed above. Because a substantial portion of our assets are held in Rand SBIC, we may
not be able to satisfy the asset-diversification requirements unless Rand SBIC also qualifies to be taxed as a RIC for U.S. federal
tax purposes.
Assuming
that we qualify to be taxed as a RIC and satisfy the Annual Distribution Requirement, we will not be subject to U.S. federal income
tax on the portion of our “investment company taxable income” and net capital gain (which is defined as net long-term
capital gain in excess of net short-term capital loss) that is timely distributed to shareholders. Similarly, assuming that Rand
SBIC qualifies to be taxed as a RIC and satisfies the Annual Distribution Requirement, Rand SBIC will also not be subject to U.S.
federal income tax on the portion of its “investment company taxable income” and net capital gain that it timely distributes
to us. We will be subject to U.S. federal income tax at the regular corporate rates on any income or capital gain not distributed
(or deemed distributed) to our shareholders. Rand SBIC will also be subject to U.S. federal income tax at the regular corporate
rates on any income or capital gain not distributed (or deemed distributed) to Rand. Additionally, we will be subject to U.S.
federal income tax at the regular corporate rates on any income earned on certain investments that needed to remain in a taxable
subsidiary in order to maintain RIC status.
Rand
and Rand SBIC, respectively, will be subject to a 4% nondeductible U.S. federal excise tax on certain undistributed income unless
each distribute in a timely manner an amount at least equal to the sum of:
(1)
98% of its ordinary income for each calendar year,
(2)
98.2% of its capital gain net income for the one-year period ending October 31 in that calendar year and
(3)
any income recognized, but not distributed, in preceding years and on which it paid no U.S. federal income tax.
In
order to maintain qualification as a RIC for U.S. federal income tax purposes going forward, Rand and Rand SBIC must each, among
other things:
(1)
meet the Annual Distribution Requirement;
(2)
qualify to be regulated as a BDC or be registered as a management investment company under the 1940 Act;
(3)
derive in each taxable year at least 90% of its gross income from dividends, interest, payments with respect to certain securities
loans, gains from the sale or other disposition of stock or other securities or currencies or other income derived with respect
to its business of investing in such stock, securities or currencies and net income derived from an interest in a “qualified
publicly-traded partnership” (as defined in the Internal Revenue Code); and
(4)
diversify its holdings so that at the end of each quarter of the taxable year:
(a)
at least 50% of the value of its assets consists of cash, cash equivalents, U.S. Government securities, securities of other RICs,
and other securities if such other securities of any one issuer do not represent more than 5% of the value of its assets or more
than 10% of the outstanding voting securities of the issuer (which for these purposes includes the equity securities of a “qualified
publicly-traded partnership”); and
(b)
no more than 25% of the value of its assets is invested in the securities, other than U.S. Government securities or securities
of other RICs, (i) of one issuer (ii) of two or more issuers that are controlled, as determined under applicable tax rules, by
us and that are engaged in the same or similar or related trades or businesses or (iii) of one or more “qualified publicly-traded
partnerships”. Because a substantial portion of Rand Capital Corporation’s assets consist of its shares in Rand SBIC,
we will not be eligible to be taxed as a RIC for U.S. federal income tax purposes unless Rand SBIC is also eligible to be taxed
as a RIC for U.S. federal tax purposes.
We
may be required to recognize taxable income in circumstances in which we do not receive cash. For example, if we hold debt obligations
that have original issue discount (OID) or debt instruments with payment-in-kind (“PIK”) interest, we must include
in income, each year, a portion of this non-cash income that accrues over the life of the obligation, regardless of whether cash
is received by us in that taxable year. We may also have to include in income other amounts that we have not yet received in cash,
such as PIK interest and deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation
such as warrants or stock. Because any OID income or other amounts accrued will be included in our investment company taxable
income for the year of accrual, we may be required to make a distribution to our shareholders in order to satisfy the Annual Distribution
Requirement, even though we will not have received any corresponding cash.
Even
if Rand and Rand SBIC qualify for taxation as RICs, they will be subject to corporate-level U.S. federal income tax on any unrealized
net built-in gains in their respective assets as of the first day they qualify as RICs to the extent that such gains are realized
by them during the five-year period following the first day that they qualify as RICs. As of December 31, 2019, neither Rand nor
Rand SBIC have unrealized net built-in gains.
If
Rand and Rand SBIC qualify for taxation as RICs, distributions out of our earnings and profits to shareholders generally will
be taxable to shareholders for U.S. federal income tax purposes, either as ordinary income or capital gains, depending upon the
nature of the income giving rise to the distribution. The tax consequences to a shareholder attributable to the acquisition, ownership,
and disposition of our common stock, are complex and will depend on the facts of the shareholder’s unique circumstances.
Item
1A. Risk Factors
Risks
related to our Business and Structure
We
are dependent upon RCM for our future success.
Upon
the completion of the Transactions, our day-to-day investment operations are managed by our investment adviser and administrator,
RCM, subject to oversight and supervision by our Board. We no longer have any employees, and although Allen F. “Pete”
Grum and Daniel P. Penberthy each remain as an officer of the Corporation, neither is an employee of the Corporation. As a result,
we depend on the diligence, skill, investment expertise and network of business contacts of RCM’s investment professionals,
including Mr. Grum and Mr. Penberthy, and the investment committee of RCM (the “Investment Committee”) to source appropriate
investments for us. We depend on members of RCM’s investment team and the Investment Committee to appropriately analyze
our investments and on members of the Investment Committee to make investment decisions for us. RCM’s investment team evaluates,
negotiates, structures, closes and monitors our investments. Our future success will depend on the continued availability of the
members of RCM’s investment team and the Investment Committee and the other investment professionals available to RCM. Although
each of the then-current employees of the Corporation entered into employment arrangements with RCM at the closing of the Transactions,
the Corporation does not have any employment agreements with these individuals or other key personnel of RCM, including members
of the Investment Committee, and we cannot provide any assurance that unforeseen business, medical, personal or other circumstances
would not lead any such individual to terminate his or her relationship with RCM. The loss of a material number of investment
professionals to which RCM has access or members of the Investment Committee, could have a material adverse effect on our ability
to achieve our investment objectives as well as on our financial condition and results of operations. In addition, we cannot assure
you that RCM will remain our investment adviser or that we will continue to have access to RCM’s investment professionals
or the Investment Committee or its information and deal flow.
RCM
has no prior experience managing or acting as an investment adviser for a BDC.
Prior
to its entry into the Investment Management Agreement with Rand, RCM was a newly formed entity that had no prior experience managing
or acting as an investment adviser for a BDC. Although the Corporation’s existing employees became employees of RCM after
the closing of the Transactions, all investment decisions to be made by RCM are made by its Investment Committee, which consists
of five persons, of which Allen F. “Pete” Grum and Daniel P. Penberthy are two of the five members. The investment
philosophy and techniques to be used by RCM, and in particular its Investment Committee, to manage the Corporation may differ
from the investment philosophy and techniques previously employed by RCM’s investment team in identifying and managing other
investments and that were previously used by the Corporation when it was internally managed. RCM intends to focus on investing
in interest-yielding debt securities. In addition, RCM is seeking to source potential investments using its relationships and
the business networks and family office networks of the members of the Investment Committee. However, we can offer no assurance
that RCM will be successful with respect to its investment decisions in acting as our investment adviser or that RCM or the Investment
Committee will be successful in their attempts to source and originate additional potential transactions that are appropriate
for Rand’s investment strategy through the use of existing business networks, and our investment returns could be substantially
lower than the returns we have achieved in the past.
Our
financial results will depend on RCM’s skill to manage and deploy capital effectively.
Our
ability to achieve long-term capital appreciation on our existing equity investments and to maintain a current cash flow from
our debt investments while shifting our portfolio to contain a greater percentage of interest-yielding securities depends on RCM’s
capability to effectively identify, invest and manage our capital.
Accomplishing
this investment objective effectively will be based on RCM’s handling of the investment process, starting with its ability
to find investments that offer favorable terms and meet our investment objective. RCM will also need to monitor our portfolio
companies’ performance and may be called upon to provide managerial assistance. These competing demands on their time may
slow the rate of investment.
Even
if RCM is able to grow and build on our investment portfolio, any failure by RCM to manage the growth of our portfolio effectively
could have a material adverse effect on our business, financial condition, results of operations and prospects. If RCM cannot
successfully manage our investment portfolio or implement our investment objectives, this could negatively impact our stock price.
We
are subject to risks created by our regulated environment.
We
are regulated by the SEC and the SBA. Changes in the laws or regulations that govern BDCs and SBICs could significantly affect
our business. Regulations and laws may be changed periodically, and the interpretations of the relevant regulations and laws are
also subject to change. Any change in the regulations and laws governing our business could have a material impact on our financial
condition and our results of operations. Moreover, the laws and regulations that govern BDCs and SBICs may place conflicting demands
on the manner in which we operate, and the resolution of those conflicts may restrict or otherwise adversely affect our operations.
RCM,
on our behalf, may be unable to invest a significant portion of the net proceeds from the Transactions on acceptable terms or
within a reasonable timeframe.
In
connection with the closing of the Transactions, the Corporation issued 8,333,333 shares of common stock to East at a price of
$3.00 per share for an aggregate purchase price of $25.0 million. This purchase price was paid through the contribution to the
Corporation by East of existing loans and other securities that had a fair value as of the closing date for the Transactions of
approximately $9.5 million and a cash payment of approximately $15.5 million. Delays by RCM in investing the net proceeds raised
in the Transactions may cause our performance to be worse than that of other fully invested BDCs or other lenders or investors
pursuing comparable investment strategies. We cannot assure you that RCM will be able to identify investments that meet our investment
objective or that any investment that we make using these proceeds will produce a positive return. RCM may be unable to invest
the net proceeds from the Transactions on acceptable terms within the time period that we anticipate or at all, which could harm
our financial condition and operating results.
We
anticipate that, depending on market conditions, it may take RCM a substantial period of time to invest substantially all of the
net proceeds from the Transactions in securities meeting our investment objectives. During this period, we will invest the net
proceeds from the Transactions primarily in cash, cash equivalents and U.S. Government securities, which may produce returns that
are significantly lower than the returns which we expect to achieve when our portfolio is fully invested in securities meeting
our investment objectives. Until such time as the net proceeds from the Transactions are invested in securities meeting our investment
objectives, the market price for our common stock may decline. Thus, the return on an investment in us may be lower than when,
if ever, our portfolio is fully invested in securities meeting our investment objective.
We
are subject to risks created by borrowing funds from the SBA.
Our
liabilities consist primarily of debt instruments issued through the SBA, which have fixed interest rates. Until and unless we
are able to invest substantially all of the proceeds from these SBA debentures at annualized interest or other rates of return
that substantially exceed annualized interest rates that Rand SBIC must pay the SBA, our operating results may be adversely affected
which may, in turn, depress the market price of our common stock.
In
addition, our outstanding $11.0 million in SBA debentures will reach maturity and become payable between 2022 and 2029. In order
to repay our outstanding SBA debentures, we will need to identify sources of additional funding if the proceeds received upon
the exits of our investments are insufficient to fund our operations and repay our SBA obligations. We cannot be assured that
the proceeds to be received upon the exits from our investments will be sufficient to meet our funding needs or, if such proceeds
are insufficient, that we will be able to obtain access to the necessary funding on terms that are acceptable to us.
We
are subject to risks created by the valuation of our portfolio investments.
At
December 31, 2019, 100% of our investments are in private securities that are not publicly traded. There is typically no public
market for securities of the small privately held companies in which we invest. Investments are valued in accordance with our
established valuation policy and are stated at fair value as determined in good faith by RCM and approved by our Board. In the
absence of a readily ascertainable market value, the estimated value of our investment portfolio may differ significantly, favorably
or unfavorably, from the values that would be placed on the portfolio if a ready market for the securities existed. Any changes
in estimated value are recorded in the consolidated statement of operations as “Net change in unrealized depreciation or
appreciation on investments.” In addition, the participation of RCM’s investment professionals in our valuation process,
could result in a conflict of interest as RCM’s Base Management Fee under the Investment Management Agreement is based,
in part, on the value of our gross assets, and the Incentive Fees payable under the Investment Management Agreement will be based,
in part, on realized gains and realized and unrealized losses.
RCM,
acting as our investment adviser, operates in a competitive market for investment opportunities.
RCM,
acting as our investment adviser, operates in a competitive market for investment opportunities. RCM faces competition in our
investing activities from many entities including other SBICs, private venture capital funds, investment affiliates of large companies,
wealthy individuals and other domestic or foreign investors. The competition is not limited to entities that operate in the same
general geographical area as we do. As a regulated BDC, we are required to disclose quarterly and annually the name and business
description of our portfolio companies and the value of their portfolio securities. Most of our competitors are not subject to
this disclosure requirement or similar types of disclosure requirements. This obligation to disclose this information could hinder
RCM’s ability to invest in potential portfolio companies on our behalf. Additionally, other regulations, current and future,
may make us less attractive as a potential investor to a given portfolio company than a private venture capital fund.
There
are potential conflicts of interest, including the management of other investment funds and accounts by the principals and certain
members of the Investment Committee of RCM, which could impact our investment returns.
The
principals and certain members of the Investment Committee of RCM manage other funds and accounts for other entities affiliated
with members of the Investment Committee. Accordingly, they have obligations to those investors, the fulfillment of which may
not be in the best interests of, or may be adverse to the interests of, us or our shareholders. Although the principals, members
of the Investment Committee and other professional staff of RCM are expected to devote as much time to our management as appropriate
to enable RCM to perform its duties in accordance with the Investment Management Agreement, the members of the Investment Committee
and investment professionals of RCM may have conflicts in allocating their time and services among RCM, on the one hand, and the
other investment vehicles managed by affiliated entities of RCM, on the other hand.
RCM,
including members of its Investment Committee, may face conflicts in allocating investment opportunities between us and other
investment vehicles affiliated with members of the Investment Committee that have overlapping investment objectives with ours.
Although RCM, including members of the Investment Committee, will endeavor to allocate investment opportunities in a fair and
equitable manner in accordance with its allocation policies and procedures, it is possible that, in the future, we may not be
given the opportunity to participate in investments made by investment funds managed by RCM or members of the Investment Committee
if such investment is prohibited by law.
Our
ability to enter into transactions with affiliates of RCM will be restricted.
We,
and certain of our controlled affiliates, are prohibited under the 1940 Act from knowingly participating in certain transactions
with our upstream affiliates, or RCM and its affiliates, without the prior approval of the “required majority” of
our directors as defined in Section 57(o) of the 1940 Act and, in some cases, the SEC. Any person that owns, directly or indirectly,
5% or more of our outstanding voting securities is our upstream affiliate for purposes of the 1940 Act, and we are generally prohibited
from buying or selling any security (other than our securities) from or to such affiliate, absent the prior approval of the “required
majority” of our directors as defined in Section 57(o) of the 1940 Act. The 1940 Act also prohibits “joint”
transactions with an upstream affiliate, or RCM or its affiliates, which could include investments in the same portfolio company
(whether at the same or different times), without prior approval of the “required majority” of our directors as defined
in Section 57(o) of the 1940 Act. In addition, we and certain of our controlled affiliates will be prohibited from buying or selling
any security from or to, or entering into joint transactions with, RCM and its affiliates, or any person, including East, who
owns more than 25% of our voting securities or is otherwise deemed to control, be controlled by, or be under common control with
us, absent the prior approval of the SEC through an exemptive order (other than in certain limited situations pursuant to current
regulatory guidance). Given East’s approximately 58% ownership position in the common stock of the Corporation, this prohibition
may impact our ability to participate in certain transactions or investments, including with respect to certain of the loans and
other securities that were contributed to the Corporation by East as part of the consideration for the stock purchase by East
in the Transactions. The analysis of whether a particular transaction constitutes a joint transaction requires a review of the
relevant facts and circumstances then existing.
As
a BDC, we are required to comply with certain regulatory requirements. For example, we will generally not be permitted to make
loans to companies controlled by RCM or other funds managed by RCM. We will also not be permitted to make any co-investments with
RCM or its affiliates (including any fund managed by RCM or an investment adviser controlling, controlled by or under common control
with RCM) without exemptive relief from the SEC, subject to certain exceptions.
The
proposed fee structure under the Investment Management Agreement may induce RCM to pursue speculative investments and incur leverage,
which may not be in the best interests of the shareholders.
Under
the terms of the Investment Management Agreement, the Base Management Fee is payable even if the value of your investment declines.
The Base Management Fee is calculated based on the total assets (other than cash or cash equivalents but including assets purchased
with borrowed funds), as determined according to procedures duly adopted by the Board. Accordingly, the Base Management Fee is
payable regardless of whether the value of Rand’s total assets or your investment has decreased during the then-current
quarter and creates an incentive for RCM to incur leverage, which may not be consistent with our shareholders’ interests.
The
Incentive Fee payable to RCM is calculated based on a percentage of our return on invested capital. The terms of the Incentive
Fee calculation may create an incentive for RCM to make investments on our behalf that are risky or more speculative than would
be the case in the absence of such a compensation arrangement. Unlike the Base Management Fee, the Income Based Fee is payable
only if the hurdle rate is achieved. Because the portfolio earns investment income on gross assets while the hurdle rate is based
on net assets, and because the use of leverage increases gross assets without any corresponding increase in net asset, RCM may
be incentivized to incur leverage to grow the portfolio, which will tend to enhance returns where our portfolio has positive returns
and increase the chances that such hurdle rate is achieved. Conversely, the use of leverage may increase losses where our portfolio
has negative returns, which would impair the value of our common stock.
In
addition, RCM receives the Incentive Fees based, in part, upon net capital gains realized on our investments under the Capital
Gains Fee. Unlike the Income Based Fee, there is no hurdle rate applicable to the Capital Gains Fee. As a result, RCM may have
an incentive to invest more capital in investments that are likely to result in capital gains as compared to income producing
securities. Such a practice could result in our investing in more speculative equity securities than would otherwise be the case,
which could result in higher investment losses, particularly during economic downturns.
RCM
may be paid incentive compensation even if we incur a net loss, and we cannot recover any portion of the incentive fee previously
paid.
RCM
is entitled to incentive compensation under our Investment Management Agreement for each fiscal quarter under the Income Based
Fee in an amount equal to a percentage of our pre-incentive fee net investment income, subject to a hurdle rate, a catch-up provision,
a cap and a deferral mechanism. For purposes of calculating the Income Based Fee, our pre-incentive fee net investment income
excludes realized and unrealized capital losses that we may incur in the fiscal quarter, even if such capital losses result in
a net loss for that quarter. Thus, we may be required to pay RCM an incentive compensation under the Income Based Fee for a fiscal
quarter even if we incur a net loss for that quarter. In addition, if we pay the Capital Gains Fee and thereafter experience additional
realized capital losses or unrealized capital losses, we will not be able to recover any portion of the incentive fee previously
paid.
RCM’s
liability will be limited under the Investment Management Agreement and the Administration Agreement, and we will be required
to indemnify RCM against certain liabilities, which may lead RCM to act in a riskier manner on our behalf than it would when acting
for its own account.
Under
the Investment Management Agreement and the Administration Agreement, RCM does not assume any responsibility to us other than
to render the services described in the Investment Management Agreement and Administration Agreement, as applicable, and it is
not responsible for any action of our Board in declining to follow RCM’s advice or recommendations. Pursuant to the Investment
Management Agreement and the Administration Agreement, RCM, its members and their respective officers, managers, partners, agents,
employees, controlling persons, members and any other person affiliated with any of them are not liable to us for their acts under
the Investment Management Agreement and Administration Agreement, as applicable, absent willful misfeasance, bad faith, gross
negligence or reckless disregard in the performance of their duties. We have agreed to indemnify, defend and protect RCM its members
and their respective officers, managers, partners, agents, employees, controlling persons, members and any other person affiliated
with any of them with respect to all damages, liabilities, costs and expenses arising out of or otherwise based upon the performance
of any of RCM’s duties or obligations under the Investment Management Agreement or Administration Agreement, as applicable,
or otherwise as investment adviser or administrator, as applicable, for us, and not arising out of willful misfeasance, bad faith,
gross negligence or reckless disregard in the performance of their duties under the Investment Management Agreement or the Administration
Agreement. These protections may lead RCM to act in a riskier manner when acting on our behalf than it would when acting for its
own account.
Our
investment adviser and administrator, RCM, has the right to 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.
Our
investment adviser and administrator, RCM, has the right, under both the Investment Management Agreement and the Administration
Agreement, to resign at any time upon not less than 60 days’ written notice, whether we have found a replacement or not.
If RCM resigns, we may not be able to find a new investment adviser or administrator 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
are likely to be adversely affected and the market price of our common stock may decline. 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 financial condition, business and results
of operations.
In
connection with our proposed RIC Election, we may not be able to pay distributions to our shareholders, our distributions may
not grow over time and a portion of our distributions may be a return of capital.
In
connection with our proposed RIC Election, we intend to pay distributions in the form of cash dividends to our shareholders out
of assets legally available for distribution. However, we cannot assure investors that we will achieve investment results that
will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions. Our ability to
pay distributions might be adversely affected by, among other things, the impact of one or more of the risk factors described
herein. In addition, the inability to satisfy the asset coverage test applicable to us as a BDC can limit our ability to pay distributions.
All distributions will be paid at the discretion of our Board and will depend on our earnings, our financial condition, maintenance
of our RIC status, compliance with applicable BDC regulations and such other factors as our Board may deem relevant from time
to time. We cannot assure shareholders that we will pay distributions on our common stock in the future or at all.
When
we make distributions, we are required to determine the extent to which such distributions are paid out of current or accumulated
earnings and profits. Distributions in excess of current and accumulated earnings and profits will be treated as a non-taxable
return of capital to the extent of an investor’s basis in our stock and, assuming that an investor holds our stock as a
capital asset, thereafter as a capital gain. Generally, a non-taxable return of capital will reduce an investor’s basis
in our stock for federal tax purposes, which will result in higher tax liability when the stock is sold. Shareholders should read
any written disclosure accompanying a distribution carefully and should not assume that the source of any distribution is our
ordinary income or gains.
In
connection with our proposed RIC Election, we will be subject to corporate-level income tax if we are unable to satisfy certain
RIC qualification requirements under Subchapter M of the Code or do not satisfy the annual distribution requirement.
Although
we intend to elect to be treated as a RIC commencing with our tax year ending December 31, 2020, no assurance can be given that
we will be able to qualify for and maintain our qualification as a RIC. In order to satisfy the requirements for RIC tax treatment,
we must meet the following annual distribution, income source and asset diversification requirements to be relieved of federal
taxes on income and gains distributed to our shareholders.
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The
annual distribution requirement for a RIC will be satisfied if we distribute to our shareholders on an annual basis at least
90% of our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses,
if any. If we are unable to obtain cash from sources in order to make these distributions, we could fail to qualify for RIC
tax treatment and thus become subject to corporate-level income tax.
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The
income source requirement will be satisfied if we obtain at least 90% of our income for each year from dividends, interest,
gains from the sale of stock or securities or similar sources.
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The
asset diversification requirement will be satisfied if we meet certain asset diversification requirements at the end of each
quarter of our taxable year. To satisfy this requirement, at least 50% of the value of our assets must consist of cash, cash
equivalents, U.S. Government securities, securities of other regulated investment companies, and other acceptable securities;
and no more than 25% of the value of our assets can be invested in the securities, other than U.S. Government securities or
securities of other regulated investment companies, of one issuer, of two or more issuers that are controlled, as determined
under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain
“qualified publicly traded partnerships.” Failure to meet these requirements may result in our having to dispose
of certain investments quickly in order to prevent the loss of regulated investment company status. Because most of our investments
will be in private companies, and therefore will be relatively illiquid, any such dispositions could be made at disadvantageous
prices and could result in substantial losses.
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If
we fail to satisfy certain RIC qualification requirements under Subchapter M of the Code or to meet the annual distribution requirement
for any reason and are subject to corporate income tax, the resulting corporate taxes could substantially reduce our net assets,
the amount of income available for distribution and the amount of our distributions, if any. Such a failure would have a material
adverse effect on us and our shareholders.
In
connection with our proposed RIC Election, we may have difficulty paying required distributions to shareholders if we recognize
income before or without receiving cash representing such income.
In
connection with our proposed RIC Election, we will be required to distribute annually at least 90% of our ordinary income and
realized net short-term capital gains in excess of realized net long-term capital losses to maintain our eligibility for RIC tax
treatment. For U.S. federal income tax purposes, we will include in taxable income certain amounts that we have not yet received
in cash, such as contracted payment-in-kind (“PIK”) interest, which represents contractual interest added to the loan
balance and due at the end of the loan term. The increases in loan balances as a result of contracted PIK arrangements will be
included in income in advance of receiving cash payment, and will be separately identified on our consolidated statements of cash
flows. We also may be required to include in income certain other amounts that we will not receive in cash.
Any
warrants that we receive in connection with our debt investments will generally be valued as part of the negotiation process with
the particular portfolio company. As a result, a portion of the aggregate purchase price for the debt investments and warrants
will be allocated to the warrants that we receive. This will generally result in our debt instruments having original issue discount
(“OID”) for tax purposes, which we must recognize as ordinary income as such original issue discount accrues regardless
of whether we have received any corresponding payment of such interest. Other features of debt instruments that we hold may also
cause such instruments to generate original issue discount.
Since
in certain cases we may recognize income before or without receiving cash representing such income, we may have difficulty meeting
the requirement to distribute at least 90% of our ordinary income and realized net short-term capital gains in excess of realized
net long-term capital losses to maintain our eligibility for RIC tax treatment. Accordingly, we may have to use cash on hand or
sell some of our assets, raise additional equity capital or reduce new investment originations to meet these distribution requirements.
If we do not have sufficient cash on hand or are unable to obtain cash from other sources to satisfy such distribution requirements,
we may fail to qualify for RIC tax treatment and thus may become subject to corporate-level income tax.
If
we do not invest a sufficient portion of our assets in qualifying assets, we could fail to maintain our qualification as a BDC
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.
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 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.
We
are subject to cybersecurity risks and incidents that may adversely affect our operations, the operations of RCM or the companies
in which we invest. A failure in our cybersecurity systems could impair our ability to conduct business and damage our business
relationships, compromise or corrupt our confidential information and ultimately negatively impact business, financial condition
and operating results.
Our
and RCM’s operations are dependent on secure information technology systems for data processing, storage and reporting.
Increased cybersecurity vulnerabilities, threats and more sophisticated and targeted cyber-attacks pose a risk to the security
of our and RCM’s information and the information of our portfolio companies. Like other companies, we may experience threats
to our data and systems, including malware and computer virus attacks, unauthorized access, system failures and disruptions. If
one or more of these events occurs, it could potentially jeopardize the confidential, proprietary and other information processed
and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in
our operations, which could result in damage to our reputation, financial losses, litigation, increased costs or regulatory penalties.
In addition, these cyber-attacks could affect our and RCM’s computer network, our website or our other service providers
(such as, but not limited to, accountants, lawyers, and transfer agents) and could result in operating disruptions or information
misappropriation, which could have a material adverse effect on our business operations and the integrity and availability of
our financial information. We have attempted to mitigate these cybersecurity risks by employing a number of processes, procedures
and internal controls within the Corporation, but we remain potentially vulnerable to additional known and unknown threats.
We
may experience fluctuations in our annual and quarterly results.
We
could experience fluctuations in our annual and quarterly operating results due to a number of factors, some of which are beyond
our control, including RCM’s ability or inability to make investments in companies that meet our investment criteria, RCM’s
plans to transition over time Rand’s portfolio to include more interest-yielding securities, the interest rate payable on
the debt securities acquired and the default rate on such securities, the level of our expenses, variations in and the timing
of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in the markets in
which we operate and general economic conditions. As a result of these factors, results for any period should not be relied upon
as being indicative of performance in future quarters or any future fiscal years.
Risks
related to our Investments
We
have a limited number of companies in our portfolio of investments, and may be subjected to greater risk if any of these companies
default.
Our
portfolio investment values are concentrated in a small number of companies and as such, we may experience a significant loss
in our net asset value if one or more of these companies performs poorly or goes out of business. The unrealized or realized depreciation
in the value of the securities of any one of these companies would negatively impact our net asset value.
The
lack of liquidity in our investments may adversely affect our business.
RCM,
on our behalf, invests, and we expect that RCM will continue, on our behalf, to invest, in portfolio companies whose securities
are not publicly traded and may be subject to restrictions on resale, and as a result will be less liquid than publicly traded
securities. Most of our investments are or will be either equity securities or debt securities acquired directly from small, private
companies. The illiquidity of most of our portfolio may adversely affect our ability to dispose of the securities at times when
it may be advantageous for us to liquidate investments. In addition, we may not realize the full value of these private investments
if we have to liquidate all or a part of our portfolio investment quickly, given the lack of available markets for their sale.
Economic
downturns or recessions may adversely affect our portfolio companies’ financial performance and therefore harm our operating
results.
The
United States economy has periodically experienced periods of instability and recessions and the financial results of the small
companies in which we invest could be more acutely affected negatively by this instability and suffer deterioration in operational
or financial results. This deterioration may have a negative effect on our financial performance.
Investing
in private companies involves a high degree of risk.
We
typically invest a substantial portion of our assets in small private companies. These private businesses may be thinly capitalized,
unproven companies with risky technologies, products or services, may lack management depth, and may not have attained profitability.
Because of the speculative nature and the lack of a public market for these investments, there is significantly greater risk of
loss than is the case with securities traded on a public exchange. We expect that some of our investments will become worthless
and that some will appear likely to become successful but will never realize their potential. We have historically been risk seeking
rather than risk averse in our approach to our investments. Given the incentive compensation components of our arrangement with
RCM under the Investment Management Agreement, RCM has similar incentives to be risk seeking rather than risk averse in making
its investment decisions.
Even
if our portfolio companies are able to develop commercially viable technologies, products or services, the market for those new
technologies, products and services is likely to be highly competitive and rapidly changing. Commercial success is difficult to
predict and the marketing efforts of the portfolio companies may not be successful.
An
investment strategy focused primarily on privately held companies presents certain challenges, including the lack of available
information about these companies, a dependence on the talents and efforts of only a few key portfolio company personnel and a
greater vulnerability to economic downturns.
We
invest primarily in privately held companies. Generally, little public information exists about these companies, and we will be
required to rely on the ability of RCM’s investment professionals to obtain adequate information to evaluate the potential
returns from investing in these companies. If RCM is unable to uncover all material information about these companies, it may
not, acting on our behalf, make a fully informed investment decision, and we may lose money on our investments. Also, privately
held companies frequently have less diverse product lines and smaller market presence than larger competitors. These factors could
adversely affect our investment returns as compared to companies investing primarily in the securities of public companies.
We
provide debt and equity capital primarily to small companies, which may present a greater risk of loss than providing debt and
equity capital to larger companies.
Our
portfolio consists primarily of debt and equity investments in small companies. Compared to larger companies, small companies
generally have more limited access to capital and higher funding costs, may be in a weaker financial position and may need more
capital to expand, compete and operate their business. They also typically have fewer administrative resources, which can lead
to greater uncertainty in their ability to generate accurate and reliable financial data, including their ability to deliver audited
financial statements. In addition, many small companies may be unable to obtain financing from the public capital markets or other
traditional sources, such as commercial banks, in part because loans made to these types of companies entail higher risks than
loans made to companies that have larger businesses, greater financial resources or are otherwise able to access traditional credit
sources on more attractive terms.
A
variety of factors may affect the ability of borrowers to make scheduled payments on debt securities or loans, including failure
to satisfy financial targets and covenants, a downturn in a borrower’s industry or changes in the economy in general. In
addition, investing in small companies in general involves a number of significant risks, including that small companies:
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may
have limited financial resources and may be unable to meet their obligations under their debt securities that we hold, which
may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of us realizing any
guarantees we may have obtained in connection with our investment;
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typically
have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render
small companies more vulnerable to competitors’ actions and market conditions, as well as general economic downturns;
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are
more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability,
resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and,
in turn, on us;
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generally
have less predictable operating results, may be engaged in rapidly changing businesses with products subject to a substantial
risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion or maintain
their competitive position;
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may
from time to time be parties to litigation, and our executive officers, directors and our investment adviser may, in the ordinary
course of business, be named as defendants in litigation arising from our investments in the portfolio companies;
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may
have difficulty accessing the capital markets to meet future capital needs, which may limit their ability to grow or to repay
their outstanding indebtedness upon maturity; and
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may
be particularly vulnerable to changes in customer preferences and market conditions, depend on a limited number of customers,
and face intense competition, including from companies with greater financial, technical, managerial and marketing resources.
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Any
of these factors or changes thereto could impair a small company’s financial condition, results of operation, cash flow
or result in other adverse events, such as bankruptcy, any of which could limit a borrower’s ability to make scheduled payments
on our debt securities. This, in turn, could result in losses in our investments and a decrease in our net interest income and
net asset value.
We
generally do not control our portfolio companies.
We
do not have an expectation to control the decision making in our portfolio companies, even though we may have a board seat or
board observation rights. Because of this, we are subject to the risk that our portfolio companies will make business decisions
with which we disagree or will incur risks or otherwise act in ways that do not maximize their value and serve our interests as
minority debt and equity holders. Due to the lack of liquidity in our investments in these private companies, we may not be able
to dispose of our investment in these portfolio companies as freely as we would like or at a valuation that is appropriate. As
a result, a portfolio company may make decisions that would decrease the value of our portfolio holdings.
We
typically are a minority shareholder in our portfolio companies.
We
typically invest as a minority shareholder in our portfolio companies. As a minority shareholder, we are unable to require the
company to seek or entertain liquidity events as a way to exit our investments. This may cause us to hold investments longer than
planned or to seek a sale that may not reflect the full value of our investment.
We
may not have the funds or ability to make follow-on investments in our portfolio companies.
We
may not have the funds or ability to make additional investments in our portfolio companies. After our initial investment in a
company, we may be asked to participate in another round of financing by the company. There is no assurance that we will make,
or have sufficient funds to make, these follow-on investments. Any decision to not make an additional investment in a portfolio
company may have a negative impact on the portfolio company in need of the capital, and have a negative impact on our ownership
in the company.
Risks
related to our Common Stock
We
may not begin to declare and pay regular cash dividends.
In
connection with our proposed RIC Election, we expect to adopt a new dividend policy that includes regular cash dividends to shareholders.
While we intend to adopt a new dividend policy that includes regular cash dividends to shareholders, we cannot assure you that
we will declare and pay any dividends. All dividends will be paid at the discretion of our Board and will depend on our earnings,
our financial condition, maintenance of our status as a RIC and such other factors as our Board may deem relevant from time to
time. In addition, with respect to Rand SBIC, any dividend or distribution from Rand SBIC to Rand will need to be in compliance
with the rules and regulations of the SBA and, if Rand SBIC is unable to comply with the SBA’s rules and regulations, require
Rand SBIC to seek and obtain approval or a waiver from the SBA in order to make any such dividend or distribution. We cannot assure
you that Rand SBIC will be able to obtain any such approval or waiver from the SBA. Our ability to declare and pay regular cash
dividends will depend upon whether we achieve investment results that will allow us to pay a specified level of cash dividends.
Our ability to pay dividends might be adversely affected by, among other things, RCM’s inability to successfully or timely
execute on its investment strategy and the impact of one or more of the other risk factors described herein.
East
exercises significant influence over us in connection with its ownership of our common stock and as a result of its ownership
position in RCM.
East
beneficially owns approximately 58% of Rand’s outstanding common stock. As a result, East is able to direct the outcome
of any matters submitted for shareholder action, including approval of significant corporate transactions, such as amendments
to our governing documents, business combinations, consolidations and mergers. East has substantial influence on us, and could
exercise its influence in a manner that conflicts with the interests of other shareholders. The presence of a significant shareholder
may also have the effect of making it more difficult for a third party to acquire us or for the Board to discourage a third party
from seeking to acquire us.
In
addition, pursuant to the terms of the Shareholder Agreement, East has the right to designate two or three persons, depending
upon the size of the Board, for nomination for election to the Board. East has the right to designate (i) up to two persons if
the size of the Board is composed of fewer than seven directors or (ii) up to three persons if the size of the Board is composed
of seven or more directors. Under the terms of the Shareholder Agreement, East has designated Adam S. Gusky and Benjamin E. Godley
for nomination for election to the Board. The designation right provided to East under the terms of the Shareholder Agreement
provides East with a significant presence on the Board and direct influence on matters presented to the Board, although all directors,
whether or not nominated by East, owe fiduciary duties to all shareholders.
Finally,
East has a significant ownership position in RCM, which serves as our investment adviser and administrator. Given this ownership
position in RCM, East has significant influence on the operations of RCM, including with respect to the investment management
and administrative services provided by RCM to the Corporation.
Investing
in our shares may be inappropriate for an investor’s risk tolerance.
Our
investments, in accordance with our investment objective and principal strategies, result in a greater than average amount of
risk and volatility and may result in loss of principal. Our investments in portfolio companies are highly speculative and aggressive
and, therefore, an investment in our shares may not be suitable for investors for whom such risk is inappropriate. Neither our
investments nor an investment in our shares constitutes a balanced investment program.
Sales
of substantial amounts of our common stock may have an adverse effect on the market price of our securities.
Sales
of substantial amounts of our common stock, or the availability of such securities for sale, could adversely affect the prevailing
market prices for our common stock.
Our
shares often trade at a discount to our net asset value.
Shares
of business development companies may trade at a market price that is less than the net asset value that is attributable to those
shares and our shares have often traded at such a discount. This characteristic of closed-end investment companies is separate
and distinct from the risk that our net asset value per share may decline. It is not possible to predict if, or when, our shares
will trade at, above, or below net asset value.