Solar Capital
Ltd. (Solar, Solar Capital, the Company, we or our), a Maryland corporation formed in November 2007, is a closed-end, externally managed, non-diversified management investment company that
has elected to be treated as a business development company (BDC) under the Investment Company Act of 1940, as amended (the 1940 Act). Furthermore, as the Company is an investment company, it continues to apply the guidance
in FASB Accounting Standards Codification (ASC) Topic 946. In addition, for tax purposes we have elected to be treated as a regulated investment company (RIC) under Subchapter M of the Internal Revenue Code of 1986, as
amended (the Code).
In February 2010, we completed our initial public offering and a concurrent private
offering of shares to management. Prior to our initial public offering, Solar Capital LLC merged with and into Solar Capital Ltd. (the Merger), leaving Solar Capital Ltd. as the surviving entity. Solar Capital Ltd. issued shares of
common stock and $125 million in senior unsecured notes (the Senior Unsecured Notes) to the existing Solar Capital LLC unit holders in connection with the Merger. The Senior Unsecured Notes that were issued in connection with the Merger
were fully repaid in December 2010. Prior to the Merger, Solar Capital Ltd. had no assets or operations and as a result, the books and records of Solar Capital LLC have become the historical books and records of the Company.
We invest primarily in U.S. middle market companies, where we believe the supply of primary capital is limited and the investment
opportunities are most attractive. Our investment objective is to generate both current income and capital appreciation through debt and equity investments. We invest primarily in leveraged middle market companies in the form of senior secured
loans, mezzanine loans and equity securities. From time to time, we may also invest in public companies that are thinly traded. Our business is focused primarily on the direct origination of investments through portfolio companies or their financial
sponsors. Our investments generally range between $20 million and $100 million each, although we expect that this investment size will vary proportionately with the size of our capital base. In addition, we may invest a portion of our portfolio in
other types of investments, which we refer to as opportunistic investments, which are not our primary focus but are intended to enhance our overall returns. These investments may include, but are not limited to, direct investments in public
companies that are not thinly traded and securities of leveraged companies located in select countries outside of the United States. We are managed by Solar Capital Partners, LLC (Solar Capital Partners). Solar Capital Management, LLC
(Solar Capital Management) provides the administrative services necessary for us to operate.
As of
December 31, 2013, our investment portfolio totaled $1.1 billion and our net asset value was $995.6 million. Our portfolio was comprised of debt and equity investments in 40 portfolio companies with our portfolio of income producing
investments having a weighted average annualized yield on a fair value basis of approximately 11.3%.
During the fiscal year
ended December 31, 2013, we originated approximately $330 million of investments in 19 portfolio companies. Investments sold or prepaid during the fiscal year ended December 31, 2013 totaled approximately $658 million.
Solar Capital Partners
Solar Capital Partners, our investment adviser, is controlled and led by Michael S. Gross, our chairman and chief executive officer,
and Bruce Spohler, our chief operating officer. They are supported by a team of dedicated investment professionals that have extensive experience in leveraged lending and private equity, as well as significant contacts with financial sponsors.
In addition, Solar Capital Partners presently serves as the investment adviser for Solar Senior Capital Ltd, or Solar
Senior, a publicly traded business development company with approximately $375 million of investable
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capital that invests in the senior debt securities of leveraged middle market companies similar to those we intend to target for investment. Through December 31, 2013, the investment team
led by Messrs. Gross and Spohler has invested approximately $3.9 billion in more than 140 different portfolio companies for Solar Capital and Solar Senior, involving an aggregate of more than 100 different financial sponsors. As of
February 21, 2014, Mr. Gross and Mr. Spohler beneficially owned, either directly or indirectly, approximately 4.8% and 4.7%, respectively, of our outstanding common stock.
Solar Capital Management
Pursuant to an administration agreement (the
Administration Agreement), Solar Capital Management furnishes us with office facilities, equipment and clerical, bookkeeping and record keeping services at such facilities. Under the Administration Agreement, Solar Capital Management
also performs, or oversees the performance of, our required administrative services, which include, among other things, being responsible for the financial records which we are required to maintain and preparing reports to our stockholders. In
addition, Solar Capital Management assists us in determining and publishing our net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports to our stockholders, and generally oversees the
payment of our expenses and the performance of administrative and professional services rendered to us by others. Solar Capital Management also provides managerial assistance, if any, on our behalf to those portfolio companies that request such
assistance.
Operating and Regulatory Structure
A BDC is regulated by the 1940 Act. A BDC must be organized in the United States for the purpose of investing in or lending to primarily private companies and making significant managerial assistance
available to them. A BDC may use capital provided by public stockholders and from other sources to make long-term, private investments in businesses. A BDC provides stockholders the ability to retain the liquidity of a publicly traded stock while
sharing in the possible benefits, if any, of investing in primarily privately owned companies.
We may not change the nature
of our business so as to cease to be, or withdraw our election as, a BDC unless authorized by vote of a majority of our outstanding voting securities, as required by the 1940 Act. A majority of the outstanding voting securities of a company is
defined under the 1940 Act as the lesser of: (a) 67% or more of such companys voting securities present at a meeting if more than 50% of the outstanding voting securities of such company are present or represented by proxy, or
(b) more than 50% of the outstanding voting securities of such company. We do not anticipate any substantial change in the nature of our business.
As with other companies regulated by the 1940 Act, a BDC must adhere to certain substantive regulatory requirements. A majority of our directors must be persons who are not interested persons, as that
term is defined in the 1940 Act. Additionally, we are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect the BDC. Furthermore, as a BDC, we are prohibited from protecting any director or officer
against any liability to us or our stockholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such persons office.
As a BDC, we are required to meet an asset coverage ratio, reflecting the value of our total assets to our total senior securities, which
include all of our borrowings and any preferred stock we may issue in the future, of at least 200%. We may also be prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of
our directors who are not interested persons and, in some cases, prior approval by the Securities and Exchange Commission (SEC).
We are generally not able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock,
at a price below the then-current net asset value of our common stock if our board of directors determines that such sale is in our best interests and the best interests of our stockholders, and our stockholders approve such sale. In
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addition, we may generally issue new shares of our common stock at a price below net asset value in rights offerings to existing stockholders, in payment of dividends and in certain other limited
circumstances.
As a BDC, we are generally limited in our ability to invest in any portfolio company in which our investment
adviser or any of its affiliates currently have an investment or to make any co-investments with our investment adviser or its affiliates without an exemptive order from the SEC, subject to certain exceptions.
We will be periodically examined by the SEC for compliance with 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 the BDCs total assets. The principal categories of qualifying assets relevant to our proposed business are the following:
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(1)
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Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an
eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. An eligible
portfolio company is defined in the 1940 Act as any issuer which:
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(a) is organized under the
laws of, and has its principal place of business in, the United States;
(b) is not an investment company
(other than a small business investment company wholly owned by the BDC) or a company that would be an investment company but for certain exclusions under the 1940 Act; and
(c) satisfies any of the following:
i.) does not have any class of securities that is traded on a national securities exchange;
ii.) has a class of securities listed on a national securities exchange, but has an aggregate market value of outstanding
voting and non-voting common equity of less than $250 million;
iii.) is controlled by a BDC or a group of
companies including a BDC and the BDC has an affiliated person who is a director of the eligible portfolio company; or
iv.) is a small and solvent company having total assets of not more than $4.0 million and capital and surplus of not less than $2.0 million.
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(2)
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Securities of any eligible portfolio company which we control.
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(3)
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Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions
incident thereto, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities, was unable to meet its obligations as they came due without material assistance other than
conventional lending or financing arrangements.
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(4)
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Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own 60% of
the outstanding equity of the eligible portfolio company.
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(5)
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Securities received in exchange for or distributed on or with respect to securities described in (1) through (4) above, or pursuant to the exercise of
warrants or rights relating to such securities.
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(6)
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Cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment.
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(7)
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Office furniture and equipment, interests in real estate and leasehold improvements and facilities maintained to conduct the business operations of the
business development company, deferred
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organization and operating expenses, and other noninvestment assets necessary and appropriate to its operations as a business development company, including notes of indebtedness of directors,
officers, employees, and general partners held by a business development company as payment for securities of such company issued in connection with an executive compensation plan described in section 57(j) of the 1940 Act.
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Under Section 55(b) of the 1940 Act, the value of a BDCs assets shall be determined as of the date of the most recent
financial statements filed by such company with the SEC pursuant to section 13 of the Securities Exchange Act of 1934 (the 1934 Act), and shall be determined no less frequently than annually.
Managerial Assistance to Portfolio Companies
As a BDC, we offer, and must provide upon request, managerial assistance to our portfolio companies. This assistance could involve, among other things, monitoring the operations of our portfolio
companies, participating in board and management meetings, consulting with and advising officers of portfolio companies and providing other organizational and financial guidance. We may also receive fees for these services. Solar Capital Management
provides such managerial assistance, if any, on our behalf to portfolio companies that request this assistance.
Temporary Investments
Pending investment in other types of qualifying assets, as described above, our investments may consist of cash, cash equivalents, U.S. government securities or high-quality investment grade
debt securities maturing in one year or less from the time of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets are qualifying assets. Typically, we will invest in U.S. Treasury bills or in repurchase
agreements, provided that such repurchase agreements are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and
the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price which is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the
proportion of our assets that may be invested in such repurchase agreements. However, if more than 25% of our total assets constitute repurchase agreements from a single counterparty, we would not meet the diversification tests in order to qualify
as a RIC for federal income tax purposes. Thus, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. Our investment adviser will monitor the creditworthiness of the counterparties with which we
enter into repurchase agreement transactions.
Senior Securities
We are permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to our common stock
if our asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, while any senior securities remain outstanding, we must make provisions to prohibit any distribution to our stockholders
or the repurchase of such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase. We may also borrow amounts up to 5% of the value of our total assets for temporary or emergency
purposes without regard to asset coverage. We may borrow money, which would magnify the potential for gain or loss on amounts invested and may increase the risk of investing in us.
Code of Ethics
We and Solar Capital Partners have each adopted a code of ethics pursuant to Rule 17j-1 under the 1940 Act and Rule 204A-1 under the Investment Advisers Act of 1940 (the Advisers Act),
respectively, that establishes procedures for personal investments and restricts certain transactions by our personnel. Our codes of ethics generally do not permit investments by our employees in securities that may be purchased or held by us. You
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may read and copy these codes of ethics at the SECs Public Reference Room in Washington, D.C. You may obtain information on the operation of the Public Reference Room by calling the SEC at
1 (800) SEC- 0330. In addition, each code of ethics is available on the EDGAR Database on the SECs Internet site at http://www.sec.gov. You may also obtain copies of the codes of ethics, after paying a duplicating fee, by electronic
request at the following Email address: publicinfo@sec.gov, or by writing the SECs Public Reference Section, 100 F Street, N.E., Washington, D.C. 20549.
Compliance Policies and Procedures
We and our investment adviser
have adopted and implemented written policies and procedures reasonably designed to detect and prevent violation of the federal securities laws. We are required to review these compliance policies and procedures annually for their adequacy and the
effectiveness of their implementation and to designate a chief compliance officer to be responsible for their administration. Guy Talarico currently serves as our chief compliance officer.
Proxy Voting Policies and Procedures
We have delegated our proxy voting responsibility to our investment adviser. A summary of the Proxy Voting Policies and Procedures of our adviser are set forth below. The guidelines are reviewed
periodically by the adviser and our non-interested directors, and, accordingly, are subject to change.
As an investment
adviser registered under the Investment Advisers Act of 1940, Solar Capital Partners has a fiduciary duty to act solely in the best interests of its clients. As part of this duty, it recognizes that it must vote securities held by its clients in a
timely manner free of conflicts of interest. These policies and procedures for voting proxies for investment advisory clients are intended to comply with Section 206 of, and Rule 206(4)-6 under, the Advisers Act.
Our investment adviser votes proxies relating to our portfolio securities in the best interest of our stockholders. Solar Capital
Partners reviews on a case-by-case basis each proposal submitted for a proxy vote to determine its impact on our investments. Although it generally votes against proposals that may have a negative impact on our investments, it may vote for such a
proposal if there exists compelling long-term reasons to do so. The proxy voting decisions of our investment adviser are made by the senior investment professionals who are responsible for monitoring each of our investments. To ensure that our vote
is not the product of a conflict of interest, it requires that: (i) anyone involved in the decision making process disclose to a managing member of Solar Capital Partners any potential conflict that he or she is aware of and any contact that he
or she has had with any interested party regarding a proxy vote; and (ii) employees involved in the decision making process or vote administration are prohibited from revealing how we intend to vote on a proposal in order to reduce any
attempted influence from interested parties.
You may obtain information about how we voted proxies by making a written
request for proxy voting information to: Solar Capital Partners, LLC, 500 Park Avenue, New York, NY 10022.
Privacy Principles
We are committed to maintaining the privacy of our stockholders and to safeguarding their non-public personal information.
The following information is provided to help you understand what personal information we collect, how we protect that information and why, in certain cases, we may share information with select other parties.
Generally, we do not receive any non-public personal information relating to our stockholders, although certain non-public personal
information of our stockholders may become available to us. We do not disclose any non-public personal information about our stockholders (or former stockholders) to anyone, except as permitted by law or as is necessary in order to service
stockholder accounts (for example, to a transfer agent or third party administrator).
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We restrict access to non-public personal information about our stockholders to employees of
our investment adviser and its affiliates with a legitimate business need for the information. We maintain physical, electronic and procedural safeguards designed to protect the non-public personal information of our stockholders.
Taxation as a Regulated Investment Company
As a BDC, we elected to be treated, and intend to qualify annually thereafter, as a RIC under Subchapter M of the Code. As a RIC, we generally will not have to pay corporate-level federal income taxes on
any ordinary income or capital gains that we distribute to our stockholders as dividends. To continue to qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below). In
addition, to qualify for RIC tax treatment we must distribute to our stockholders, for each taxable year, at least 90% of our investment company taxable income, which is generally our ordinary income plus the excess of our realized net
short-term capital gains over our realized net long-term capital losses (the Annual Distribution Requirement). If we qualify as a RIC and satisfy the Annual Distribution Requirement, then we will not be subject to federal income tax on
the portion of our investment company taxable income and net capital gain (i.e., realized net long-term capital gains in excess of realized net short-term capital losses) we distribute to stockholders. 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 not distributed) to our stockholders.
We will be subject to a 4% nondeductible federal excise tax on certain undistributed income unless we distribute in a timely manner an
amount at least equal to the sum of (1) 98% of our ordinary income for each calendar year, (2) 98.2% of our capital gain net income for the one-year period ending October 31 in that calendar year and (3) any income realized, but
not distributed, and on which we paid no federal income tax, in preceding years (the Excise Tax Avoidance Requirement).
In order to qualify as a RIC for federal income tax purposes, we must, among other things:
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at all times during each taxable year, have in effect an election to be treated as a BDC under the 1940 Act;
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derive in each taxable year at least 90% of our gross income from (a) dividends, interest, payments with respect to certain securities loans,
gains from the sale of stock or other securities or currencies, or other income derived with respect to our business of investing in such stock, securities or currencies and (b) net income derived from an interest in a qualified publicly
traded partnership; and
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diversify our holdings so that at the end of each quarter of the taxable year:
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at least 50% of the value of our 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 our assets or more than 10% of the outstanding voting securities of the issuer; and
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no more than 25% of the value of our assets is invested in (i) the securities, other than U.S. government securities or securities of other RICs,
of one issuer, (ii) the securities 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) the securities of one or
more qualified publicly traded partnerships.
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The Regulated Investment Company Modernization Act
of 2010, which was generally effective for 2011 and subsequent tax years, provides some relief from RIC disqualification due to failures of the income and asset diversification requirements, although there may be additional taxes due in such
cases.
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 are treated under applicable tax rules as having original issue discount (such as debt instruments with payment-in-kind (PIK) interest or, in certain cases, increasing interest rates or debt instruments issued
with warrants), we must include in income each year a portion of the original issue
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discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. Because any original issue discount 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 stockholders in order to satisfy the Annual Distribution Requirement, even though we will not have received any
corresponding cash amount.
Because we may use debt financing, we will be subject to certain asset coverage ratio requirements
under the 1940 Act and financial covenants under loan and credit agreements that could, under certain circumstances, restrict us from making distributions necessary to satisfy the Annual Distribution Requirement. If we are unable to obtain cash from
other sources or are otherwise limited in our ability to make distributions, we could fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax.
Certain of our investment practices may be subject to special and complex U.S. federal income tax provisions that may, among other
things: (i) disallow, suspend or otherwise limit the allowance of certain losses or deductions; (ii) convert lower taxed long-term capital gain into higher taxed short-term capital gain or ordinary income; (iii) convert an ordinary
loss or a deduction into a capital loss (the deductibility of which is more limited); (iv) cause us to recognize income or gain without a corresponding receipt of cash; (v) adversely affect the time as to when a purchase or sale of
securities is deemed to occur; (vi) adversely alter the characterization of certain complex financial transactions; and (vii) produce income that will not be qualifying income for purposes of the 90% gross income test described above. We
will monitor our transactions and may make certain tax elections in order to mitigate the potential adverse effect of these provisions.
Gain or loss realized by us from the sale or exchange of warrants acquired by us as well as any loss attributable to the lapse of such warrants generally will be treated as capital gain or loss. The
treatment of such gain or loss as long-term or short-term will depend on how long we held a particular warrant. Upon the exercise of a warrant acquired by us, our tax basis in the stock purchased under the warrant will equal the sum of the amount
paid for the warrant plus the strike price paid on the exercise of the warrant. Except as set forth in Failure to Qualify as a Regulated Investment Company, the remainder of this discussion assumes we will qualify as a RIC for each
taxable year.
Failure to Qualify as a Regulated Investment Company
If we were unable to qualify for treatment as a RIC, we would be subject to tax on all of our taxable income at regular corporate rates.
We would not be able to deduct distributions to stockholders, nor would they be required to be made. Such distributions would be taxable to our stockholders as dividends and, provided certain holding period and other requirements were met,
could qualify for treatment as qualified dividend income in the hands of non-corporate stockholders (and thus eligible for the same lower maximum tax rate applicable to long-term capital gains) to the extent of our current and
accumulated earnings and profits. Subject to certain limitations under the Code, corporate shareholders would be eligible for the dividends received deduction. Distributions in excess of our current and accumulated earnings and profits would be
treated first as a return of capital to the extent of the stockholders tax basis, and any remaining distributions would be treated as a capital gain. To re-qualify as a RIC in a subsequent taxable year, we would be required to satisfy the RIC
qualification requirements for that year and dispose of any earnings and profits from any year in which we failed to qualify as a RIC. Subject to a limited exception applicable to RICs that qualified as such under Subchapter M of the Code for at
least one year prior to disqualification and that re-qualify as a RIC no later than the second year following the non-qualifying year, we could be subject to tax on any unrealized net built-in gains in the assets held by us during the period in
which we failed to qualify as a RIC that are recognized within the subsequent 10 years, unless we made a special election to pay corporate-level tax on such built-in gain at the time of our requalification as a RIC.
Investment Advisory Fees
Pursuant to an investment advisory and management agreement (the Investment Advisory and Management Agreement), we have agreed
to pay Solar Capital Partners a fee for investment advisory and management services consisting of two components a base management fee and an incentive fee.
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The base management fee is calculated at an annual rate of 2.00% of our gross assets. For
services rendered under the Investment Advisory and Management Agreement, the base management fee is payable quarterly in arrears. The base management fee is calculated based on the average value of our gross assets at the end of the two most
recently completed calendar quarters, and appropriately adjusted for any share issuances or repurchases during the current calendar quarter.
The incentive fee has two parts, as follows: one is calculated and payable quarterly in arrears based on our pre-incentive fee net investment income for the immediately preceding calendar quarter. For
this purpose, pre-incentive fee net investment income means 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) accrued during the calendar quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under the Administration
Agreement to Solar Capital Management, and any interest expense and dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a
deferred interest feature (such as original issue discount, debt instruments with pay in kind interest and zero coupon securities), accrued income that we have not yet received in cash. Pre-incentive fee net investment income does not include any
realized capital gains, computed net of all realized 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 at the end of the
immediately preceding calendar quarter, is compared to a hurdle of 1.75% per quarter (7.00% annualized). Our net investment income used to calculate this part of the incentive fee is also included in the amount of our gross assets used to
calculate the 2.00% base management fee. We pay Solar Capital Partners an incentive fee with respect to our pre-incentive fee net investment income in each calendar quarter as follows:
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no incentive fee in any calendar quarter in which our pre-incentive fee net investment income does not exceed the hurdle of 1.75%;
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100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds
the hurdle but is less than 2.1875% in any calendar quarter (8.75% annualized). We refer to this portion of our pre-incentive fee net investment income (which exceeds the hurdle but is less than 2.1875%) as the catch-up. The
catch-up is meant to provide our investment adviser with 20% of our pre-incentive fee net investment income as if a hurdle did not apply if this net investment income exceeds 2.1875% in any calendar quarter; and
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20% of the amount of our pre-incentive fee net investment income, if any, that exceeds 2.1875% in any calendar quarter (8.75% annualized) is payable to
Solar Capital Partners (once the hurdle is reached and the catch-up is achieved, 20% of all pre-incentive fee investment income thereafter is allocated to Solar Capital Partners).
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The following is a graphical representation of the calculation of the income-related portion of the incentive fee:
Quarterly Incentive Fee Based on Net Investment Income
Pre-incentive fee net investment income
(expressed as a percentage of
the value of net assets)
Percentage of pre-incentive fee net investment income
allocated to Solar Capital Partners
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These calculations are appropriately pro-rated for any period of less than three months and
adjusted for any share issuances or repurchases during the relevant quarter. You should be aware that a rise in the general level of interest rates can be expected to lead to higher interest rates applicable to our debt investments. Accordingly, an
increase in interest rates would make it easier for us to meet or exceed the incentive fee hurdle rate and may result in a substantial increase of the amount of incentive fees payable to our investment adviser with respect to pre-incentive fee net
investment income.
The second part of the incentive fee is determined and payable in arrears as of the end of each calendar
year (or upon termination of the Investment Advisory and Management Agreement, as of the termination date), and equals 20% of our realized capital gains, if any, on a cumulative basis from inception through the end of each calendar year, computed
net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fees with respect to each of the investments in our portfolio.
Examples of Quarterly Incentive Fee Calculation
Example 1: Income Related Portion of Incentive Fee (*):
Alternative 1:
Assumptions
Investment income (including interest, dividends, fees, etc.) = 1.25%
Hurdle
rate (1) = 1.75%
Management fee (2) = 0.50%
Other expenses (legal, accounting, custodian, transfer agent, etc.) (3) = 0.20%
Pre-incentive fee net investment income
(investment income (management fee + other expenses)) = 0.55%
Pre-incentive net investment income does not exceed hurdle rate, therefore there is no incentive fee.
Alternative 2:
Assumptions
Investment income (including interest, dividends, fees, etc.) = 2.70%
Hurdle
rate (1) = 1.75%
Management fee (2) = 0.50%
Other expenses (legal, accounting, custodian, transfer agent, etc.) (3) = 0.20%
Pre-incentive fee net investment income
(investment income (management fee + other expenses)) = 2.00%
Incentive
fee = 100% × pre-incentive fee net investment income, subject to the catch-up (4)
= 100% × (2.00%
1.75%)
= 0.25%
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Alternative 3:
Assumptions
Investment income (including interest, dividends, fees, etc.)
= 3.00%
Hurdle rate (1) = 1.75%
Management fee (2) = 0.50%
Other expenses (legal, accounting, custodian,
transfer agent, etc.) (3) = 0.20%
Pre-incentive fee net investment income
(investment income (management fee + other expenses)) = 2.30%
Incentive fee = 20% × pre-incentive fee net investment income, subject to catch-up (4)
Incentive fee = 100% × catch-up + (20% × (pre-incentive fee net investment income 2.1875%))
Catch-up = 2.1875% 1.75%
= 0.4375%
Incentive fee = (100% × 0.4375%) + (20% × (2.3%
2.1875%))
= 0.4375% + (20% × 0.1125%)
= 0.4375% + 0.0225%
= 0.46%
(*)
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The hypothetical amount of pre-incentive fee net investment income shown is based on a percentage of total net assets.
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(1)
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Represents 7% annualized hurdle rate.
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(2)
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Represents 2% annualized management fee.
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(3)
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Excludes organizational and offering expenses.
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(4)
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The catch-up provision is intended to provide our investment adviser with an incentive fee of 20% on all of our pre-incentive fee net investment income as
if a hurdle rate did not apply when our net investment income exceeds 2.1875% in any calendar quarter.
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Example 2: Capital
Gains Portion of Incentive Fee:
Alternative 1:
Assumptions
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Year 1: $20 million investment made in Company A (Investment A), and $30 million investment made in Company B (Investment B)
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Year 2: Investment A sold for $50 million and fair market value (FMV) of Investment B determined to be $32 million
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Year 3: FMV of Investment B determined to be $25 million
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Year 4: Investment B sold for $31 million
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10
The capital gains portion of the incentive fee would be:
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Year 2: Capital gains incentive fee of $6 million ($30 million realized capital gains on sale of Investment A multiplied by 20%)
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$5 million (20% multiplied by ($30 million cumulative capital gains less $5 million cumulative capital depreciation)) less $6 million (previous capital gains fee paid in Year 2)
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Year 4: Capital gains incentive fee of $200,000
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$6.2 million ($31 million cumulative realized capital gains multiplied by 20%) less $6 million (capital gains fee taken in Year 2)
Alternative 2:
Assumptions
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Year 1: $20 million investment made in Company A (Investment A), $30 million investment made in Company B (Investment B) and
$25 million investment made in Company C (Investment C)
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Year 2: Investment A sold for $50 million, FMV of Investment B determined to be $25 million and FMV of Investment C determined to be $25 million
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Year 3: FMV of Investment B determined to be $27 million and Investment C sold for $30 million
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Year 4: FMV of Investment B determined to be $24 million
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Year 5: Investment B sold for $20 million
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The capital gains incentive fee, if any, would be:
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Year 2: $5 million capital gains incentive fee
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20% multiplied by $25 million ($30 million realized capital gains on Investment A less unrealized capital depreciation on Investment B)
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Year 3: $1.4 million capital gains incentive fee
(1)
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$6.4 million (20% multiplied by $32 million ($35 million cumulative realized capital gains less $3 million unrealized capital depreciation)) less $5 million capital gains fee received in Year 2
$5 million (20% multiplied by $25 million (cumulative realized capital gains of $35 million less realized capital losses of $10 million)) less $6.4 million cumulative capital gains fee paid in Year 2 and
Year 3.
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(1)
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As illustrated in Year 3 of Alternative 2 above, if Solar Capital were to be wound up on a date other than December 31 of any year, Solar Capital may have paid
aggregate capital gain incentive fees that are more than the amount of such fees that would be payable if Solar Capital had been wound up on December 31 of such year.
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11
Payment of Our Expenses
All investment professionals of the investment adviser and their respective staffs, when and to the extent engaged in providing investment advisory and management services, and the compensation and
routine overhead expenses of such personnel allocable to such services, are provided and paid for by Solar Capital Partners. We bear all other costs and expenses of our operations and transactions, including (without limitation):
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the cost of our organization and public offerings;
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the cost of calculating our net asset value, including the cost of any third-party valuation services;
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the cost of effecting sales and repurchases of our shares and other securities;
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interest payable on debt, if any, to finance our investments;
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fees payable to third parties relating to, or associated with, making investments, including fees and expenses associated with performing due diligence
reviews of prospective investments and advisory fees;
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transfer agent and custodial fees;
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fees and expenses associated with marketing efforts;
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federal and state registration fees, any stock exchange listing fees;
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federal, state and local taxes;
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independent directors fees and expenses;
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fidelity bond, directors and officers errors and omissions liability insurance and other insurance premiums;
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direct costs and expenses of administration, including printing, mailing, long distance telephone and staff;
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fees and expenses associated with independent audits and outside legal costs;
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costs associated with our reporting and compliance obligations under the 1940 Act and applicable federal and state securities laws; and
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all other expenses incurred by either Solar Capital Management or us in connection with administering our business, including payments under the
Administration Agreement that will be based upon our allocable portion of overhead and other expenses incurred by Solar Capital Management in performing its obligations under the Administration Agreement, including rent, the fees and expenses
associated with performing compliance functions, and our allocable portion of the costs of compensation and related expenses of our chief compliance officer and our chief financial officer and any administrative support staff.
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Investments
Solar Capital seeks to create a diverse portfolio that includes senior secured loans, mezzanine loans and equity securities by investing approximately $20 to $100 million of capital, on average, in the
securities of leveraged companies, including middle-market companies. Structurally, mezzanine loans usually rank subordinate in priority of payment to senior debt, such as senior bank debt, and are often unsecured. As such, other creditors may rank
senior to us in the event of insolvency. However, mezzanine loans rank senior to common and preferred equity in a borrowers capital structure. Mezzanine loans may have both elements of debt and equity instruments, offering fixed returns in the
form of interest payments associated with senior debt, while providing lenders an opportunity to participate in the capital appreciation of a borrower, if any, through an equity interest. This equity interest may take the form of warrants. Due to
its higher risk profile and often less restrictive
12
covenants as compared to senior loans, mezzanine loans generally earn a higher return than senior secured loans. The warrants associated with mezzanine loans, if any, are typically detachable,
which may allow for lenders to receive repayment of their principal on an agreed amortization schedule while retaining their equity interest in the borrower. Mezzanine loans also may include a put feature, which permits the holder to
sell its equity interest back to the borrower at a price determined through an agreed formula. We believe that mezzanine loans have historically offered an attractive investment opportunity based upon their returns and resilience during economic
downturns.
In addition to senior secured loans and mezzanine loans, we may invest a portion of our portfolio in opportunistic
investments, which are not our primary focus, but are intended to enhance our returns to our investors. These investments may include direct investments in public companies that are not thinly traded and securities of leveraged companies located in
select countries outside of the United States. The securities that we invest in are typically rated below investment grade. Securities rated below investment grade are often referred to as leveraged loans, high yield or
junk securities, and may be considered high risk compared to debt instruments that are rated investment grade. In addition, some of our debt investments will not fully amortize during their lifetime, which could result in a
loss or a substantial amount of unpaid principal and interest due upon maturity. We may invest up to 30% of our total assets in such opportunistic investments, including senior loans issued by non-U.S. issuers, subject to compliance with our
regulatory obligations as a business development company under the 1940 Act.
We may borrow funds to make investments. As a
result, we will be exposed to the risks of leverage, which may be considered a speculative investment technique. The use of leverage magnifies the potential for loss on amounts invested and therefore increases the risks associated with investing in
our securities. In addition, the costs associated with our borrowings, including any increase in management fees payable to our investment adviser, Solar Capital Partners, will be borne by our common stockholders.
Additionally, we may in the future seek to securitize our loans to generate cash for funding new investments. To securitize loans, we may
create a wholly owned subsidiary and contribute a pool of loans to the subsidiary. This could include the sale of interests in the subsidiary on a non-recourse basis to purchasers who we would expect to be willing to accept a lower interest rate to
invest in investment grade loan pools, and we would retain a portion of the equity in the securitized pool of loans.
Moreover, we may acquire investments in the secondary market and, in analyzing such investments, we expect to employ a similar analytical
process as we use for our primary investments.
We may utilize instruments such as forward contracts, currency options and
interest rate swaps, caps, collars and floors to seek to hedge against fluctuations in the relative values of our portfolio positions from changes in currency exchange rates and market interest rates. Hedging against a decline in the values of our
portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. However, such hedging can establish other positions designed to gain from those same
developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the underlying portfolio positions should increase. It may not be possible to
hedge against an exchange rate or interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price. Moreover, for a variety of reasons, we may not seek to establish a perfect
correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss. In addition, it may not be possible to hedge
partially, fully or perfectly against currency fluctuations affecting the value of securities denominated in non-U.S. currencies because the value of those securities is likely to fluctuate as a result of factors not related to currency
fluctuations.
Our principal focus is to provide senior secured loans and mezzanine loans to leveraged companies in a variety
of industries. We generally seek to target companies that generate positive cash flows. We generally seek to invest in companies from the broad variety of industries in which our investment adviser has direct expertise.
13
The following is a representative list of the industries in which we may invest:
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Aerospace & Defense
Air Freight & Logistics
Automobiles
Asset Management & Custody Banks
Building Products
Chemicals
Commercial Services & Supplies
Communications Equipment
Construction & Engineering
Consumer Finance
Containers & Packaging
Distributors
Diversified Consumer Services
Diversified Financial Services
Diversified Real Estate Activities
Diversified Telecommunications Services
Education Services
Food Products
Footwear
Health Care Equipment & Supplies
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Health Care Services
Health Care Technology
Hotels, Restaurants & Leisure
Industrial Conglomerates
Insurance
Internet Software & Services
IT Services
Leisure Equipment & Products
Machinery
Media
Multiline Retail
Paper & Forest Products
Personal Products
Professional Services
Research & Consulting Services
Software
Specialty Retail
Textiles, Apparel & Luxury Goods
Utilities
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We may also invest in other industries if we are presented with attractive opportunities.
We may invest, to the extent permitted by law, in the securities and instruments of other investment companies, including private funds.
We may also co-invest on a concurrent basis with affiliates of ours, subject to compliance with applicable regulations and our allocation procedures. Certain types of negotiated co-investments may be made only if we receive an order from the SEC
permitting us to do so. There can be no assurance that any such order will be obtained.
At December 31, 2013, our
portfolio consisted of 40 portfolio companies and was invested 40.8% in senior secured loans, 23.4% in subordinated debt, 2.4% in preferred equity and 33.4% in common equity and warrants, in each case, measured at fair value. We expect that our
portfolio will continue to include primarily senior secured and mezzanine loans as well as, to a lesser extent, equity-related securities. In addition, we also expect to invest a portion of our portfolio in portion of the portfolio in opportunistic
investments, which are not our primary focus, but are intended to enhance our risk-adjusted returns to stockholders. These investments may include, but are not limited to, securities of public companies and debt and equity securities of companies
located outside of the United States.
While our primary investment objective is to generate current income and capital
appreciation through investments in U.S. senior and subordinated loans, other debt securities and equity, we may also invest a portion of the portfolio in opportunistic investments, including foreign securities.
Listed below are our top ten portfolio companies and industries based on their fair value and represented as a percentage of total assets
as of December 31, 2013 and 2012:
14
TOP TEN PORTFOLIO COMPANIES AND INDUSTRIES AS OF DECEMBER 31, 2013
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Portfolio Company
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% of
Total Assets
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Crystal Capital Financial Holdings LLC
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17.9
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%
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Earthbound Farm.
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3.5
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%
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WireCo Worldgroup Inc.
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2.8
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%
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Isotoner Corporation
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2.6
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%
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Adams Outdoor Advertising
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2.6
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%
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Tecomet, Inc.
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2.6
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%
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Quantum Foods, LLC
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1.9
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%
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Rug Doctor.
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1.8
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%
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Alegeus Technologies Holdings Corp.
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1.7
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%
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MYI Acquiror Corporation
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1.5
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%
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Industry
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% of
Total Assets
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Diversified Financial Services
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17.9
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%
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Food Products
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6.8
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%
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Insurance
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4.6
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%
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Specialty Retail
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3.3
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%
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Media
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3.2
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%
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Aerospace & Defense
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2.9
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%
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Building Products
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2.8
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%
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Health Care Equipment & Supplies
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2.6
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%
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Health Care Technology
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2.2
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%
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Consumer Finance
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2.0
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%
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TOP TEN PORTFOLIO COMPANIES AND INDUSTRIES AS OF DECEMBER 31, 2012
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Portfolio Company
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% of
Total Assets
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Crystal Capital Financial Holdings LLC
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19.2
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%
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DS Waters of America, Inc.
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11.0
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%
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Midcap Financial Intermediate Holdings LLC
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5.9
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%
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ARK Real Estate
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4.8
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%
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Earthbound Farm
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3.9
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%
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WireCo. Worldgroup Inc.
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3.4
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%
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Adams Outdoor Advertising
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3.0
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%
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Rug Doctor L.P.
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3.0
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%
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Trident USA Health Services, LLC
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2.9
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%
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ViaWest Inc.
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2.9
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%
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Industry
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% of
Total Assets
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|
Diversified Financial Services
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19.2
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%
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Beverage, Food & Tobacco
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12.6
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%
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Banking
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8.4
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%
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Personal, Food & Misc. Services
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7.6
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%
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Insurance
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6.7
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%
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Buildings & Real Estate
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4.8
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%
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Healthcare, Education & Childcare
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4.2
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%
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Farming & Agriculture
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3.9
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%
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Aerospace & Defense
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3.9
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%
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Leisure, Amusement & Entertainment
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3.6
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%
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15
Listed below is the geographic breakdown of the portfolio based on fair value as of
December 31, 2013 and 2012:
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Geographic Region
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% of Portfolio
at December 31, 2013
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Geographic Region
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% of Portfolio
at December 31, 2012
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United States
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96.9
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%
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United States
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94.9
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%
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Canada
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3.1
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%
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|
Canada
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2.5
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%
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Western Europe
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|
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Western Europe
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2.5
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%
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Australia
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|
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Australia
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0.1
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%
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|
|
|
|
|
|
|
|
|
|
|
|
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100.0
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%
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100.0
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%
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Investment Selection Process
Solar Capital Partners is committed to and utilizes a value-oriented investment philosophy with a focus on the preservation of capital and a commitment to managing downside exposure.
Portfolio Company Characteristics
We have identified several criteria that we believe are important in identifying and investing in prospective portfolio companies. These criteria provide general guidelines for our investment decisions;
however, not all of these criteria will be met by each prospective portfolio company in which we choose to invest.
Stable Earnings and Strong Free Cash Flow.
We seek to invest in companies who have demonstrated stable earnings
through economic cycles. We target companies that can de-lever through consistent generation of cash flows rather than relying solely on growth to service and repay our loans.
Value Orientation.
Our investment philosophy places a premium on fundamental analysis from an investors perspective and has a distinct value orientation. We focus on companies in
which we can invest at relatively low multiples of operating cash flow and that are profitable at the time of investment on an operating cash flow basis.
Value of Assets.
The prospective value of the assets, if any, that collateralizes the loans in which we invest, is an important factor in our credit analysis. Our analysis emphasizes
both tangible assets, such as accounts receivable, inventory, equipment and real estate, and intangible assets, such as intellectual property, customer lists, networks and databases. In some of our transactions the portfolio companys fundings
may be derived from a borrowing base determined by the value of such companys assets.
Strong Competitive Position
in Industry.
We seek to invest in target companies that have developed leading market positions within their respective markets and are well positioned to capitalize on growth opportunities. We seek companies that demonstrate
significant competitive advantages versus their competitors, which we believe should help to protect their market position and profitability.
Diversified Customer and Supplier Base.
We seek to invest in businesses that have a diversified customer and supplier base. We believe that companies with a diversified customer and
supplier base are generally better able to endure economic downturns, industry consolidation, changing business preferences and other factors that may negatively impact their customers, suppliers and competitors.
Exit Strategy.
We predominantly invest in companies which provide multiple alternatives for an eventual exit. We look
for opportunities that provide an exit typically within three years of the initial capital commitment.
We generally seek
companies that we believe will provide a steady stream of cash flow to repay our loans and reinvest in their respective businesses. We believe that such internally generated cash flow, leading to the payment of our interest, and the repayment of our
principal, represent a key means by which we will be able to exit from our investments over time.
16
In addition, we also seek to invest in companies whose business models or expected future
cash flows offer attractive exit possibilities. These companies include candidates for strategic acquisition by other industry participants and companies that may repay our investments through an initial public offering of common stock or another
capital market transaction. We generally underwrite our investments on a held-to-maturity basis, but expensive capital is often repaid prior to stated maturity.
Experienced and Committed Management.
We generally require that portfolio companies have an experienced management team. We also require portfolio companies have in place proper
incentives to induce management to succeed and to act in concert with our interests as investors, including having significant equity interests.
Strong Sponsorship.
We generally aim to invest alongside other sophisticated investors. We typically seek to partner with successful financial sponsors who have historically generated
high returns. We believe that investing in these sponsors portfolio companies enables us to benefit from their direct involvement and due diligence.
The illustration below provides Solar Capitals target portfolio companies and the targeted size of its investment in a companys capital structure:
(1)
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Investment size may vary proportionally as the size of the capital base changes.
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Solar Capitals investment team works in concert with sponsors to proactively manage investment opportunities by acting as a partner throughout the investment process. We actively focus on the
middle-market financial sponsor community, with a particular focus on the upper-end of the middle-market (sponsors with equity funds of $800 million to $3 billion). We favor such sponsors because they typically:
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buy larger companies with strong business franchises;
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invest significant amounts of equity in their portfolio companies;
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value flexibility and creativity in structuring their transactions;
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possess longer track records over multiple investment funds;
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have a deeper management bench;
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|
have better ability to withstand downturns; and
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|
possess the ability to support portfolio companies with additional capital.
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17
We divide our coverage of these sponsors among our more senior investment professionals, who
are responsible for day-to-day interaction with financial sponsors. Our coverage approach aims to act proactively, consider all investments in the capital structure, provide quick feedback, deliver on commitments, and are constructive throughout the
life cycle of an investment.
Due Diligence
Our private equity approach to credit investing typically incorporates extensive in-depth due diligence often alongside the
private equity sponsor. In conducting due diligence, we will use publicly available information as well as information from relationships with former and current management teams, consultants, competitors and investment bankers. We believe that our
due diligence methodology allows us to screen a high volume of potential investment opportunities on a consistent and thorough basis.
Our due diligence typically includes:
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|
|
review of historical and prospective financial information;
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|
review and valuation of assets;
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research relating to the companys management, industry, markets, products and services and competitors;
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discussions with management, employees, customers or vendors of the potential portfolio company;
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review of senior loan documents; and
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|
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|
background investigations.
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We also expect to evaluate the private equity sponsor making the investment. Further, due to Solar Capital Partners considerable repeat business with sponsors, we have direct experience with the
management teams of many sponsors. A private equity sponsor is typically the controlling shareholder upon completion of an investment and as such is considered critical to the success of the investment. The equity sponsor is evaluated along several
key criteria, including:
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|
|
investment track record;
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|
|
|
capacity and willingness to provide additional financial support to the company through additional capital contributions, if necessary; and
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Throughout the due diligence process, a deal team is in constant dialogue with the management team of the company in which we are considering to invest to ensure that any concerns are addressed as early
as possible through the process and that unsuitable investments are filtered out before considerable time has been invested.
Upon the completion of due diligence and a decision to proceed with an investment in a company, the investment professionals leading the
investment present the investment opportunity to Solar Capital Partners investment committee, which then determine whether to pursue the potential investment. Additional due diligence with respect to any investment may be conducted on our
behalf by attorneys and independent accountants prior to the closing of the investment, as well as other outside advisers, as appropriate.
The Investment Committee
All new investments are required to be
approved by a consensus of the investment committee of Solar Capital Partners, which is led by Messrs. Gross and Spohler. The members of Solar Capital Partners investment
18
committee receive no compensation from us. Such members may be employees or partners of Solar Capital Partners and may receive compensation or profit distributions from Solar Capital Partners.
Investment Structure
Once we determine that a prospective portfolio company is suitable for investment, we work with the management of that company and its other capital providers, including senior, junior and equity capital
providers, to structure an investment. We negotiate among these parties to agree on how our investment is expected to perform relative to the other capital in the portfolio companys capital structure.
We invest in portfolio companies in the form of senior secured loans. We seek to obtain security interests in the assets of our portfolio
companies that serve as collateral in support of the repayment of these loans. This collateral may take the form of first or second priority liens on the assets of a portfolio company.
We structure our mezzanine investments primarily as unsecured, subordinated loans that provide for relatively high, fixed or floating
interest rates that provide us with significant current interest income. These loans typically have interest-only payments in the early years, with amortization of principal deferred to the later years of the mezzanine loans. In some cases, we may
enter into loans that, by their terms, convert into equity or additional debt securities or defer payments of interest for the first few years after our investment. Also, in some cases our mezzanine loans may be collateralized by a subordinated lien
on some or all of the assets of the borrower. Typically, our mezzanine loans have maturities of five to ten years.
Typically,
our senior secured and mezzanine loans have final maturities of five to ten years. However, we expect that our portfolio companies often may repay these loans early, generally within two to four years from the date of initial investment. To preserve
an acceptable return on investment, we seek to structure these loans with prepayment premiums.
In the case of our senior
secured and mezzanine loan investments, we tailor the terms of the investment to the facts and circumstances of the transaction and the prospective portfolio company, negotiating a structure that protects our rights and manages our risk while
creating incentives for the portfolio company to achieve its business plan and improve its profitability. For example, in addition to seeking a senior or fulcrum position in the capital structure of our portfolio companies, we will seek to limit the
downside potential of our investments by:
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|
|
requiring a total return on our investments (including both interest and potential capital appreciation) that compensates us for credit risk;
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|
|
|
incorporating put rights and call protection into the investment structure; and
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|
|
|
negotiating covenants in connection with our investments that afford our portfolio companies as much flexibility in managing their businesses as
possible, consistent with preservation of our capital. Such restrictions may include affirmative and negative covenants, default penalties, lien protection, change of control provisions and board rights, including either observation or participation
rights.
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Our investments may include equity features, such as warrants or options to buy a minority interest
in the portfolio company. Any warrants we receive with our debt securities generally require only a nominal cost to exercise, and thus, as a portfolio company appreciates in value, we may achieve additional investment return from this equity
interest. We may structure the warrants to provide provisions protecting our rights as a minority interest holder, as well as puts, or rights to sell such securities back to the company, upon the occurrence of specified events. In many cases, we
also obtain registration rights in connection with these equity securities, which may include demand and piggyback registration rights. In addition, we may from time to time make direct equity investments in portfolio companies.
We generally seek to hold most of our investments to maturity or repayment, but will sell our investments earlier, including
if a liquidity event takes place such as the sale or recapitalization of a portfolio company.
19
Managerial assistance
As a BDC, we offer, and must provide upon request, managerial assistance to our portfolio companies. This assistance could involve, among other things, monitoring the operations of our portfolio
companies, participating in board and management meetings, consulting with and advising officers of portfolio companies and providing other organizational and financial guidance. We may receive fees for these services.
Ongoing Relationships with Portfolio Companies
Solar Capital Partners monitors our portfolio companies on an ongoing basis. Solar Capital Partners monitors the financial trends of each portfolio company to determine if it is meeting its business plan
and to assess the appropriate course of action for each company.
Solar Capital Partners has several methods of evaluating and
monitoring the performance and fair value of our investments, which include the following:
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|
|
Assessment of success in adhering to each portfolio companys business plan and compliance with covenants;
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|
|
|
Periodic and regular contact with portfolio company management and, if appropriate, the financial or strategic sponsor, to discuss financial position,
requirements and accomplishments;
|
|
|
|
Comparisons to other Solar Capital portfolio companies in the industry, if any;
|
|
|
|
Attendance at and participation in board meetings; and
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|
|
|
Review of monthly and quarterly financial statements and financial projections for portfolio companies.
|
In addition to various risk management and monitoring tools, Solar Capital Partners also uses an investment rating system to characterize
and monitor our expected level of returns on each investment in our portfolio.
We use an investment rating scale of 1 to 4.
The following is a description of the conditions associated with each investment rating:
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|
|
Investment
Rating
|
|
Summary Description
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1
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Involves the least amount of risk in our portfolio, the portfolio company is performing above expectations, and the trends and risk factors are generally favorable (including a
potential exit)
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2
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Risk that is similar to the risk at the time of origination, the portfolio company is performing as expected, and the risk factors are neutral to favorable; all new investments
are initially assessed a grade of 2
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3
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The portfolio company is performing below expectations, may be out of compliance with debt covenants, and requires procedures for closer monitoring
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4
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The investment is performing well below expectations and is not anticipated to be repaid in full
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Solar Capital Partners monitors and, when appropriate, changes the investment ratings assigned to each
investment in our portfolio. As of December 31, 2013, the weighted average investment rating on the fair market value of our portfolio was a 2. In connection with our valuation process, Solar Capital Partners reviews these investment ratings on
a quarterly basis.
Valuation Procedures
We conduct the valuation of our assets, pursuant to which our net asset value shall be determined, at all times consistent with U.S.
generally accepted accounting principles (GAAP) and the 1940 Act and generally
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value our assets (and certain liabilities) on a quarterly basis, or more frequently if required. Our valuation procedures are set forth in more detail below:
Securities for which market quotations are readily available on an exchange shall be valued at the closing price on the day of valuation.
We may also obtain quotes with respect to certain of our investments from pricing services or brokers or dealers in order to value assets. When doing so, we determine whether the quote obtained is sufficient according to GAAP to determine the fair
value of the security. If determined adequate, we use the quote obtained.
Securities for which reliable market quotations are
not readily available or for which the pricing source does not provide a valuation or methodology or provides a valuation or methodology that, in the judgment of our investment adviser or board of directors, does not represent fair value, shall each
be valued as follows: (i) each portfolio company or investment is initially valued by the investment professionals responsible for the portfolio investment; (ii) preliminary valuation conclusions are documented and discussed with our
senior management; (iii) independent third-party valuation firms engaged by, or on behalf of, the board of directors will conduct independent appraisals and review managements preliminary valuations and make their own assessment for all
material assets; (iv) the board of directors will discuss valuations and determine the fair value of each investment in our portfolio in good faith based on the input of the investment adviser and, where appropriate, the respective third-party
valuation firms.
The recommendation of fair value will generally consider the following factors among others, as relevant:
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the nature and realizable value of any collateral;
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the portfolio companys ability to make payments;
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the portfolio companys earnings and discounted cash flow;
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the markets in which the issuer does business; and
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comparisons to publicly traded securities.
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Securities for which market quotations are not readily available or for which a pricing source is not sufficient may include, but are not limited to, the following:
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private placements and restricted securities that do not have an active trading market;
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securities whose trading has been suspended or for which market quotes are no longer available;
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debt securities that have recently gone into default and for which there is no current market;
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securities whose prices are stale;
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securities affected by significant events; and
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securities that the investment adviser believes were priced incorrectly.
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Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our consolidated financial statements
express the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on our consolidated financial statements.
Competition
Our primary competitors provide financing to middle-market
companies and include other business development companies, commercial and investment banks, commercial financing companies and, to the extent they provide an alternative form of financing, private equity funds. Additionally, alternative investment
vehicles, such as hedge funds, frequently invest in middle-market companies. As a result, competition for investment opportunities at middle-market companies can be intense. However, we continue to believe that there has been a
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reduction in the amount of debt capital available since the downturn in the credit markets, which began in mid-2007, and that this has resulted in a less competitive environment for making new
investments. While many middle-market companies were previously able to raise senior debt financing through traditional large financial institutions, we believe this approach to financing remains more difficult with the implementation of U.S. and
international financial reforms, such as Basel 3, limits the capacity of large financial institutions to hold non-investment grade leveraged loans on their balance sheets. We continue to believe that many of these financial institutions have
de-emphasized their service and product offerings to middle-market companies in particular.
Many of our competitors are
substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of
our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the
regulatory restrictions that the 1940 Act imposes on us as a business development company. We use the industry information available to Messrs. Gross and Spohler and the other investment professionals of Solar Capital Partners to assess
investment risks and determine appropriate pricing for our investments in portfolio companies. In addition, we believe that the relationships of Messrs. Gross and Spohler and the other investment professionals of our investment adviser enable
us to learn about, and compete effectively for, financing opportunities with attractive leveraged companies in the industries in which we seek to invest.
Staffing
We do not currently have any employees. Mr. Gross, our
chairman and chief executive officer, and Mr. Spohler, our chief operating officer, currently serve as managing members of our investment adviser, Solar Capital Partners, and Brian Gerson, our executive vice president, currently serves as a
partner. Richard Peteka, our chief financial officer and corporate secretary, is an officer and employee of Solar Capital Management, and performs his functions as chief financial officer under the terms of our Administration Agreement. Guy
Talarico, our chief compliance officer, is the chief executive officer of Alaric Compliance Services, LLC, and performs his functions as our chief compliance officer under the terms of an agreement between Solar Capital Management and Alaric
Compliance Services, LLC. Solar Capital Management has retained Mr. Talarico and Alaric Compliance Services, LLC pursuant to its obligations under our Administration Agreement.
Our day-to-day investment operations are managed by Solar Capital Partners. Solar Capital Management is responsible for all other
day-to-day operations. We will reimburse Solar Capital Management for the allocable portion of overhead and other expenses incurred by it in performing its obligations under the Administration Agreement, including rent, the fees and expenses
associated with performing compliance functions, and the compensation of our chief compliance officer and chief financial officer and any administrative support staff.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 imposes a wide
variety of regulatory requirements on publicly-held companies and their insiders. Many of these requirements affect us. For example:
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Pursuant to Rule 13a-14 of the 1934 Act, our Chief Executive Officer and Chief Financial Officer must certify the accuracy of the consolidated
financial statements contained in our periodic reports;
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Pursuant to Item 307 of Regulation S-K, our periodic reports must disclose our conclusions about the effectiveness of our disclosure controls and
procedures;
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Pursuant to Rule 13a-15 of the 1934 Act, our management must prepare a report regarding its assessment of the effectiveness of internal controls over
financial reporting and obtain an audit of the effectiveness of internal controls over financial reporting performed by our independent registered public accounting firm; and
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Pursuant to Item 308 of Regulation S-K and Rule 13a-15 of the 1934 Act, our periodic reports must disclose whether there were significant changes
in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
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The Sarbanes-Oxley Act requires us to review our current policies and procedures to determine whether we
comply with the Sarbanes-Oxley Act and the regulations promulgated thereunder. We will continue to monitor our compliance with all regulations that are adopted under the Sarbanes-Oxley Act and will take actions necessary to ensure that we are in
compliance therewith.
Available Information
You may read and copy any materials we file with the SEC at the SECs Public Reference Room at 100 F Street, NE, Washington, DC 20549, on official business days during the hours of 10:00 am to 3:00
pm. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers
that file electronically with the SEC. The address of that site is
(http://www.sec.gov)
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Our internet address is
www.solarcapltd.com
. We make available free of charge on our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable
after we electronically file such material with, or furnish it to, the SEC. Information contained on our website is not incorporated by reference into this annual report on Form 10-K, and you should not consider information contained on our
website to be part of this annual report on Form 10-K.
An
investment in our securities involves certain risks relating to our structure and investment objectives. The risks set forth below are not the only risks we face, and we face other risks which we have not yet identified, which we do not currently
deem material or which are not yet predictable. If any of the following risks occur, our business, financial condition and results of operations could be materially adversely affected. In such case, our net asset value and the trading price of our
common stock could decline, and you may lose all or part of your investment.
Risks Related to Our Investments
We operate in a highly competitive market for investment opportunities.
A number of entities compete with us to make the types of investments that we target in leveraged companies. We compete with other BDCs,
public and private funds, commercial and investment banks, commercial financing companies and, to the extent they provide an alternative form of financing, private equity funds. Many of our competitors are substantially larger and have considerably
greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk
tolerances or different risk assessments than we do, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that
the 1940 Act imposes on us. We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this competition, we may not be able
to take advantage of attractive investment opportunities from time to time, and we can offer no assurance that we will be able to identify and make investments that are consistent with our investment objective.
We do not seek to compete primarily based on the interest rates we will offer, and we believe that some of our competitors may make loans
with interest rates that will be comparable to or lower than the rates we offer.
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We may lose investment opportunities if we do not match our competitors pricing, terms and structure. However, if we match our competitors pricing, terms and structure, we may
experience decreased net interest income and increased risk of credit loss.
Our investments are very risky and highly
speculative.
We invest primarily in senior secured term loans, mezzanine loans and preferred securities, and select
equity investments issued by leveraged companies.
Senior Secured Loans.
When we make a senior secured term
loan investment in a portfolio company, we generally take a security interest in the available assets of the portfolio company, including the equity interests of its subsidiaries, which we expect to help mitigate the risk that we will not be repaid.
However, there is a risk that the collateral securing our loans may decrease in value over time, may be difficult to sell in a timely manner, may be difficult to appraise and may fluctuate in value based upon the success of the business and market
conditions, including as a result of the inability of the portfolio company to raise additional capital, and, in some circumstances, our lien could be subordinated to claims of other creditors. In addition, deterioration in a portfolio
companys financial condition and prospects, including its inability to raise additional capital, may be accompanied by deterioration in the value of the collateral for the loan. Consequently, the fact that a loan is secured does not guarantee
that we will receive principal and interest payments according to the loans terms, or at all, or that we will be able to collect on the loan should we be forced to enforce our remedies.
Mezzanine Loans and Preferred Securities.
Our mezzanine and preferred investments are generally subordinated to senior
loans and are generally unsecured. As such, other creditors may rank senior to us in the event of an insolvency. This may result in an above average amount of risk and loss of principal.
Equity Investments.
When we invest in senior secured loans, mezzanine loans or preferred securities, we may acquire
common equity securities as well. In addition, we may invest directly in the equity securities of portfolio companies. Our goal is ultimately to exit such equity interests and realize gains upon our disposition of such interests. However, the equity
interests we receive may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be
sufficient to offset any other losses we experience.
In addition, investing in middle-market companies involves a number of
significant risks, including:
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these companies 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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they typically have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them
more vulnerable to competitors actions and market conditions, as well as general economic downturns;
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they 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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they generally have less predictable operating results, may from time to time be parties to litigation, 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. In addition, 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; and
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they 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.
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The lack of liquidity in our investments may adversely affect our business.
We generally make investments in private companies. We invest and expect to continue investing in companies whose
securities have no established trading market and whose securities are and will be subject to legal and other restrictions on resale or whose securities are and will be less liquid than are publicly-traded securities. The illiquidity of our
investments may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have
previously recorded our investments. As a result, we do not expect to achieve liquidity in our investments in the near-term. However, to maintain our qualification as a business development company and as a RIC, we may have to dispose of investments
if we do not satisfy one or more of the applicable criteria under the respective regulatory frameworks. In addition, we may face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we have material
non-public information regarding such portfolio company.
Our portfolio may be concentrated in a limited number of
portfolio companies and industries, which will subject us to a risk of significant loss if any of these companies performs poorly or defaults on its obligations under any of its debt instruments or if there is a downturn in a particular industry.
Our portfolio may be concentrated in a limited number of portfolio companies and industries. Beyond the asset
diversification requirements associated with our qualification as a RIC under Subchapter M of the Code, we do not have fixed guidelines for diversification, and while we are not targeting any specific industries, our investments may be concentrated
in relatively few industries or portfolio companies. As a result, the aggregate returns we realize may be significantly adversely affected if a small number of investments perform poorly or if we need to write down the value of any one investment.
Additionally, a downturn in any particular industry in which we are invested could also significantly impact the aggregate returns we realize.
Our investments in securities rated below investment grade are speculative in nature and are subject to additional risk factors such as increased possibility of default, illiquidity of the security,
and changes in value based on changes in interest rates.
The securities that we invest in are typically rated below
investment grade. Securities rated below investment grade are often referred to as leveraged loans, high yield or junk securities, and may be considered high risk compared to debt instruments that are
rated investment grade. High yield securities are regarded as having predominantly speculative characteristics with respect to the issuers capacity to pay interest and repay principal in accordance with the terms of the obligations and involve
major risk exposure to adverse conditions. In addition, high yield securities generally offer a higher current yield than that available from higher grade issues, but typically involve greater risk. These securities are especially sensitive to
adverse changes in general economic conditions, to changes in the financial condition of their issuers and to price fluctuation in response to changes in interest rates. During periods of economic downturn or rising interest rates, issuers of below
investment grade instruments may experience financial stress that could adversely affect their ability to make payments of principal and interest and increase the possibility of default.
The secondary market for high yield securities may not be as liquid as the secondary market for more highly rated securities. In
addition, some of our debt investments will not fully amortize during their lifetime, which could result in a loss or a substantial amount of unpaid principal and interest due upon maturity.
Capital markets have recently been in a period of disruption and instability. These market conditions have materially and adversely
affected debt and equity capital markets in the United States and abroad, which had, and may in the future have, a negative impact on our business and operations.
The global capital markets have recently been in a period of disruption as evidenced by a lack of liquidity in the debt capital markets, significant write-offs in the financial services sector, the
re-pricing of credit risk in the broadly syndicated credit market and the failure of certain major financial institutions. Despite actions of the
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United States federal government and foreign governments, these events contributed to worsening general economic conditions that materially and adversely impacted the broader financial and credit
markets and reduced the availability of debt and equity capital for the market as a whole and financial services firms in particular. These conditions could continue for a prolonged period of time or worsen in the future. While these conditions
persist, we and other companies in the financial services sector may have to access, if available, alternative markets for debt and equity capital. Equity capital may be difficult to raise because, subject to some limited exceptions which as of the
date of this prospectus apply to us, as a BDC we are generally not able to issue additional shares of our common stock at a price less than net asset value without first obtaining approval for such issuance from our stockholders and our independent
directors. At our 2013 Annual Stockholders Meeting, our stockholders approved our ability to sell or otherwise issue shares of our common stock, not exceeding 25% of our then outstanding common stock immediately prior to each such offering, at a
price or prices below the then current net asset value per share, in each case subject to the approval of our board of directors and compliance with the conditions set forth in the proxy statement pertaining thereto, during a period beginning on
April 30, 2013 and expiring on the earlier of the one-year anniversary of the date of the 2013 Annual Stockholders Meeting and the date of our 2014 Annual Stockholders Meeting, which is expected to be held in May 2014. However, notwithstanding
such stockholder approval, since our initial public offering on February 9, 2010, we have not sold any shares of our common stock at a price below our then current net asset value per share. Any offering of our common stock that requires
stockholder approval must occur, if at all, within one year after receiving such stockholder approval. In addition, our ability to incur indebtedness (including by issuing preferred stock) is limited by applicable regulations such that our asset
coverage, as defined in the 1940 Act, must equal at least 200% immediately after each time we incur indebtedness. The debt capital that will be available, if at all, may be at a higher cost and on less favorable terms and conditions in the future.
Any inability to raise capital could have a negative effect on our business, financial condition and results of operations.
The illiquidity of our investments may make it difficult for us to sell such investments if required. As a result, we may realize
significantly less than the value at which we have recorded our investments. In addition, significant changes in the capital markets, including the recent extreme volatility and disruption, have had, and may in the future have, a negative effect on
the valuations of our investments and on the potential for liquidity events involving our investments. An inability to raise capital, and any required sale of our investments for liquidity purposes, could have a material adverse impact on our
business, financial condition or results of operations.
If we cannot obtain additional capital because of either
regulatory or market price constraints, we could be forced to curtail or cease our new lending and investment activities, our net asset value could decrease and our level of distributions and liquidity could be affected adversely.
Our ability to secure additional financing and satisfy our financial obligations under indebtedness outstanding from
time to time will depend upon our future operating performance, which is subject to the prevailing general economic and credit market conditions, including interest rate levels and the availability of credit generally, and financial, business and
other factors, many of which are beyond our control. The prolonged continuation or worsening of current economic and capital market conditions could have a material adverse effect on our ability to secure financing on favorable terms, if at all.
If we are unable to obtain debt capital, then our equity investors will not benefit from the potential for increased returns
on equity resulting from leverage to the extent that our investment strategy is successful and we may be limited in our ability to make new commitments or fundings to our portfolio companies.
Uncertainty about the financial stability of the United States and of several countries in the European Union (EU) could have a
significant adverse effect on our business, results of operations and financial condition.
Due to federal budget
deficit concerns, S&P downgraded the federal governments credit rating from AAA to AA+ for the first time in history on August 5, 2011. Further, Moodys and Fitch have warned that they may
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downgrade the federal governments credit rating. Further downgrades or warnings by S&P or other rating agencies, and the governments credit and deficit concerns in general, could
cause interest rates and borrowing costs to rise, which may negatively impact both the perception of credit risk associated with our debt portfolio and our ability to access the debt markets on favorable terms. In addition, a decreased credit rating
could create broader financial turmoil and uncertainty, which may weigh heavily on our financial performance and the value of our common stock.
In 2010, a financial crisis emerged in Europe, triggered by high budget deficits and rising direct and contingent sovereign debt in Greece, Ireland, Italy, Portugal and Spain, which created concerns about
the ability of these nations to continue to service their sovereign debt obligations. Risks and ongoing concerns resulting from the debt crisis in Europe could have a detrimental impact on the global economic recovery, sovereign and non-sovereign
debt in these countries and the financial condition of European financial institutions. Market and economic disruptions have affected, and may continue to affect, consumer confidence levels and spending, personal bankruptcy rates, levels of
incurrence and default on consumer debt and home prices, among other factors. We cannot assure you that the market disruptions in Europe, including the increased cost of funding for certain governments and financial institutions, will not spread,
and we cannot assure you that future assistance packages will be available, or if available, sufficient to stabilize the affected countries and markets in Europe or elsewhere. To the extent uncertainty regarding any economic recovery in Europe
continues to negatively impact consumer confidence and consumer credit factors, our business and results of operations could be significantly and adversely affected.
On December 18, 2013, the U.S. Federal Reserve announced that it would scale back its bond-buying program, or quantitative easing, which is designed to stimulate the economy and expand the Federal
Reserves holdings of long-term securities until key economic indicators, such as the unemployment rate, show signs of improvement. The Federal Reserve signaled it would reduce its purchases of long-term Treasury bonds and would scale back on
its purchases of mortgage-backed securities. It is unclear what effect, if any, the incremental reduction in the rate of the Federal Reserves monthly purchases will have on the value of our investments. However, it is possible that absent
continued quantitative easing by the Federal Reserve, these developments, along with the European sovereign debt crisis, could cause interest rates and borrowing costs to rise, which may negatively impact our ability to access the debt markets on
favorable terms.
A failure or the perceived risk of a failure to raise the statutory debt limit of the United States
could have a material adverse effect on our business, financial condition and results of operations.
As has been
widely reported, the United States Treasury Secretary has stated that the federal government may not be able to meet its debt payments in the relatively near future unless the federal debt ceiling is raised. If legislation increasing the debt
ceiling is not enacted and the debt ceiling is reached, the federal government may stop or delay making payments on its obligations. A failure by Congress to raise the debt limit would increase the risk of default by the United States on its
obligations, as well as the risk of other economic dislocations.
If the U.S. government fails to complete its budget process
or to provide for a continuing resolution before the expiration of the current continuing resolution, another federal government shutdown may result. Such a failure or the perceived risk of such a failure, consequently, could have a material adverse
effect on the financial markets and economic conditions in the United States and throughout the world. It could also limit our ability and the ability of our portfolio companies to obtain financing, and it could have a material adverse effect on the
valuation of our portfolio companies. Consequently, the continued uncertainty in the general economic environment, including the recent government shutdown and potential debt ceiling implications, as well in specific economies of several individual
geographic markets in which our portfolio companies operate, could adversely affect our business, financial condition and results of operations.
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Uncertainty relating to the LIBOR calculation process may adversely affect the value
of our portfolio of the LIBOR-indexed, floating-rate debt securities.
Concerns have been publicized that some of the
member banks surveyed by the British Bankers Association (BBA) in connection with the calculation of LIBOR across a range of maturities and currencies may have been under-reporting or otherwise manipulating the inter-bank lending
rate applicable to them in order to profit on their derivatives positions or to avoid an appearance of capital insufficiency or adverse reputational or other consequences that may have resulted from reporting inter-bank lending rates higher than
those they actually submitted. A number of BBA member banks have entered into settlements with their regulators and law enforcement agencies with respect to alleged manipulation of LIBOR, and investigations by regulators and governmental authorities
in various jurisdictions are ongoing.
Actions by the BBA, regulators or law enforcement agencies may result in changes to the
manner in which LIBOR is determined. Uncertainty as to the nature of such potential changes may adversely affect the market for LIBOR-based securities, including our portfolio of LIBOR-indexed, floating-rate debt securities. In addition, any further
changes or reforms to the determination or supervision of LIBOR may result in a sudden or prolonged increase or decrease in reported LIBOR, which could have an adverse impact on the market for LIBOR-based securities or the value of our portfolio of
LIBOR-indexed, floating-rate debt securities.
Economic recessions or downturns could impair our portfolio companies and
harm our operating results.
Many of our portfolio companies may be susceptible to economic slowdowns or recessions and
may be unable to repay our loans during these periods. Therefore, our non-performing assets may increase and the value of our portfolio may decrease during these periods as we are required to record the values of our investments. Adverse economic
conditions also may decrease the value of collateral securing some of our loans and the value of our equity investments at fair value. Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in revenues, net
income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing
investments and harm our operating results.
A portfolio companys failure to satisfy financial or operating covenants
imposed by us or other lenders could lead to defaults and, potentially, acceleration of the time when the loans are due and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize the portfolio
companys ability to meet its obligations under the debt that we hold. We may incur additional expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company. In addition, if one of
our portfolio companies were to go bankrupt, depending on the facts and circumstances, including the extent to which we actually provided significant managerial assistance to that portfolio company, a bankruptcy court might re-characterize our debt
holdings and subordinate all or a portion of our claim to that of other creditors.
These portfolio companies may face intense
competition, including competition from companies with greater financial resources, more extensive research and development, manufacturing, marketing and service capabilities and greater number of qualified and experienced managerial and technical
personnel. They may need additional financing which they are unable to secure and which we are unable or unwilling to provide, or they may be subject to adverse developments unrelated to the technologies they acquire.
We may suffer a loss if a portfolio company defaults on a loan and the underlying collateral is not sufficient.
In the event of a default by a portfolio company on a secured loan, we will only have recourse to the assets collateralizing the loan. If
the underlying collateral value is less than the loan amount, we will suffer a loss. In addition, we sometimes make loans that are unsecured, which are subject to the risk that other lenders may be directly secured by the assets of the portfolio
company. In the event of a default, those collateralized lenders
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would have priority over us with respect to the proceeds of a sale of the underlying assets. In cases described above, we may lack control over the underlying asset collateralizing our loan or
the underlying assets of the portfolio company prior to a default, and as a result the value of the collateral may be reduced by acts or omissions by owners or managers of the assets.
In the event of bankruptcy of a portfolio company, we may not have full recourse to its assets in order to satisfy our loan, or our loan
may be subject to equitable subordination. In addition, certain of our loans are subordinate to other debt of the portfolio company. If a portfolio company defaults on our loan or on debt senior to our loan, or in the event of a portfolio company
bankruptcy, our loan will be satisfied only after the senior debt receives payment. Where debt senior to our loan exists, the presence of inter-creditor arrangements may limit our ability to amend our loan documents, assign our loans, accept
prepayments, exercise our remedies (through standstill periods) and control decisions made in bankruptcy proceedings relating to the portfolio company. Bankruptcy and portfolio company litigation can significantly increase collection
losses and the time needed for us to acquire the underlying collateral in the event of a default, during which time the collateral may decline in value, causing us to suffer losses.
If the value of collateral underlying our loan declines or interest rates increase during the term of our loan, a portfolio company may
not be able to obtain the necessary funds to repay our loan at maturity through refinancing. Decreasing collateral value and/or increasing interest rates may hinder a portfolio companys ability to refinance our loan because the underlying
collateral cannot satisfy the debt service coverage requirements necessary to obtain new financing. If a borrower is unable to repay our loan at maturity, we could suffer a loss which may adversely impact our financial performance.
The business, financial condition and results of operations of our portfolio companies could be adversely affected by worldwide
economic conditions, as well as political and economic conditions in the countries in which they conduct business.
The
business and operating results of our portfolio companies may be impacted by worldwide economic conditions. Although the U.S. economy has in recent years shown signs of recovery from the 20082009 global recession, the strength and duration of
any economic recovery will be impacted by worldwide economic growth. For instance, a number of recent reports indicate that growth in China and other emerging markets may be slowing relative to historical growth rates. The significant debt in U.S.
and European countries is expected to hinder growth in those countries for the foreseeable future. Multiple factors relating to the international operations of some of our portfolio companies and to particular countries in which they operate could
negatively impact their business, financial condition and results of operations.
Some of the products of our portfolio
companies are developed, manufactured, assembled, tested or marketed outside the U.S. Any conflict or uncertainty in these countries, including due to natural disasters, public health concerns, political unrest or safety concerns, could harm their
business, financial condition and results of operations. In addition, if the government of any country in which their products are developed, manufactured or sold sets technical or regulatory standards for products developed or manufactured in or
imported into their country that are not widely shared, it may lead some of their customers to suspend imports of their products into that country, require manufacturers or developers in that country to manufacture or develop products with different
technical or regulatory standards and disrupt cross-border manufacturing, marketing or business relationships which, in each case, could harm their businesses.
The effect of global climate change may impact the operations of our portfolio companies.
There may be evidence of global climate change. Climate change creates physical and financial risk and some of our portfolio companies may be adversely affected by climate change. For example, the needs
of customers of energy companies vary with weather conditions, primarily temperature and humidity. To the extent weather conditions are affected by climate change, energy use could increase or decrease depending on the
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duration and magnitude of any changes. Increases in the cost of energy could adversely affect the cost of operations of our portfolio companies if the use of energy products or services is
material to their business. A decrease in energy use due to weather changes may affect some of our portfolio companies financial condition, through decreased revenues. Extreme weather conditions in general require more system backup, adding to
costs, and can contribute to increased system stresses, including service interruptions. Energy companies could also be affected by the potential for lawsuits against or taxes or other regulatory costs imposed on greenhouse gas emitters, based on
links drawn between greenhouse gas emissions and climate change.
Price declines and illiquidity in the corporate debt
markets may adversely affect, and may continue to adversely affect, the fair value of our portfolio investments, reducing our net asset value through increased net unrealized depreciation. Any unrealized depreciation that we experience on our loan
portfolio may be an indication of future realized losses, which could reduce our income available for distribution and could adversely affect our ability to service our outstanding borrowings.
As a BDC, we are required to carry our investments at market value or, if no market value is ascertainable, at fair value as determined in
good faith by or under the direction of our board of directors. Decreases in the market values or fair values of our investments are recorded as unrealized depreciation. Any unrealized depreciation in our loan portfolio could be an indication of a
portfolio companys inability to meet its repayment obligations to us with respect to the affected loans. This could result in realized losses in the future and ultimately in reductions of our income available for distribution in future periods
and could materially adversely affect our ability to service our outstanding borrowings. The unprecedented declines in prices and liquidity in the corporate debt markets from 2008 through mid-2010 resulted in significant net unrealized depreciation
in our portfolio, reducing our net asset value. Depending on market conditions, we could incur substantial losses in future periods, which could further reduce our net asset value and have a material adverse impact on our business, financial
condition and results of operations.
Our failure to make follow-on investments in our portfolio companies could impair
the value of our portfolio.
Following an initial investment in a portfolio company, we may make additional investments
in that portfolio company as follow-on investments, in order to: (i) increase or maintain in whole or in part our equity ownership percentage; (ii) exercise warrants, options or convertible securities that were acquired in the
original or subsequent financing; or (iii) attempt to preserve or enhance the value of our investment. We may elect not to make follow-on investments or otherwise lack sufficient funds to make those investments. We will have the discretion to
make any follow-on investments, subject to the availability of capital resources. The failure to make follow-on investments may, in some circumstances, jeopardize the continued viability of a portfolio company and our initial investment, or may
result in a missed opportunity for us to increase our participation in a successful operation. Even if we have sufficient capital to make a desired follow-on investment, we may elect not to make a follow-on investment because we may not want to
increase our concentration of risk, either because we prefer other opportunities or because we are subject to BDC requirements that would prevent such follow-on investments or the desire to maintain our RIC tax status.
Where we do not hold controlling equity interests in our portfolio companies, we may not be in a position to exercise control over
our portfolio companies or to prevent decisions by management of our portfolio companies that could decrease the value of our investments.
Although we hold controlling equity positions in some of our portfolio companies, we do not currently hold controlling equity positions in the majority of our portfolio company investments. As a result,
we are subject to the risk that a portfolio company in which we do not have a controlling interest may make business decisions with which we disagree, and that the management and/or stockholders of such portfolio company may take risks or otherwise
act in ways that are adverse to our interests. Due to the lack of liquidity of the debt and equity
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investments that we typically hold in our portfolio companies, we may not be able to dispose of our investments in the event we disagree with the actions of a portfolio company and may therefore
suffer a decrease in the value of our investments.
Prepayments of our debt investments by our portfolio companies could
adversely impact our results of operations and reduce our return on equity.
We are subject to the risk that the
investments we make in our portfolio companies may be prepaid prior to maturity. When this occurs, we may reduce our borrowings outstanding or reinvest these proceeds in temporary investments, pending their future investment in new portfolio
companies. These temporary investments, if any, will typically have substantially lower yields than the debt investment being prepaid and we could experience significant delays in reinvesting these amounts. Any future investment in a new portfolio
company may also be at lower yields than the debt investment that was prepaid. As a result, our results of operations could be materially adversely affected if one or more of our portfolio companies elect to prepay amounts owed to us. Additionally,
prepayments could negatively impact our return on equity, which could result in a decline in the market price of our common stock.
We may choose to waive or defer enforcement of covenants in the debt securities held in our portfolio, which may cause us to lose all or part of our investment in these companies.
We structure the debt investments in our portfolio companies to include business and financial covenants placing
affirmative and negative obligations on the operation of the companys business and its financial condition. However, from time to time we may elect to waive breaches of these covenants, including our right to payment, or waive or defer
enforcement of remedies, such as acceleration of obligations or foreclosure on collateral, depending upon the financial condition and prospects of the particular portfolio company. These actions may reduce the likelihood of our receiving the full
amount of future payments of interest or principal and be accompanied by a deterioration in the value of the underlying collateral as many of these companies may have limited financial resources, may be unable to meet future obligations and may go
bankrupt. This could negatively impact our ability to pay dividends, could adversely affect our results of operation and financial condition and cause the loss of all or part of your investment.
Our loans could be subject to equitable subordination by a court which would increase our risk of loss with respect to such loans.
Courts may apply the doctrine of equitable subordination to subordinate the claim or lien of a lender against a
borrower to claims or liens of other creditors of the borrower, when the lender or its affiliates is found to have engaged in unfair, inequitable or fraudulent conduct. The courts have also applied the doctrine of equitable subordination when a
lender or its affiliates is found to have exerted inappropriate control over a client, including control resulting from the ownership of equity interests in a client. We have made direct equity investments or received warrants in connection with
loans. Payments on one or more of our loans, particularly a loan to a client in which we also hold an equity interest, may be subject to claims of equitable subordination. If we were deemed to have the ability to control or otherwise exercise
influence over the business and affairs of one or more of our portfolio companies resulting in economic hardship to other creditors of that company, this control or influence may constitute grounds for equitable subordination and a court may treat
one or more of our loans as if it were unsecured or common equity in the portfolio company. In that case, if the portfolio company were to liquidate, we would be entitled to repayment of our loan on a pro-rata basis with other unsecured debt or, if
the effect of subordination was to place us at the level of common equity, then on an equal basis with other holders of the portfolio companys common equity only after all of its obligations relating to its debt and preferred securities had
been satisfied.
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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 are required to
rely on the ability of Solar Capital Partners investment professionals to obtain adequate information to evaluate the potential returns from investing in these companies. If we are unable to uncover all material information about these
companies, we may not 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.
Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.
We invest primarily in senior secured loans, mezzanine loans, preferred securities, and equity securities issued by our portfolio companies. Our portfolio companies typically have, or may be permitted to
incur, other debt that ranks equally with, or senior to, the debt securities in which we invest. By their terms, such debt instruments may provide that the holders are entitled to receive payment of interest or principal on or before the dates on
which we are entitled to receive payments in respect of the debt securities in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking
senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying such senior creditors, such portfolio company may not have any
remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with debt securities in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of
an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company. Any such limitations on the ability of our portfolio companies to make principal or interest payments to us, if at all, may reduce our net asset
value and have a negative material adverse impact to our business, financial condition and results of operation.
Our
investments in foreign securities may involve significant risks in addition to the risks inherent in U.S. investments.
Our investment strategy contemplates potential investments in debt securities of foreign companies. Investing in foreign companies may
expose us to additional risks not typically associated with investing in U.S. companies. These risks include changes in exchange control regulations, political and social instability, expropriation, imposition of foreign taxes, less liquid markets
and less available information than is generally the case in the United States, higher transaction costs, less government supervision of exchanges, brokers and issuers, less developed bankruptcy laws, difficulty in enforcing contractual obligations,
lack of uniform accounting and auditing standards and greater price volatility.
Although most of our investments will be U.S.
dollar-denominated, any investments denominated in a foreign currency will be subject to the risk that the value of a particular currency will change in relation to one or more other currencies. Among the factors that may affect currency values are
trade balances, the level of short-term interest rates, differences in relative values of similar assets in different currencies, long-term opportunities for investment and capital appreciation, and political developments. We may employ hedging
techniques to minimize these risks, but we can offer no assurance that we will, in fact, hedge currency risk, or that if we do, such strategies will be effective.
We may expose ourselves to risks if we engage in hedging transactions.
If we engage in hedging transactions, we may expose ourselves to risks associated with such transactions. We may utilize instruments such as forward contracts, currency options and interest rate swaps,
caps, collars and
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floors to seek to hedge against fluctuations in the relative values of our portfolio positions from changes in currency exchange rates and market interest rates. Hedging against a decline in the
values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. However, such hedging can establish other positions designed to gain from
those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the underlying portfolio positions should increase. It may not be
possible to hedge against an exchange rate or interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price. Moreover, for a variety of reasons, we may not seek to
establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss. In addition, it may not be
possible to hedge fully or perfectly against currency fluctuations affecting the value of securities denominated in non-U.S. currencies because the value of those securities is likely to fluctuate as a result of factors not related to currency
fluctuations. To the extent we engage in hedging transactions, we also face the risk that counterparties to the derivative instruments we hold may default, which may expose us to unexpected losses from positions where we believed that our risk had
been appropriately hedged.
Our investment adviser may not be able to achieve the same or similar returns as those
achieved by our senior investment professionals while they were employed at prior positions.
Although in the past our
senior investment professionals held senior positions at a number of investment firms, their track record and achievements are not necessarily indicative of future results that will be achieved by our investment adviser. In their roles at such other
firms, our senior investment professionals were part of investment teams, and they were not solely responsible for generating investment ideas. In addition, such investment teams arrived at investment decisions by consensus.
Risks Relating to an Investment in Our Securities
Our shares may trade at a substantial discount from net asset value and may continue to do so over the long term.
Shares of closed-end investment companies have frequently traded at a market price that is less than the net asset value that is attributable to those shares. The possibility that our shares of common
stock will trade at a substantial discount from net asset value over the long term is separate and distinct from the risk that our net asset value will decrease. We cannot predict whether shares of our common stock will trade above, at or below our
net asset value. If our common stock trades below its net asset value, we will generally not be able to issue additional shares or sell our common stock at its market price without first obtaining the approval for such issuance from our stockholders
and our independent directors. At our 2013 Annual Stockholders Meeting, our stockholders approved our ability to sell or otherwise issue shares of our common stock, not exceeding 25% of our then outstanding common stock immediately prior to each
such offering, at a price or prices below the then current net asset value per share, in each case subject to the approval of our board of directors and compliance with the conditions set forth in the proxy statement pertaining thereto, during a
period beginning on April 30, 2013 and expiring on the earlier of the one-year anniversary of the date of the 2013 Annual Stockholders Meeting and the date of our 2014 Annual Stockholders Meeting, which is expected to be held in May 2014.
However, notwithstanding such stockholder approval, since our initial public offering on February 9, 2010, we have not sold any shares of our common stock at a price below our then current net asset value per share. Any offering of our common
stock that requires stockholder approval must occur, if at all, within one year after receiving such stockholder approval. If additional funds are not available to us, we could be forced to curtail or cease our new lending and investment activities,
and our net asset value could decrease and our level of distributions could be impacted.
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Our common stock price may be volatile and may decrease substantially.
The trading price of our common stock may fluctuate substantially. The price of our common stock that will prevail in
the market may be higher or lower than the price you pay, depending on many factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include, but are not limited to, the following:
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price and volume fluctuations in the overall stock market from time to time;
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investor demand for our shares;
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significant volatility in the market price and trading volume of securities of BDCs or other companies in our sector, which are not necessarily related
to the operating performance of these companies;
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changes in regulatory policies or tax guidelines with respect to RICs or BDCs;
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failure to qualify as a RIC, or the loss of RIC status;
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any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts;
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changes, or perceived changes, in the value of our portfolio investments;
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departures of Solar Capital Partners key personnel;
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operating performance of companies comparable to us; or
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general economic conditions and trends and other external factors.
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In the past, following periods of volatility in the market price of a companys securities, securities class action litigation has
often been brought against that company. Due to the potential volatility of our stock price, we may become the target of securities litigation in the future. Securities litigation could result in substantial costs and divert managements
attention and resources from our business.
There is a risk that our stockholders may not receive distributions or that
our distributions may not grow over time.
We intend to make distributions on a quarterly basis to our stockholders out
of assets legally available for distribution. We cannot assure you 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. In addition, due to the
asset coverage test applicable to us as a BDC, we may be limited in our ability to make distributions. As a RIC, if we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including failure to
obtain, or possible loss of, the federal income tax benefits allowable to RICs. We cannot assure you that you will receive distributions at a particular level or at all.
We may choose to pay dividends in our own common stock, in which case our stockholders may be required to pay federal income taxes in excess of the cash dividends they receive.
We may distribute taxable dividends that are payable in cash or shares of our common stock at the election of each stockholder. Under
certain applicable provisions of the Code and the Treasury regulations, distributions payable in cash or in shares of stock at the election of stockholders are treated as taxable dividends. The Internal Revenue Service has issued private rulings
indicating that this rule will apply even where the total amount of cash that may be distributed is limited to no more than 20% of the total distribution. Under these rulings, if too many stockholders elect to receive their distributions in cash,
each such stockholder would receive a pro rata share of the total cash to be distributed and would receive the remainder of their distribution in shares of stock. If we decide to make any distributions consistent with these rulings that are payable
in part in our stock, taxable stockholders receiving such dividends will be required to include the full amount of the dividend (whether received in cash, our stock, or a combination thereof) as ordinary income (or as long-term capital gain to the
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extent such distribution is properly reported as a capital gain dividend) to the extent of our current and accumulated earnings and profits for U.S. federal income tax purposes. As a result, a
U.S. stockholder may be required to pay tax with respect to such dividends in excess of any cash received. If a U.S. stockholder sells the stock it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount
included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such dividends,
including in respect of all or a portion of such dividend that is payable in stock. In addition, if a significant number of our stockholders determine to sell shares of our stock in order to pay taxes owed on dividends, it may put downward pressure
on the trading price of our stock.
Sales of substantial amounts of our common stock in the public market may have an
adverse effect on the market price of our common stock.
The shares of our common stock beneficially owned by each of
Messrs. Gross and Spohler immediately prior to completion of our initial public offering, including any shares that are attributable to such shares issued pursuant to our dividend reinvestment plan, are no longer subject to lock-up restrictions that
each of Messrs. Gross and Spohler agreed to in connection with our initial public offering, and are generally available for resale without restriction, subject to the provisions of Rule 144 promulgated under the Securities Act. In addition, on
November 30, 2010, Messrs. Gross and Spohler jointly acquired 115,000 shares of our common stock in a private placement transaction conducted in accordance with Regulation D under the Securities Act. Such shares have been registered with the
SEC and are generally available for resale. Sales of substantial amounts of our common stock, or the availability of such common stock for sale, could adversely affect the prevailing market prices for our common stock. If this occurs and continues,
it could impair our ability to raise additional capital through the sale of securities should we desire to do so.
The
net asset value per share of our common stock may be diluted if we issue or sell shares of our common stock at prices below the then current net asset value per share of our common stock or securities to subscribe for or convertible into shares of
our common stock.
At our 2013 Annual Stockholders Meeting, our stockholders approved our ability to sell or otherwise
issue shares of our common stock, not exceeding 25% of our then outstanding common stock immediately prior to each such offering, at a price or prices below the then current net asset value per share, in each case subject to the approval of our
board of directors and compliance with the conditions set forth in the proxy statement pertaining thereto, during a period beginning on April 30, 2013 and expiring on the earlier of the one-year anniversary of the date of the 2013 Annual
Stockholders Meeting and the date of our 2014 Annual Stockholders Meeting, which is expected to be held in May 2014. However, notwithstanding such stockholder approval, since our initial public offering on February 9, 2010, we have not sold any
shares of our common stock at a price below our then current net asset value per share. Any offering of our common stock that requires stockholder approval must occur, if at all, within one year after receiving such stockholder approval.
In addition, at our 2011 Annual Stockholders Meeting, our stockholders authorized us to sell or otherwise issue warrants or securities to
subscribe for or convertible into shares of our common stock subject to certain limitations (including, without limitation, that the number of shares issuable does not exceed 25% of our then outstanding common stock and that the exercise or
conversion price thereof is not, at the date of issuance, less than the market value per share of our common stock). Such authorization has no expiration.
We may also use newly issued shares to implement our dividend reinvestment plan, whether our shares are trading at a premium or at a discount to our then current net asset value per share. Any decision to
issue or sell shares of our common stock below our then current net asset value per share or securities to subscribe for or convertible into shares of our common stock would be subject to the determination by our board of directors that such
issuance or sale is in our and our stockholders best interests.
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If we were to issue or sell shares of our common stock below our then current net asset
value per share, such issuances or sales would result in an immediate dilution to the net asset value per share of our common stock. This dilution would occur as a result of the issuance or sale of shares at a price below the then current net asset
value per share of our common stock and a proportionately greater decrease in the stockholders interest in our earnings and assets and their voting interest in us than the increase in our assets resulting from such issuance or sale. Because
the number of shares of common stock that could be so issued and the timing of any issuance is not currently known, the actual dilutive effect cannot be predicted.
In addition, if we issue warrants or securities to subscribe for or convertible into shares of our common stock, subject to certain limitations, the exercise or conversion price per share could be less
than net asset value per share at the time of exercise or conversion (including through the operation of anti-dilution protections). Because we would incur expenses in connection with any issuance of such securities, such issuance could result in a
dilution of the net asset value per share at the time of exercise or conversion. This dilution would include reduction in net asset value per share as a result of the proportionately greater decrease in the stockholders interest in our
earnings and assets and their voting interest than the increase in our assets resulting from such issuance.
Further, if our
current stockholders do not purchase any shares to maintain their percentage interest, regardless of whether such offering is above or below the then current net asset value per share, their voting power will be diluted. For example, if we sell an
additional 10% of our common shares at a 5% discount from net asset value, a stockholder who does not participate in that offering for its proportionate interest will suffer net asset value dilution of up to 0.5% or $5 per $1000 of net asset value.
Similarly, all dividends declared in cash payable to stockholders that are participants in our dividend reinvestment plan are
generally automatically reinvested in shares of our common stock. As a result, stockholders that do not participate in the dividend reinvestment plan may experience dilution over time. Stockholders who do not elect to receive dividends in shares of
common stock may experience accretion to the net asset value of their shares if our shares are trading at a premium and dilution if our shares are trading at a discount. The level of accretion or discount would depend on various factors, including
the proportion of our stockholders who participate in the plan, the level of premium or discount at which our shares are trading and the amount of the dividend payable to a stockholder.
If we issue preferred stock, the net asset value and market value of our common stock may become more volatile.
We cannot assure you that the issuance of preferred stock would result in a higher yield or return to the holders of the common stock. The
issuance of preferred stock would likely cause the net asset value and market value of the common stock to become more volatile. If the dividend rate on the preferred stock were to approach the net rate of return on our investment portfolio, the
benefit of leverage to the holders of the common stock would be reduced. If the dividend rate on the preferred stock were to exceed the net rate of return on our portfolio, the leverage would result in a lower rate of return to the holders of common
stock than if we had not issued preferred stock. Any decline in the net asset value of our investments would be borne entirely by the holders of common stock. Therefore, if the market value of our portfolio were to decline, the leverage would result
in a greater decrease in net asset value to the holders of common stock than if we were not leveraged through the issuance of preferred stock. This greater net asset value decrease would also tend to cause a greater decline in the market price for
the common stock. We might be in danger of failing to maintain the required asset coverage of the preferred stock or of losing our ratings on the preferred stock or, in an extreme case, our current investment income might not be sufficient to meet
the dividend requirements on the preferred stock. In order to counteract such an event, we might need to liquidate investments in order to fund a redemption of some or all of the preferred stock. In addition, we would pay (and the holders of common
stock would bear) all costs and expenses relating to the issuance and ongoing maintenance of the preferred stock, including higher advisory fees if our total return exceeds the dividend rate on the preferred stock. Holders of preferred stock may
have different interests than holders of common stock and may at times have disproportionate influence over our affairs.
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Holders of any preferred stock we might issue would have the right to elect members of
the board of directors and class voting rights on certain matters.
Holders of any preferred stock we might issue,
voting separately as a single class, would have the right to elect two members of the board of directors at all times and in the event dividends become two full years in arrears would have the right to elect a majority of the directors until such
arrearage is completely eliminated. In addition, preferred stockholders have class voting rights on certain matters, including changes in fundamental investment restrictions and conversion to open-end status, and accordingly can veto any such
changes. Restrictions imposed on the declarations and payment of dividends or other distributions to the holders of our common stock and preferred stock, both by the 1940 Act and by requirements imposed by rating agencies or the terms of our credit
facilities, might impair our ability to maintain our qualification as a RIC for federal income tax purposes. While we would intend to redeem our preferred stock to the extent necessary to enable us to distribute our income as required to maintain
our qualification as a RIC, there can be no assurance that such actions could be effected in time to meet the tax requirements.
Risks
Relating to Our Business and Structure
We are dependent upon Solar Capital Partners key personnel for our
future success.
We depend on the diligence, skill and network of business contacts of Messrs. Gross and Spohler, who
serve as managing members of Solar Capital Partners and who lead Solar Capital Partners investment team. Messrs. Gross and Spohler, together with the other dedicated investment professionals available to Solar Capital Partners,
evaluate, negotiate, structure, close and monitor our investments. Our future success will depend on the continued service of Messrs. Gross and Spohler and the other investment professionals available to Solar Capital Partners. We cannot assure
you that unforeseen business, medical, personal or other circumstances would not lead any such individual to terminate his relationship with us. The loss of Mr. Gross or Mr. Spohler, or any of the other senior investment professionals who
serve on Solar Capital Partners investment team, could have a material adverse effect on our ability to achieve our investment objective as well as on our financial condition and results of operations. In addition, we can offer no assurance
that Solar Capital Partners will remain our investment adviser.
The senior investment professionals of Solar Capital Partners
are and may in the future become affiliated with entities engaged in business activities similar to those intended to be conducted by us, and may have conflicts of interest in allocating their time. We expect that Messrs. Gross and Spohler will
dedicate a significant portion of their time to the activities of Solar Capital; however, they may be engaged in other business activities which could divert their time and attention in the future. Specifically each of Messrs. Gross and Spohler
serve as chief executive officer and chief operating officer, respectively, of Solar Senior Capital Ltd.
Our business
model depends to a significant extent upon strong referral relationships with financial sponsors, and the inability of the senior investment professionals of our investment adviser to maintain or develop these relationships, or the failure of these
relationships to generate investment opportunities, could adversely affect our business.
We expect that the principals
of our investment adviser will maintain and develop their relationships with financial sponsors, and we will rely to a significant extent upon these relationships to provide us with potential investment opportunities. If the senior investment
professionals of our investment adviser fail to maintain their existing relationships or develop new relationships with other sponsors or sources of investment opportunities, we will not be able to grow our investment portfolio. In addition,
individuals with whom the senior investment professionals of our investment adviser have relationships are not obligated to provide us with investment opportunities, and, therefore, there is no assurance that such relationships will generate
investment opportunities for us.
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A disruption in the capital markets and the credit markets could negatively affect our
business.
As a BDC, we must maintain our ability to raise additional capital for investment purposes. Without
sufficient access to the capital markets or credit markets, we may be forced to curtail our business operations or we may not be able to pursue new business opportunities. Disruptive conditions in the financial industry and the impact of new
legislation in response to those conditions could restrict our business operations and could adversely impact our results of operations and financial condition.
If the fair value of our assets declines substantially, we may fail to maintain the asset coverage ratios imposed upon us by the 1940 Act and the senior secured credit facility (the Credit
Facility). Any such failure could result in an event of default and all of our debt being declared immediately due and payable and would affect our ability to issue senior securities, including borrowings, and pay dividends, which could
materially impair our business operations. Our liquidity could be impaired further by an inability to access the capital markets or to draw on our credit facilities. For example, we cannot be certain that we will be able to renew our credit
facilities as they mature or to consummate new borrowing facilities to provide capital for normal operations, including new originations. Reflecting concern about the stability of the financial markets, many lenders and institutional investors have
reduced or ceased providing funding to borrowers. This market turmoil and tightening of credit have led to increased market volatility and widespread reduction of business activity generally.
If we are unable to renew or replace such facilities and consummate new facilities on commercially reasonable terms, our liquidity will
be reduced significantly. If we are unable to repay amounts outstanding under such facilities and are declared in default or are unable to renew or refinance these facilities, we would not be able to initiate significant originations or to operate
our business in the normal course. These situations may arise due to circumstances that we may be unable to control, such as inaccessibility to the credit markets, a severe decline in the value of the U.S. dollar, a further economic downturn or an
operational problem that affects third parties or us, and could materially damage our business. Moreover, we are unable to predict when economic and market conditions may become more favorable. Even if such conditions improve broadly and
significantly over the long term, adverse conditions in particular sectors of the financial markets could adversely impact our business.
Our financial condition and results of operations will depend on our ability to manage future growth effectively.
Our ability to achieve our investment objective and to grow depends on Solar Capital Partners ability to identify, invest in and monitor companies that meet our investment criteria.
Accomplishing this result on a cost-effective basis is largely a function of Solar Capital Partners structuring of the investment
process, its ability to provide competent, attentive and efficient services to us and its ability to access financing for us on acceptable terms. The investment team of Solar Capital Partners has substantial responsibilities under the Investment
Advisory and Management Agreement, and they may also be called upon to provide managerial assistance to our portfolio companies as the principals of our administrator. Such demands on their time may distract them or slow our rate of investment. In
order to grow, we and Solar Capital Partners will need to retain, train, supervise and manage new investment professionals. However, we can offer no assurance that any such investment professionals will contribute effectively to the work of the
investment adviser. Any failure to manage our future growth effectively could have a material adverse effect on our business, financial condition and results of operations.
We may need to raise additional capital to grow because we must distribute most of our income.
We may need additional capital to fund growth in our investments. We expect to issue equity securities and expect to borrow from financial institutions in the future. A reduction in the availability of
new capital could limit our ability to grow. We must distribute at least 90% of our investment company taxable income to our
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stockholders to maintain our regulated investment company status. As a result, any such cash earnings may not be available to fund investment originations. We expect to borrow from financial
institutions and issue additional debt and equity securities. If we fail to obtain funds from such sources or from other sources to fund our investments, it could limit our ability to grow, which may have an adverse effect on the value of our
securities. In addition, as a BDC, our ability to borrow or issue additional preferred stock may be restricted if our total assets are less than 200% of our total borrowings and preferred stock.
Any failure on our part to maintain our status as a BDC would reduce our operating flexibility.
The 1940 Act imposes numerous constraints on the operations of BDCs. For example, BDCs are required to invest at least 70% of their total
assets in specified types of securities, primarily in private companies or thinly-traded U.S. public companies, cash, cash equivalents, U.S. government securities and other high quality debt investments that mature in one year or less. Furthermore,
any failure to comply with the requirements imposed on BDCs by the 1940 Act could cause the SEC to bring an enforcement action against us and/or expose us to claims of private litigants. In addition, upon approval of a majority of our stockholders,
we may elect to withdraw our status as a BDC. If we decide to withdraw our election, or if we otherwise fail to qualify, or maintain our qualification, as a BDC, we may be subject to the substantially greater regulation under the 1940 Act as a
closed-end investment company. Compliance with such regulations would significantly decrease our operating flexibility, and could significantly increase our costs of doing business.
Regulations governing our operation as a BDC affect our ability to, and the way in which we raise additional capital. As a BDC, the
necessity of raising additional capital may expose us to risks, including the typical risks associated with leverage.
In order to satisfy the tax requirements applicable to a RIC, to avoid payment of excise taxes and to minimize or avoid payment of income
taxes, we intend to distribute to our stockholders substantially all of our ordinary income and realized net capital gains except for certain realized net long-term capital gains, which we may retain, pay applicable income taxes with respect thereto
and elect to treat as deemed distributions to our stockholders. We may issue debt securities or preferred stock and/or borrow money from banks or other financial institutions, which we refer to collectively as senior securities, up to
the maximum amount permitted by the 1940 Act. Under the provisions of the 1940 Act, we will be permitted, as a BDC, to issue senior securities in amounts such that our asset coverage ratio, as defined in the 1940 Act, equals at least 200% of gross
assets less all liabilities and indebtedness not represented by senior securities, after each issuance of senior securities. If the value of our assets declines, we may be unable to satisfy this test. If that happens, we may be required to sell a
portion of our investments and, depending on the nature of our leverage, repay a portion of our indebtedness at a time when such sales may be disadvantageous. Also, any amounts that we use to service our indebtedness would not be available for
distributions to our common stockholders. Furthermore, as a result of issuing senior securities, we would also be exposed to typical risks associated with leverage, including an increased risk of loss.
As of December 31, 2013, we had $50 million outstanding on the Credit Facility, composed of $0 of revolving credit and
$50 million of term loans. We also had $75 million outstanding of senior secured notes (the Senior Secured Notes) and $100 million outstanding of 6.75% unsecured senior notes due 2042 (the Unsecured Notes). If we issue
preferred stock, the preferred stock would rank senior to common stock in our capital structure, preferred stockholders would have separate voting rights on certain matters and might have other rights, preferences, or privileges more
favorable than those of our common stockholders, and the issuance of preferred stock could have the effect of delaying, deferring or preventing a transaction or a change of control that might involve a premium price for holders of our common stock
or otherwise be in your best interest.
We are not generally able to issue and sell our common stock at a price below net
asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the then-current net asset value per share of our common stock if our board of directors determines that such
sale is in the best interests of Solar Capital and its stockholders, and our stockholders approve such sale. In
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any such case, the price at which our securities are to be issued and sold may not be less than a price that, in the determination of our board of directors, closely approximates the market value
of such securities (less any distributing commission or discount). If we raise additional funds by issuing more common stock or senior securities convertible into, or exchangeable for, our common stock, then the percentage ownership of our
stockholders at that time will decrease, and you might experience dilution. This dilution would occur as a result of a proportionately greater decrease in a stockholders interest in our earnings and assets and voting interest in us than the
increase in our assets resulting from such issuance. Because the number of future shares of common stock that may be issued below our net asset value per share and the price and timing of such issuances are not currently known, we cannot predict the
actual dilutive effect of any such issuance. We cannot determine the resulting reduction in our net asset value per share of any such issuance. We also cannot predict whether shares of our common stock will trade above, at or below our net asset
value.
At our 2013 Annual Stockholders Meeting, our stockholders approved our ability to sell or otherwise issue shares of
our common stock, not exceeding 25% of our then outstanding common stock immediately prior to each such offering, at a price or prices below the then current net asset value per share, in each case subject to the approval of our board of directors
and compliance with the conditions set forth in the proxy statement pertaining thereto, during a period beginning on April 30, 2013 and expiring on the earlier of the one-year anniversary of the date of the 2013 Annual Stockholders Meeting and
the date of our 2014 Annual Stockholders Meeting, which is expected to be held in May 2014. However, notwithstanding such stockholder approval, since our initial public offering on February 9, 2010, we have not sold any shares of our common
stock at a price below our then current net asset value per share. Any offering of our common stock that requires stockholder approval must occur, if at all, within one year after receiving such stockholder approval.
The trading market or market value of our publicly issued debt securities may fluctuate.
Our publicly issued debt securities, including the Unsecured Notes, may or may not have an established trading market. We cannot assure
you that a trading market for our publicly issued debt securities will be maintained. In addition to our creditworthiness, many factors may materially adversely affect the trading market for, and market value of, our publicly issued debt securities.
These factors include, but are not limited to, the following:
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the time remaining to the maturity of these debt securities;
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the outstanding principal amount of debt securities with terms identical to these debt securities;
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the ratings assigned by national statistical ratings agencies;
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the general economic environment;
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the supply of debt securities trading in the secondary market, if any;
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the redemption or repayment features, if any, of these debt securities;
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the level, direction and volatility of market interest rates generally; and
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market rates of interest higher or lower than rates borne by the debt securities. You should also be aware that there may be a limited number of buyers
when you decide to sell your debt securities. This too may materially adversely affect the market value of the debt securities or the trading market for the debt securities.
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Our credit ratings may not reflect all risks of an investment in our debt securities.
Our credit ratings are an assessment by third parties of our ability to pay our obligations. Consequently, real or anticipated changes in
our credit ratings will generally affect the market value of our debt securities. Our credit ratings, however, may not reflect the potential impact of risks related to market conditions generally or other factors discussed above on the market value
of or trading market for the publicly issued debt securities.
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Our stockholders will experience dilution in their ownership percentage if they opt
out of our dividend reinvestment plan.
All dividends declared in cash payable to stockholders that are participants in
our dividend reinvestment plan are automatically reinvested in shares of our common stock. As a result, our stockholders that opt out of our dividend reinvestment plan will experience dilution in their ownership percentage of our common stock over
time.
We may borrow money, which would magnify the potential for loss on amounts invested and may increase the risk of
investing in us.
The use of leverage magnifies the potential for loss on amounts invested and, therefore, increases
the risks associated with investing in our securities. As of December 31, 2013, we had $50 million outstanding on the Credit Facility, composed of $0 of revolving credit and $50 million of term loans. We also had $75 million outstanding of
the Senior Secured Notes and $100 million outstanding of the Unsecured Notes. We may borrow from and issue senior debt securities to banks, insurance companies and other lenders in the future. Lenders of these senior securities, including the Credit
Facility and Notes, will have fixed dollar claims on our assets that are superior to the claims of our common stockholders, and we would expect such lenders to seek recovery against our assets in the event of a default. If the value of our assets
decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged. Similarly, any decrease in our income would cause net income to decline more sharply than it would have had we not borrowed.
Such a decline could also negatively affect our ability to make dividend payments on our common stock. Leverage is generally considered a speculative investment technique. Our ability to service any debt that we incur will depend largely on our
financial performance and will be subject to prevailing economic conditions and competitive pressures. Moreover, as the management fee payable to our investment adviser, Solar Capital Partners, will be payable based on our gross assets, including
those assets acquired through the use of leverage, Solar Capital Partners will have a financial incentive to incur leverage which may not be consistent with our stockholders interests. In addition, our common stockholders will bear the burden
of any increase in our expenses as a result of leverage, including any increase in the management fee payable to Solar Capital Partners.
As a BDC, we generally are required to meet a coverage ratio of total assets to total borrowings and other senior securities, which include all of our borrowings and any preferred stock that we may issue
in the future, of at least 200%. Additionally, the Credit Facility requires us to comply with certain financial and other restriction covenants including maintaining an asset coverage ratio of not less than 200% at any time. Failure to maintain
compliance with these covenants could result in an event of default and all of our debt being declared immediately due and payable. If this ratio declines below 200%, we may not be able to incur additional debt and could be required by law to sell a
portion of our investments to repay some debt when it is disadvantageous to do so, which could have a material adverse effect on our operations, and we may not be able to make distributions. The amount of leverage that we employ will depend on our
investment advisers and our board of directors assessment of market and other factors at the time of any proposed borrowing. We cannot assure you that we will be able to obtain credit at all or on terms acceptable to us.
In addition, the Credit Facility imposes, and any other debt facility into which we may enter would likely impose financial and operating
covenants that restrict our business activities, including limitations that could hinder our ability to finance additional loans and investments or to make the distributions required to maintain our status as a RIC under Subchapter M of the Code.
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Illustration.
The following table illustrates the effect of leverage on returns
from an investment in our common stock assuming various annual returns on the portfolio, net of interest expense. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing in the table below.
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Assumed total return
(net of interest expense)
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(10)%
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(5)%
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0%
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5%
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10%
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Corresponding return to stockholder(1)
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(18.3%)
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(9.7%)
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(1.1%)
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7.5%
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16.1%
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(1)
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Assumes $1.71 billion in total assets and $225 million in total debt outstanding, which reflects our total assets and total debt outstanding as of December 31,
2013, and a cost of funds of 4.83%. Excludes non-leverage related expenses.
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It is likely that the terms
of any current or future long-term or revolving credit or warehouse facility we may enter into in the future could constrain our ability to grow our business.
Under our borrowings and the Credit Facility, current lenders have, and any future lender or lenders may have, fixed dollar claims on our assets that are senior to the claims of our stockholders and,
thus, will have a preference over our stockholders with respect to our assets in the collateral pool. Our current Credit Facility and borrowings also subject us to various financial and operating covenants, including, but not limited to, maintaining
certain financial ratios and minimum tangible net worth amounts. Future credit facilities and borrowings will likely subject us to similar or additional covenants. In addition, we may grant a securities interest in our assets in connection with any
such credit facilities and borrowings.
The Credit Facility generally contains customary default provisions such as a minimum
net worth amount, a profitability test, and a restriction on changing our business and loan quality standards. In addition, the Credit Facility requires or is expected to require the repayment of all outstanding debt on the maturity which may
disrupt our business and potentially the business of our portfolio companies that are financed through the Credit Facility. An event of default under the Credit Facility would likely result, among other things, in termination of the availability of
further funds under the Credit Facility and accelerated maturity dates for all amounts outstanding under the facilities, which would likely disrupt our business and, potentially, the business of the portfolio companies whose loans we finance through
the facilities. This could reduce our revenues and, by delaying any cash payment allowed to us under our facilities until the lender has been paid in full, reduce our liquidity and cash flow and impair our ability to grow our business and maintain
our status as a RIC.
The terms of future available financing may place limits on our financial and operation flexibility. If
we are unable to obtain sufficient capital in the future, we may be forced to reduce or discontinue our operations, not be able to make new investments, or otherwise respond to changing business conditions or competitive pressures.
To the extent we use debt or preferred stock to finance our investments, changes in interest rates will affect our cost of capital
and net investment income.
To the extent we borrow money, or issue preferred stock, to make investments, our net
investment income will depend, in part, upon the difference between the rate at which we borrow funds or pay dividends on preferred stock and the rate at which we invest those funds. As a result, we can offer no assurance that a significant change
in market interest rates will not have a material adverse effect on our net investment income in the event we use debt to finance our investments. In periods of rising interest rates, our cost of funds would increase, except to the extent we issue
fixed rate debt or preferred stock, which could reduce our net investment income. We expect that our long-term fixed-rate investments will be financed primarily with equity and long-term debt. We may use interest rate risk management techniques in
an effort to limit our exposure to interest rate fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the 1940 Act.
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You should also be aware that a rise in the general level of interest rates can be expected
to lead to higher interest rates applicable to our debt investments. Accordingly, an increase in interest rates would make it easier for us to meet or exceed the incentive fee hurdle rate and may result in a substantial increase of the amount of
incentive fees payable to our investment adviser with respect to our pre-incentive fee net investment income.
We may in
the future determine to fund a portion of our investments with preferred stock, which would magnify the potential for loss and the risks of investing in us in the same way as our borrowings.
Preferred stock, which is another form of leverage, has the same risks to our common stockholders as borrowings because the dividends on
any preferred stock we issue must be cumulative. Payment of such dividends and repayment of the liquidation preference of such preferred stock must take preference over any dividends or other payments to our common stockholders, and preferred
stockholders are not subject to any of our expenses or losses and are not entitled to participate in any income or appreciation in excess of their stated preference.
Pending legislation may allow us to incur additional leverage.
As a
business development company, under the 1940 Act generally we are not permitted to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed
50% of the value of our total assets). Recent legislation introduced in the U.S. House of Representatives, if passed, would modify this section of the 1940 Act and increase the amount of debt that business development companies may incur by
modifying the percentage from 200% to 150%. As a result, we may be able to incur additional indebtedness in the future and therefore your risk of an investment in us may increase.
There will be uncertainty as to the value of our portfolio investments.
A large percentage of our portfolio investments are in the form of securities that are not publicly traded. The fair value of securities
and other investments that are not publicly traded may not be readily determinable. We value these securities on a quarterly basis in accordance with our valuation policy, which is at all times consistent with U.S. generally accepted accounting
policies (GAAP). Our board of directors utilizes the services of third-party valuation firms to aid it in determining the fair value of these securities. The board of directors discusses valuations and determines the fair value in good
faith based on the input of our investment adviser and the respective third-party valuation firms. The factors that may be considered in fair value pricing our investments include the nature and realizable value of any collateral, the portfolio
companys ability to make payments and its earnings, the markets in which the portfolio company does business, comparisons to publicly traded companies, discounted cash flow and other relevant factors. Because such valuations, and particularly
valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been
used if a ready market for these securities existed. Our net asset value could be adversely affected if our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the
disposal of such securities.
Our quarterly and annual operating results are subject to fluctuation as a result of the
nature of our business, and if we fail to achieve our investment objective, the net asset value of our common stock may decline.
We could experience fluctuations in our quarterly and annual operating results due to a number of factors, some of which are beyond our control, including, but not limited to, the interest rate payable on
the debt securities that we acquire, 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, changes in our portfolio composition, the degree to
which we encounter competition in our markets, market volatility in our publicly traded securities and the securities of our portfolio companies, and general economic conditions. As a result of these factors, results
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for any period should not be relied upon as being indicative of performance in future periods. In addition, any of these factors could negatively impact our ability to achieve our investment
objectives, which may cause our net asset value of our common stock to decline.
Our investments may be in portfolio
companies which may have limited operating histories and financial resources.
We expect that our portfolio will
continue to consist of investments that may have relatively limited operating histories. These companies may be particularly vulnerable to U.S. and foreign economic downturns such as the current recession and European financial crisis may have more
limited access to capital and higher funding costs, may have a weaker financial position and may need more capital to expand or compete. These businesses also may experience substantial variations in operating results. They may face intense
competition, including from companies with greater financial, technical and marketing resources. Furthermore, some of these companies do business in regulated industries and could be affected by changes in government regulation. Accordingly, these
factors could impair their cash flow or result in other events, such as bankruptcy, which could limit their ability to repay their obligations to us, and may adversely affect the return on, or the recovery of, our investment in these companies. We
cannot assure you that any of our investments in our portfolio companies will be successful. Our portfolio companies compete with larger, more established companies with greater access to, and resources for, further development in these new
technologies. We may lose our entire investment in any or all of our portfolio companies.
Our equity ownership in a
portfolio company may represent a control investment. Our ability to exit an investment in a timely manner because we are in a control position or have access to inside information in the portfolio company could result in a realized loss on the
investment.
If we obtain a control investment in a portfolio company our ability to divest ourselves from a debt or
equity investment could be restricted due to illiquidity in a private stock, limited trading volume on a public companys stock, inside information on a companys performance, insider blackout periods, or other factors that could prohibit
us from disposing of the investment as we would if it were not a control investment. Additionally, we may choose not to take certain actions to protect a debt investment in a control investment portfolio company. As a result, we could experience a
decrease in the value of our portfolio company holdings and potentially incur a realized loss on the investment.
There
are significant potential conflicts of interest which could impact our investment returns.
Our executive officers and
directors, as well as the current and future partners of our investment adviser, Solar Capital Partners, may serve as officers, directors or principals of entities that operate in the same or a related line of business as we do. For example, Solar
Capital Partners presently serves as investment adviser to Solar Senior, a publicly-traded BDC which focuses on investing primarily in senior secured loans, including first lien, uni-tranche and second lien debt instruments. In addition,
Michael S. Gross, our chairman and chief executive officer, Bruce Spohler, our chief operating officer, and Richard Peteka, our chief financial officer, serve in similar capacities for Solar Senior. Accordingly, they may have obligations
to investors in those entities, the fulfillment of which obligations might not be in the best interests of us or our stockholders. In addition, we note that any affiliated investment vehicle formed in the future and managed by our investment adviser
or its affiliates may, notwithstanding different stated investment objectives, have overlapping investment objectives with our own and, accordingly, may invest in asset classes similar to those targeted by us. As a result, Solar Capital Partners may
face conflicts in allocating investment opportunities between us and such other entities. Although Solar Capital Partners will endeavor to allocate investment opportunities in a fair and equitable manner, it is possible that, in the future, we may
not be given the opportunity to participate in investments made by investment funds managed by our investment adviser or an investment manager affiliated with our investment adviser. In any such case, when Solar Capital Partners identifies an
investment, it will be forced to choose which investment fund should make the investment.
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If our investment adviser forms other affiliates in the future, we may co-invest on a
concurrent basis with such other affiliates, subject to compliance with applicable regulations and regulatory guidance and our allocation procedures.
In the course of our investing activities, we pay management and incentive fees to Solar Capital Partners and reimburse Solar Capital Partners for certain expenses it incurs. As a result, investors in our
common stock will invest on a gross basis and receive distributions on a net basis after expenses, resulting in a lower rate of return than an investor might achieve through direct investments. Accordingly, there may be times
when the management team of Solar Capital Partners has interests that differ from those of our stockholders, giving rise to a conflict.
We have entered into a royalty-free license agreement with our investment adviser, pursuant to which our investment adviser has granted us a non-exclusive license to use the name Solar
Capital. Under the license agreement, we have the right to use the Solar Capital name for so long as Solar Capital Partners or one of its affiliates remains our investment adviser. In addition, we reimburse Solar Capital
Management, an affiliate of Solar Capital Partners, our allocable portion of overhead and other expenses incurred by Solar Capital Management in performing its obligations under the Administration Agreement, including rent, the fees and expenses
associated with performing compliance functions, and our allocable portion of the compensation of our chief financial officer and any administrative support staff. These arrangements create conflicts of interest that our board of directors must
monitor.
We may be obligated to pay our investment adviser incentive compensation even if we incur a loss.
Our investment adviser will be entitled to incentive compensation for each fiscal quarter in an amount equal to a
percentage of the excess of our pre-incentive fee net investment income for that quarter (before deducting incentive compensation) above a performance threshold for that quarter. Accordingly, since the performance threshold is based on a percentage
of our net asset value, decreases in our net asset value make it easier to achieve the performance threshold. Our pre-incentive fee net investment income for incentive compensation purposes excludes realized and unrealized capital losses or
depreciation that we may incur in the fiscal quarter, even if such capital losses or depreciation result in a net loss on our statement of operations for that quarter. Thus, we may be required to pay Solar Capital Partners incentive compensation for
a fiscal quarter even if there is a decline in the value of our portfolio or we incur a net loss for that quarter.
Our
incentive fee may induce Solar Capital Partners to pursue speculative investments.
The incentive fee payable by us to
Solar Capital Partners may create an incentive for Solar Capital Partners to pursue investments on our behalf that are riskier or more speculative than would be the case in the absence of such compensation arrangement. The incentive fee payable to
our investment adviser is calculated based on a percentage of our return on invested capital. This may encourage our investment adviser to use leverage to increase the return on our investments. Under certain circumstances, the use of leverage may
increase the likelihood of default, which would impair the value of our common stock. In addition, the investment adviser receives the incentive fee based, in part, upon net capital gains realized on our investments. Unlike that portion of the
incentive fee based on income, there is no hurdle rate applicable to the portion of the incentive fee based on net capital gains. As a result, the investment adviser may have a tendency 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 securities than would otherwise be the case, which could result in higher investment losses, particularly during economic
downturns.
The incentive fee payable by us to our investment adviser also may induce Solar Capital Partners to invest on our
behalf in instruments that have a deferred interest feature, even if such deferred payments would not provide cash necessary to enable us to pay current distributions to our shareholders. Under these investments, we would accrue interest over the
life of the investment but would not receive the cash income from the investment until the end of the term. Our net investment income used to calculate the income portion of our investment fee,
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however, includes accrued interest. Thus, a portion of this incentive fee would be based on income that we have not yet received in cash. In addition, the catch-up portion of the
incentive fee may encourage Solar Capital Partners to accelerate or defer interest payable by portfolio companies from one calendar quarter to another, potentially resulting in fluctuations in timing and dividend amounts.
We may invest, to the extent permitted by law, in the securities and instruments of other investment companies, including private funds,
and, to the extent we so invest, will bear our ratable share of any such investment companys expenses, including management and performance fees. We will also remain obligated to pay management and incentive fees to Solar Capital Partners with
respect to the assets invested in the securities and instruments of other investment companies. With respect to each of these investments, each of our stockholders will bear his or her share of the management and incentive fee of Solar Capital
Partners as well as indirectly bearing the management and performance fees and other expenses of any investment companies in which we invest.
We will become subject to corporate-level income tax if we are unable to qualify and maintain our qualification as a regulated investment company under Subchapter M of the Code.
Although we have elected to be treated as a RIC under Subchapter M of the Code, no assurance can be given that we will be able to qualify
for and maintain RIC status. To maintain RIC tax treatment under the Code, we must meet the following annual distribution, income source and asset diversification requirements.
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The annual distribution requirement for a RIC will be satisfied if we distribute to our stockholders 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. Because we may use debt financing, we are subject to certain asset coverage ratio requirements under the 1940 Act and financial
covenants under loan and credit agreements that could, under certain circumstances, restrict us from making distributions necessary to satisfy the distribution requirement. If we are unable to obtain cash from other sources, 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. Failure to meet those requirements may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC 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 qualify for RIC tax treatment for any reason and become 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. Such a failure would have a material adverse effect on us, the net asset value of our common stock and the total return, if any, obtainable from your investment in our common stock. Any
net operating losses that we incur in periods during which we qualify as a RIC will not offset net capital gains (i.e., net realized long-term capital gains in excess of net realized short-term capital losses) that we are otherwise required to
distribute, and we cannot pass such net operating losses through to our stockholders. In addition, net operating losses that we carry over to a taxable year in which we qualify as a RIC normally cannot offset ordinary income or capital gains.
We may have difficulty satisfying the annual distribution requirement in order to qualify and maintain RIC status if we
recognize income before or without receiving cash representing such income.
In accordance with generally accepted
accounting principles and tax requirements, we include in income certain amounts that we have not yet received in cash, such as contractual payment-in-kind (PIK) interest,
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which represents contractual interest added to a loan balance and due at the end of such loans term. In addition to the cash yields received on our loans, in some instances, certain loans
may also include any of the following: end-of-term payments, exit fees, balloon payment fees or prepayment fees. The increases in loan balances as a result of contractual PIK arrangements are included in income for the period in which such PIK
interest was accrued, which is often in advance of receiving cash payment, and are separately identified on our statements of cash flows. We also may be required to include in income certain other amounts prior to receiving the related 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 original issue
discount for tax purposes, which we must recognize as ordinary income, increasing the amount that we are required to distribute to qualify for the federal income tax benefits applicable to RICs. Because these warrants generally will not
produce distributable cash for us at the same time as we are required to make distributions in respect of the related original issue discount, we would need to obtain cash from other sources or to pay a portion of our distributions using shares of
newly issued common stock, consistent with Internal Revenue Service requirements, to satisfy such distribution requirements.
Other features of the debt instruments that we hold may also cause such instruments to generate an original issue discount, resulting in
a dividend distribution requirement in excess of current cash interest received. Since in certain cases we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the RIC tax requirement to
distribute 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. Under such circumstances, we may have to sell some of our investments at times we would not
consider advantageous, raise additional debt or equity capital or reduce new investment originations to meet these distribution requirements. If we are unable to obtain cash from other sources and are otherwise unable to satisfy such distribution
requirements, we may fail to qualify for the federal income tax benefits allowable to RICs and, thus, become subject to a corporate-level income tax on all our income.
Our board of directors is authorized to reclassify any unissued shares of common stock into one or more classes of preferred stock, which could convey special rights and privileges to its owners.
Under Maryland General Corporation Law and our charter, our board of directors is authorized to classify and
reclassify any authorized but unissued shares of stock into one or more classes of stock, including preferred stock. Prior to issuance of shares of each class or series, the board of directors is required by Maryland law and our charter to set the
terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each class or series. Thus, the board of directors could
authorize the issuance of shares of preferred stock with terms and conditions which could have the effect of delaying, deferring or preventing a transaction or a change in control that might involve a premium price for holders of our common stock or
otherwise be in their best interest. The cost of any such reclassification would be borne by our existing common stockholders. Certain matters under the 1940 Act require the separate vote of the holders of any issued and outstanding preferred stock.
For example, holders of preferred stock would vote separately from the holders of common stock on a proposal to cease operations as a BDC. In addition, the 1940 Act provides that holders of preferred stock are entitled to vote separately from
holders of common stock to elect two preferred stock directors. We currently have no plans to issue preferred stock. The issuance of preferred shares convertible into shares of common stock might also reduce the net income and net asset value per
share of our common stock upon conversion, provided, that we will only be permitted to issue such convertible preferred stock to the extent we comply with the requirements of Section 61 of the 1940 Act, including obtaining common stockholder
approval. These effects, among others, could have an adverse effect on your investment in our common stock.
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Provisions of the Maryland General Corporation Law and of our charter and bylaws could
deter takeover attempts and have an adverse impact on the price of our common stock.
The Maryland General Corporation
Law and our charter and bylaws contain provisions that may discourage, delay or make more difficult a change in control of Solar Capital or the removal of our directors. We are subject to the Maryland Business Combination Act, subject to any
applicable requirements of the 1940 Act. Our board of directors has adopted a resolution exempting from the Business Combination Act any business combination between us and any other person, subject to prior approval of such business combination by
our board, including approval by a majority of our disinterested directors. If the resolution exempting business combinations is repealed or our board does not approve a business combination, the Business Combination Act may discourage third parties
from trying to acquire control of us and increase the difficulty of consummating such an offer. Our bylaws exempt from the Maryland Control Share Acquisition Act acquisitions of our stock by any person. If we amend our bylaws to repeal the exemption
from the Control Share Acquisition Act, the Control Share Acquisition Act also may make it more difficult for a third party to obtain control of us and increase the difficulty of consummating such a transaction. However, we will amend our bylaws to
be subject to the Control Share Act only if our board of directors determines that it would be in our best interests and if the SEC staff does not object to our determination that our being subject to the Control Share Act does not conflict with the
1940 Act. The SEC staff has issued informal guidance setting forth its position that certain provisions of the Control Share Act would, if implemented, violate Section 18(i) of the 1940 Act.
We have also adopted measures that may make it difficult for a third party to obtain control of us, including provisions of our charter
classifying our board of directors in three classes serving staggered three-year terms, and authorizing our board of directors to classify or reclassify shares of our stock in one or more classes or series, to cause the issuance of additional shares
of our stock, to amend our charter without stockholder approval and to increase or decrease the number of shares of stock that we have authority to issue. These provisions, as well as other provisions of our charter and bylaws, may delay, defer or
prevent a transaction or a change in control that might otherwise be in the best interests of our stockholders.
We are
highly dependent on information systems and systems failures could significantly disrupt our business, which may, in turn, negatively affect the market price of our common stock and our ability to pay dividends.
Our business is highly dependent on our and third parties communications and information systems. Any failure or interruption of
those systems, including as a result of the termination of an agreement with any third-party service providers, could cause delays or other problems in our activities. Our financial, accounting, data processing, backup or other operating systems and
facilities may fail to operate properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control and adversely affect our business. There could be:
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sudden electrical or telecommunications outages;
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natural disasters such as earthquakes, tornadoes and hurricanes;
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events arising from local or larger scale political or social matters, including terrorist acts; and
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These events, in turn, could have a material adverse effect on our operating results and negatively affect the market price of our common stock and our ability to pay dividends to our stockholders.
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Our board of directors may change our investment objective, operating policies and
strategies without prior notice or stockholder approval.
Our board of directors has the authority to modify or waive
certain of our operating policies and strategies without prior notice (except as required by the 1940 Act) and without stockholder approval. However, absent stockholder approval, we may not change the nature of our business so as to cease to be, or
withdraw our election as a BDC. We cannot predict the effect any changes to our current operating policies and strategies would have on our business, operating results and value of our stock. Nevertheless, the effects may adversely affect our
business and impact our ability to make distributions.
Our business is subject to increasingly complex corporate
governance, public disclosure and accounting requirements that could adversely affect our business and financial results.
We are subject to changing rules and regulations of federal and state government as well as the stock exchange on which our common stock is listed. These entities, including the Public Company Accounting
Oversight Board, the SEC and the NASDAQ Stock Market, have issued a significant number of new and increasingly complex requirements and regulations over the course of the last several years and continue to develop additional regulations and
requirements in response to laws enacted by Congress.
On July 21, 2010, the Wall Street Reform and Consumer Protection
Act, or Dodd-Frank Act, was signed into law. Although passage of the Dodd-Frank Act has resulted in extensive rulemaking and regulatory changes that affect us and the financial industry as a whole, many of its provisions remain subject to extended
implementation periods and delayed effective dates and will require extensive rulemaking by regulatory authorities. While the full impact of the Dodd-Frank Act on us and our portfolio companies may not be known for an extended period of time, the
Dodd-Frank Act, including future rules implementing its provisions and the interpretation of those rules, along with other legislative and regulatory proposals directed at the financial services industry or affecting taxation that are proposed or
pending in the U.S. Congress, may negatively impact the operations, cash flows or financial condition of us or our portfolio companies, impose additional costs on us or our portfolio companies, intensify the regulatory supervision of us or our
portfolio companies or otherwise adversely affect our business or the business of our portfolio companies.
Changes in
laws or regulations governing our operations may adversely affect our business.
Changes in the laws or regulations, or
the interpretations of the laws and regulations, which govern business development companies, RICs or non-depository commercial lenders could significantly affect our operations and our cost of doing business. We are subject to federal, state and
local laws and regulations and are subject to judicial and administrative decisions that affect our operations, including our loan originations, maximum interest rates, fees and other charges, disclosures to portfolio companies, the terms of secured
transactions, collection and foreclosure procedures, and other trade practices. If these laws, regulations or decisions change, or if we expand our business into jurisdictions that have adopted more stringent requirements than those in which we
currently conduct business, then we may have to incur significant expenses in order to comply or we may have to restrict our operations. In addition, if we do not comply with applicable laws, regulations and decisions, then we may lose licenses
needed for the conduct of our business and be subject to civil fines and criminal penalties, any of which could have a material adverse effect upon our business results of operations or financial condition.
Over the last several years, there has been an increase in regulatory attention to the extension of credit outside of the traditional
banking sector, raising the possibility that some portion of the non-bank financial sector will be subject to new regulation. While it cannot be known at this time whether these regulations will be implemented or what form they will take, increased
regulation of non-bank credit extension could negatively impact our operations, cash flows or financial condition, impose additional costs on us, intensify the regulatory supervision of us or otherwise adversely affect our business.
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Our investment adviser can resign on 60 days notice, and we may not be able
to find a suitable replacement within that time, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations.
Our investment adviser has the right, under the Investment Advisory and Management Agreement, to resign at any time upon
60 days written notice, whether we have found a replacement or not. If our investment adviser resigns, we may not be able to find a new investment adviser or hire internal management with similar expertise and ability to provide the same
or equivalent services on acceptable terms within 60 days, or at all. If we are unable to do so quickly, our operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to
pay distributions are likely to be adversely affected and the market price of our shares may decline. In addition, the coordination of our internal management and investment activities is likely to suffer if we are unable to identify and reach an
agreement with a single institution or group of executives having the expertise possessed by our investment adviser and its affiliates. Even if we are able to retain comparable management, whether internal or external, the integration of such
management and their lack of familiarity with our investment objective may result in additional costs and time delays that may adversely affect our financial condition, business and results of operations.
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