FIDUS INVESTMENT Corp 10-K

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Our common stock began trading on June 21, 2011 on the NASDAQ Global Market under the symbol “FDUS.” Effective January 3, 2012, our common stock was included in the NASDAQ Global Select Market. The last reported price for our common stock on February 23, 2021 was $14.40 per share. As of February 23, 2021, we had 20 stockholders of record. We intend to continue to pay quarterly distributions to our stockholders. Our distributions may include returns of paid-in capital, as well as declared dividends from earnings and profits. Our quarterly distributions, if any, are determined by our board of directors. We have elected to be taxed as a RIC under Subchapter M of the Code. As long as we qualify for tax treatment as a RIC, we will not be taxed on our investment company taxable income or net capital gain, to the extent that such income or gain is distributed, or deemed to be distributed, to stockholders on a timely basis. On February 9, 2021, our board of directors declared a regular quarterly dividend of $0.31 per share and a supplemental dividend of $0.07 per share payable on March 26, 2021 to holders of record as of March 12, 2021. We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of our status as a RIC. We cannot assure stockholders that they will receive any distributions at a particular level. We have adopted a dividend reinvestment plan that provides for reinvestment of our distributions on behalf of our stockholders, unless a stockholder elects to receive cash. As a result, if our board of directors authorizes, and we declare, a cash distribution, then our stockholders who have not “opted out” of our dividend reinvestment plan will have their cash distribution automatically reinvested in additional shares of our common stock, rather than receiving the cash distribution. Under the terms of our dividend reinvestment plan, dividends will primarily be paid in newly issued shares of common stock. However, we reserve the right to purchase shares in the open market in connection with the implementation of the plan. This feature of the plan means that, under certain circumstances, we may issue shares of our common stock at a price below net asset value per share, which could cause our stockholders to experience dilution. To maintain our tax treatment as a RIC, we must, among other things, distribute at least 90.0% of our net ordinary income and our net short-term capital gains in excess of our net long-term capital losses, if any. In order to avoid certain excise taxes imposed on RICs, we currently intend to distribute during each calendar year an amount at least equal to the sum of (1) 98.0% of our net ordinary income for the calendar year, (2) 98.2% of our capital gain net income for the calendar year and (3) any net ordinary income and capital gain net income that we recognized for preceding years, but were not distributed during such years, and on which we paid no U.S. federal income tax. We may retain for investment some or all of our net capital gain (i.e., net long-term capital gains in excess of net short-term capital losses) and treat such amounts as deemed distributions to our stockholders. If we do this, you will be treated as if you received an actual distribution of the capital gain we retain and then reinvested the net after-tax proceeds in our common stock. You also may be eligible to claim a tax credit (or, in certain circumstances, a tax refund) equal to your allocable share of the tax we paid on the capital gain deemed distributed to you. Please refer to “Material U.S. Federal Income Tax Considerations” for further information regarding the consequences of our retention of net capital gain. We can offer no assurance that we will achieve results that will permit the payment of any cash distributions and, if we issue senior securities, we will be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our borrowings. See “Regulation” and “Material U.S. Federal Income Tax Considerations.” We may make distributions that are payable in cash or shares of our common stock at the election of each stockholder. In accordance with Treasury regulations and published guidance issued by the Internal Revenue Service, a publicly offered RIC may treat distributions of its own stock as counting towards its RIC distribution requirements if each stockholder may elect to receive his, her, or its entire distribution in either cash or stock of the RIC. The IRS has issued a revenue procedure indicating that this rule will apply if the total amount of cash to be distributed is not less than 20% of the total distribution. Under the revenue procedure, if too many stockholders elect to receive their distributions in cash, the cash available for distribution must be allocated among the shareholders electing to receive cash (with the balance of the distribution paid in stock). If we decide to make any distributions that are payable in part in shares of our stock, U.S. stockholders receiving such distributions generally will be required to include the full amount of the distribution (whether received in cash, shares of our stock, or a combination thereof) as ordinary income (or as long-term capital gain to the extent such distribution is properly reported as a capital gain dividend) to the extent of our current and accumulated earnings and profits. As a result, a U.S. stockholder may be required to pay tax with respect to such distributions in excess of any cash received. If a U.S. stockholder sells the stock it receives in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the distribution, 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. federal tax with respect to such distributions, including in respect of all or a portion of such distributions that are 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 such distributions, it may put downward pressure on the trading price of shares of our stock. 52 Table of Contents Distributions in excess of our current and accumulated profits and earnings would be treated first as a return of capital to the extent of the stockholder’s tax basis, and any remaining distributions would be treated as a capital gain. The determination of the tax attributes of our distributions will be made annually as of the end of our fiscal year based upon our taxable income for the full year and distributions paid for the full year. Therefore, a determination made on a quarterly basis may not be representative of the actual tax attributes of our distributions for a full year. Each year, a statement on Form 1099-DIV identifying the source of the distribution will be sent to our U.S. stockholders of record. Our board of directors presently intends to declare and pay quarterly dividends. Our ability to pay dividends could be affected by future business performance, liquidity, capital needs, alternative investment opportunities and loan covenants. The tax character of distributions declared and paid in 2020 is described in Note 12 to our consolidated financial statements. Stock Performance Graph This graph compares the stockholder return on our common stock from December 31, 2015 to December 31, 2020 with that of the Russell 2000 Financial Services Index and the Standard & Poor’s 500 Total Return Stock Index. This graph assumes that on December 31, 2015, $100 was invested in our common stock, the Russell 2000 Financial Services Index, and the Standard & Poor’s 500 Total Return Stock Index. The graph also assumes the reinvestment of all cash dividends prior to any tax effect. The graph and other information furnished under this Part II Item 5 of this Annual Report shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under, or to the liabilities of Section 18 of, the Exchange Act. The stock price performance included in the below graph is not necessarily indicative of future stock performance. 53 Table of Contents Outstanding Securities The following table shows our outstanding classes of securities as of December 31, 2020: (a) Title of Class (b) Amount Authorized (c) Amount Held by us or for Our Account d) Amount Outstanding Exclusive of Amounts Shown Under (c) Common Stock 100,000,000 — 24,437,400 SBA Debentures $ 325.0 million (1) — $ 147.0 million Credit Facility $ 100.0 million — $ — Notes $ 307.3 million — $ 307.3 million (1) For more information regarding our limitations as to SBA debenture issuances, see “Regulation — Small Business Administration Regulations.” Fees and Expenses The following table is intended to assist you in understanding the costs and expenses that an investor in this offering will bear directly or indirectly. We caution you that some of the percentages indicated in the table below are estimates and may vary. Except where the context suggests otherwise, whenever there is a reference to fees or expenses paid by “you,” “us,” “the Company” or “Fidus,” or that “we” will pay fees or expenses, stockholders will indirectly bear such fees or expenses as investors in us. Stockholder transaction expenses: Sales load (as a percentage of offering price) — (1 ) Offering Expenses born by us (as a percentage of offering price) — (2 ) Dividend reinvestment plan expenses — (3 ) Total stockholder transaction expenses paid by us (as a percentage of offering price) — (4 ) Annual expenses (as a percentage of net assets attributable to common stock) (5) : Base Management Fee 3.29 % (6 ) Incentive fees, net of income incentive fee waiver, payable under Investment Advisory Agreement 2.17 % (7 ) Interest payments on borrowed funds 5.76 % (8 ) Other expenses 1.31 % (9 ) Total annual expenses 12.53 % (10 ) (1) In the event that securities are sold to or through underwriters, a corresponding prospectus supplement will disclose the applicable sales load. (2) In the event that we conduct an offering of any of our securities, a corresponding prospectus supplement will disclose the estimated offering expenses because they will be ultimately borne by the Company (and indirectly by our stockholders). (3) The expenses of administering our dividend reinvestment plan are included in other expenses. (4) Total stockholder transaction expenses may include a sales load and will be disclosed in a future prospectus supplement, if any. (5) Net assets attributable to common stock equals average net assets, which is calculated as the average of the net assets balances as of each quarter end during the year ended December 31, 2020 and the prior year end. (6) Our base management fee is 1.75% of the average value of our total assets (other than cash and cash equivalents but including assets purchased with borrowed amounts). This item represents actual base management fees incurred for the year ended December 31, 2020. We may from time to time decide it is appropriate to change the terms of the Investment Advisory Agreement. Under the 1940 Act, any material change to our Investment Advisory Agreement must be submitted to stockholders for approval. The 3.29% reflected in the table is calculated on our net assets (rather than our total assets). See “Management and Other Agreements—Investment Advisory Agreement.” (7) This item represents actual fees incurred on pre-incentive fee net investment income (income incentive fee) for the year ended December 31, 2020. As of December 31, 2020, there was no capital gains incentive fee payable (in cash), and accordingly no capital gains incentive fee amount has been included in the estimated expenses figure reflected in the table above. For the year ended December 31, 2020, we accrued capital gains incentive fees (reversal) of ($1.7) million in accordance with U.S. GAAP, which equals (0.43)% of net assets attributable to common stock; such amount has not been included in the estimated expenses figure reflected in the table above. For the year ended December 31, 2020, the Investment Advisor, in consultation with the Board, agreed to voluntarily waive $0.4 million of the income incentive fee. 54 Table of Contents The incentive fee consists of two parts: The first, payable quarterly in arrears, equals 20.0% of our pre-incentive fee net investment income, expressed as a rate of return on the value of our net assets, (including interest that is accrued but not yet received in cash), subject to a 2.0% quarterly (8.0% annualized) hurdle rate and a “catch-up” provision measured as of the end of each calendar quarter. Under this provision, in any calendar quarter, our investment advisor receives no incentive fee until our pre-incentive fee net investment income equals the hurdle rate of 2.0% but then receives, as a “catch-up,” 100.0% 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 rate but is less than 2.5%. The effect of this provision is that, if pre-incentive fee net investment income exceeds 2.5% in any calendar quarter, our investment advisor will receive 20.0% of our pre-incentive fee net investment income as if a hurdle rate did not apply. The second part, payable annually in arrears, equals 20.0% of our realized capital gains net of realized capital losses and unrealized capital depreciation, if any, on a cumulative basis from inception through the end of the fiscal year (or upon the termination of the Investment Advisory Agreement, as of the termination date), less the aggregate amount of any previously paid capital gain incentive fees. In accordance with U.S. GAAP, we accrue the capital gains incentive fee in our consolidated financial statements considering the fair value of investments on that date (i.e., the amount of fee which would be payable under a hypothetical liquidation based on the fair value of investments as of that date), which differs from the calculation of the amount payable in cash by the inclusion of unrealized capital appreciation. See “Management and Other Agreements—Investment Advisory Agreement.” (8) As of December 31, 2020, we had outstanding SBA debentures of $147.0 million; we had $307.3 million outstanding of our Notes; we had no outstanding borrowings under our senior secured revolving credit agreement with certain lenders party thereto and ING Capital, LLC, as administrative agent (the “Credit Facility”), which has total commitment of $100.0 million. Interest payments on borrowed funds is based on estimated annual interest and fee expenses on outstanding SBA debentures, Notes and borrowings under the Credit Facility as of December 31, 2020 with a weighted average stated interest rate of 4.680% as of that date. We also pay a commitment fee between 0.5% and 3.0% per annum based the unutilized commitment under our Credit Facility. We have estimated the annual interest expense on borrowed funds and caution you that our actual interest expense will depend on prevailing interest rates and our rate of borrowing, which may be substantially higher than the estimate provided in this table. (9) Other expenses represent our estimated annual operating expenses, as a percentage of net assets attributable to common shares estimated for the current year, including professional fees, directors’ fees, insurance costs, expenses of our dividend reinvestment plan and payments under the Administration Agreement based on our allocable portion of overhead and other expenses incurred by our administrator. See “Management and Other Agreements—Administration Agreement.” Other expenses exclude interest payments on borrowed funds, and if we issue debt securities or preferred stock, interest payments on debt securities and distributions with respect to preferred stock. “Other expenses” are based on actual other expenses for the year ended December 31, 2020. (10) “Total annual expenses” as a percentage of consolidated net assets attributable to common stock are higher than the total annual expenses percentage would be for a company that is not leveraged. We borrow money to leverage our net assets and increase our total assets. The SEC requires that the “total annual expenses” percentage be calculated as a percentage of net assets (defined as total assets less total liabilities), rather than the total assets, including assets that have been purchased with borrowed amounts. If the “total annual expenses” percentage were calculated instead as a percentage of average consolidated total assets, our “total annual expenses” would be 6.27% of average consolidated total assets. Example The following example demonstrates the projected dollar amount of total cumulative expenses over various periods with respect to a hypothetical investment in us. In calculating the following expense amounts, we have assumed we would have no additional leverage, that none of our assets are cash or cash equivalents and that our annual operating expenses would remain at the levels set forth in the table above. Transaction expenses are not included in the following example. 1 year 3 years 5 years 10 years You would pay the following expenses on a $1,000 investment, assuming a 5.0% annual return $ 128 $ 356 $ 549 $ 914 You would pay the following expenses on a $1,000 investment, assuming a 5.0% annual return resulting entirely from net realized capital gains (all of which is subject to our incentive fee on capital gains) $ 135 $ 372 $ 571 $ 936 The foregoing table is to assist you in understanding the various costs and expenses that an investor in our common stock will bear directly or indirectly. While the example assumes, as required by the SEC, a 5.0% annual return, our performance will vary and may result in a return greater or less than 5.0%. Assuming a 5.0% annual return, the incentive fee under the Investment 55 Table of Contents Advisory Agreement would either not be payable or have an insignificant impact on the expense amounts shown above. If we achieve sufficient returns on our investments, including through the realization of capital gains, to trigger an incentive fee of a material amount, our expenses, and returns to our investors, would be higher. In addition, while the example assumes reinvestment of all distributions at net asset value, if our board of directors authorizes and we declare a cash dividend, participants in our dividend reinvestment plan who have not otherwise elected to receive cash will receive a number of shares of our common stock, determined by dividing the total dollar amount of the distribution payable to a participant by the market price per share of our common stock at the close of trading on the valuation date for the distribution. See “Part II, Item 5” for additional information regarding our dividend reinvestment plan. This example and the expenses in the table above should not be considered a representation of our future expenses, and actual expenses (including the cost of debt, if any, and other expenses) may be greater or less than those shown. Recent Sales of Unregistered Securities We did not engage in any sales of unregistered securities during the fiscal year ended December 31, 2020. Issuer Purchases of Equity Securities We have an open market stock repurchase program (the “Stock Repurchase Program”) under which we may acquire up to $5.0 million of our outstanding common stock. Under the Stock Repurchase Program, we may, but are not obligated to, repurchase outstanding common stock in the open market from time to time provided that we comply with the prohibitions under our insider trading policies and the requirements of Rule 10b-18 of the Securities Exchange Act of 1934, as amended, including certain price, market value and timing constraints. The timing, manner, price and amount of any share repurchases will be determined by our management, in its discretion, based upon the evaluation of economic and market conditions, stock price, capital availability, applicable legal and regulatory requirements and other corporate considerations. On October 26, 2020, the Board extended the Stock Repurchase Program through December 31, 2021, or until the approved dollar amount has been used to repurchase shares. The Stock Repurchase Program does not require us to repurchase any specific number of shares and the Company cannot assure that any shares will be repurchased under the Stock Repurchase Program. The Stock Repurchase Program may be suspended, extended, modified, or discontinued at any time. During the years ended December 31, 2020 and 2018, we repurchased 25,719 and 44,821 shares of common stock on the open market for $0.3 and $0.6 million, respectively. We did not make any repurchases of common stock during the year ended December 31, 2019. Refer to Note 9 to our consolidated financial statements for additional information concerning stock repurchases. 56 Table of Contents Item 6. Selected Consolidated Financial Data The following selected consolidated financial data of FIC and its subsidiaries, including the Funds, as of and for the years ended December 31, 2020, 2019, 2018, 2017, and 2016, is derived from the consolidated financial statements that have been audited by RSM US LLP, an independent registered public accounting firm. This financial data should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this Annual Report and with Management’s Discussion and Analysis of Financial Condition and Results of Operations which follows. Years Ended December 31, 2020 2019 2018 2017 2016 (Dollars in Thousands, Except Per Share Data) Statement of operations data: Total investment income $ 85,123 $ 77,106 $ 76,425 $ 68,615 $ 60,229 Interest and financing expenses 19,678 17,072 12,659 9,803 10,594 Base management fee 12,932 12,399 11,365 9,788 8,254 Incentive fee - income 8,952 7,445 9,413 8,913 7,375 Incentive fee - capital gains (1,684 ) 3,299 2,938 2,055 2,294 All other expenses 5,158 4,422 4,272 4,069 3,986 Total expenses before income incentive fee waiver 45,036 44,637 40,647 34,628 32,503 Incentive fee waiver - income (423 ) — — — — Total expenses, net of income incentive fee waiver 44,613 44,637 40,647 34,628 32,503 Net investment income before income taxes 40,510 32,469 35,778 33,987 27,726 Income tax provision (benefit) 862 500 720 220 425 Net investment income 39,648 31,969 35,058 33,767 27,301 Net realized gains (losses) (968 ) (1,171 ) (10,269 ) 17,904 (13,835 ) Net change in unrealized appreciation (depreciation) (6,578 ) 18,188 25,718 (5,426 ) 29,009 Income tax (provision) benefit from realized gains on investments (577 ) (121 ) (758 ) (2,204 ) (205 ) Realized losses on extinguishment of debt (299 ) (399 ) (297 ) (90 ) — Net increase in net assets resulting from operations $ 31,226 $ 48,466 $ 49,452 $ 43,951 $ 42,270 Per share data: Net asset value (at end of period) $ 16.81 $ 16.85 $ 16.47 $ 16.05 $ 15.76 Net investment income $ 1.62 $ 1.31 $ 1.43 $ 1.44 $ 1.45 Net gain (loss) on investments $ (0.33 ) $ 0.69 $ 0.60 $ 0.44 $ 0.82 Realized losses on extinguishment of debt $ (0.01 ) $ (0.02 ) $ (0.01 ) $ (0.01 ) $ — Net increase in net assets resulting from operations $ 1.28 $ 1.98 $ 2.02 $ 1.87 $ 2.27 Dividends $ 1.33 $ 1.60 $ 1.60 $ 1.60 $ 1.60 Other data: Weighted average annual yield on debt investments (1) 12.2 % 12.0 % 12.6 % 13.0 % 13.1 % Number of portfolio companies at year end 69 64 63 63 57 Expense ratios (as percentage of average net assets (2) ): Operating expenses 6.4 % 6.8 % 7.0 % 6.6 % 7.8 % Interest expense 5.0 % 4.2 % 3.2 % 2.6 % 3.7 % Total return based on market value (3) 1.0 % 37.6 % (15.8 %) 3.2 % 23.8 % Total return based on net asset value (4) 7.6 % 12.0 % 12.6 % 11.9 % 15.0 % (1) Weighted average yields are computed using the effective interest rates for debt investments at cost as of the period end date, including accretion of original issue discount and loan origination fees, but excluding investments on non-accrual status, if any. The weighted average yield of our debt investments is not the same as a return on investment for our stockholders but, rather, relates to a portion of our investment portfolio and is calculated before the payment of all of our and our subsidiaries’ fees and expenses. (2) Average net assets is calculated as the average of the net asset balances as of each quarter end during the fiscal year and the prior year end. (3) Total return based on market value equals the change in the market value of our common stock per share during the period divided by the market value per share at the beginning of the period, and assumes reinvestment of dividends at prices obtained by our dividend reinvestment plan during the period. The return does not reflect any sales load that may be paid by an investor. (4) Total return based on net asset value per share equals the change in net asset value per share during the period, plus dividends paid per share during the period, less other non-operating changes during the period, and divided by beginning net asset value per share for the period. Non-operating changes include any items that affect net asset value per share other than increase from investment operations, such as the effects of share issuances and repurchases and other miscellaneous items. As of December 31, 2020 2019 2018 2017 2016 (Dollars in Thousands) Statement of assets and liabilities data: Total investments, fair value $ 742,869 $ 766,919 $ 642,982 $ 596,308 $ 524,454 Total assets 875,740 789,439 693,876 646,263 586,742 Borrowings (5) 454,250 364,750 277,500 242,800 224,000 Total net assets 410,760 412,310 402,985 393,273 353,785 (5) Represents principal balance outstanding. 57 Table of Contents Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Consolidated Financial Data,” FIC’s consolidated financial statements and related notes appearing elsewhere in this annual report on Form 10-K (“Annual Report”). The information contained in this section contains forward-looking statements that involve risk and uncertainties. Please see “Risk Factors” and “Special Note Regarding Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements. Overview General and Corporate Structure We provide customized debt and equity financing solutions to lower middle-market companies, which we define as U.S. based companies having revenues between $10.0 million and $150.0 million. Our investment objective is to provide attractive risk-adjusted returns by generating both current income from our debt investments and capital appreciation from our equity related investments. Our investment strategy includes partnering with business owners, management teams and financial sponsors by providing customized financing for ownership transactions, recapitalizations, strategic acquisitions, business expansion and other growth initiatives. We seek to maintain a diversified portfolio of investments in order to help mitigate the potential effects of adverse economic events related to particular companies, regions or industries. FIC was formed as a Maryland corporation on February 14, 2011. We completed our initial public offering, or IPO, in June 2011. On June 20, 2011, FIC acquired all of the limited partnership interests of Fund I and membership interests of Fidus Mezzanine Capital GP, LLC, its general partner, resulting in Fund I becoming our wholly-owned SBIC subsidiary. Immediately following the acquisition, we and Fund I elected to be treated as business development companies, or BDCs, under the 1940 Act and our investment activities have been managed by Fidus Investment Advisors, LLC, our investment advisor, and supervised by our board of directors, a majority of whom are independent of us. On March 29, 2013, we commenced operations of a second wholly-owned subsidiary, Fund II. On April 18, 2018, we commenced operations of a third wholly-owned subsidiary, Fund III. Fund II and Fund III received their SBIC licenses on May 28, 2013, and March 21, 2019, respectively. We plan to continue to operate the Funds as SBICs, subject to SBA approval, and to utilize the proceeds of the sale of SBA-guaranteed debentures to enhance returns to our stockholders. As of September 9, 2019, Fund I completed a wind-down plan, relinquished its SBIC license, and can no longer issue additional SBA debentures. We have also made, and continue to make, investments directly through FIC. We believe that utilizing FIC and the Funds as investment vehicles provides us with access to a broader array of investment opportunities. We have certain wholly-owned taxable subsidiaries (the “Taxable Subsidiaries”), each of which generally holds one or more of our portfolio investments listed on the consolidated schedules of investments. The Taxable Subsidiaries are consolidated for financial reporting purposes, such that our consolidated financial statements reflect our investment in the portfolio company investments owned by the Taxable Subsidiaries. The purpose of the Taxable Subsidiaries is to permit us to hold equity investments in portfolio companies that are taxed as partnerships for U.S. federal income tax purposes (such as entities organized as limited liability companies (“LLCs”) or other forms of pass through entities) while complying with the “source-of-income” requirements contained in the RIC tax provisions. The Taxable Subsidiaries are not consolidated with us for U.S. federal corporate income tax purposes, and each Taxable Subsidiary will be subject to U.S. federal corporate income tax on its taxable income. Any such income or expense is reflected in the consolidated statements of operations. COVID-19 Update On March 11, 2020, the World Health Organization declared the novel coronavirus, or COVID-19, as a pandemic, and on March 13, 2020 the United States declared a national emergency with respect to COVID-19. The outbreak of COVID-19 has severely impacted global economic activity and caused significant volatility and negative pressure in financial markets. The global impact of the outbreak has been rapidly evolving and many countries, including the United States, have reacted by instituting quarantines, restricting travel and hospitality, and temporarily closing or limiting operations at many corporate offices, retail stores, restaurants, fitness clubs and manufacturing facilities and factories in affected jurisdictions. Such actions are creating disruption in global supply chains and adversely impacting a number of industries. The outbreak could have a continued adverse impact on economic and market conditions and trigger a period of global economic slowdown. The rapid development and fluidity of this situation precludes any prediction as to the ultimate adverse impact of COVID-19. Nevertheless, COVID-19 presents material uncertainty and risks with respect to the underlying value of the Company’s portfolio companies, the Company’s business, financial condition, results of operations and cash flows, such as the potential negative impact to financing arrangements, company decisions to delay, defer and/or modify the character of dividends in order to preserve liquidity, increased costs of operations, changes in law and/or regulation, and uncertainty regarding government and regulatory policy. 58 Table of Contents We have evaluated subsequent events from January 2, 2021 to February 25, 2021. However, as the discussion in this Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations relates to the Company’s financial statements for the year ended December 31, 2020, the analysis contained herein may not fully account for impacts relating to the COVID-19 pandemic. In that regard, for example, as of December 31, 2020, the Company valued its portfolio investments in conformity with GAAP based on the facts and circumstances known by the Company at that time, or reasonably expected to be known at that time. Due to the overall volatility that the COVID-19 pandemic has caused during the months that followed our December 31, 2020 valuation, any valuations conducted now or in the future in conformity with GAAP could result in a lower fair value of our portfolio. The potential impact to our results going forward will depend to a large extent on future developments and new information that may emerge regarding the duration and severity of COVID-19 and the actions taken by authorities and other entities to contain the coronavirus or treat its impact, all of which are beyond our control. Accordingly, the Company cannot predict the extent to which its financial condition and results of operations will be affected at this time. Revenues : We generate revenue in the form of interest and fee income on debt investments and dividends, if any, on equity investments. Our debt investments, whether in the form of second lien, subordinated or first lien loans, typically have terms of five to seven years and most bear interest at a fixed rate, but some bear interest at a floating rate. In some instances, we receive payments on our debt investments based on scheduled amortization of the outstanding balances. In addition, we may receive repayments of some of our debt investments prior to their scheduled maturity dates, which may include prepayment penalties. The frequency or volume of these repayments fluctuates significantly from period to period. Our portfolio activity may reflect the proceeds of sales of securities. In some cases, our investments provide for deferred interest payments or PIK interest. The principal amount of debt investments and any accrued but unpaid interest generally become due at the maturity date. In addition, we may generate revenue in the form of commitment, origination, amendment, or structuring fees and fees for providing managerial assistance. Debt investment origination fees, OID and market discount or premium, if any, are capitalized, and we accrete or amortize such amounts into interest income. We record prepayment penalties on debt investments as fee income when earned. Interest and dividend income is recorded on the accrual basis to the extent that we expect to collect such amounts. Interest is accrued daily based on the outstanding principal amount and the contractual terms of the debt investment. Dividend income is recorded as dividends are declared or at the point an obligation exists for the portfolio company to make a distribution, and is generally recognized when received. Distributions of earnings from portfolio companies are evaluated to determine if the distribution is a distribution of earnings or a return of capital. Distributions of earnings are included in dividend income while a return of capital is recorded as a reduction in the cost basis of the investment. Estimates are adjusted as necessary after the relevant tax forms are received from the portfolio company. Debt investments or preferred equity investments (for which we are accruing PIK dividends) are placed on non-accrual status when principal, interest or dividend payments become materially past due, or when there is reasonable doubt that principal, interest or dividends will be collected. Interest and dividend payments received on non-accrual investments may be recognized as interest or dividend income or may be applied to the investment principal balance based on management’s judgment. Non-accrual investments are restored to accrual status when past due principal, interest or dividends are paid and, in management’s judgment, payments are likely to remain current. See “Critical Accounting Policies and Use of Estimates – Revenue Recognition.” We recognize realized gains or losses on investments based on the difference between the net proceeds from the disposition and the cost basis of the investment, without regard to unrealized gains or losses previously recognized. We record current period changes in fair value of investments that are measured at fair value as a component of the net change in unrealized appreciation (depreciation) on investments in the consolidated statements of operations. Expenses : All investment professionals of our investment advisor and/or its affiliates, when and to the extent engaged in providing investment advisory and management services to us, and the compensation and routine overhead expenses allocable to personnel who provide these services to us, are provided and paid for by our investment advisor and not by us. We bear all other out-of-pocket costs and expenses of our operations and transactions, including, without limitation, those relating to: • organization; • calculating our net asset value (including the cost and expenses of any independent valuation firm); • fees and expenses incurred by our investment advisor under the Investment Advisory Agreement or payable to third parties, including agents, consultants or other advisors, in monitoring financial and legal affairs for us and in monitoring our investments and performing due diligence on our prospective portfolio companies or otherwise relating to, or associated with, evaluating and making investments, including “dead deal” costs; • interest payable on debt, if any, incurred to finance our investments; • offerings of our common stock and other securities; • investment advisory fees and management fees; • administration fees and expenses, if any, payable under the Administration Agreement (including payments under the Administration Agreement between us and our investment advisor based upon our allocable portion of our investment advisor’s overhead in performing its obligations under the Administration Agreement, including rent and the allocable portion of the cost of our officers, including our chief compliance officer, our chief financial officer, and their respective staffs); • transfer agent, dividend agent and custodial fees and expenses; • federal and state registration fees; 59 Table of Contents • all costs of registration and listing our shares on any securities exchange; • U.S. federal, state and local taxes; • Independent Directors’ fees and expenses; • costs of preparing and filing reports or other documents required by the SEC or other regulators including printing costs; • costs of any reports, proxy statements or other notices to stockholders, including printing and mailing costs; • our allocable portion of any fidelity bond, directors and officers/errors and omissions liability insurance, and any other insurance premiums; • direct costs and expenses of administration, including printing, mailing, long distance telephone, copying, secretarial and other staff, independent auditors and outside legal costs; • proxy voting expenses; and • all other expenses reasonably incurred by us or our investment advisor in connection with administering our business. Portfolio Composition, Investment Activity and Yield During the years ended December 31, 2020 and 2019, we invested $190.0 million and $219.2 million in debt and equity investments, respectively, including 12 and 12 new portfolio companies, respectively. During the years ended December 31, 2020 and 2019, we received proceeds from sales or repayments, including principal, return of capital dividends and net realized gains (losses), of $210.8 million and $120.6 million, respectively, including exits of 7 and 11 portfolio companies, respectively. The following table summarizes investment purchases and sales and repayments of investments by type for the years ended December 31, 2020 and 2019 (dollars in millions). Purchases of Investments Sales and Repayments of Investments 2020 2019 2020 2019 Second Lien Debt $ 54.9 29.0 % $ 54.3 24.7 % $ 74.5 35.4 % $ 50.4 41.9 % Subordinated Debt 14.5 7.6 70.0 32.0 48.3 22.9 36.1 29.9 First Lien Debt 109.9 57.8 84.0 38.3 32.3 15.3 13.8 11.4 Equity 10.7 5.6 10.9 5.0 51.2 24.3 16.2 13.4 Warrants — — — — 4.5 2.1 4.1 3.4 Royalty Rights — — — — — — — — Total $ 190.0 100.0 % $ 219.2 100.0 % $ 210.8 100.0 % $ 120.6 100.0 % As of December 31, 2020, the fair value of our investment portfolio totaled $742.9 million and consisted of 66 active portfolio companies and three portfolio companies that have sold their underlying operations. As of December 31, 2020, 22 portfolio companies’ debt investments bore interest at a variable rate, which represented $230.9 million, or 36.8%, of our debt investment portfolio on a fair value basis, and the remainder of our debt investment portfolio was comprised of fixed rate investments. Overall, the portfolio had net unrealized appreciation of $55.8 million as of December 31, 2020. As of December 31, 2020, our average active portfolio company investment at amortized cost was $10.4 million, which excludes investments in the three portfolio companies that have sold their underlying operations. As of December 31, 2019, the fair value of our investment portfolio totaled $766.9 million and consisted of 61 active portfolio companies and three portfolio companies that have sold their underlying operations. As of December 31, 2019, 17 portfolio companies’ debt investments bore interest at a variable rate, which represented $181.3 million, or 28.7%, of our debt investment portfolio on a fair value basis, and the remainder of our debt investment portfolio was comprised of fixed rate investments. Overall, the portfolio had net unrealized appreciation of $62.4 million as of December 31, 2019. As of December 31, 2019, our average active portfolio company investment at amortized cost was $11.5 million, which excludes investments in the three portfolio companies that have sold their underlying operations. The weighted average yield on debt investments as of December 31, 2020 and 2019 was 12.2% and 12.0%, respectively. The weighted average yield of our debt investments is not the same as a return on investment for our stockholders but, rather, relates to a portion of our investment portfolio and is calculated before the payment of all of our and our subsidiaries’ fees and expenses. The weighted average yields were computed using the effective interest rates for debt investments at cost as of December 31, 2020 and 2019, including the accretion of OID and debt investment origination fees, but excluding investments on non-accrual status, if any. The following table shows the portfolio composition by investment type at fair value and cost and as a percentage of total investments (dollars in millions): 60 Table of Contents Fair Value Cost December 31, 2020 December 31, 2019 December 31, 2020 December 31, 2019 Second Lien Debt $ 332.2 44.7 % $ 383.1 49.9 % $ 341.9 49.7 % $ 392.2 55.7 % Subordinated Debt 107.9 14.5 140.8 18.4 107.3 15.6 140.7 20.0 First Lien Debt 187.4 25.2 108.3 14.1 184.6 26.9 107.7 15.3 Equity 112.8 15.2 126.6 16.5 50.0 7.3 58.1 8.2 Warrants 2.6 0.4 8.1 1.1 3.2 0.5 5.8 0.8 Royalty Rights — — — — — — — — Total $ 742.9 100.0 % $ 766.9 100.0 % $ 687.0 100.0 % $ 704.5 100.0 % All investments made by us as of December 31, 2020 and 2019 were made in portfolio companies headquartered in the U.S. The following table shows portfolio composition by geographic region at fair value and cost and as a percentage of total investments (dollars in millions). The geographic composition is determined by the location of the corporate headquarters of the portfolio company, which may not be indicative of the primary source of the portfolio company’s business. Fair Value Cost December 31, 2020 December 31, 2019 December 31, 2020 December 31, 2019 Midwest $ 225.7 30.4 % $ 208.2 27.1 % $ 189.6 27.6 % $ 181.3 25.7 % Southeast 153.3 20.6 160.0 20.9 130.0 18.9 138.1 19.6 Northeast 123.3 16.6 154.7 20.2 127.8 18.6 142.1 20.2 West 108.7 14.6 76.3 9.9 109.2 15.9 76.6 10.9 Southwest 131.9 17.8 167.7 21.9 130.4 19.0 166.4 23.6 Total $ 742.9 100.0 % $ 766.9 100.0 % $ 687.0 100.0 % $ 704.5 100.0 % The following table shows the detailed industry composition of our portfolio at fair value and cost as a percentage of total investments: 61 Table of Contents Fair Value Cost December 31, 2020 December 31, 2019 December 31, 2020 December 31, 2019 Specialty Distribution 15.8 % 16.9 % 17.0 % 18.3 % Information Technology Services 12.8 11.8 13.2 11.9 Business Services 12.3 12.1 13.0 13.0 Healthcare Products 9.0 8.6 4.8 5.7 Component Manufacturing 7.4 5.2 6.9 6.2 Healthcare Services 5.4 5.6 6.0 5.8 Aerospace & Defense Manufacturing 5.2 4.5 5.6 3.8 Consumer Products 5.1 2.8 5.5 3.4 Retail 3.6 3.8 4.4 4.2 Promotional Products 3.3 3.5 3.7 3.6 Building Products Manufacturing 3.2 2.7 3.8 3.3 Transportation Services 3.0 3.4 3.1 3.3 Oil & Gas Services 2.8 4.3 0.4 0.8 Utilities: Services 2.5 2.4 2.7 2.6 Environmental Industries 2.4 2.4 2.7 2.6 Packaging 2.1 2.0 2.1 2.1 Oil & Gas Distribution 1.5 0.8 1.5 0.8 Industrial Cleaning & Coatings 1.4 2.0 1.9 2.2 Utility Equipment Manufacturing 0.9 0.9 1.3 1.2 Vending Equipment Manufacturing 0.3 4.3 0.3 5.1 Restaurants 0.0 (1) 0.0 (1) 0.1 0.1 Specialty Chemicals 0.0 (1) 0.0 (1) 0.0 (1) 0.0 (1) Total 100.0 % 100.0 % 100.0 % 100.0 % (1) Percentage is less than 0.1% of respective total. Portfolio Asset Quality In addition to various risk management and monitoring tools, our investment advisor uses an internally developed investment rating system to characterize and monitor the credit profile and our expected level of returns on each investment in our portfolio. We use a five-level numeric rating scale. The following is a description of the conditions associated with each investment rating: • Investment Rating 1 is used for investments that involve the least amount of risk in our portfolio. The portfolio company is performing above expectations, the debt investment is expected to be paid in the near term and the trends and risk factors are favorable, and may include an expected capital gain on the equity investment. • Investment Rating 2 is used for investments that involve a level of risk similar to the risk at the time of origination. The portfolio company is performing substantially within our expectations and the risk factors are neutral or favorable. Each new portfolio investment enters our portfolio with Investment Rating 2. • Investment Rating 3 is used for investments performing below expectations and indicates the investment’s risk has increased somewhat since origination. The portfolio company requires closer monitoring, but we expect a full return of principal and collection of all interest and/or dividends. • Investment Rating 4 is used for investments performing materially below expectations and the risk has increased materially since origination. The investment has the potential for some loss of investment return, but we expect no loss of principal. • Investment Rating 5 is used for investments performing substantially below our expectations and the risks have increased substantially since origination. We expect some loss of principal. 62 Table of Contents The following table shows the distribution of our investments on the 1 to 5 investment rating scale at fair value and cost as of December 31, 2020 and 2019 (dollars in millions): Fair Value Cost Investment Rating December 31, 2020 December 31, 2019 December 31, 2020 December 31, 2019 1 $ 109.3 14.7 % $ 100.1 13.1 % $ 38.7 5.6 % $ 29.0 4.2 % 2 544.4 73.3 580.5 75.7 537.6 78.3 570.1 80.9 3 80.1 10.8 84.6 11.0 87.5 12.7 96.7 13.7 4 9.0 1.2 1.7 0.2 13.7 2.0 5.8 0.8 5 0.1 — — — 9.5 1.4 2.9 0.4 Total $ 742.9 100.0 % $ 766.9 100.0 % $ 687.0 100.0 % $ 704.5 100.0 % Based on our investment rating system, the weighted average rating of our portfolio as of December 31, 2020 and 2019 was 2.0 and 2.0, respectively, on a fair value basis and 2.2 and 2.1, respectively, on a cost basis. Non-Accrual As of December 31, 2020 and December 31, 2019, we had debt investments in one portfolio company on non-accrual status (dollars in millions): December 31, 2020 December 31, 2019 Portfolio Company Fair Value Cost Fair Value Cost Frontline Food Services, LLC (f/k/a Accent Food Services, LLC) $ — (1) $ — (1) $ 33.1 $ 35.3 EBL, LLC (EbLens) 5.5 (2) 9.2 (2) — (3) — (3) Total $ 5.5 $ 9.2 $ 33.1 $ 35.3 (1) Portfolio company was no longer held at period end. (2) Portfolio company was on PIK-only on non-accrual status at period end, meaning the Company has ceased recognizing PIK interest income on the investment. (3) Portfolio company debt investments were not on non-accrual status at period end. Discussion and Analysis of Results of Operations Comparison of fiscal years ended December 31, 2020, 2019, and 2018 Investment Income Below is a summary of the changes in total investment income for the years ended December 31, 2020, 2019, and 2018, as well as a comparison of those periods year-over-year (dollars in millions, percent change calculated based on underlying dollar amounts in thousands): Years Ended December 31, 2020 vs. 2019 2019 vs. 2018 2020 2019 2018 $ Change % Change (1) $ Change % Change (1) Interest income $ 73.5 $ 62.2 $ 60.9 $ 11.3 18.2 % $ 1.3 2.1 % Payment-in-kind interest income 4.7 9.1 6.6 (4.4 ) (48.8 %) 2.5 38.4 % Dividend income 2.4 1.4 4.0 1.0 73.2 % (2.6 ) (64.5 %) Fee income 4.5 4.3 4.8 0.2 3.9 % (0.5 ) (11.0 %) Interest on idle funds — 0.1 0.1 (0.1 ) (89.2 %) — NM Total investment income $ 85.1 $ 77.1 $ 76.4 $ 8.0 10.4 % $ 0.7 0.9 % (1) NM = Not meaningful For the year ended December 31, 2020, total investment income was $85.1 million, an increase of $8.0 million or 10.4%, from the $77.1 million of total investment income for the year ended December 31, 2019. As reflected in the table above, the increase is primarily attributable to the following: • $6.9 million increase in total interest income (including payment-in-kind interest income) resulting from higher weighted average debt yield and higher average debt investment balances outstanding, during 2020 as compared to 2019. • $1.0 million increase in dividend income, during 2020 as compared to 2019, due to increased levels of distributions received from equity investments. • $0.2 million increase in fee income resulting from an increase in debt amendment fee income partially offset by a decrease in origination and prepayment fees income during 2020 as compared to 2019. 63 Table of Contents For the year ended December 31, 2019, total investment income was $77.1 million, an increase of $0.7 million or 0.9%, from the $76.4 million of total investment income for the year ended December 31, 2018. As reflected in the table above, the increase is primarily attributable to the following: • $3.8 million increase in total interest income (including payment-in-kind interest income) resulting from higher average debt investment balances outstanding, partially offset by a decrease in weighted average debt yield, during 2019 as compared to 2018. • $2.6 million decrease in dividend income, during 2019 as compared to 2018, due to decreased levels of distributions received from equity investments. • $0.5 million decrease in fee income resulting from a decrease in prepayment fee income, and partially offset by an increase in debt amendment fee income and origination fees, during 2019 as compared to 2018. Expenses Below is a summary of the changes in total expenses, including income tax provision, for the years ended December 31, 2020, 2019, and 2018, as well as a comparison of those periods year-over-year (dollars in millions, percent change calculated based on underlying dollar amounts in thousands): Years Ended December 31, 2020 vs. 2019 2019 vs. 2018 2020 2019 2018 $ Change % Change (1) $ Change % Change (1) Interest and financing expenses $ 19.7 $ 17.1 $ 12.7 $ 2.6 15.3 % $ 4.4 34.9 % Base management fee 12.9 12.4 11.4 0.5 4.3 % 1.0 9.1 % Incentive fee - income 9.0 7.4 9.4 1.6 20.2 % (2.0 ) (20.9 %) Incentive fee - capital gains (1.7 ) 3.3 2.9 (5.0 ) (151.0 %) 0.4 12.3 % Administrative service expenses 1.7 1.6 1.5 0.1 8.7 % 0.1 8.3 % Professional fees 2.1 1.5 1.3 0.6 34.6 % 0.2 15.6 % Other general and administrative expenses 1.3 1.3 1.4 — NM (0.1 ) (12.3 %) Total expenses, before incentive fee waiver 45.0 44.6 40.6 0.4 0.9 % 4.0 9.8 % Incentive fee waiver - income (0.4 ) — — (0.4 ) NM — NM Total expenses, net of incentive fee waiver before income tax provision 44.6 44.6 40.6 — NM 4.0 9.1 % Income tax provision 0.9 0.5 0.8 0.4 72.4 % (0.3 ) 0.0 % Total expenses, including income tax provision $ 45.5 $ 45.1 $ 41.4 $ 0.4 0.7 % $ 3.7 9.1 % (1) NM = Not meaningful For the year ended December 31, 2020, total expenses, including income tax provision, were $45.5 million, an increase of $0.4 million or 0.7%, from the $45.1 million of total expenses, including income tax provision, for the year ended December 31, 2019. As reflected in the table above, the increase is primarily attributable to the following: • $2.6 million increase in interest and financing expenses due to an increase in average borrowings outstanding and an increase in weighted average interest rate on borrowings during 2020 as compared to 2019. • $1.2 million net increase in the income incentive fee comprised of a $1.6 million increase in the income incentive fee due to a $3.8 million increase in pre-incentive fee net investment income during 2020 offset by a one-time $0.4 million income incentive fee waiver, as compared to the same period in 2019. • $0.6 million increase in professional fees during 2020 as compared to 2019. • $0.5 million increase in base management fee due to higher average total assets during 2020 as compared to 2019. • $5.0 million decrease in the capital gains incentive fee due to a $25.0 million decrease in net gain on investments (net realized gains (losses) plus net change in unrealized appreciation (depreciation) on investments) during 2020, as compared to the same period in 2019. For the year ended December 31, 2019, total expenses, including income tax provision, were $45.1 million, an increase of $3.7 million or 9.1%, from the $41.4 million of total expenses, including income tax provision, for the year ended December 31, 2018. As reflected in the table above, the increase is primarily attributable to the following: • $4.4 million increase in interest and financing expenses due to an increase in average borrowings outstanding and an increase in weighted average interest rate on borrowings during 2019 as compared to 2018. • $2.0 million decrease in the income incentive fee due to a $4.7 million decrease in pre-incentive fee net investment income during 2019, as compared to the same period in 2018. 64 Table of Contents • $1.0 million increase in base management fee due to higher average total assets during 2019 as compared to 2018. • $0.4 million increase in the capital gains incentive fee due to a $2.2 million increase in net gain on investments (net realized gains (losses) plus net change in unrealized appreciation (depreciation) on investments) during 2019, as compared to the same period in 2018. • $0.1 million decrease in other general and administrative expenses during 2019 resulting from the write-off of deferred equity offering costs related to our previous Form N-2 registration statement in 2018. Net Investment Income Net investment income was $39.6 million, $32.0 million, and $35.1 million for the years ended December 31, 2020, 2019, and 2018, respectively. Net investment income increased by $7.6 million, or 24.0%, during fiscal 2020 as compared to fiscal 2019, as a result of the $8.0 million increase in total investment income compared to a $0.4 million increase in total expenses, including the income incentive fee waiver and income tax provision. Net investment income decreased by $3.1 million, or 8.8%, during fiscal 2019 as compared to fiscal 2018, as a result of the $0.7 million increase in total investment income compared to a $3.8 million increase in total expenses, including income tax provision. 65 Table of Contents Net Gain (Loss) on Investments For the year ended December 31, 2020, the total net realized loss on investments, before income tax provision on realized gains, was $(1.0) million. Income tax (provision) benefit from realized gains on investments was $(0.6) million for the year ended December 31, 2020. Significant realized gains (losses) for the year ended December 31, 2020 are summarized below (dollars in millions): Net Realized Portfolio Company Realization Event (1) Gains (Losses) Pfanstiehl, Inc. Sold 50% of equity investment $ 12.8 Fiber Materials, Inc. Sale of portfolio company 9.7 Microbiology Research Associates, Inc. Exit of portfolio company 1.7 Medsurant Holdings, LLC Sold 50% of equity investment 1.7 Revenue Management Solutions, LLC Sold 50% of equity investment 1.5 Worldwide Express Operations, LLC Sold 50% of equity investment 1.1 Gurobi Optimization, LLC Sold 50% of equity investment 1.0 ControlScan, Inc. Exit of portfolio company 1.0 Pugh Lubricants, LLC Exit of portfolio company 0.9 Hub Acquisition Sub, LLC (dba Hub Pen) Sold 50% of equity investment 0.6 Global Plasma Solutions, Inc. Sale of equity investment 0.5 Midwest Transit Equipment, Inc. Sold 50% of equity investment 0.5 Pinnergy, Ltd. Sale of equity investment 0.3 Alzheimer’s Research and Treatment Center, LLC Sold 50% of equity investment 0.3 Hoonuit, LLC Exit of portfolio company 0.2 BCM One Group Holdings, Inc. Sold 50% of equity investment 0.2 Software Technology, LLC Sold 50% of equity investment 0.2 LNG Indy, LLC (dba Kinetrex Energy) Sold 50% of equity investment 0.2 New Era Technology, Inc. Escrow distribution 0.1 Wheel Pros, Inc. Sold 50% of equity investment 0.1 Apex Microtechnology, Inc. Escrow distribution 0.1 Allied 100 Group, Inc. Sold 50% of equity investment 0.1 Restaurant Finance Co, LLC Escrow distribution 0.1 Vanguard Dealer Services, L.L.C. Escrow distribution 0.1 Allredi, LLC (fka Marco Group International OpCo, LLC) Sold 50% of equity investment 0.1 Other 0.1 Palisade Company, LLC Sold 50% of equity investment (0.1 ) Frontline Food Services, LLC (f/k/a Accent Food Services, LLC) Write-off of debt and equity investments (36.1 ) Net realized gain (loss) on investments (1.0 ) Income tax provision from realized gains on investments (0.6 ) Net realized gain (loss), net of income tax provision, on investments $ (1.6 ) (1) As it relates to realization events, we define an ‘exit’ of a portfolio company as situations where we have completely exited our position in all of the portfolio company’s securities and no longer carry the portfolio company on our schedule of investments. We define a ‘sale’ of a portfolio company, distinguished from an exit, as situations where the underlying operations of a portfolio company have been sold, but where we retain a residual ownership interest in the legacy entity (we generally distinguish these residual portfolio company investments from ‘active’ portfolio company investments). For the year ended December 31, 2019, the total net realized loss on investments, before income tax provision on realized gains, was $(1.2) million. Income tax (provision) benefit from realized gains on investments was $(0.1) million for the year ended December 31, 2019. Significant realized gains (losses) for the year ended December 31, 2019 are summarized below (dollars in millions): 66 Table of Contents Net Realized Portfolio Company Realization Event (1) Gains (Losses) The Wolf Organization, LLC Exit of portfolio company $ 4.0 Vanguard Dealer Services, L.L.C. Sale of portfolio company 3.7 New Era Technology, Inc. Exit of portfolio company 3.1 Simplex Manufacturing Co. Exit of portfolio company 2.9 US Pack Logistics LLC Exit of portfolio company 0.8 Other 0.2 Malabar International Escrow distribution 0.1 inthinc Technology Solutions, Inc. Exit of portfolio company (0.2 ) Trantech Radiator Products, Inc. Exit of portfolio company (0.3 ) Consolidated Infrastructure Group Holdings, LP Exit of portfolio company (0.4 ) K2 Industrial Services, Inc. Exit of portfolio company (1.3 ) Oaktree Medical Centre, P.C. (dba Pain Management Associates) Exit of portfolio company (13.8 ) Net realized gain (loss) on investments (1.2 ) Income tax provision from realized gains on investments (0.1 ) Net realized gain (loss), net of income tax provision, on investments $ (1.3 ) (1) As it relates to realization events, we define an ‘exit’ of a portfolio company as situations where we have completely exited our position in all of the portfolio company’s securities and no longer carry the portfolio company on our schedule of investments. We define a ‘sale’ of a portfolio company, distinguished from an exit, as situations where the underlying operations of a portfolio company have been sold, but where we retain a residual ownership interest in the legacy entity (we generally distinguish these residual portfolio company investments from ‘active’ portfolio company investments). For the year ended December 31, 2018, the total net realized loss on investments, before income tax provision on realized gains, was $(10.3) million. Income tax (provision) benefit from realized gains on investments was $(0.8) million for the year ended December 31, 2018. Significant realized gains (losses) for the year ended December 31, 2018 are summarized below (dollars in millions): Net Realized Portfolio Company Realization Event (1) Gains (Losses) World Wide Packaging, LLC Exit of portfolio company $ 7.0 Apex Microtechnology, Inc. Exit of portfolio company 6.7 FAR Research Inc. Sale of portfolio company 3.3 Caldwell & Gregory, LLC Exit of portfolio company 1.0 Thermoforming Technology Group LLC (dba Brown Machine Group) Sale of portfolio company 0.7 Malabar International Escrow distribution 0.3 Worldwide Express Operations, LLC Distributions tax character true-up 0.2 Ice House America, LLC Exit of portfolio company 0.1 Other 0.1 IOS Acquisitions, Inc. Exit of portfolio company (0.1 ) Inflexxion, Inc. Exit of portfolio company (6.5 ) Restaurant Finance Co, LLC Exit of portfolio company (6.8 ) Cavallo Bus Lines Holdings, LLC Exit of portfolio company (7.4 ) Six Month Smiles Holdings, Inc. Exit of portfolio company (8.9 ) Net realized gain (loss) on investments (10.3 ) Income tax provision from realized gains on investments (0.8 ) Net realized gain (loss), net of income tax provision, on investments $ (11.1 ) (1) As it relates to realization events, we define an ‘exit’ of a portfolio company as situations where we have completely exited our position in all of the portfolio company’s securities and no longer carry the portfolio company on our schedule of investments. We define a ‘sale’ of a portfolio company, distinguished from an exit, as situations where the underlying operations of a portfolio company have been sold, but where we retain a residual ownership interest in the legacy entity (we generally distinguish these residual portfolio company investments from ‘active’ portfolio company investments). 67 Table of Contents During the years ended December 31, 2020, 2019, and 2018, we recorded a net change in unrealized appreciation (depreciation) on investments attributable to the following (dollars in millions): Year Ended December 31, Unrealized Appreciation (Depreciation) 2020 2019 2018 Exit, sale or restructuring of investments $ (0.8 ) $ 7.4 $ 11.2 Fair value adjustments to debt investments (27.8 ) (7.1 ) (18.0 ) Fair value adjustments to equity investments 22.0 17.9 32.5 Net change in unrealized appreciation (depreciation) $ (6.6 ) $ 18.2 $ 25.7 Net Increase in Net Assets Resulting From Operations Net increase in net assets resulting from operations was $31.2 million, $48.5 million, and $49.5 million for the years ended December 31, 2020, 2019, and 2018, respectively, as a result of the events described above. Liquidity and Capital Resources As of December 31, 2020, we had $124.3 million in cash and cash equivalents and our net assets totaled $410.8 million. We believe that our current cash and cash equivalents on hand, our continued access to SBA-guaranteed debentures, our Credit Facility and our anticipated cash flows from investments will provide adequate capital resources with which to operate and finance our investment business and make distributions to our stockholders for at least the next 12 months. We intend to generate additional cash primarily from the future offerings of securities (including the “at-the-market” program) and future borrowings, as well as cash flows from operations, including income earned from investments in our portfolio companies. On both a short-term and long-term basis, our primary use of funds will be investments in portfolio companies and cash distributions to our stockholders. During the year ended December 31, 2020, we repaid $16.5 million of SBA debentures which would have matured during the period September 1, 2024 through September 1, 2028 Our remaining outstanding SBA debentures continue to mature in 2025 and subsequent years through 2030, which will require repayment on or before the respective maturity dates. Cash Flows For the year ended December 31, 2020, we experienced a net increase in cash and cash equivalents in the amount of $109.3 million. During that period, we were provided $56.0 million of cash from operating activities, which included proceeds received from sales and repayments of investments of $210.8 million, which were partially offset by the funding of $190.0 million of investments. During the same period, we received proceeds from the issuances of SBA debentures of $6.0 million and proceeds from the issuance of our 2026 Notes of $125.0 million; which were partially offset by repayments of SBA debentures of $16.5 million, net repayments of $25.0 million from borrowings under our Credit Facility, cash dividends paid to stockholders of $32.5 million, and the payment of deferred financing costs related to our debt financings of $3.4 million and repurchases of common stock under the Stock Repurchase Program (as defined below) of $0.3 million. For the year ended December 31, 2019, we experienced a net decrease in cash and cash equivalents in the amount of $27.0 million. During that period, we used $68.7 million of cash for operating activities, which included the funding of $219.2 million of investments, which were partially offset by proceeds received from sales and repayments of investments of $120.6 million. During the same period, we received proceeds from the issuances of SBA debentures of $7.5 million and proceeds from the issuance of our Public Notes of $132.3 million; which were partially offset by repayments of SBA debentures of $41.0 million, net repayments of $11.5 million from borrowings under our Credit Facility, cash dividends paid to stockholders of $39.1 million, and the payment of deferred financing costs related to our debt financings of $6.4 million. For the year ended December 31, 2018, we experienced a net increase in cash and cash equivalents in the amount of $0.4 million. During that period, we used $8.1 million of cash for operating activities, which included the funding of $212.3 million of investments, which were partially offset by proceeds received from sales and repayments of investments of $188.3 million. During the same period, we received proceeds from the issuances of SBA debentures of $27.0 million, net proceeds of $25.0 million from borrowings under our Credit Facility and proceeds from the issuance of our Public Notes of $50.0 million; which were partially offset by repayments of SBA debentures of $67.3 million, cash dividends paid to stockholders of $39.2 million, the payment of deferred financing costs related to our debt financings of $2.7 million and repurchases of common stock under the Stock Repurchase Program (as defined below) of $0.6 million. Capital Resources We anticipate that we will continue to fund our investment activities on a long-term basis through a combination of additional debt and equity capital. 68 Table of Contents SBA debentures The Funds are licensed SBICs, and have the ability to issue debentures guaranteed by the SBA at favorable interest rates. Under the Small Business Investment Act and the SBA rules applicable to SBICs, an SBIC can have outstanding at any time debentures guaranteed by the SBA in an amount up to twice its regulatory capital. The SBA regulations currently limit the amount that is available to be borrowed by any SBIC and guaranteed by the SBA to 300.0% of an SBIC’s regulatory capital or $175.0 million, whichever is less. For two or more SBICs under common control, the maximum amount of outstanding SBA debentures cannot exceed $350.0 million. SBA debentures have fixed interest rates that approximate prevailing 10-year Treasury Note rates plus a spread and have a maturity of ten years with interest payable semi-annually. The principal amount of the SBA debentures is not required to be paid before maturity but may be pre-paid at any time. As of December 31, 2020, Fund II and Fund III had $133.5 million and $13.5 million of outstanding SBA debentures, respectively. As of September 9, 2019, Fund I completed a wind-down plan, relinquished its SBIC license and can no longer issue additional SBA debentures. Subject to SBA regulatory requirements and approval, Fund III may access up to $161.5 million of additional SBA debentures under the SBIC debenture program. For more information on the SBA debentures, please refer to Note 6 to our consolidated financial statements. Credit Facility In June 2014, we entered into the Credit Facility to provide additional funding for our investment and operational activities. On April 24, 2019, we entered into the Amended Credit Agreement, which amends, restates, and replaces the Credit Facility. On June 26, 2020, the Company amended the Amended Credit Agreement, however the material terms were unchanged. Among other revisions, the amendment to the Amended Credit Agreement modifies certain covenants therein, including to amend the minimum consolidated interest coverage ratio to be 2.25 to 1.00 for the four quarter period ending on June 30, 2020, 2.00 to 1.00 for the four quarter periods ending on each of September 30, 2020 and December 31, 2020, and 1.75 to 1.00 for each four quarter period ending at the end of each quarter thereafter. The Credit Facility is secured by substantially all of our assets, excluding the assets of the Funds. Under the Amended Credit Agreement, (i) revolving commitments by lenders were increased from $90.0 million to $100.0 million, with an accordion feature that allows for an increase in total commitments up to $250.0 million, subject to satisfaction of certain conditions at the time of any such future increase, (ii) the maturity date of the credit facility was extended from June 16, 2019 to April 24, 2023, and (iii) borrowings under the Credit Facility bear interest, at our election, at a rate per annum equal to (a) 3.00% (or 2.75% if certain conditions are satisfied, including if (x) no equity interests are included in the borrowing base, (y) the contribution to the borrowing base of eligible portfolio investments that are performing first lien bank loans is greater than or equal to 35%, and (z) the contribution to the borrowing base of eligible portfolio investments that are performing first lien bank loans, performing last out loans, or performing second lien loans is greater than or equal to 60%) plus the one, two, three or six month LIBOR rate, as applicable, or (b) 2.00% (or 1.75% if the above conditions are satisfied) plus the highest of (A) a prime rate, (B) the Federal Funds rate plus 0.5%, (C) three month LIBOR plus 1.0%, and (D) zero. We pay a commitment fee that varies depending on the size of the unused portion of the Credit Facility: 3.00% per annum on the unused portion of the Credit Facility at or below 35% of the commitments and 0.50% per annum on any remaining unused portion of the Credit Facility between the total commitments and the 35% minimum utilization. The Amended Credit Agreement also modifies certain covenants in the Credit Facility, including to provide for a minimum asset coverage ratio of 2.00 to 1 (on a regulatory basis). The Credit Facility is secured by a first priority security interest in all of our assets, excluding the assets of our SBIC subsidiaries. Amounts available to borrow under the Credit Facility are subject to a minimum borrowing/collateral base that applies an advance rate to certain investments held by us, excluding investments held by the Funds. We are subject to limitations with respect to the investments securing the Credit Facility, including, but not limited to, restrictions on sector concentrations, loan size, payment frequency and status and collateral interests, as well as restrictions on portfolio company leverage, which may also affect the borrowing base and therefore amounts available to borrow. We have made customary representations and warranties and we are required to comply with various covenants, reporting requirements and other customary requirements for similar credit facilities. These covenants are subject to important limitations and exceptions that are described in the documents governing the Credit Facility. As of December 31, 2020, we were in compliance with all covenants of the Credit Facility and there were no borrowings outstanding under the Credit Facility. Notes On February 2, 2018, we closed the public offering of approximately $43.5 million in aggregate principal amount of our 5.875% notes due 2023, or the “2023 Notes.” On February 22, 2018, the underwriters exercised their option to purchase an additional $6.5 million in aggregate principal of the 2023 Notes. The total net proceeds to us from the 2023 Notes, including the exercise of the underwriters’ option, after deducting underwriting discounts of approximately $1.5 million and estimated offering expenses of $0.4 million, were approximately $48.1 million. The 2023 Notes will mature on February 1, 2023 and bear interest at a rate of 5.875%. The 2023 Notes may be redeemed in whole or in part at any time or from time to time at our option on or after February 1, 2020. Interest on the 2023 Notes is payable quarterly on February 1, May 1, August 1 and November 1 of each year. The 2023 Notes are listed on the NASDAQ Global Select Market under the trading symbol “FDUSL.” As of December 31, 2020, the outstanding principal balance of the 2023 Notes was $50.0 million. Subsequent to December 31, 2020, the Company redeemed, in full, the issued and outstanding 2023 Notes. See “Recent Developments” for more information. 69 Table of Contents On February 8, 2019, we closed the public offering of approximately $60.0 million in aggregate principal amount of our 6.000% notes due 2024, or the “February 2024 Notes.” On February 19, 2019, the underwriters exercised their option to purchase an additional $9.0 million in aggregate principal of the February 2024 Notes. The total net proceeds to us from the February 2024 Notes, including the exercise of the underwriters’ option, after deducting underwriting discounts of approximately $2.1 million and estimated offering expenses of $0.4 million, were approximately $66.5 million. The February 2024 Notes will mature on February 15, 2024 and bear interest at a rate of 6.000%. The February 2024 Notes may be redeemed in whole or in part at any time or from time to time at our option on or after February 15, 2021. Interest on the February 2024 Notes is payable quarterly on February 15, May 15, August 15 and November 15 of each year, beginning May 15, 2019. The February 2024 Notes are listed on the NASDAQ Global Select Market under the trading symbol “FDUSZ.” As of December 31, 2020, the outstanding principal balance of the February 2024 Notes was $69.0 million. Subsequent to December 31, 2020, the Company redeemed, in part, the issued and outstanding February 2024 Notes. See “Recent Developments” for more information. On October 16, 2019, we closed the public offering of approximately $55.0 million in aggregate principal amount of our 5.375% notes due 2024, or the “November 2024 Notes” (and collectively with the 2023 Notes and the February 2024 Notes, the “Public Notes”). On October 23, 2019, the underwriters exercised their option to purchase an additional $8.3 million in aggregate principal of the November 2024 Notes. The total net proceeds to us from the November 2024 Notes, including the exercise of the underwriters’ option, after deducting underwriting discounts of approximately $1.9 million and estimated offering expenses of $0.3 million, were approximately $61.1 million. The November 2024 Notes will mature on November 1, 2024 and bear interest at a rate of 5.375%. The November 2024 Notes may be redeemed in whole or in part at any time or from time to time at our option on or after November 1, 2021. Interest on the November 2024 Notes is payable quarterly on February 1, May 1, August 1 and November 1 of each year, beginning February 1, 2020. The November 2024 Notes are listed on the NASDAQ Global Select Market under the trading symbol “FDUSG.” As of December 31, 2020, the outstanding principal balance of the November 2024 Notes was approximately $63.3 million. On December 23, 2020, we closed the offering of approximately $125.0 million in aggregate principal amount of our 4.75% notes due 2026, or the “2026 Notes” (collectively with the Public Notes, the “Notes”). The total net proceeds to us from the 2026 Notes after deducting underwriting discounts of approximately $2.5 million and estimated offering expenses of $0.4 million, were approximately $122.1 million. The 2026 Notes will mature on January 31, 2026 and bear interest at a rate of 4.75%. The 2026 Notes may be redeemed in whole or in part at any time or from time to time at our option subject to a make whole provision if redeemed more than three months prior to maturity. Interest on the 2026 Notes is payable on January 31 and July 31 of each year, beginning July 31, 2021. We do not intent to list the 2026 Notes on any securities exchange or automated dealer quotation system. The Notes are unsecured obligations and rank pari passu with our future unsecured indebtedness; effectively subordinated to all of our existing and future secured indebtedness; and structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries, financing vehicles, or similar facilities we may form in the future, with respect to claims on the assets of any such subsidiaries, financing vehicles, or similar facilities. As of December 31, 2020, the weighted average stated interest rates for our SBA debentures and the Notes were 3.297% and 5.342%, respectively. As of December 31, 2020, we had $100.0 million of unutilized commitment under our Credit Facility. As of December 31, 2020, the weighted average stated interest rate on total debt outstanding was 4.680%. As a BDC, we are generally required to meet an asset coverage ratio of at least 150.0% (defined as the ratio which the value of our consolidated total assets, less all consolidated liabilities and indebtedness not represented by senior securities, bears to the aggregate amount of senior securities representing indebtedness), which includes borrowings and any preferred stock we may issue in the future. This requirement limits the amount that we may borrow. We have received exemptive relief from the U.S. Securities and Exchange Commission (“SEC”) to allow us to exclude any indebtedness guaranteed by the SBA and issued by the Funds from the 150.0% asset coverage requirements, which, in turn, will enable us to fund more investments with debt capital. As a BDC, we are generally not permitted 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 the Board, including the Independent Directors, determines that such sale is in the best interests of us and our stockholders, and if our stockholders approve such sale. On June 4, 2020, our stockholders voted to allow us to sell or otherwise issue common stock at a price below net asset value per share for a period of one year ending on the earlier of June 4, 2021 or the date of our 2021 Annual Meeting of Stockholders. We expect to present to our stockholders a similar proposal at our 2021 Annual Meeting of Stockholders. Our stockholders specified that the cumulative number of shares sold in each offering during the one-year period ending on the earlier of June 4, 2021 or the date of our 2021 Annual Meeting of Stockholders may not exceed 25.0% of our outstanding common stock immediately prior to each such sale. 70 Table of Contents Stock Repurchase Program We have an open market stock repurchase program (the “Stock Repurchase Program”) under which we may acquire up to $5.0 million of our outstanding common stock. Under the Stock Repurchase Program, we may, but are not obligated to, repurchase outstanding common stock in the open market from time to time provided that we comply with the prohibitions under our insider trading policies and the requirements of Rule 10b-18 of the Securities Exchange Act of 1934, as amended, including certain price, market value and timing constraints. The timing, manner, price and amount of any share repurchases will be determined by our management, in its discretion, based upon the evaluation of economic and market conditions, stock price, capital availability, applicable legal and regulatory requirements and other corporate considerations. On October 26, 2020, the Board extended the Stock Repurchase Program through December 31, 2021, or until the approved dollar amount has been used to repurchase shares. The Stock Repurchase Program does not require us to repurchase any specific number of shares and we cannot assure that any shares will be repurchased under the Stock Repurchase Program. The Stock Repurchase Program may be suspended, extended, modified or discontinued at any time. During the years ended December 31, 2020 and 2018, the Company repurchased 25,719 and 44,821 shares, respectively, of common stock on the open market for $0.3 and $0.6 million, respectively. The Company did not make any repurchases of common stock during the year ended December 31, 2019. Refer to Note 8 to our consolidated financial statements for additional information concerning stock repurchases. Critical Accounting Policies and Use of Estimates The preparation of financial statements in accordance with GAAP requires management to make certain estimates and assumptions affecting amounts reported in the financial statements. We have identified investment valuation and revenue recognition as our most critical accounting estimates. We continuously evaluate our estimates, including those related to the matters described below. These estimates are based on the information that is currently available to us and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions or conditions. A discussion of our critical accounting policies follows. Valuation of Portfolio Investments As a BDC, we report our assets and liabilities at fair value at all times consistent with GAAP and the 1940 Act. Accordingly, we are required to periodically determine the fair value of all of our portfolio investments. Our investments generally consist of illiquid securities including debt and equity investments in lower middle-market companies. Investments for which market quotations are readily available are valued at such market quotations. Because we expect that there will not be a readily available market for substantially all of the investments in our portfolio, we value substantially all of our portfolio investments at fair value as determined in good faith by our board of directors using a documented valuation policy and consistently applied valuation process. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the difference could be material. With respect to investments for which market quotations are not readily available, our board of directors undertakes a multi-step valuation process each quarter, as described below: • our quarterly valuation process begins with each portfolio company or investment being initially evaluated and rated by the investment professionals of our investment advisor responsible for the portfolio investment; • preliminary valuation conclusions are then documented and discussed with the investment committee of our investment advisor; • our board of directors engages one or more independent valuation firm(s) to conduct independent appraisals of a selection of our portfolio investments for which market quotations are not readily available. Each portfolio company investment is generally appraised by the valuation firm(s) at least once every calendar year and each new portfolio company investment is appraised at least once in the twelve-month period following the initial investment. In certain instances, we may determine that it is not cost-effective, and as a result it is not in our stockholders’ best interest, to request the independent appraisal of certain portfolio company investments. Such instances include, but are not limited to, situations where we determine that the fair value of the portfolio company investment is relatively insignificant to the fair value of the total portfolio. Our board of directors consulted with the independent valuation firm(s) in arriving at our determination of fair value for 12 and 13 of our portfolio company investments representing 25.8% and 30.9% of the total portfolio investments at fair value (exclusive of new portfolio company investments made during the three months ended December 31, 2020 and 2019, respectively) as of December 31, 2020 and 2019, respectively; • the audit committee of our board of directors reviews the preliminary valuations of our investment advisor and of the independent valuation firm(s) and responds and supplements the valuation recommendations to reflect any comments; and • our board of directors discusses the valuations and determines the fair value of each investment in our portfolio in good faith, based on the input of our investment advisor, the independent valuation firm(s) and the audit committee. 71 Table of Contents In making the good faith determination of the value of portfolio investments, we start with the cost basis of the security. The transaction price is typically the best estimate of fair value at inception. When evidence supports a subsequent change to the carrying value from the original transaction price, adjustments are made to reflect the expected exit values. Consistent with the policies and methodologies adopted by our board of directors, we perform detailed valuations of our debt and equity investments, including an analysis on the Company’s unfunded debt investment commitments, using both the market and income approaches as appropriate. Under the market approach, we typically use the enterprise value methodology to determine the fair value of an investment. There is no one methodology to estimate enterprise value and, in fact, for any one portfolio company, enterprise value is generally best expressed as a range of values, from which we derive a single estimate of enterprise value. Under the income approach, we typically prepare and analyze discounted cash flow models to estimate the present value of future cash flows of either an individual debt investment or of the underlying portfolio company itself. We evaluate investments in portfolio companies using the most recent portfolio company financial statements and forecasts. We also consult with the portfolio company’s senior management to obtain further updates on the portfolio company’s performance, including information such as industry trends, new product development and other operational issues. For our debt investments the primary valuation technique used to estimate the fair value is the discounted cash flow method. However, if there is deterioration in credit quality or a debt investment is in workout status, we may consider other methods in determining the fair value, including the value attributable to the debt investment from the enterprise value of the portfolio company or the proceeds that would be received in a liquidation analysis. Our discounted cash flow models estimate a range of fair values by applying an appropriate discount rate to the future cash flow streams of our debt investments, based on future interest and principal payments as set forth in the associated debt investment agreements. We prepare a weighted average cost of capital for use in the discounted cash flow model for each investment, based on factors including, but not limited to: current pricing and credit metrics for similar proposed or executed investment transactions of private companies; the portfolio company’s historical financial results and outlook; and the portfolio company’s current leverage and credit quality as compared to leverage and credit quality as of the date the investment was made. We may also consider the following factors when determining the fair value of debt investments: the portfolio company’s ability to make future scheduled payments; prepayment penalties and other fees; estimated remaining life; the nature and realizable value of any collateral securing such debt investment; and changes in the interest rate environment and the credit markets that generally may affect the price at which similar investments may be made. We estimate the remaining life of our debt investments to generally be the legal maturity date of the instrument, as we generally intend to hold debt investments to maturity. However, if we have information available to us that the debt investment is expected to be repaid in the near term, we would use an estimated remaining life based on the expected repayment date. For our equity investments, including equity securities and warrants, we generally use a market approach, including valuation methodologies consistent with industry practice, to estimate the enterprise value of portfolio companies. Typically, the enterprise value of a private company is based on multiples of EBITDA, net income, revenues, or in limited cases, book value. In estimating the enterprise value of a portfolio company, we analyze various factors consistent with industry practice, including but not limited to original transaction multiples, the portfolio company’s historical and projected financial results, applicable market trading and transaction comparables, applicable market yields and leverage levels, the nature and realizable value of any collateral, the markets in which the portfolio company does business, and comparisons of financial ratios of peer companies that are public. We may also utilize an income approach when estimating the fair value of our equity securities, either as a primary methodology if consistent with industry practice or if the market approach is otherwise not applicable, or as a supporting methodology to corroborate the fair value ranges determined by the market approach. We typically prepare and analyze discounted cash flow models based on projections of the future free cash flows (or earnings) of the portfolio company. We consider various factors, including but not limited to the portfolio company’s projected financial results, applicable market trading and transaction comparables, applicable market yields and leverage levels, the markets in which the portfolio company does business, and comparisons of financial ratios of peer companies that are public. The fair value of our royalty rights are calculated based on projected future cash flows and the specific provisions contained in the pertinent royalty agreement. The determination of the fair value of such royalty rights is not a significant component of our valuation process. Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our consolidated financial statements express the uncertainties with respect to the possible effect of such valuations, and any changes in such valuations, on the consolidated financial statements. Revenue Recognition Investments and related investment income. Realized gains or losses on investments are recorded upon the sale or disposition of a portfolio investment and are calculated as the difference between the net proceeds from the sale or disposition and the cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized. Net change in unrealized appreciation or depreciation on the consolidated statements of operations includes changes in the fair value of investments from the prior period, as determined by our board of directors through the application of our valuation policy, as well as reclassifications of any prior period unrealized appreciation or depreciation on exited investments to realized gains or losses on investments. 72 Table of Contents Interest and dividend income . Interest and dividend income are recorded on the accrual basis to the extent that we expect to collect such amounts. Interest is accrued daily based on the outstanding principal amount and the contractual terms of the debt. Dividend income is recorded as dividends are declared or at the point an obligation exists for the portfolio company to make a distribution, and is generally recognized when received. Distributions from portfolio companies are evaluated to determine if the distribution is a distribution of earnings or a return of capital. Distributions of earnings are included in dividend income while a return of capital is recorded as a reduction in the cost basis of the investment. Estimates are adjusted as necessary after the relevant tax forms are received from the portfolio company. PIK income. Certain of our investments contain a PIK income provision. The PIK income, computed at the contractual rate specified in the applicable investment agreement, is added to the principal balance of the investment, rather than being paid in cash, and recorded as interest or dividend income, as applicable, on the consolidated statements of operations. Generally, PIK can be paid-in-kind or all in cash. We stop accruing PIK income when there is reasonable doubt that PIK income will be collected. PIK income that has been contractually capitalized to the principal balance of the investment prior to the non-accrual designation date is not reserved against interest or dividend income, but rather is assessed through the valuation of the investment (with corresponding adjustments to unrealized depreciation, as applicable). PIK income is included in our taxable income and, therefore, affects the amount we are required to pay to our stockholders in the form of dividends in order to maintain our tax treatment as a RIC and to avoid paying corporate-level U.S. federal income tax, even though we have not yet collected the cash. Non-accrual. Debt investments or preferred equity investments (for which we are accruing PIK dividends) are placed on non-accrual status when principal, interest or dividend payments become materially past due, or when there is reasonable doubt that principal, interest or dividends will be collected. Interest and dividend payments received on non-accrual investments may be recognized as interest or dividend income or applied to the investment principal balance based on management’s judgment. Non-accrual investments are restored to accrual status when past due principal, interest or dividends are paid and, in management’s judgment, are likely to remain current. Warrants. In connection with our debt investments, we will sometimes receive warrants or other equity-related securities (Warrants). We determine the cost basis of Warrants based upon their respective fair values on the date of receipt in proportion to the total fair value of the debt and Warrants received. Any resulting difference between the face amount of the debt and its recorded fair value resulting from the assignment of value to the Warrants is treated as OID and accreted into interest income using the effective interest method over the term of the debt investment. Upon the prepayment of a debt investment, any unaccreted OID is accelerated into interest income. Fee income. All transaction fees earned in connection with our investments are recognized as fee income and are generally non-recurring. Such fees typically include fees for services, including structuring and advisory services, provided to portfolio companies. We recognize income from fees for providing such structuring and advisory services when the services are rendered or the transactions are completed. Upon the prepayment of a debt investment, any prepayment penalties are recorded as fee income when earned. In 2020, the Company elected to change the manner in which it presents the recognition of management services fees income. Previously, the Company classified management services fees as a component of interest on idle funds and other income on the Consolidated Statement of Operations. Comparative prior periods presented have been reclassified retrospectively to conform to the revised presentation. There is no change in historical net increase in net assets resulting from operations due to this change in presentation. We also typically receive debt investment origination or closing fees in connection with investments. Such debt investment origination and closing fees are capitalized as unearned income and offset against investment cost basis on our consolidated statements of assets and liabilities and accreted into interest income over the term of the investment. Upon the prepayment of a debt investment, any unaccreted debt investment origination and closing fees are accelerated into interest income. Recently Issued Accounting Standards In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) – Changes to the Disclosure Requirements for Fair Value Measurement , which is intended to improve fair value disclosure requirements by removing disclosures that are not cost-beneficial, clarifying disclosures’ specific requirements, and adding relevant disclosure requirements. The guidance is effective for annual and interim reporting periods beginning after December 15, 2019. We adopted the ASU effective January 1, 2020. No significant changes to the fair value disclosures were necessary in the notes to the consolidated financial statements in order to comply with ASU 2018-13. In March 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2020-04, “ Reference Rate Reform (Topic 848), ” which provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. ASU 2020-04 is effective for all entities as of March 12, 2020 through December 31, 2022. The expedients and exceptions provided by the amendments do not apply to contract modifications and hedging relationships entered into or evaluated after December 31, 2022, except for hedging transactions as of December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. The Company is evaluating the potential impact that the adoption of ASU 2020-04 will have on the Company’s consolidated financial statements. 73 Table of Contents SEC Rule 12b-2 Update In March 2020, the SEC adopted a final rule under SEC Release No. 34-88365 (the “Final Rule”), amending the accelerated filer and large accelerated filer definitions in Exchange Act Rule 12b-2. The amendments include a provision under which a BDC will be excluded from the “accelerated filer” and “large accelerated filer” definitions if the BDC has (1) a public float of $75 million or more, but less than $700 million, and (2) has annual investment income of less than $100 million. In addition, BDCs are subject to the same transition provisions for accelerated filer and large accelerated filer status as other issuers, but instead substituting investment income for revenue. The amendments will reduce the number of issuers required to comply with the auditor attestation on the internal control over financial reporting requirement provided under Section 404(b) of the Sarbanes-Oxley Act of 2002. The Final Rule applies to annual report filings due on or after April 27, 2020. As a result, the Company is no longer an accelerated filer. SEC Rule 1-02(w)(2) Update In May 2020, the SEC adopted rule amendments that will impact the requirement of investment companies, including BDCs, to disclose the financial statements of certain of their portfolio companies or certain acquired funds (the “Final Rules”). The Final Rules adopted a new definition of “significant subsidiary” set forth in Rule 1-02(w)(2) of Regulation S-X under the Securities Act. Rules 3-09 and 4-08(g) of Regulation S-X require investment companies to include separate financial statements or summary financial information, respectively, in such investment company’s periodic reports for any portfolio company that meets the definition of “significant subsidiary.” The Final Rules adopt a new definition of “significant subsidiary” applicable only to investment companies that (i) modifies the investment test and the income test, and (ii) eliminates the asset test currently in the definition of “significant subsidiary” in Rule 1-02(w) of Regulation S-X. The new Rule 1-02(w)(2) of Regulation S-X is intended to more accurately capture those portfolio companies that are more likely to materially impact the financial condition of an investment company. The Final Rules became effective on January 1, 2021, but voluntary compliance is permitted in advance of the effective date. The Company has elected to early adopt this rule change as of December 31, 2020. SEC Regulation S-K Update In November 2020, the SEC issued a final rule that modernized and simplifies Management’s Discussion and Analysis of Financial Condition and Results of Operations and certain financial disclosure requirements in Regulation S-K (the “Amendments”). Specifically, the Amendments: (i) eliminate Item 301 of Regulation S-K (Selected Financial Data); (ii) simplify Item 302 of Regulation S-K (Supplementary Financial Information); and (iii) amend certain aspects of Item 303 of Regulation S-K (Managements Discussion and Analysis of Financial Condition and Results of Operations). The Amendments became effective on February 10, 2021 and compliance will be required for the registrant’s fiscal year ending on or after August 9, 2021. Early adoption of the Amendments is permitted on an item-by-item basis after the effective date; however, a registrant must fully comply with each adopted item in its entirety. The Company is currently evaluating the impact of the Amendments on its consolidated financial statements. Off-Balance Sheet Arrangements We may be a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our portfolio companies. We had off-balance sheet arrangements consisting of outstanding commitments to fund various undrawn revolving loans, other debt investments and capital commitments totaling $5.6 million and $4.8 million as of December 31, 2020 and 2019, respectively. Such outstanding commitments are summarized in the following table (dollars in millions): December 31, 2020 December 31, 2019 Portfolio Company - Investment Total Commitment Unfunded Commitment Total Commitment Unfunded Commitment Combined Systems, Inc. - Revolving Loan $ 4.0 $ 1.0 $ — $ — Elements Brands, LLC - Revolving Loan 3.0 0.8 — — FDS Avionics Corp. (dba Flight Display Systems) - Revolving Loan 0.2 — 0.2 — French Transit, LLC - Revolving Loan — — 1.0 1.0 Rhino Assembly Company, LLC - Delayed Draw Commitment 0.9 0.9 0.9 0.9 Safety Products Group, LLC - Common Equity (Units) 2.9 (1) 2.9 (1) 2.9 (1) 2.9 (1) Total $ 11.0 $ 5.6 $ 5.0 $ 4.8 (1) Portfolio company was no longer held at period end. The commitment represents our maximum potential liability related to certain guaranteed obligations stemming from the prior sale of the portfolio company’s underlying operations . Additional detail for each of the commitments above is provided in our consolidated schedules of investments. 74 Table of Contents Contractual Obligations As of December 31, 2020, our future fixed commitments (1) for cash payments are as follows: Total Less Than 1 Year 1 - 3 Years 3 - 5 Years More Than 5 Years (Dollars in millions) SBA debentures $ 147.0 $ — $ — $ 39.2 $ 107.8 Credit Facility borrowings — — — — — Notes 307.3 — 50.0 132.3 125.0 Total $ 454.3 $ — $ 50.0 $ 171.5 $ 232.8 (1) Fixed commitments in the table above include the principal balance of the obligations as of December 31, 2020. While these obligations are outstanding, we will also incur related interest expense. The amount of interest expense that we ultimately incur will depend on the timing of repayments (which may occur on or before the stated maturity dates), and, as it relates to our Credit Facility, changes in the underlying variable reference interest rates. As of December 31, 2020, the weighted average stated interest rates for our SBA debentures and the Notes were 3.297% and 5.342%, respectively. As of December 31, 2020, we had $100.0 million of unutilized commitment under our Credit Facility. We have certain contracts under which we have material future commitments. We entered into the Investment Advisory Agreement with our investment advisor in accordance with the 1940 Act. Under the Investment Advisory Agreement, our investment advisor provides us with investment advisory and management services. We pay the following amounts for these services (a) a management fee equal to a percentage of the average of our total assets (excluding cash and cash equivalents) and (b) an incentive fee based on our performance. See “Business — Management and Other Agreements — Investment Advisory Agreement — Management Fee.” Under the Administration Agreement, our investment advisor furnishes us with office facilities and equipment, provides us clerical, bookkeeping and record keeping services at such facilities and provides us with other administrative services necessary to conduct our day-to-day operations. See “Business — Management and Other Agreements — Administration Agreement.” If any of our contractual obligations discussed above are terminated, our costs under any new agreements that we enter into may increase. In addition, we would likely incur significant time and expense in locating alternative parties to provide the services we expect to receive under our Investment Advisory Agreement and our Administration Agreement. Any new investment advisory agreement would also be subject to approval by our Independent Directors and our stockholders. Related Party Transactions We have entered into a number of business relationships with affiliated or related parties, including the following: • We have entered into the Investment Advisory Agreement with Fidus Investment Advisors, LLC, as our investment advisor. Pursuant to the agreement our investment advisor manages our day-to-day operating and investing activities. We pay our investment advisor a fee for its services under the Investment Advisory Agreement consisting of two components — a base management fee and an incentive fee. See Note 5 to our consolidated financial statements. • Edward H. Ross, our Chairman and Chief Executive Officer, and Thomas C. Lauer, our President, are managers of Fidus Investment Advisors, LLC. In May 2015, Fidus Investment Advisors, LLC entered into a combination with Fidus Partners, LLC (the “Combination”), by which members of Fidus Investment Advisors LLC and Fidus Partners, LLC (“Partners”) contributed all of their respective membership interest in Fidus Investment Advisors LLC and Partners to a newly formed limited liability company, Fidus Group Holdings, LLC (“Holdings”). As a result, Fidus Investment Advisors LLC is a wholly-owned subsidiary of Holdings, which is a limited liability company organized under the laws of Delaware. • We entered into the Administration Agreement with Fidus Investment Advisors, LLC to provide us with the office facilities and administrative services necessary to conduct day-to-day operations. See Note 5 to our consolidated financial statements. • We entered into a license agreement with Fidus Partners, LLC, pursuant to which Fidus Partners, LLC has granted us a non-exclusive, royalty-free license to use the name “Fidus.” • On February 25, 2020, the Company entered into a Limited Partnership Agreement (the “Agreement”) with Fidus Equity Fund I, L.P. (“FEF I”). Pursuant to the Agreement, we will serve as the General Partner of FEF I. Owned by third-party investors, FEF I was formed to purchase 50% of select equity investments from us. On February 25, 2020, we sold 50% of our equity investments in 20 portfolio companies to FEF I and received net proceeds of $35.9 million, resulting in a realized gain, net of estimated taxes, of approximately $20.4 million. We will not receive any fees from FEF I for any services provided in our capacity as the General Partner of FEF I. 75 Table of Contents • The Investment Advisor, in consultation with the Board, agreed to voluntarily waive $0.4 of the income incentive fee for the year ended December 31, 2020. There was no income incentive fee waiver for the year ended December 31, 2019. In connection with the IPO and our election to be regulated as a BDC, we applied for and received exemptive relief from the SEC on March 27, 2012 to allow us to take certain actions that would otherwise be prohibited by the 1940 Act, as applicable to BDCs. Effective June 30, 2014, pursuant to separate exemptive relief from the SEC, any SBA debentures issued by Fund II and Fund III are not considered senior securities for purposes of the asset coverage requirements. While we may co-invest with investment entities managed by our investment advisor or its affiliates, to the extent permitted by the 1940 Act and the rules and regulations thereunder, the 1940 Act imposes significant limits on co-investment. The SEC staff has granted us relief sought in an exemptive application that expands our ability to co-invest in portfolio companies with other funds managed by our investment advisor or its affiliates (“Affiliated Funds”) in a manner consistent with our investment objective, positions, policies, strategies and restrictions as well as regulatory requirements and other pertinent factors, subject to compliance with certain conditions (the “Order”). Pursuant to the Order, we are permitted to co-invest with our affiliates if a “required majority” (as defined in Section 57(o) of the 1940 Act) or our independent directors make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the transactions, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching by us or our stockholders on the part of any person concerned, and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objective and strategies. In addition, we and our Investment Advisor have each adopted a joint code of ethics pursuant to Rule 17j-1 under the 1940 Act that governs the conduct of our and the Investment Advisor’s officers, directors and employees. Additionally, the Investment Advisor has adopted a code of ethics pursuant to rule 204A-1 under the Advisers Act and in accordance with Rule 17j-1(c) under the 1940 Act. We have also adopted a code of business conduct that is applicable to all officers, directors and employees of Fidus and our Investment Advisor. Our officers and directors also remain subject to the duties imposed by both the 1940 Act and the Maryland General Corporation Law. Recent Developments On January 11, 2021, we exited our debt investment in Bandon Fitness (Texas), Inc. We received payment in full of $15.6 million on our first lien debt, which includes a prepayment fee. On January 14, 2021, we exited our debt investment in Alzheimer’s Research and Treatment Center, LLC. We received payment in full of $6.6 million on our first lien debt, which includes a prepayment fee. On January 19, 2021, we redeemed $50.0 million of the aggregate principal amount on the 2023 Notes, resulting in a realized loss on extinguishment of debt of approximately $0.8 million. On January 22, 2021, we invested $11.0 million in first lien debt and $0.5 million in common equity of GP&C Operations, LLC (dba Garlock Printing and Converting), a converter of plastic film into flexible packaging solutions. On January 26, 2021, we exited our debt investment in Ohio Medical, LLC. We received payment in full of $10.0 million on our second lien debt. We subsequently invested $5.0 million in a new second lien debt investment in Ohio Medical, LLC. On February 9, 2021, the Board declared a regular quarterly dividend of $0.31 per share and supplemental dividend of $0.07 per share payable March 26, 2021 to stockholders of record as of March 12, 2021. On February 10, 2021, we invested $6.5 million in first lien debt and made a commitment up to $2.0 million of additional first lien debt of Wonderware Holdings, LLC (dba CORE Business Technologies), a provider of revenue management and payments solutions for government, healthcare and education. On February 11, 2021, we invested $8.9 million in first lien debt and made a commitment up to $0.4 million of additional first lien debt of Xeeva, Inc., a global provider of intelligent, cloud-based indirect spend management software solutions. On February 12, 2021, we exited our debt and equity investments in FDS Avionics Corp. (dba Flight Display Systems). Flight Display Systems was acquired and combined with Calculex Inc. and Argon Corporation under a new holding company, Spectra A&D Holdings (“Spectra”). We received payment in full of $5.1 million on our second lien and revolving debt. We sold our preferred and a portion of our common equity investments for a realized gain of approximately $1.0 million. In conjunction with the transaction, we invested $8.0 million in first lien debt and $4.1 million in preferred equity, of which $2.0 million was rolled over from our original common equity investment in Flight Display Systems. On February 16, 2021, we redeemed $50.0 million of the $69.0 million aggregate principal amount on the February 2024 Notes, resulting in a realized loss on extinguishment of debt of approximately $1.1 million. On February 19, 2021, we exited our debt investment in Wheel Pros, Inc. We received payment in full of $20.4 million on our second lien debt, which includes a prepayment fee. 76 Table of Contents Subsequent to December 31, 2020, the global outbreak of the COVID-19 pandemic has adversely affected some of the Company’s investments and continues to have adverse consequences on the U.S. and global economies. The ultimate economic fallout from the pandemic, and the long-term impact on economies, markets, industries and individual portfolio companies, remains uncertain. At the time of this filing, there is no indication of a reportable subsequent event impacting the Company’s financial statements for the year ended December 31, 2020. The Company cannot predict the extent to which its financial condition and results of operations will be adversely affected at this time. The potential impact to our results will depend to a large extent on future developments and new information that may emerge regarding the duration and severity of COVID-19. The Company continues to observe and respond to the evolving COVID-19 environment and its potential impact on areas across its business.