Item 1. Business
ITEM 1.
BUSINESS
Overview
Organization
We were incorporated under the General Corporation Law of the State of Delaware on February 18, 2005. On June 22, 2005, we completed our initial
public offering and commenced operations. We operate as an externally managed, closed-end, non-diversified management investment company and have elected to be treated
as a BDC under the Investment Company Act of 1940, as amended (the 1940 Act). For U.S. federal income tax purposes, we have elected to be treated as a RIC under Subchapter M of the Internal Revenue Code of 1986, as amended (the
Code). To continue to qualify as a RIC for U.S. federal income tax purposes and obtain favorable RIC tax treatment, we must meet certain requirements, including certain minimum distribution requirements.
Shares of our common stock, 6.375% Series E Cumulative Term Preferred Stock (Series E Term Preferred Stock), and our 5.00% Notes due 2026
(2026 Notes) are traded on the Nasdaq Global Select Market (Nasdaq) under the trading symbols GAIN, GAINL, and GAINN, respectively.
Investment Adviser and Administrator
We are
externally managed by the Adviser, an affiliate of ours and an SEC registered investment adviser, pursuant to an investment advisory and management agreement (the Advisory Agreement). We have also entered into an administration agreement
(the Administration Agreement) with Gladstone Administration, LLC (the Administrator), an affiliate of ours and the Adviser. Each of the Adviser and the Administrator are privately-held companies that are indirectly owned and
controlled by David Gladstone, our chairman and chief executive officer. David Dullum, our president, also serves as the executive vice president of private equity (buyouts) of the Adviser. Michael LiCalsi, our general counsel and secretary, also
serves as the Administrators president, general counsel, and secretary, as well as the executive vice president of administration of the Adviser. Mr. Gladstone and Terry Lee Brubaker, our vice chairman and chief operating officer, also
serve on the board of directors of the Adviser, the board of managers of the Administrator, and as executive officers of the Adviser and the Administrator. The Administrator employs, among others, our chief financial officer and treasurer, chief
valuation officer, chief compliance officer, general counsel and secretary and their respective staffs. The Adviser and Administrator have extensive experience in our lines of business and also provide investment advisory and administrative
services, respectively, to our affiliates, including: Gladstone Commercial Corporation (Gladstone Commercial), a publicly-traded real estate investment trust; Gladstone Capital Corporation (Gladstone Capital), a
publicly-traded BDC and RIC; and Gladstone Land Corporation, a publicly-traded real estate investment trust (together with Gladstone Commercial and Gladstone Capital, collectively the Affiliated Public Funds). In
the future, the Adviser and Administrator may provide investment advisory and administrative services, respectively, to other funds and companies, both public and private.
The Adviser was organized as a corporation under the laws of the State of Delaware on July 2, 2002 and is a registered investment adviser under the
Investment Advisers Act of 1940, as amended. The Administrator was organized as a limited liability company under the laws of the State of Delaware on March 18, 2005. The Adviser and Administrator are headquartered in McLean, Virginia, a suburb
of Washington, D.C. The Adviser also has offices in several other states.
Investment Objectives and Strategy
We were established for the purpose of investing in debt and equity securities of established private businesses operating in the U.S. Our investment
objectives are to: (i) achieve and grow current income by investing in debt securities of established businesses that we believe will provide stable earnings and cash flow to pay expenses, make principal and interest payments on our outstanding
indebtedness and make distributions to stockholders that grow over time; and (ii) provide our stockholders with long-term capital appreciation in the value of our
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assets by investing in equity securities of established businesses, generally in combination with the aforementioned debt securities, that we believe can grow over time to permit us to sell our
equity investments for capital gains. To achieve our investment objectives, our investment strategy is to invest in several categories of debt and equity securities, with individual investments in a particular portfolio company generally totaling up
to $40 million, although investment size may vary, depending upon our total assets or available capital at the time of investment. We expect that our investment portfolio over time will consist of approximately 75% in debt securities and 25% in
equity securities, at cost. As of March 31, 2021, our investment portfolio was comprised of 74.4% in debt securities and 25.6% in equity securities, at cost.
We focus on investing in lower middle market private businesses (which we generally define as private companies with annual earnings before interest, taxes,
depreciation and amortization (EBITDA) of $3 million to $20 million) (Lower Middle Market) in the U.S. that meet certain criteria, including, the following: the sustainability of the business free cash flow and its
ability to grow it over time, adequate assets for loan collateral, experienced management teams with a significant ownership interest in the portfolio company, reasonable capitalization of the portfolio company, including an ample equity
contribution or cushion based on prevailing enterprise valuation multiples, and the potential to realize appreciation and gain liquidity in our equity position, if any. We anticipate that liquidity in our equity position will be achieved through a
merger, acquisition, or recapitalization of the portfolio company, a public offering of the portfolio companys stock or, to a lesser extent, by exercising our right to require the portfolio company to repurchase our warrants, as applicable,
though there can be no assurance that we will always have these rights. We invest in portfolio companies that need funds for growth capital, to finance acquisitions, including management buyouts, recapitalize or, to a lesser extent, refinance their
existing debt facilities. We seek to avoid investing in high-risk, early-stage enterprises.
We invest by ourselves or jointly with other funds and/or
management of the portfolio company, depending on the opportunity. In July 2012, the SEC granted us an exemptive order (the Co-Investment Order) that expanded our ability to co-invest, under certain circumstances, with certain of our affiliates, including Gladstone Capital and any future BDC or closed-end management investment company that is
advised (or sub-advised if it controls the fund) by the Adviser, or any combination of the foregoing, subject to the conditions in the Co-Investment Order. Since 2012,
we have opportunistically made several co-investments with Gladstone Capital pursuant to the Co-Investment Order. We believe the
Co-Investment Order has enhanced and will continue to enhance our ability to further our investment objectives and strategies. If we are participating in an investment with one or more co-investors, whether or not an affiliate of ours, our investment is likely to be smaller than if we were investing alone.
In general, our investments in debt securities have a term of five years, accrue interest at variable rates (based on the
one-month London Interbank Offered Rate (LIBOR)) and, to a lesser extent, at fixed rates. As of March 31, 2021, our loan portfolio consisted of 97.7% variable rate loans with floors and 2.3%
fixed rate loans, based on the total principal balance of all outstanding debt investments. We seek debt instruments that pay interest monthly or, at a minimum, quarterly, and which may include a yield enhancement such as a success fee or, to a
lesser extent, deferred interest provision and are primarily interest only, with all principal and any accrued but unpaid interest due at maturity. Generally, success fees accrue at a set rate and are contractually due upon a change of control of
the portfolio company. Some debt securities may have deferred interest whereby some portion of the interest payment is added to the principal balance so that the interest is paid, together with the principal, at maturity. This form of deferred
interest is often called paid-in-kind (PIK) interest. As of March 31, 2021, we did not have any securities with a PIK feature.
Typically, our investments in equity securities take the form of common stock, preferred stock, limited liability company interests, or warrants or options to
purchase any of the foregoing. Often, these equity investments occur in connection with our original investment, buyouts and recapitalizations of a business, or refinancing existing debt. From our initial public offering in 2005 through
March 31, 2021, we invested in 53 companies, excluding investments in syndicated loans.
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We expect that our investment portfolio will continue to primarily include the following three categories of
investments in private companies in the U.S.:
Secured First Lien Debt Securities: We seek to invest a portion of our assets in first lien secured debt
securities also known as senior loans, senior term loans, lines of credit and senior notes. Using its assets as collateral, the borrower typically uses first lien secured debt to cover a substantial portion of the funding needs of the business.
These debt securities usually take the form of first priority liens on all, or substantially all, of the assets of the business.
Secured Second Lien Debt Securities: We seek to invest a portion of our assets in second lien secured debt
securities, which may also be referred to as subordinated loans, subordinated notes and mezzanine loans. These second lien secured debt securities rank junior to the borrowers first lien secured debt securities and may be secured by second
priority liens on all or a portion of the assets of the business. Additionally, we may receive other yield enhancements in addition to or in lieu of success fees, such as warrants to buy common and preferred stock or limited liability interests, in
connection with these second lien secured debt securities.
Preferred and Common Equity/Equivalents: We seek to invest a portion of our assets in equity
securities, which consist of preferred and common equity, limited liability company interests, warrants or options to acquire such securities, and are generally in combination with our debt investment in a business. Additionally, we may receive
equity investments derived from restructurings on some of our existing debt investments. In many cases, we will own a significant portion of the equity of the businesses in which we invest.
Because the majority of the loans in our portfolio consist of term debt in private companies that typically cannot or will not expend the resources to have
their debt securities rated by a credit rating agency, we expect that most, if not all, of the debt securities we acquire will be unrated. Investors should assume that these loans would be rated below what is considered investment grade
quality. Investments rated below investment grade are often referred to as high yield securities or junk bonds and may be considered higher risk as compared to investment grade debt instruments.
Investment Policies
We seek to achieve a high
level of current income and capital gains through investments in secured debt securities and preferred and common stock that we generally acquire in connection with buyouts and other recapitalizations. The following investment policies, along with
the investment objectives, may not be changed without the approval of our board of directors (our Board of Directors), a majority of whom are not interested persons as defined in Section 2(a)(19) of the 1940 Act:
We will at all times conduct our business so as to retain our status as a BDC. To that status, we must be
operated for the purpose of investing in certain categories of qualifying assets. In addition, we may not acquire any assets (other than non-investment assets necessary and appropriate to our operations as a
BDC or qualifying assets) if, after giving effect to such acquisition, the value of our qualifying assets is less than 70% of the value of our total assets. We anticipate that the securities we seek to acquire will generally be
qualifying assets. See Regulation as a BDC Qualifying Assets for a discussion of the types of qualifying assets in which we are permitted to invest pursuant to Section 55(a) of the 1940 Act.
We will at all times endeavor to conduct our business so as to retain our status as a RIC under the Code. To do
so, we must maintain our status as a BDC and meet income source, asset diversification and annual distribution requirements. We may issue senior securities, such as debt or preferred stock, to the extent permitted by the 1940 Act for the purpose of
making investments, to fund share repurchases, or for temporary emergency or other purposes.
With the exception of our policy to
conduct our business as a BDC, these investment policies are not fundamental and may be changed without stockholder approval.
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Investment Concentrations
As of March 31, 2021, our investment portfolio consisted of investments in 28 portfolio companies located in 17 states across 13 different industries with
an aggregate fair value of $633.8 million. Our investments in Pioneer Square Brands, Inc. (Pioneer Square), Counsel Press, Inc. (Counsel Press), Old World Christmas, Inc. (Old World), J.R. Hobbs
Co.Atlanta, LLC (J.R. Hobbs), and Bassett Creek Services, Inc. (Bassett Creek) represented our five largest portfolio investments at fair value and collectively comprised $233.9 million, or 36.9%, of our total
investment portfolio at fair value as of March 31, 2021. The following table summarizes our investments by security type as of March 31, 2021 and 2020:
March 31, 2021
March 31, 2020
Cost
Fair Value
Cost
Fair Value
Secured first lien debt
$
379,512
57.2
%
$
368,688
58.2
%
$
310,019
50.9
%
$
308,248
54.5
%
Secured second lien debt
114,206
17.2
102,897
16.2
143,155
23.5
123,340
21.8
Total debt
493,718
74.4
471,585
74.4
453,174
74.4
431,588
76.3
Preferred equity
166,361
25.1
159,478
25.2
152,998
25.1
119,849
21.2
Common equity/equivalents
3,484
0.5
2,766
0.4
3,410
0.5
14,487
2.5
Total equity/equivalents
169,845
25.6
162,244
25.6
156,408
25.6
134,336
23.7
Total investments
$
663,563
100.0
%
$
633,829
100.0
%
$
609,582
100.0
%
$
565,924
100.0
%
Our investments at fair value consisted of the following industry classifications as of March 31, 2021 and 2020:
March 31, 2021
March 31, 2020
Fair Value
Percentage
of Total
Investments
Fair Value
Percentage
of Total
Investments
Diversified/Conglomerate Services
$
261,714
41.3
%
$
226,805
40.1
%
Home and Office Furnishings, Housewares, and Durable Consumer Products
94,663
15.0
83,705
14.8
Personal and Non-Durable Consumer Products
(Manufacturing Only)
60,852
9.6
34,865
6.2
Leisure, Amusement, Motion Pictures, Entertainment
45,209
7.1
35,240
6.2
Healthcare, Education, and Childcare
31,194
4.9
25,563
4.5
Aerospace and Defense
27,630
4.4
26,158
4.6
Diversified/Conglomerate Manufacturing
25,181
4.0
28,147
5.0
Chemicals, Plastics, and Rubber
22,985
3.6
16,737
3.0
Telecommunications
15,582
2.5
15,792
2.8
Beverage, Food, and Tobacco
15,519
2.4
12,545
2.2
Cargo Transport
15,211
2.4
13,316
2.4
Machinery (Non-agriculture, Non-construction, and Non-electronic)
14,199
2.2
23,091
4.1
Containers, Packaging, and Glass
20,360
3.6
Other < 2.0%
3,890
0.6
3,600
0.5
Total investments
$
633,829
100.0
%
$
565,924
100.0
%
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Our investments at fair value were included in the following U.S. geographic regions as of March 31,
2021 and 2020:
March 31, 2021
March 31, 2020
Location
Fair Value
Percentage
of Total
Investments
Fair Value
Percentage
of Total
Investments
South
$
182,529
28.8
%
$
182,178
32.2
%
Northeast
163,938
25.9
146,434
25.9
West
160,581
25.3
90,214
15.9
Midwest
126,781
20.0
147,098
26.0
Total investments
$
633,829
100.0
%
$
565,924
100.0
%
The geographic region indicates the location of the headquarters for our portfolio companies. A portfolio company may have
additional business locations in other geographic regions.
Investment Process
Overview of Investment and Approval Process
To
originate investments, the Advisers investment professionals use an extensive referral network comprised primarily of private equity sponsors, venture capitalists, leveraged buyout funds, investment bankers, attorneys, accountants, commercial
bankers and business brokers. The Advisers investment professionals review information received from these and other sources in search of potential financing opportunities. If a potential opportunity matches our investment objectives, the
investment professionals will seek an initial screening of the opportunity with our president, David Dullum, to authorize the submission of an indication of interest (IOI) to the prospective portfolio company. If the prospective
portfolio company passes this initial screening and the IOI is accepted by the prospective company, the investment professionals will seek approval to issue a letter of intent (LOI) from the Advisers investment committee, which is
composed of Messrs. Gladstone, Brubaker, and Dullum, to the prospective company. If this LOI is issued, then the Adviser and Gladstone Securities, LLC (Gladstone Securities) (collectively, the Due Diligence Team) will conduct
a due diligence investigation and create a detailed profile summarizing the prospective portfolio companys historical financial statements, industry, competitive position and management team and analyzing its conformity to our general
investment criteria. The investment professionals then present this profile to the Advisers investment committee, which must approve each investment.
Prospective Portfolio Company Characteristics
We
have identified certain characteristics that we believe are important in identifying and investing in prospective portfolio companies. The criteria listed below provide general guidelines for our investment decisions, although not all of these
criteria may be met by each portfolio company.
Experienced Management: We typically require that the companies in which we invest have experienced
management teams or a hiring plan in place to install an experienced management team. We also require the companies to have in place proper incentives to induce management to succeed and act in concert with our interests as an investor, including
having significant equity or other interests in the financial performance of their companies.
Value- and Income-Orientation and Positive Cash Flow: Our investment philosophy places a premium on
fundamental analysis from an investors perspective and has a distinct value- and income-orientation. In seeking value, we focus on established companies in which we can invest at relatively low multiples of EBITDA, and that have positive
operating cash flow at the time of investment. In seeking income, we typically invest in companies that generate relatively stable to growing sales, cash
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flows, and EBITDA to fixed charges coverage, which provides some assurance that the companies will be able to service their debt. We do not expect to invest in
start-up companies or companies with what we believe to be speculative business plans.
Strong Competitive Position in an Industry: We seek to invest in companies that have developed strong
market positions and significant relative market share within their respective markets and that we believe are well-positioned to capitalize on growth opportunities. We seek companies that demonstrate significant competitive advantages versus their
competitors, which we believe will help to protect their market positions and profitability.
Liquidation Value of Assets: The projected liquidation value of the assets, if any, is an important factor
in our investment analysis in collateralizing our debt securities.
Extensive Due Diligence
The Due Diligence Team conducts what we believe are extensive due diligence investigations of our prospective portfolio companies and investment opportunities.
The due diligence investigation may begin with a review of publicly available information followed by in-depth business analysis, including some or all of the following:
A review of the prospective portfolio companys historical and projected financial information, including a
quality of earnings analysis;
Visits to the prospective portfolio companys business site(s) and evaluation of potential environmental
issues;
Interviews with the prospective portfolio companys management, employees, customers and vendors;
Review of loan documents and material contracts;
Background checks and a management capabilities assessment on the prospective portfolio companys management
team; and
Research, including market analyses, on the prospective portfolio companys products, services or particular
industry and its competitive position therein.
Upon completion of a due diligence investigation and a decision to proceed with an
investment, the Advisers investment professionals who have primary responsibility for the investment present the investment opportunity to the Advisers investment committee. The investment committee then determines whether to pursue the
potential investment. Prior to the closing of an investment, additional due diligence may be conducted on our behalf by attorneys, independent accountants, and other outside advisers, as appropriate.
We also rely on the long-term relationships that the Advisers investment professionals have with leveraged buyout funds, investment bankers, commercial
bankers, private equity sponsors, attorneys, accountants, and business brokers. In addition, the extensive direct experiences of our executive officers and managing directors in the operations of Lower Middle Market companies and providing debt and
equity capital to Lower Middle Market companies plays a significant role in our investment evaluation and assessment of risk.
Investment Structure
Once the Adviser has determined that an investment meets our standards and investment criteria, the Adviser works with the management of that
company and other capital providers to structure the transaction in a way that we believe will provide us with the greatest opportunity to maximize our return on the investment, while providing appropriate incentives to management of the company. As
discussed above, the capital classes through which we typically structure a deal include first lien secured debt, second lien secured debt, and preferred and common equity or equivalents. Through its risk management process, the Adviser seeks to
limit the downside risk of our investments by:
Making investments with an expected total return (including interest, yield enhancements and potential equity
appreciation) that it believes compensates us for the credit risk of the investment;
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Seeking collateral or superior positions in the portfolio companys capital structure where possible;
Incorporating put and call protection rights into the investment structure where possible;
Negotiating covenants in connection with our investments that afford our portfolio companies as much flexibility
as possible in managing their businesses, while also preserving our capital; and
Holding board seats or securing board observation rights at the portfolio company.
We expect to hold most of our debt investments until maturity or repayment. From time to time, we may sell our investments (including our equity investments)
earlier if a liquidity event takes place, such as a recapitalization of a portfolio company, an initial public offering, or a sale to a third party, including strategic buyers, private equity funds, or existing investors in the portfolio company,
and which may be privately negotiated transactions.
Competitive Advantages
A large number of entities compete with us and make the types of investments that we seek to make in Lower Middle Market companies. Such competitors include
private equity funds, leveraged buyout funds, other BDCs, investment banks and other equity and non-equity based investment funds, and other financing sources, including traditional financial services
companies such as commercial banks. Many of our competitors are substantially larger than we are and have considerably greater funding sources or are able to access capital more cost effectively. In addition, certain of our competitors may have
higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish a larger portfolio of investments. Furthermore, many of these competitors are not subject to the regulatory
restrictions that the 1940 Act imposes on us as a BDC. However, we believe that we have the following competitive advantages over many other providers of financing to Lower Middle Market companies.
Management Expertise
Our Adviser has a separate
investment committee for the Company and each of the Affiliated Public Funds, although Messrs. Gladstone and Brubaker serve as members of the Advisers investment committees for each of the Company and each of the Affiliated Public Funds.
Messrs. Gladstone and Dullum have extensive experience in investing in Lower Middle Market companies and with operating in the BDC marketplace in general. Mr. Brubaker has substantial experience in acquisitions and operations of companies.
These three individuals, who are part of our executive management team and comprise the Advisers investment committee for the Company, dedicate a significant portion of their time to managing our investment portfolio. They have extensive
experience providing capital to Lower Middle Market companies and have worked together at the Gladstone family of companies for more than ten years. In addition, we have access to the resources and expertise of the Advisers investment
professionals and support staff who possess a broad range of transactional, financial, managerial, and investment skills. See the additional discussion regarding management of portfolio companies by our Adviser below under Ongoing
Management of Investments and Portfolio Company Relationships.
Increased Access to Investment Opportunities Developed Through Extensive
Research Capability and Network of Contacts
The Adviser seeks to identify potential investments through active origination and due diligence and
through its dialogue with numerous management teams, members of the financial community and potential corporate partners with whom the Advisers investment professionals have long-term relationships. We believe that the Advisers
investment professionals have developed a broad network of contacts within the investment, commercial banking, private equity and investment management communities, and that their reputation, experience, and focus on investing in Lower Middle Market
companies enables us to source and identify well-positioned prospective portfolio companies, which provide attractive investment opportunities. Additionally, the Adviser expects to generate information from its professionals network of
accountants, consultants, lawyers and management teams of portfolio companies and other contacts to support the Advisers investment activities.
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Disciplined, Value- and Income-Oriented Investment Philosophy with a Focus on Preservation of Capital
In making its investment decisions, the Adviser focuses on the risk and reward profile of each prospective portfolio company, seeking to minimize the
risk of capital loss without foregoing the potential for capital appreciation. We expect the Adviser to use the same investment philosophy that its professionals use in the management of the other Affiliated Public Funds and to commit resources to
manage downside exposure. The Advisers approach seeks to reduce our risk in investments by using some or all of the following approaches:
Focusing on companies with attractive and sustainable market positions and cash flow;
Investing in companies with experienced and established management teams;
Engaging in extensive due diligence from the perspective of a long-term investor;
Investing at low price-to-cash
flow multiples; and
Adopting flexible transaction structures by drawing on the experience of the investment professionals of the
Adviser and its affiliates.
Longer Investment Horizon
Unlike private equity and other funds that are typically organized as finite-life partnerships (generally seven to ten years), we are not subject to standard
periodic capital return requirements. These structures often force private equity and other funds to seek returns on their investments by causing their portfolio companies to pursue mergers, public equity offerings, or other liquidity events more
quickly than might otherwise be optimal or desirable, potentially resulting in a lower overall return to investors and/or an adverse impact on their portfolio companies. In contrast, we are a corporation of perpetual duration and are
exchange-traded. We believe that our flexibility to make investments with a long-term view and without the capital return requirements of traditional private investment vehicles provides us with the opportunity to achieve greater long-term returns
on invested capital.
Flexible Transaction Structuring
We believe the Advisers and our management teams broad expertise and years of combined experience enable the Adviser to identify, assess, and
structure investments successfully across all levels of a companys capital structure and manage potential risk and return at all stages of the economic cycle. We are not subject to many of the regulatory limitations that govern traditional
lending institutions, such as banks. As a result, we are flexible in selecting and structuring investments, adjusting investment criteria and transaction structures and, in some cases, the types of securities in which we invest, thereby affording us
a competitive advantage of providing both, equity and debt financing, which may limit uncertainty related to the close of the transaction and the risk of refinancing during periods of market yield compression. We believe that this approach enables
the Adviser to develop a financing structure which best fits the investment and growth profile of the underlying business and yields attractive investment opportunities that will continue to generate current income and capital gain potential
throughout the economic cycle, including during turbulent periods in the capital markets, such as the current COVID-19 pandemic.
Ongoing Management of Investments and Portfolio Company Relationships
The Advisers investment professionals actively oversee each investment by continuously evaluating the portfolio companys performance and typically
working collaboratively with the portfolio companys management to identify and incorporate best resources and practices that help us achieve our projected investment performance.
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Monitoring
The Advisers investment professionals monitor the financial performance, trends, and changing risks of each portfolio company on an ongoing basis to
determine if each portfolio company is performing within expectations and to guide the portfolio companys management in taking the appropriate courses of action. The Adviser employs various methods of evaluating and monitoring the performance
of our investments in portfolio companies, which can include the following:
Monthly analysis of financial and operating performance;
Frequent assessment of the portfolio companys performance against its business plan and our investment
expectations;
Attendance at and/or participation in the portfolio companys board of directors or management meetings;
Continuous assessment of portfolio company management, governance and strategic direction;
Continuous assessment of the portfolio companys industry and competitive environment; and
Frequent review and assessment of the portfolio companys operating outlook and financial projections.
Relationship Management
The Advisers investment professionals interact with various parties involved with a portfolio company, or investment, by actively engaging with internal
and external constituents, including:
Management;
Boards of directors;
Financial sponsors;
Capital partners;
Auditors; and
Advisers and consultants.
Managerial Assistance and Services
As a BDC, we
make available significant managerial assistance, as defined in the 1940 Act, to our portfolio companies and provide other services (other than such managerial assistance) to such portfolio companies. Neither we, nor the Adviser, currently receive
fees in connection with the managerial assistance we make available. At times, the Adviser may also provide other services to our portfolio companies under certain agreements and may receive fees for services other than managerial assistance. Such
services may include: (i) assistance obtaining, sourcing or structuring credit facilities, long term loans or additional equity from unaffiliated third parties; (ii) negotiating important contractual financial relationships;
(iii) consulting services regarding restructuring of the portfolio company and financial modeling as it relates to raising additional debt and equity capital from unaffiliated third parties; and (iv) a primary role in interviewing, vetting
and negotiating employment contracts with candidates in connection with adding and retaining key portfolio company management team members. The Adviser non-contractually, unconditionally, and irrevocably
credits 100% of any fees received for such services against the base management fee that we would otherwise be required to pay to the Adviser, as discussed below in Transactions with Related Parties Investment Advisory and
Management Agreement Base Management Fee; however, pursuant to the terms of the Advisory Agreement, a small percentage of certain of such fees is retained by the Adviser in the form of reimbursement, at cost, for tasks completed by
personnel of the Adviser, primarily related to the valuation of portfolio companies.
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Gladstone Securities also provides other services (such as investment banking and due diligence services) to
certain of our portfolio companies and receives fees for the provision of such services, see Transactions with Related Parties Other Transactions below.
Valuation Process
The following is a general
description of our investment valuation policy (the Policy) (which has been approved by our Board of Directors) that the professionals of the Adviser and Administrator, with oversight and direction from our chief valuation officer, an
employee of the Administrator that reports directly to our Board of Directors (collectively, the Valuation Team), use each quarter to determine the fair value of our investment portfolio. In accordance with the 1940 Act, our Board of
Directors has the ultimate responsibility for reviewing and determining, in good faith, the fair value of our investments for which market quotations are not readily available based on the Policy. The Adviser values our investments in accordance
with the requirements of the 1940 Act and accounting principles generally accepted in the U.S. (GAAP). There is no single standard for determining fair value (especially for privately-held businesses), as fair value depends upon the
specific facts and circumstances of each individual investment. Each quarter, our Board of Directors reviews the Policy to determine if changes thereto are advisable and whether the Valuation Team has applied the Policy consistently. With respect to
the valuation of our investment portfolio, the Valuation Team performs the following steps each quarter:
Each investment is initially assessed by the Valuation Team using the Policy, which may include:
Obtaining fair value quotes or utilizing valuation inputs from third party valuation firms; and
Using techniques, such as total enterprise value, yield analysis, market quotes and other factors, including: the
nature and realizable value of the collateral, including external parties guaranties; any relevant offers or letters of intent to acquire the portfolio company; timing of expected repayments; and the markets in which the portfolio company
operates.
Preliminary valuation conclusions are then discussed amongst the Valuation Team and with our management and
documented for review by our Board of Directors. Written valuation recommendations and supporting material are sent to the Board of Directors in advance of the quarterly meetings.
The Valuation Committee of the Board of Directors (comprised entirely of independent directors) meets to review
the valuation recommendations and supporting materials, discusses the information provided by the Valuation Team, determines whether the Valuation Team has followed the Policy, determines whether the Valuation Teams recommended fair value is
reasonable in light of the Policy, and reviews other facts and circumstances. Then, the Valuation Committee and chief valuation officer present the Valuation Committees findings to the entire Board of Directors, so that the full Board of
Directors may review and determine in good faith the fair value of investments in accordance with the Policy.
Fair value measurements
of our investments may involve subjective judgment and estimates. Due to the uncertainty inherent in valuing these securities, the determinations of fair value may fluctuate from period to period and may differ materially from the values that could
be obtained if a ready market for these securities existed. Our net asset value (NAV) could be materially affected if the determinations regarding the fair value of our investments are materially different from the values that we
ultimately realize upon our disposal of such securities. Our valuation policies, procedures and processes are more fully described under Managements Discussion and Analysis of Financial Condition and Results of
Operations Critical Accounting Policies Investment Valuation.
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Transactions with Related Parties
Investment Advisory and Management Agreement
Pursuant to our Advisory Agreement, we pay the Adviser certain fees as compensation for its services, consisting of a base management fee and an incentive fee,
each as described below. On July 14, 2020, our Board of Directors, including a majority of the directors who are not parties to the Advisory Agreement or interested persons of either party, approved the renewal of the Advisory Agreement through
August 31, 2021. Our Board of Directors considered the following factors as the basis for its decision to renew the Advisory Agreement: (1) the nature, extent and quality of services provided by the Adviser to our stockholders,
(2) the investment performance of the Company and the Adviser, (3) the costs of the services to be provided and profits to be realized by the Adviser and its affiliates from the relationship with the Company, (4) the extent to which
economies of scale will be realized as the Company and the Affiliated Public Funds grow and whether the fee level under the Advisory Agreement reflects the economies of scale for the Companys investors, (5) the fee structure of the
advisory and administrative agreements of comparable funds, (6) indirect profits to the Adviser created through the Company and (7) in light of the foregoing considerations, the overall fairness of the advisory fee paid under the Advisory
Agreement.
Base Management Fee
The base management
fee is payable quarterly to the Adviser pursuant to our Advisory Agreement and is assessed at an annual rate of 2.0%, computed on the basis of the value of our average gross assets at the end of the two most recently completed quarters (inclusive of
the current quarter), which are total assets, including investments made with proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings, valued at the end of the applicable quarters within the respective period,
and adjusted appropriately for any share issuances or repurchases during the period.
Additionally, as stated above, pursuant to the requirements of the
1940 Act, the Adviser makes available significant managerial assistance to our portfolio companies. The Adviser may also provide other services to our portfolio companies under certain agreements and may receive fees for services other than
managerial assistance. Such services may include: (i) assistance obtaining, sourcing or structuring credit facilities, long term loans or additional equity from unaffiliated third parties; (ii) negotiating important contractual financial
relationships; (iii) consulting services regarding restructuring of the portfolio company and financial modeling as it relates to raising additional debt and equity capital from unaffiliated third parties; and (iv) a primary role in
interviewing, vetting and negotiating employment contracts with candidates in connection with adding and retaining key portfolio company management team members. The Adviser non-contractually, unconditionally,
and irrevocably credits 100% of any fees received for such services against the base management fee that we would otherwise be required to pay to the Adviser; however, pursuant to the terms of the Advisory Agreement, a small percentage of certain of
such fees is retained by the Adviser in the form of reimbursement, at cost, for tasks completed by personnel of the Adviser, primarily related to the valuation of portfolio companies. Loan servicing fees that are payable to the Adviser pursuant to
our Fifth Amended and Restated Credit Agreement, as amended (the Credit Facility), are also 100% credited against the base management fee as discussed below Loan Servicing Fee Pursuant to Credit Facility.
Incentive Fee
The incentive fee payable to the Adviser
under our Advisory Agreement consists of two parts: an income-based incentive fee and a capital gains-based incentive fee.
The income-based incentive fee
rewards the Adviser if our quarterly net investment income (before giving effect to any incentive fee) exceeds 1.75% of our net assets, which we define as total assets less indebtedness and before taking into account any incentive fees payable or
contractually due but not payable during the period, at the end of the immediately preceding calendar quarter, adjusted appropriately for any share issuances or
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repurchases during the period (the Hurdle Rate). The income-based incentive fee with respect to our pre-incentive fee net investment income is
payable quarterly to the Adviser and is computed as follows:
No incentive fee in any calendar quarter in which our pre-incentive fee
net investment income does not exceed the Hurdle Rate;
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 2.1875% of our net assets, adjusted appropriately for any share issuances or repurchases
during the period, in any calendar quarter; and
20.0% of the amount of our pre-incentive fee net investment income, if
any, that exceeds 2.1875% of our net assets, adjusted appropriately for any share issuances or repurchases during the period, in any calendar quarter.
Quarterly Incentive Fee Based on Net Investment Income
Pre-incentive fee net investment income
(expressed as a percentage of the value of net assets)
Percentage of pre-incentive fee net investment income
allocated to income-related portion of incentive fee
The second part of the incentive fee is a capital gains-based incentive fee that is determined and payable in arrears as of the end of each fiscal year (or
upon termination of the Advisory Agreement, as of the termination date), and equals 20.0% of our realized capital gains, less any realized capital losses and unrealized depreciation, calculated as of the end of the preceding calendar year. The
capital gains-based incentive fee payable to the Adviser is calculated based on (i) cumulative aggregate realized capital gains since our inception, less (ii) cumulative aggregate realized capital losses since our inception, less
(iii) the entire portfolios aggregate unrealized capital depreciation, if any, as of the date of the calculation. If this number is positive at the applicable calculation date, then the capital gains-based incentive fee for such year
equals 20.0% of such amount, less the aggregate amount of any capital gains-based incentive fees paid in respect of our portfolio in all prior years. For calculation purposes, cumulative aggregate realized capital gains, if any, equals the sum of
the excess between the net sales price of each investment, when sold, and the original cost of such investment since our inception. Cumulative aggregate realized capital losses equals the sum of the deficit between the net sales price of each
investment, when sold, and the original cost of such investment since our inception. The entire portfolios aggregate unrealized capital depreciation, if any, equals the sum of the deficit between the fair value of each investment security as
of the applicable calculation date and the original cost of such investment security. As of and for the year ended March 31, 2021, no capital gains-based incentive fees were contractually due or paid to the Adviser. During the year ended
March 31, 2020, capital gains-based incentive fees of $8.1 million were contractually due and paid to the Adviser, which was the first payment of a capital gains-based incentive fee since our inception.
In accordance with GAAP, accrual of the capital gains-based incentive fee is determined as if our investments had been liquidated at their fair values as of
the end of the reporting period. Therefore, GAAP requires that the capital gains-based incentive fee accrual consider the aggregate unrealized capital appreciation in the calculation, as a capital gains-based incentive fee would be payable if such
unrealized capital appreciation were realized. There can be no assurance that any such unrealized capital appreciation will be realized in the future. Accordingly, a GAAP accrual is calculated at the end of the reporting period based on
(i) cumulative aggregate realized capital gains since our inception, plus (ii) the entire portfolios aggregate unrealized capital appreciation,
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if any, less (iii) cumulative aggregate realized capital losses since our inception, less (iv) the entire portfolios aggregate unrealized capital depreciation, if any. If such
amount is positive at the end of a reporting period, a capital gains-based incentive fee equal to 20.0% of such amount, less the aggregate amount of capital gains-based incentive fees accrued in all prior
years, is recorded, regardless of whether such amount is contractually due under the terms of the Advisory Agreement. If such amount is negative, then there is no accrual for such period and prior period accruals are reversed, as appropriate. During
the year ended March 31, 2021, we recorded capital gains-based incentive fees of $5.0 million. During the year ended March 31, 2020, we recorded a reversal of capital gains-based incentive fees of $6.7 million. During the year ended
March 31, 2019, we recorded capital gains-based incentive fees of $17.8 million.
Loan Servicing Fee Pursuant to Credit Facility
The Adviser also services the loans held by our wholly-owned subsidiary, Gladstone Business Investment, LLC (Business Investment) (the
borrower under the Credit Facility), in return for which the Adviser receives a 2.0% annual fee based on the monthly aggregate outstanding balance of loans pledged under the Credit Facility. Since Business Investment is a consolidated subsidiary of
ours, coupled with the fact that the total base management fee paid to the Adviser pursuant to the Advisory Agreement cannot exceed 2.0% of total assets (less any uninvested cash or cash equivalents resulting from borrowings) during any given
calendar year, we treat the payment of the loan servicing fee pursuant to the Credit Facility as a pre-payment of the base management fee under the Advisory Agreement. Accordingly, these loan servicing fees
are 100% non-contractually, unconditionally, and irrevocably credited back to us by the Adviser.
Administration Agreement
We reimburse the
Administrator pursuant to the Administration Agreement for our allocable portion of the Administrators expenses incurred while performing services to us, which are primarily rent and salaries and benefits expenses of the Administrators
employees, including, our chief financial officer and treasurer, chief valuation officer, chief compliance officer, general counsel and secretary (who also serves as the Administrators president, general counsel, and secretary), and their
respective staffs.
Our allocable portion of the Administrators expenses is generally derived by multiplying the Administrators total expenses
by the approximate percentage of time during the current quarter that the Administrators employees performed services for us in relation to their time spent performing services for all companies serviced by the Administrator. On July 14,
2020, our Board of Directors, including a majority of the directors who are not parties to the Administration Agreement or interested persons of either party, approved the annual renewal of the Administration Agreement through August 31, 2021.
Other Transactions
Mr. Gladstone also
serves on the board of managers of our affiliate, Gladstone Securities, a privately-held broker-dealer registered with the Financial Industry Regulatory Authority and insured by the Securities Investor Protection Corporation. Gladstone Securities is
100% indirectly owned and controlled by Mr. Gladstone and has provided other services, such as investment banking and due diligence services, to certain of our portfolio companies, for which Gladstone Securities receives a fee. Any such fees
paid by portfolio companies to Gladstone Securities do not impact the fees we pay to the Adviser or the non-contractual, unconditional, and irrevocable credits against the base management fee. Refer to Note 4
Related Party Transactions in the accompanying Notes to Consolidated Financial Statements for additional information.
Material U.S. Federal Income Tax Considerations
This is a general summary of certain material U.S. federal income tax considerations applicable to us, to our qualification and taxation as a RIC for U.S.
federal income tax purposes under Subchapter M of the Code and to the ownership and disposition of our shares. This summary does not purport to be a complete description of all of the tax considerations relating thereto. In particular, we have not
described certain considerations that may be
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relevant to certain types of stockholders subject to special treatment under U.S. federal income tax laws. This summary does not discuss any aspect of state, local or foreign tax laws, or the
U.S. estate or gift tax.
RIC Status
To
qualify for treatment as a RIC under Subchapter M of the Code, we must generally distribute to our stockholders, for each taxable year, at least 90% of our taxable ordinary income plus the excess of our realized net short-term capital gains over our
realized net long-term capital losses (Investment Company Taxable Income). We refer to this as the annual distribution requirement. We must also meet several additional requirements, including:
Business Development Company status: At all times during the taxable year, we must maintain our
status as a BDC.
Income source requirements: At least 90% of our gross income for each taxable year must be from dividends,
interest, payments with respect to securities loans, gains from sales or other dispositions of securities or other income (including certain deemed inclusions) derived with respect to our business of investing in securities, and net income derived
from an interest in a qualified publicly-traded partnership.
Asset diversification requirements: As of the close of each quarter of our taxable year: (1) at least
50% of the value of our assets must consist of cash, cash items, U.S. government securities, the securities of other regulated investment companies and other securities to the extent that (a) we do not hold more than 10% of the outstanding
voting securities of an issuer of such other securities and (b) such other securities of any one issuer do not represent more than 5% of our total assets (the 50% threshold), and (2) no more than 25% of the value of our total
assets may be invested in the securities (other than U.S. government securities or the securities of other regulated investment companies) of (i) one issuer, (ii) two or more issuers that are controlled by us and are engaged in the same or
similar or related trades or businesses, and (iii) one or more qualified publicly-traded partnerships.
Failure to Qualify as
a RIC
If we are unable to qualify for treatment as a RIC, we would be subject to U.S. federal income tax on all of our taxable income at the
regular corporate income tax rate and would be subject to any applicable state and local taxes, even if we distributed all of our Investment Company Taxable Income to our stockholders. We would not be able to deduct distributions to our
stockholders, nor would we be required to make such distributions. Distributions would be taxable to our stockholders as ordinary dividend income to the extent of our current or accumulated earnings and profits. Subject to certain limitations under
the Code, corporate distributees would be eligible for the dividends received deduction, if applicable. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the
stockholders adjusted tax basis, and then as capital gain. If we fail to meet the RIC requirements for more than two consecutive years and then seek to requalify as a RIC, we generally would be subject to corporate-level U.S. federal income
tax on any unrealized appreciation with respect to our assets unless we make a special election to pay corporate-level U.S. federal income tax on any such unrealized appreciation during the succeeding five-year period.
Qualification as a RIC
If we qualify as a RIC and
meet the annual distribution requirement, we will not be subject to U.S. federal income tax on the portion of our Investment Company Taxable Income and net capital gain (realized net long-term capital gain in excess of realized net short-term
capital loss) that we timely distribute (or are deemed to distribute) to our stockholders. We would, however, be subject to a 4% nondeductible federal excise tax if we do not distribute, actually or on a deemed basis, an amount at least equal to the
sum of (i) 98% of our ordinary income for the calendar year, (ii) 98.2% of our net capital gains for the one-year period ending on October 31 of
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the calendar year and (iii) any income realized, but not distributed, in the preceding period (to the extent that income tax was not imposed on such amounts), less certain reductions, as
applicable. For the calendar years ended December 31, 2020, 2019 and 2018, we incurred $0.5 million, $0.8 million and $0.3 million, respectively, in excise taxes. As of March 31, 2021, our capital loss carryforward was $0.
Taxation of Our U.S. Stockholders
Distributions
For any period during which we
qualify as a RIC for U.S. federal income tax purposes, distributions to our stockholders attributable to our Investment Company Taxable Income generally will be taxable as ordinary income to our stockholders to the extent of our current or
accumulated earnings and profits. We first allocate our earnings and profits to distributions to our preferred stockholders and then to distributions to our common stockholders based on priority in our capital structure. Any distributions in excess
of our earnings and profits will first be treated as a return of capital to the extent of the stockholders adjusted basis in his or her shares of stock and thereafter as capital gain. Distributions of our long-term capital gains, reported by
us as such, will be taxable to our stockholders as long-term capital gains regardless of the stockholders holding period of the stock and whether the distributions are paid in cash or invested in additional stock. Corporate U.S. stockholders
generally are eligible for the 50% dividends received deduction with respect to dividends received from us, but only to the extent such amount is attributable to dividends received by us from taxable domestic corporations.
A RIC that has two or more classes of stock generally is required to allocate to each class proportionate amounts of each type of its income (such as ordinary
income, capital gains, qualified dividend income and dividends qualifying for the dividends-received deduction) based upon the percentage of total distributions paid to each class for the tax year. Accordingly, we intend to allocate capital gain
distributions, distributions of qualified dividend income, and distributions qualifying for the dividends-received deduction, if any, between our common shares and preferred shares in proportion to the total distributions paid to each class with
respect to such tax year.
Any distribution declared by us in October, November or December of any calendar year, payable to our stockholders of
record on a specified date in such a month and actually paid during January of the following year, will be treated as if it were paid by us and received by our stockholders on December 31 of the previous year. In addition, we may elect (in
accordance with Section 855(a) of the Code) to relate a distribution back to the prior taxable year if we (1) declare such distribution prior to the later of the extended due date for filing our return for that taxable year or the 15 th day of the ninth month following the close of the taxable year, (2) make the election in that return, and (3) distribute the amount in the 12-month
period following the close of the taxable year but not later than the first regular distribution payment of the same type following the declaration. Any such election will not alter the general rule that a stockholder will be treated as receiving a
distribution in the taxable year in which the distribution is made, subject to the October, November, December rule described above. For the fiscal year ended March 31, 2021, Investment Company Taxable Income exceeded distributions
declared and paid, and, in accordance with Section 855(a) of the Code, we elected to treat $16.1 million of the first distributions paid to common stockholders in the fiscal year ending March 31, 2022 as having been paid in the fiscal
year ended March 31, 2021. In addition, for the fiscal year ended March 31, 2021, net capital gains exceeded distributions declared and paid, and, in accordance with Section 855(a) of the Code, we elected to treat $8.5 million of
the first distributions paid to common stockholders in the fiscal year ending March 31, 2022 as having been paid in the fiscal year ended March 31, 2021.
If a common stockholder participates in our opt in dividend reinvestment plan, then the common stockholder will have their cash dividends and
distributions automatically reinvested in additional shares of our common stock, rather than receiving cash dividends and distributions. Any distributions reinvested under the plan will be taxable to the common stockholder to the same extent, and
with the same character, as if the common stockholder had received the distribution in cash. The common stockholder will have an adjusted basis in the additional common shares purchased through the plan equal to the dollar amount that would have
been received if the U.S. stockholder had received the dividend or distribution in cash. The additional common shares will have
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a new holding period commencing on the day following the day on which the shares are credited to the common stockholders account. The plan agent purchases shares in the open market in
connection with the obligations under the plan. We do not have a dividend reinvestment plan for our preferred stockholders.
We may distribute our net
long-term capital gains, if any, in cash or elect to retain some or all of such gains, pay taxes at the U.S. federal corporate-level income tax rate on the amount retained, and designate the retained amount as a deemed distribution. If
we elect to retain net long-term capital gains and deem them distributed, each U.S. common stockholder will be treated as if they received a distribution of their pro-rata share of the retained net long-term
capital gain and the U.S. federal income tax paid. As a result, each U.S. common stockholder will (i) be required to report their pro-rata share of the retained gain on their tax return as long-term
capital gain, (ii) receive a refundable tax credit for their pro-rata share of federal income tax paid by us on the retained gain, and (iii) increase the tax basis of their shares of common stock by
an amount equal to the deemed distribution less the tax credit. To use the deemed distribution approach, we must provide written notice to our common stockholders prior to the expiration of 60 days after the close of the relevant taxable year. For
the year ended March 31, 2021, we did not elect to retain long-term capital gains and to treat them as deemed distributions to common stockholders. For the years ended March 31, 2020 and 2019, we elected to retain $38.0 million, or
$1.15 per common share, and $50.0 million, or $1.52 per common share, respectively, of net long-term capital gains and to treat them as deemed distributions to common stockholders. We incurred $8.0 million, or $0.24 per common share, and
$10.5 million, or $0.32 per common share, respectively, for the years ended March 31, 2020 and 2019, of U.S. federal income taxes on behalf of common stockholders related to the retention of capital gains, which are included in Taxes on
deemed distribution of long-term capital gains on our accompanying Consolidated Statements of Operations .
Sale of Our Shares
A U.S. stockholder generally will recognize taxable gain or loss if the U.S. stockholder sells or otherwise disposes of the shares of our common or
preferred stock. Any gain arising from such sale or disposition generally will be treated as long-term capital gain or loss if the U.S. stockholder has held the shares for more than one year. Otherwise, it will be classified as short-term
capital gain or loss. However, any capital loss arising from the sale or disposition of shares of our stock held for six months or less will be treated as long-term capital loss to the extent of the amount of capital gain dividends received, or
undistributed capital gain deemed received, with respect to such shares. Under the tax laws in effect as of the date of this filing, individual U.S. stockholders are subject to a maximum federal income tax rate of 20% on their net capital gain
(i.e. the excess of realized net long-term capital gain over realized net short-term capital loss for a taxable year) including any long-term capital gain derived from an investment in our shares. Such rate is lower than the maximum rate on ordinary
income currently payable by individuals. Corporate U.S. stockholders currently are subject to federal income tax on net capital gain at the same rates applied to their ordinary income. Capital losses are subject to limitations on use for both
corporate and non-corporate stockholders. Certain U.S. stockholders who are individuals, estates or trusts generally are also subject to a 3.8% Medicare tax on, among other things, dividends on and capital
gain from the sale or other disposition of shares of our stock.
Backup Withholding and Other Required Withholding
We may be required to withhold U.S. federal income tax, or backup withholding, from all taxable distributions to any
non-corporate U.S. stockholder (i) who fails to furnish us with a correct taxpayer identification number or a certificate that such stockholder is exempt from backup withholding, or (ii) with
respect to whom the Internal Revenue Service (IRS) notifies us that such stockholder has failed to properly report certain interest and dividend income to the IRS and to respond to notices to that effect. An individuals taxpayer
identification number is generally his or her social security number. Any amount withheld under backup withholding is allowed as a credit against the U.S. stockholders federal income tax liability, provided that proper information is
provided to the IRS.
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The Foreign Account Tax Compliance Act imposes a U.S. federal withholding tax on certain types of payments
made to foreign financial institutions and certain other non-U.S. entities unless certain due diligence, reporting, withholding, and certification obligation requirements are satisfied.
Information Reporting
We will send to each of our
U.S. stockholders, after the end of each calendar year, a notice providing the amounts includible in the U.S. stockholders taxable income for such year as ordinary income and as long-term capital gain for cash distributions received. In
addition, the U.S. federal tax status of each years distributions will generally be reported to the IRS (including the amount of dividends, if any, eligible for the preferential rates applicable to long-term capital gains).
Regulation as a BDC
We are a closed-end, non-diversified management investment company that has elected to be regulated as a BDC under Section 54 of the 1940 Act. As such, we are subject to
regulation under the 1940 Act. The 1940 Act contains prohibitions and restrictions relating to transactions between BDCs and their affiliates, principal underwriters and affiliates of those affiliates or underwriters and requires that a majority of
the directors be persons other than interested persons, as defined in the 1940 Act. In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC unless
approved by a majority of our outstanding voting securities, as defined in the 1940 Act.
We intend to conduct our business so as to retain
our status as a BDC. A BDC may use capital provided by public stockholders and from other sources to make long-term investments in private companies. A BDC provides stockholders the ability to retain the liquidity of a publicly-traded stock, while
sharing in the possible benefits, if any, of investing in primarily privately owned companies. In general, a BDC must have been organized and have its principal place of business in the U.S. and must be operated for the purpose of making investments
in qualifying assets, as described in Sections 55(a)(1) through (a)(3) of the 1940 Act.
Qualifying Assets
Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in Section 55(a) of the 1940 Act, which are referred to as
qualifying assets, unless, at the time the acquisition is made, qualifying assets, other than certain interests in furniture, equipment, real estate, or leasehold improvements (Operating Assets), represent at least 70% of total assets,
exclusive of Operating Assets. The types of qualifying assets in which we may invest under the 1940 Act include the following:
(1)
Securities purchased in transactions not involving any public offering from the issuer of such securities,
which issuer is an eligible portfolio company. An eligible portfolio company is generally defined in the 1940 Act as any issuer which:
(a)
Is organized under the laws of, and has its principal place of business in, any state or states in the U.S.;
(b)
Is not an investment company (other than a small business investment company wholly owned by the BDC or
otherwise excluded from the definition of investment company); and
(c)
Satisfies one of the following:
(i)
It does not have any class of securities with respect to which a broker or dealer may extend margin credit;
(ii)
It is controlled by the BDC and for which an affiliate of the BDC serves as a director;
(iii)
It has total assets of not more than $4 million and capital and surplus of not less than $2 million;
(iv)
It does not have any class of securities listed on a national securities exchange; or
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(v)
It has a class of securities listed on a national securities exchange, with an aggregate market value of
outstanding voting and non-voting equity of less than $250 million.
(2)
Securities received in exchange for or distributed on or with respect to securities described in
(1) above, or pursuant to the exercise of options, warrants or rights relating to such securities.
(3)
Cash, cash items, government securities or high quality debt securities maturing in one year or less from the
time of investment.
As of March 31, 2021, 99.7% of our assets were qualifying assets.
Asset Coverage
Pursuant to Section 61(a)(3)
of the 1940 Act, we are permitted, under specified conditions, to issue multiple classes of senior securities representing indebtedness. However, pursuant to Section 18(c) of the 1940 Act, we are permitted to issue only one class of senior
securities that is stock. In either case, we may only issue such senior securities if such class of senior securities, after such issuance, has an asset coverage, as defined in Section 18(h) of the 1940 Act, of at least 150%.
In addition, our ability to pay dividends or distributions (other than dividends payable in our common stock) to holders of any class of our capital stock
would be restricted if our senior securities representing indebtedness fail to have an asset coverage of at least 150% (measured at the time of declaration of such distribution and accounting for such distribution). The 1940 Act does not apply this
limitation to privately arranged debt that is not intended to be publicly distributed, unless this limitation is specifically negotiated by the lender. In addition, our ability to pay dividends or distributions (other than dividends payable in our
common stock) to our common stockholders would be restricted if our senior securities that are stock fail to have an asset coverage of at least 150% (measured at the time of declaration of such distribution and accounting for such distribution).
When the value of our assets declines, we might be unable to satisfy these asset coverage requirements. To satisfy the 150% asset coverage requirement in the event that we are seeking to pay a distribution, we might either have to (i) liquidate
a portion of our portfolio to repay a portion of our indebtedness or (ii) issue common stock. This may occur at a time when a sale of a portfolio asset may be disadvantageous, or when we have limited access to capital markets on agreeable
terms. In addition, any amounts that we use to service our indebtedness or for offering costs will not be available for distributions to our stockholders. If we are unable to regain the requisite asset coverage through these methods, we may be
forced to suspend the payment of such dividends or distributions.
Significant Managerial Assistance
A BDC generally must make available significant managerial assistance to issuers of certain of its portfolio securities that the BDC counts as a qualifying
asset for the 70% test described above. Making available significant managerial assistance means, among other things, any arrangement whereby the BDC, through its directors, officers or employees, offers to provide, and, if accepted, does so
provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company. Significant managerial assistance also includes the exercise of a controlling influence over the management
and policies of the portfolio company. However, with respect to certain, but not all such securities, where the BDC purchases such securities in conjunction with one or more other persons acting together, one of the other persons in the group may
make available such managerial assistance, or the BDC may exercise such control jointly.
Summary of Risk Factors
Below is a summary of the principal risk factors associated with an investment in our securities. In addition to the below, you should carefully consider the
information included in Risk Factors , beginning on page 22 of this Annual Report, together with all of the other information included in this Annual Report and the other reports and documents filed or furnished by us with the
SEC for a more detailed discussion of the principal risks, as well as certain other risks that you should carefully consider before deciding to invest in our securities.
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Market conditions could negatively impact our business, results of operations, cash flows and financial
condition.
Volatility in the capital markets may make it more difficult to raise capital and may adversely affect the
valuations of our investments.
Our business has been, and in the future could be further, adversely affected by the current coronavirus
pandemic and related government actions.
Our investments in lower middle market companies are extremely risky and could cause you to lose all or a part
of your investment.
The lack of liquidity of our privately held investments may adversely affect our business.
Our investments are typically long-term and will require several years to realize liquidation events.
We typically invest in transactions involving acquisitions, buyouts and recapitalizations of companies, which
will subject us to the risks associated with change in control transactions.
Our portfolio is concentrated in a limited number of companies and industries, which subjects us to an
increased risk of significant loss if any one of these companies does not repay us or if the industries experience downturns.
Any inability to renew, extend or replace our Credit Facility on terms favorable to us, or at all, could
adversely impact our liquidity and ability to fund new investments or maintain distributions to our stockholders.
Changes in laws or regulations governing our operations, or changes in the interpretation thereof, and any
failure by us to comply with laws or regulations governing our operations may adversely affect our business.
There are significant potential conflicts of interest, including with the Adviser, which could impact our
investment returns.
Our success depends on the Advisers ability to attract and retain qualified personnel in a competitive
environment.
Our incentive fee may induce the Adviser to make certain investments, including speculative investments.
We may be obligated to pay the Adviser incentive compensation even if we incur a loss.
The Adviser is not obligated to provide a credit of the base management fee or incentive fee, which could
negatively impact our earnings and our ability to maintain our current level of distributions to our stockholders.
There is a risk that you may not receive distributions or that distributions may not grow over time
Investing in our securities may involve an above average degree of risk.
Common shares
of closed-end investment companies frequently trade at a discount to the NAV.
Our mandatorily redeemable preferred stock bears a risk of early redemption by us.
Cybersecurity risks and cyber incidents may adversely affect our business by causing a disruption to our
operations, or the operations of businesses in which we invest, a compromise or corruption of our confidential information and/or damage to our business relationships, all of which could negatively impact our business, financial condition and
operating results.
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Code of Ethics
We, and all of the Gladstone family of companies, have adopted a code of ethics and business conduct applicable to all of the officers, directors and personnel
of such companies that complies with the guidelines set forth in Item 406 of Regulation S-K of the Securities Act of 1933, as amended (the Securities Act), and Rule
17j-1 of the 1940 Act. As required by the 1940 Act, this code establishes procedures for personal investments, restricts certain transactions by such personnel and requires the reporting of certain
transactions and holdings by such personnel. This code of ethics and business conduct is publicly available on our website under Investors -
GovernanceGovernance Documents at www.GladstoneInvestment.com . We intend to provide any required disclosure of any amendments to or waivers
of the provisions of this code by posting information regarding any such amendment or waiver to our website or in a Current Report on Form 8-K.
Compliance Policies and Procedures
We and the
Adviser have adopted and implemented written policies and procedures reasonably designed to prevent violation of the federal securities laws, and our Board of Directors is required to review these compliance policies and procedures annually to
assess their adequacy and the effectiveness of their implementation. We have designated a chief compliance officer, John Dellafiora, Jr., who also serves as chief compliance officer for all of our Gladstone affiliates.
Staffing
We do not currently have any employees
and do not expect to have any employees in the foreseeable future. Currently, services necessary for our business are provided by individuals who are employees of the Adviser and the Administrator pursuant to the terms of the Advisory Agreement and
the Administration Agreement, respectively. No employee of the Adviser or the Administrator dedicates all of his or her time to us. However, we expect that 20 to 25 full-time employees of the Adviser and the Administrator will spend substantial time
on our matters during the remainder of calendar year 2021 and all of calendar year 2022. To the extent we acquire more investments, we anticipate that the number of employees of the Adviser and the Administrator who devote time to our matters will
increase.
As of March 31, 2021, the Adviser and Administrator collectively had 67 full-time employees. A breakdown of these employees is summarized
by functional area in the table below:
Number of
Individuals
Functional Area
12
Executive management
19
Accounting, administration, compliance, human resources, legal, and treasury
36
Investment management, portfolio management, and due diligence
The Adviser and the Administrator aim to attract and retain capable advisory and administrative personnel, respectively, by
offering competitive base salaries and bonus structure and by providing employees with appropriate opportunities for professional growth.
Available
Information
We file with or furnish to the SEC copies of our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, proxy statements and other information meeting the information requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934, as amended (the Exchange Act), and make such reports and any amendments thereto available free of charge through the Investors SEC Filings section of our website at
www.GladstoneInvestment.com as soon as reasonably practicable after such materials are electronically filed with or furnished to the SEC. Information contained on our website is not incorporated by reference into this Annual Report. The SEC also
maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov .
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