Item 1A. Risk Factors
ITEM 1A.
RISK FACTORS
You should carefully consider these risk factors, together with all of the other information included in this Annual Report and the other reports and
documents filed by us with the SEC. The risks set out below are not the only risks we face. Additional risks and uncertainties not presently known to us, or not presently deemed material by us, may also impair our operations and performance. If any
of the following events occur, our business, financial condition, results of operations and cash flows could be materially and adversely affected. If that happens, the trading price of our securities and the NAV of our common stock could decline,
and you may lose all or part of your investment. The risk factors described below are the principal risk factors associated with an investment in our securities as well as those factors generally associated with an investment company with investment
objectives, investment policies, capital structure or trading markets similar to ours.
Risks Related to the Economy
Market conditions could negatively impact our business, results of operations, financial condition, and cash flows.
The market in which we operate is affected by a number of factors that are largely beyond our control but can nonetheless have a potentially significant,
negative impact on us. These factors include, among other things:
Changes in interest rates and credit spreads;
The availability of credit, including the price, terms and conditions under which it can be obtained;
The quality, pricing, and availability of suitable investments and losses with respect to our investments;
The ability to obtain accurate market-based valuations;
Investment values relative to the value of the underlying assets;
Prepayment rates, delinquency rates and legislative / regulatory changes with respect to our investments;
Competition;
The impact of COVID-19 generally and on the economy, the capital markets
and our portfolio companies, including the measures taken by governmental authorities to address it;
The actual and perceived state of the economy and public capital markets generally;
Amendments or repeals of legislation, or changes in regulations or regulatory interpretations thereof, and
transitions of government, including uncertainty regarding any of the foregoing;
The national and global political environment, including foreign relations and trading policies;
The impact of potential changes to the Code; and
The attractiveness of other types of investments relative to investments in Lower Middle Market companies
generally.
Changes in these factors are difficult to predict, and a change in one factor could affect other factors, which could result
in adverse effects to our business, results of operations, financial condition, and cash flows.
Volatility in the capital markets could make it more
difficult to raise capital and has, and could in the future, adversely affect the valuations of our investments.
Given the volatility and dislocation
that the capital markets are experiencing and have experienced from time to time, many BDCs have faced, and may in the future face, a challenging environment in which to raise capital. We could in the future have difficulty accessing debt and equity
capital, and a severe disruption in the global
22
Table of Contents
financial markets or deterioration in credit and financing conditions could have a material adverse effect on our business, financial condition, results of operations, and cash flows. In
addition, significant changes in the capital markets have had, and may in the future have, a negative effect on the valuations of our investments and on the potential for liquidity events involving our investments. An inability to raise capital, and
any required sale of our investments for liquidity purposes, could have a material adverse impact on our business, financial condition, results of operations, or cash flows.
Our business has been, and in the future could be further, adversely affected by the current coronavirus pandemic and related government actions.
As of the date of this Annual Report, there is a continuing outbreak of a novel and highly contagious form of coronavirus. The World Health Organization
has declared the disease (COVID-19) it causes to constitute a pandemic. The outbreak of COVID-19 has resulted in numerous deaths,
adversely impacted global commercial activity and contributed to significant volatility in certain equity and debt markets. In response to the COVID-19 pandemic, many countries, including the U.S., reacted by
instituting quarantines, prohibiting travel and ordering the closure of offices, businesses, schools, retail stores and other public venues. Businesses also implemented similar precautionary measures. Such measures created significant disruptions in
and continue to adversely impact economic activity, particularly in the transportation, hospitality, tourism, entertainment and certain other industries. As COVID-19 cases fluctuate, certain
governments have (and others in the future may) reinstituted these or other measures, which could further exacerbate the adverse impacts on economic activity.
As a result of these and other factors, the COVID-19 pandemic, and any future public health emergency or the threat
thereof, could have a significant adverse impact on us and our portfolio companies and could adversely affect our ability to fulfill our investment objectives.
The extent of the impact of COVID-19, or any public health emergency, on our operational and financial performance
will depend on many factors, including the duration and scope of such public health emergency, the extent of any related travel advisories and restrictions implemented, the impact of such public health emergencies on overall supply and demand, goods
and services, investor liquidity, consumer confidence and levels of economic activity and the extend of its disruption to important global, regional and local supply chains and economic markets, all of which are highly uncertain and cannot be
predicted.
The effects of a public health emergency may materially and adversely impact the value and performance of our investments, our ability to
source, manage and divest investments and our ability to achieve our investment objectives, all of which could result in significant losses to us. In addition, our operations and our Advisers operations may be significantly impacted, or even
temporarily or permanently halted, as a result of government quarantine measures, voluntary and precautionary restrictions on travel or meetings and other factors related to a public health emergency, including its potential adverse impact on the
health of our Advisers personnel.
Public health threats, including the COVID-19 pandemic, may
adversely impact the businesses in which we invest and affect our business, operating results, and financial condition.
Public health threats, such as COVID-19 or any other illness, may disrupt the operations of the businesses in which we invest. Such threats can create economic and political uncertainties and can contribute to global economic
instability. A public health threat poses the risk that our portfolio companies may have significantly reduced or be prevented from conducting business activities for an unknown period of time, including shutdowns that may be requested or
mandated by governmental authorities, or that they may experience disruptions in their supply chains or decreased consumer demand. As governments ease restrictions, certain of our portfolio companies may experience increases in health and safety
expenses, payroll costs and other operating expenses. These adverse economic impacts may decrease the value of our investments. These negative impacts on our portfolio companies and their performance may increase realized and unrealized losses
related to our investments, which may, in turn, adversely impact our business, financial condition or results of operations.
23
Table of Contents
Risks Related to Interest Rates
Market interest rates may have an effect on the value of our securities.
One of the factors that influences the price of our securities is the distribution yield on our securities (as a percentage of the price of our securities)
relative to market interest rates. An increase in market interest rates, which are currently at low levels relative to historical rates, may lead prospective purchasers of our securities to expect a higher distribution yield. In addition, higher
interest rates would likely increase our borrowing costs and potentially decrease funds available for distribution. As a result, higher market interest rates could cause the market price of our securities to decrease.
A change in interest rates may adversely affect our profitability and hedging arrangements may expose us to additional risks.
We anticipate using a combination of equity and long-term and short-term borrowings to finance our investment activities. As a result, a portion of our income
will depend upon the spread between the rate at which we borrow funds and the rate at which we loan these funds. An increase or decrease in interest rates could reduce the spread between the rate at which we invest and the rate at which we borrow,
and thus, adversely affect our profitability if we have not appropriately hedged against such event. Alternatively, interest rate hedging arrangements may limit our ability to participate in the benefits of lower interest rates with respect to the
hedged portfolio.
Ultimately, we expect approximately 90.0% of the loans in our portfolio to be at variable rates determined on the basis of the LIBOR
and approximately up to 10.0% to be at fixed rates. As of March 31, 2021, based on the total principal balance of debt investments outstanding, our portfolio consisted of 97.7% of loans at variable rates with floors and 2.3% at fixed rates.
As of March 31, 2021, we did not have any hedging arrangement, such as interest rate hedges. While hedging arrangements may insulate us against
adverse fluctuations in interest rates, they may also limit our ability to participate in the benefits of lower interest rates with respect to the hedged portfolio. Adverse developments resulting from changes in interest rates or any future hedging
transactions could have a material adverse effect on our business, financial condition, results of operations, and cash flows. Our ability to receive payments pursuant to a hedging arrangement is linked to the ability of the counter-party to that
hedging arrangement to make the required payments. To the extent that the counter-party to the hedging arrangement is unable to pay pursuant to the terms of the agreement, we may lose the hedging protection of the arrangement.
Also, the fair value of certain of our debt investments is based, in part, on the current market yields or interest rates of similar securities. A change in
interest rates could have a significant impact on our determination of the fair value of these debt investments. In addition, a change in interest rates could also have an impact on the fair value of any hedging arrangements then in effect that
could result in the recording of unrealized appreciation or depreciation in future periods. Therefore, adverse developments resulting from changes in interest rates could have a material adverse effect on our business, financial condition, results
of operations, and cash flows. Refer to Quantitative and Qualitative Disclosures About Market Risk for additional information on interest rate fluctuations.
The interest rates of some of our term loans to our portfolio companies are priced using a spread over LIBOR, which may be phased out in the future.
LIBOR is the basic rate of interest used in lending between banks on the London interbank market and is widely used as a reference for setting the
interest rate on loans globally. In general, our investments in debt securities have a term of five years, accrue interest at variable rates based on 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.
24
Table of Contents
As a result of concerns about the accuracy of the calculation of LIBOR, a number of British Bankers
Association (the BBA) member banks entered into settlements with certain regulators and law enforcement agencies with respect to the alleged manipulation of LIBOR. Actions by the BBA, regulators or law enforcement agencies as a result of
these or future events, may result in changes to the manner in which LIBOR is determined. Potential changes, or uncertainty related to such potential changes may adversely affect the market for LIBOR-based securities, including our portfolio of
LIBOR-indexed, floating-rate debt securities and our borrowings. In addition, changes or reforms to the determination or supervision of LIBOR may result in a sudden or prolonged increase or decrease in reported LIBOR, which could have an adverse
impact on the market for LIBOR-based securities or the value of our portfolio of LIBOR-indexed, floating-rate debt securities and our borrowings.
On
July 27, 2017, the United Kingdoms Financial Conduct Authority (FCA, which regulates LIBOR, announced that it intends to phase out LIBOR by the end of 2021. However, the FCA has indicated it will not compel panel banks to
continue to contribute to LIBOR after the end of 2021. Following consultations in December 2020 and January 2021, the ICE Benchmark Administration Limited (the IBA) announced that (i) it intends to cease publication of 1-week and 2-month U.S. dollar LIBOR at the end of 2021 and (ii) subject to compliance with applicable regulations, it intends to continue publication of the remaining
U.S. dollar LIBOR tenors until June 30, 2023, effectively extending the LIBOR transition period to June 30, 2023. There is currently no definitive information regarding the future utilization of LIBOR or of any particular replacement rate.
The committee established by the Federal Reserve, the Alternative Reference Rates Committee, announced the replacement of LIBOR with a new index, based on overnight repurchase agreements collateralized by U.S. Treasury securities, called the Secured
Overnight Financing Rate (SOFR). The Federal Reserve Bank of New York began publishing SOFR in April 2018. Other jurisdictions have also proposed their own alternative to LIBOR, including the Sterling Overnight Index Average for Sterling
markets, the Euro Short Term Rate for Euros and Tokyo Overnight Average Rate for Japanese Yens. Although SOFR appears to be the preferred replacement rate for U.S. dollar LIBOR, at this time, it is not possible to predict whether SOFR will attain
market traction as a LIBOR replacement tool, and the future of LIBOR is still uncertain. The effect of any such changes, any establishment of alternative reference rates or any other reforms to LIBOR or other reference rates that may be enacted in
the United Kingdom or elsewhere cannot be predicted at this time, and it is not possible to predict whether LIBOR will continue to be viewed as an acceptable market benchmark, what rate or rates may become accepted alternatives to LIBOR, or what the
effect of any such changes in views or alternatives may have on the financial markets for financial instruments based on LIBOR. To date, certain of the loan agreements with our portfolio companies have already been amended to include fallback
language providing a mechanism for the parties to negotiate a new reference interest rate in the event that LIBOR ceases to exist. Factors such as the pace of the transition to replacement or reformed rates, the specific terms and parameters for and
market acceptance of any alternative reference rate, prices of and the liquidity of trading markets for products based on alternative reference rates, and our ability to transition and develop appropriate systems and analytics for one or more
alternative reference rates could also have a material adverse effect on our business, financial condition and results of operations. In addition, any further changes or reforms to the determination or supervision of LIBOR may result in a sudden or
prolonged increase or decrease in reported LIBOR, which could have a material adverse effect on our business, financial condition, tax position and results of operations.
Risks Related to Our Investments
We operate in
a highly competitive market for investment opportunities.
A large number of entities compete with us to make the types of investments we seek to make
in Lower Middle Market companies. We generally compete with public and private buyout funds, commercial and investment banks, commercial financing companies, and, to the extent that they provide an alternative form of financing, hedge funds, mutual
funds, and private equity. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding
sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which would allow them to consider a wider variety of investments and establish more relationships than us.
Furthermore, many of our
25
Table of Contents
competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC. The competitive pressures we face could have a material adverse effect on our business,
financial condition and results of operations. Also, as a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time and we can offer no assurance that we will be able to identify and
make investments that are consistent with our investment objectives. We do not seek to compete based on the interest rates we offer, and we believe that some of our competitors may make loans with interest rates that will be comparable to or lower
than the rates we offer. We may lose investment opportunities if we do not match our competitors pricing, terms, and structure. However, if we match our competitors pricing, terms, and structure, we may experience decreased net interest
income and increased risk of credit loss.
Our investments in Lower Middle Market portfolio companies are extremely risky and could cause you to lose
all or a part of your investment.
Investments in Lower Middle Market portfolio companies are subject to a number of significant risks including the
following:
Lower Middle Market businesses are likely to be more significantly impacted in economic downturns than larger
businesses . Our portfolio companies may have fewer resources than larger businesses, and any economic downturns or recessions are more likely to have a material adverse effect on them. When the economy contracts, the financial results of
Lower Middle Market businesses, like those in which we invest, could experience deterioration or limited growth from current levels, which could ultimately lead to difficulty in meeting their debt service requirements and an increase in defaults.
Consequently, for any portfolio company that is adversely impacted by an economic downturn or recession, its ability to repay our loan(s) or engage in a liquidity event, such as a sale, recapitalization or initial public offering would be
diminished.
Lower Middle Market businesses may have limited financial resources and may not be able to repay the loans we
make to them. Our strategy includes providing financing to portfolio companies that typically do not have readily available access to financing. While we believe that this provides an attractive opportunity for us to generate profits, this
may make it difficult for the portfolio companies to repay their loans to us upon maturity. A borrowers ability to repay its loan(s) may be adversely affected by numerous factors, including the failure to meet its business plan, a downturn in
its industry or negative economic conditions. Deterioration in a borrowers financial condition and prospects usually will be accompanied by deterioration in the value of any collateral and a reduction in the likelihood of realizing on any
guaranties we may have obtained from the borrowers management. As of March 31, 2021, loans to three portfolio companies were on non-accrual status with an aggregate debt cost basis of
$61.1 million, or 12.4% of the cost basis of all debt investments in our portfolio. While we are working with these portfolio companies to improve their profitability and cash flows, there can be no assurance that our efforts will prove
successful. Although we will generally seek to be a secured first lien lender to a borrower, in some of our loans we expect to be subordinated to a senior lender and our security interest in any collateral would, accordingly, likely be second lien
and subordinate to another lenders security interest.
Lower Middle Market businesses typically have narrower product lines and smaller market shares than large
businesses. Our target portfolio companies tend to be more vulnerable to competitors actions and market conditions, as well as general economic downturns. In addition, our portfolio companies may face intense competition, including
competition from companies with greater financial resources, more extensive development, manufacturing, marketing and other capabilities and a larger number of qualified managerial and technical personnel.
There is generally little or no publicly available information about these businesses. Because we
seek to invest in privately owned businesses, there is generally little or no publicly available operating and financial information about our potential portfolio companies. As a result, we rely on our officers, the Adviser and its employees,
Gladstone Securities and consultants to perform due diligence
26
Table of Contents
investigations of these portfolio companies, their operations, and their prospects. We may not learn all of the material information we need to know regarding these businesses through our
investigations to make a well-informed investment decision.
Lower Middle Market businesses generally have less predictable operating results. We expect that our
portfolio companies may have significant variations in their operating results, may from time to time be exposed to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, may require
substantial additional capital to support their operations, to finance expansion or to maintain their competitive position, may otherwise have a weak financial position or may be adversely affected by changes in the business cycle. Our portfolio
companies may not meet net income, cash flow and other coverage tests typically imposed by their senior lenders. A borrowers failure to satisfy financial or operating covenants imposed by senior lenders could lead to defaults and, potentially,
foreclosure on its senior credit facility, which could additionally trigger cross-defaults in other agreements. If this were to occur, it is possible that the borrowers ability to repay our loan(s) would be jeopardized.
Lower Middle Market businesses are more likely to be dependent on one or two persons. Typically, the
success of a Lower Middle Market business also depends on the management talents and efforts of one or two persons or a small group of persons. The death, disability or resignation of one or more of these persons could have a material adverse impact
on our portfolio company and, in turn, on us.
Lower Middle Market businesses may have limited operating histories. While we intend to continue to
target stable companies with proven track records, we may invest in new companies that meet our other investment criteria. Portfolio companies with limited operating histories will be exposed to all of the operating risks that new businesses face
and may be particularly susceptible to, among other risks, market downturns, competitive pressures and the departure of key executive officers.
Debt securities of Lower Middle Market companies typically are not rated by a credit rating agency .
Typically, a Lower Middle Market business cannot or will not expend the resources to have their debt securities rated by a credit rating agency. We expect that most, if not all, of the debt securities we acquire will be unrated. Investors should
assume that these loans would be at rates below what is considered investment grade quality. Investments rated below investment grade are often referred to as high yield securities or junk bonds and may be considered high risk as
compared to investment grade debt instruments.
Lower Middle Market companies may be highly leveraged. Some of our portfolio companies are
highly leveraged, which could have adverse consequences to these companies and to us as an investor. These companies may be subject to restrictive financial and operating covenants and the leverage could impair these companies ability to
finance their future operations and capital needs. As a result, these companies flexibility to respond to changing business and economic conditions (including those currently presented by the COVID-19
pandemic) and to take advantage of business opportunities may be limited. Further, a leveraged companys income and net assets will tend to increase or decrease at a greater rate than if borrowed money were not used.
Because the loans we make and equity securities we invest in are not publicly traded, there is uncertainty regarding the value of our privately-held
securities that could adversely affect our determination of our NAV.
Substantially all of our portfolio investments are, and we expect will continue
to be, in the form of securities that are not publicly traded. The fair value of securities and other investments that are not publicly traded may not be readily determinable. Our Board of Directors has ultimate responsibility for reviewing and
determining in good faith the fair value of our investments for which market quotations are not readily available, based on the Policy. Our Board of Directors reviews valuation recommendations that are provided by the Valuation Team. In valuing our
investment portfolio, several techniques are used, including, a total enterprise value approach, a yield analysis, and market quotes. Currently, ICE Data Pricing and Reference Data, LLC provides estimates of fair
27
Table of Contents
value on generally all of our debt investments that are not valued using total enterprise value (TEV) and we use another independent valuation firm to provide valuation inputs for our
significant equity investments, which are generally valued using TEV, including earnings multiple ranges, as well as other information. In addition to these techniques, inputs and information, other factors are considered when determining fair value
of our investments, including: the nature and realizable value of the collateral, including external parties guaranties; any relevant offers or letters of intent to acquire the portfolio company; timing of expected loan repayments; and the
markets in which the portfolio company operates. Refer to Managements Discussion and Analysis of Financial Condition and Results of Operations Critical Accounting Policy Investment Valuation for
additional information on our valuation policies, procedures, and processes.
Fair value measurements of our investments may involve subjective judgments
and estimates and, due to the uncertainty inherent in valuing these securities, the determination of fair value may fluctuate from period to period and may differ materially from the values that could be obtained if a ready market for these
securities existed. Additionally, changes in the market environment and other events that may occur over the life of the investment may cause the gains or losses ultimately realized on these investments to be different than the valuations currently
assigned.
Our NAV would be adversely affected if the fair value of our investments that are approved by our Board of Directors are higher than the values
that we ultimately realize upon the disposal of such securities.
The valuation process for certain of our portfolio holdings creates a conflict of
interest.
A substantial portion of our portfolio investments are securities for which market quotations are not readily available. As a result, our
Board of Directors determines the fair value of these securities in good faith pursuant to the Policy. In connection with that determination, our Valuation Team prepares portfolio company valuations based upon the most recent portfolio company
financial statements available and projected financial results of each portfolio company. The participation of our Advisers investment professionals in our valuation process and Mr. Gladstones pecuniary interest in our Adviser may
result in a conflict of interest, as the management fees that we pay our Adviser are based on our average gross assets, less uninvested cash or cash equivalents from borrowings, and adjusted appropriately for any share issuances or repurchases
during the period.
The lack of liquidity of our privately-held investments may adversely affect our business.
We will generally make investments in private companies whose securities are not traded in any public market. Substantially all of the investments we
presently hold and the investments we expect to acquire in the future are, and will be, subject to legal and other restrictions on resale and will otherwise be less liquid than publicly-traded securities. The illiquidity of our investments may make
it difficult for us to quickly obtain cash equal to the value at which we record our investments if the need arises. This could cause us to miss important investment opportunities. In addition, if we are required to liquidate all or a portion of our
portfolio quickly, we may record substantial realized losses upon liquidation. We may also face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we, the Adviser, the Administrator, or our
respective officers, or affiliates have material non-public information regarding such portfolio company.
Due to
the uncertainty inherent in valuing these securities, the Advisers determinations of fair value may differ materially from the values that could be obtained if a ready market for these securities existed. Our NAV could be materially affected
if the Advisers determinations regarding the fair value of our investments are materially different from the values that we ultimately realize upon our disposal of such securities. Additional discussion regarding risks associated with
determinations made by the Adviser is found in the risk factor The valuation process for certain of our portfolio holdings creates a conflict of interest.
28
Table of Contents
Our financial results could be negatively affected if a significant portfolio investment fails to perform
as expected.
Our total investment in one or more companies may be significant individually or in the aggregate. As a result, if a significant
investment in one or more companies fails to perform as expected, our financial results could be more negatively affected and the magnitude of the loss could be more significant than if we had made smaller investments in more companies. Our five
largest investments represented more than 35% of the fair value of our total portfolio as of March 31, 2021 and 2020. Any disposition of a significant investment in one or more portfolio companies may negatively impact our net investment income
and limit our ability to pay distributions.
We typically invest in transactions involving acquisitions, buyouts and recapitalizations of companies,
which will subject us to the risks associated with change in control transactions.
Our strategy, in part, includes making debt and equity investments
in companies in connection with acquisitions, buyouts and recapitalizations, which subjects us to the risks associated with change in control transactions. Change in control transactions often present a number of uncertainties. Companies undergoing
change in control transactions often face challenges retaining key employees and maintaining relationships with customers and suppliers. While we hope to avoid many of these difficulties by participating in transactions where the management team is
retained and by conducting thorough due diligence in advance of our decision to invest, if our portfolio companies experience one or more of these problems, we may not realize the value that we expect in connection with our investments, which would
likely harm our operating results, financial condition, and cash flows.
Our portfolio companies may incur debt that ranks equally with, or senior to,
our investments in such companies and/or we could be subject to lender liability claims.
We primarily invest in secured first and second lien debt
securities issued by our portfolio companies. In some cases, portfolio companies will be permitted to have other debt that ranks equally with, or senior to, the debt securities in which we invest. By their terms, such debt securities may provide
that the holders thereof are entitled to receive payment of interest and principal on or before the dates on which we are entitled to receive payments in respect of the debt securities in which we invest. Also, in the event of insolvency,
liquidation, dissolution, reorganization, or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any
distribution in respect of our investment. Additionally, depending on the facts and circumstances, including the extent to which we provide managerial assistance to any portfolio company subject to bankruptcy, a bankruptcy court might re-characterize our debt investments and subordinate all or a portion of our claims to that of other creditors. After repaying such senior creditors, such portfolio company may not have any remaining assets to use
for repaying its obligation to us. We may also be subject to lender liability claims for actions taken by us with respect to a borrowers business or in instances in which we exercised control over the borrower as a result of actions taken in
rendering any managerial assistance. Furthermore, in the case of debt ranking equally with debt securities in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of an
insolvency, liquidation, dissolution, reorganization, or bankruptcy of a portfolio company.
Our portfolio is concentrated in a limited number of
companies and industries, which subjects us to an increased risk of significant loss if any one of these companies does not repay us or if the industries experience downturns.
As of March 31, 2021, we had investments in 28 portfolio companies, the five largest of which included Pioneer Square, Counsel Press, Old World, J.R.
Hobbs, and Bassett Creek, and comprised $233.9 million, or 36.9%, of our total investment portfolio, at fair value. A consequence of a limited number of investments is that the aggregate returns we realize may be substantially adversely
affected by the unfavorable performance of a small
29
Table of Contents
number of such investments or a substantial write-down of any one investment, including the potential impact of the COVID-19 pandemic (or similar future
public health emergencies). Beyond our regulatory and income tax diversification requirements, as well as Credit Facility requirements, we do not have fixed guidelines for industry concentration and our investments could potentially be concentrated
in relatively few industries. In addition, while we do not intend to invest 25% or more of our total assets in a particular industry or group of industries at the time of investment, it is possible that as the values of our portfolio companies
change, one industry or a group of industries may comprise in excess of 25% of the value of our total assets. A downturn in a particular industry in which we have invested a significant portion of our total assets could have a materially adverse
effect on us. As of March 31, 2021, our largest industry concentration was in Diversified/Conglomerate Services, representing 41.3% of our total investments, at fair value.
Our investments are typically long-term and will require several years to realize liquidation events.
Since we generally make five year term loans and hold our loans and equity positions until the loans mature and/or we exit the investment, investors should not
expect realization events, if any, to occur over the near term. In addition, we expect that any equity investments may require several years to appreciate in value and we cannot give any assurance that such appreciation will occur or ultimately be
realized.
The disposition of our investments may result in contingent liabilities.
Currently, all but one of our investments involve private securities. In connection with the disposition of an investment in private securities, we may be
required to make representations about the business and financial affairs of the underlying portfolio company typical of those made in connection with the sale of a business. We may also be required to indemnify the purchasers of such investment to
the extent that any such representations turn out to be inaccurate or with respect to certain potential liabilities. These arrangements may result in contingent liabilities that may ultimately yield funding obligations that must be satisfied through
our return of certain distributions previously made to us.
Portfolio company-related litigation or other litigation or claims against us or our
personnel could result in costs, including defense costs or damages, and the diversion of management time and resources.
In the course of investing in
and often providing significant managerial assistance to certain of our portfolio companies, certain persons employed by the Adviser sometimes serve as directors on the boards of such companies. To the extent that litigation arises out of our
investments in these companies or otherwise, even if meritless, we or such employees may be named as defendants in such litigation, which could result in additional costs, including defense costs, and the diversion of management time and resources.
We may be unable to accurately estimate our exposure to litigation risk if we record balance sheet reserves for probable loss contingencies. As a result, any reserves we establish to cover any settlements or judgments may not be sufficient to cover
our actual financial exposure, which may have a material impact on our results of operations, financial condition, or cash flows.
While we believe we
would have valid defenses to potential claims brought due to our investment in any portfolio company, and will defend any such claims vigorously, we may nevertheless expend significant amounts of money in defense costs and expenses. Further, if we
enter into settlements or suffer an adverse outcome in any litigation, we could be required to pay significant amounts. In addition, if any of our portfolio companies become subject to direct or indirect claims or other obligations, such as defense
costs or damages in litigation or settlement, our investment in such companies could diminish in value and we could suffer indirect losses. Further, these matters could cause us to expend significant management time and effort in connection with
assessment and defense of any claims. No range of potential expenses, costs or damages in connection with these matters can be estimated at this time.
30
Table of Contents
Any unrealized depreciation we experience on our investment portfolio may be an indication of future
realized losses, which could reduce any gains available for distribution.
As a BDC, we are required to carry our investments at market value or, if no
market value is ascertainable, at fair value as determined in good faith by or under the direction of our Board of Directors. We will record decreases in the market values or fair values of our investments as unrealized depreciation. Since our
inception, we have, at times, incurred a cumulative net unrealized depreciation of our portfolio. Any unrealized depreciation in our investment portfolio could result in realized losses in the future and ultimately in reductions of any gains
available for distribution to stockholders in future periods.
Risks Related to Our External Financing
In addition to regulatory limitations on our ability to raise capital, the Credit Facility contains various covenants which, if not complied with, could
accelerate our repayment obligations under the facility, thereby materially and adversely affecting our liquidity, financial condition, results of operations, cash flows, and ability to pay distributions.
We will have a continuing need for capital to finance our investments. As of March 31, 2021, we, through our wholly-owned subsidiary, Business Investment,
had $22.4 million in borrowings, at cost, outstanding under the Credit Facility, which provides for maximum borrowings of $180.0 million, with a revolving period end date of February 29, 2024 (the Revolving Period End
Date). The Credit Facility permits us to fund additional loans and investments as long as we are within the conditions and covenants set forth in the credit agreement. Among other things, the Credit Facility contains covenants that require
Business Investment to maintain its status as a separate legal entity, prohibit certain significant corporate transactions (such as mergers, consolidations, liquidations or dissolutions) and restrict certain material changes to our credit and
collection policy without the lenders consent. The Credit Facility also generally seeks to restrict distributions to stockholders to the sum of (i) our net investment income, (ii) net capital gains, and (iii) amounts deemed by
the Company to be considered as having been paid during the prior fiscal year in accordance with Section 855(a) of the Code. Loans eligible to be pledged as collateral are subject to certain limitations, including, among other things,
restrictions on geographic concentrations, industry concentrations, loan size, payment frequency and status, average life, portfolio company leverage, and lien property. The Credit Facility also requires Business Investment to comply with other
financial and operational covenants, which obligate Business Investment to, among other things, maintain certain financial ratios, including asset and interest coverage and a minimum number of obligors in the borrowing base. Additionally, the Credit
Facility contains a performance guarantee that requires the Company to maintain (i) a minimum net worth (defined in the Credit Facility to include our mandatorily redeemable term preferred stock) of the greater of $210.0 million or
$210.0 million plus 50% of all equity and subordinated debt raised minus 50% of any equity or subordinated debt redeemed or retired after November 16, 2016, which equated to $266.2 million as of March 31, 2021, (ii) asset
coverage with respect to senior securities representing indebtedness of at least 150% (or such percentage as may be set forth in Section 18 of the 1940 Act, as modified by Section 61 of the 1940 Act); and (iii) our status as a BDC
under the 1940 Act and as a RIC under the Code. As of March 31, 2021, and as defined in the performance guaranty of the Credit Facility, we had a net worth of $597.1 million, asset coverage on our senior securities representing
indebtedness of 398.0%, calculated in accordance with the requirements of Sections 18 and 61 of the 1940 Act, and an active status as a BDC and RIC. As of March 31, 2021, we were in compliance with all covenants under the Credit Facility;
however, our continued compliance depends on many factors, some of which are beyond our control.
Any unrealized depreciation in our portfolio may
increase in future periods and threaten our ability to comply with the minimum net worth covenant and other covenants under the Credit Facility. Our failure to satisfy these covenants could result in foreclosure by our lenders, which would
accelerate our repayment obligations under the facility and thereby have a material adverse effect on our business, liquidity, financial condition, results of operations, cash flows, and ability to pay distributions to our stockholders.
31
Table of Contents
Any inability to renew, extend or replace the Credit Facility on terms favorable to us, or at all, could
adversely impact our liquidity and ability to fund new investments or maintain distributions to our stockholders.
If the Credit Facility is not
renewed or extended by the Revolving Period End Date, all principal and interest will be due and payable on February 28, 2026 (two years after the Revolving Period End Date). Subject to certain terms and conditions, the Credit Facility may be
expanded to a total of $300.0 million through additional commitments of existing or new lenders. However, if such lenders are unwilling to provide additional commitments under the terms of the Credit Facility, we will be unable to expand the
Credit Facility and thus will continue to have limited availability to finance new investments under the Credit Facility. There can be no guaranty that we will be able to renew, extend or replace the Credit Facility upon its Revolving Period End
Date on terms that are favorable to us, if at all. Our ability to expand the Credit Facility, and to obtain replacement financing at or before the time of its Revolving Period End Date, will be constrained by then current economic conditions
affecting the credit markets. In the event that we are not able to expand the Credit Facility, or to renew, extend or refinance the Credit Facility by the Revolving Period End Date, this could have a material adverse effect on our liquidity and
ability to fund new investments, our ability to make distributions to our stockholders and our ability to qualify as a RIC under the Code.
If we are
unable to secure replacement financing, we may be forced to sell certain assets on disadvantageous terms, which may result in realized losses, and such realized losses could materially exceed the amount of any unrealized depreciation on these assets
as of our most recent balance sheet date, which would have a material adverse effect on our results of operations. Such circumstances would also increase the likelihood that we would be required to redeem some or all of our outstanding mandatorily
redeemable preferred stock, which could potentially require us to sell more assets. In addition to selling assets, or as an alternative, we may issue common equity to repay amounts outstanding under the Credit Facility. Depending upon the trading
prices of our common stock (and with the approval of our independent directors and stockholders), such an equity offering may have a dilutive impact on our existing stockholders interest in our earnings, assets and voting interest in us. If we
are able to renew, extend or refinance the Credit Facility prior to maturity, renewal, extension or refinancing, it could potentially result in significantly higher interest rates and related charges and may impose significant restrictions on the
use of borrowed funds to fund investments or maintain distributions to stockholders.
Because we expect to distribute substantially all of our
Investment Company Taxable Income, at least 90%, on an annual basis, our business plan is dependent upon external financing, which is constrained by the limitations of the 1940 Act.
There can be no assurance that we will be able to raise capital through issuing equity in the near future. Our business requires a substantial amount of cash
to operate and grow. We may acquire such additional capital from the following sources:
Senior Securities: We may issue senior securities representing indebtedness (including borrowings under the
Credit Facility and our 2026 Notes) and senior securities that are stock (including our Series E Term Preferred Stock), up to the maximum amount permitted by the 1940 Act. The 1940 Act currently permits us, as a BDC, to issue senior securities
representing indebtedness and senior securities which are stock, in amounts such that our asset coverage, as defined in Section 18(h) of the 1940 Act, is at least 150% on each such senior security immediately after each issuance of each such
senior security. As a result of issuing senior securities (in whatever form), we will be exposed to the risks associated with leverage. Although borrowing money for investments increases the potential for gain, it also increases the risk of a loss.
A decrease in the value of our investments will have a greater impact on the value of our common stock to the extent that we have borrowed money to make investments. There is a possibility that the costs of borrowing could exceed the income we
receive on the investments we make with such borrowed funds. In addition, our ability to pay distributions, issue senior securities or repurchase shares of our common stock would be restricted if the asset coverage on each of our senior securities
is not at least 150%. If the aggregate fair value of our assets declines, we might be unable to satisfy that 150% requirement. To satisfy the 150% asset coverage requirement in
32
Table of Contents
the event that we are seeking to pay a distribution, we might either have to (i) liquidate a portion of our loan portfolio to repay a portion of our indebtedness or (ii) issue common
stock. This may occur at a time when a sale of a portfolio asset may be disadvantageous, or when we have limited access to capital markets on agreeable terms. In addition, any amounts that we use to service our indebtedness, pay dividends on our
preferred stock or for offering costs will not be available for distributions to common stockholders. 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 are stock.
Common and Convertible Preferred Stock : Because we are constrained in our ability to issue debt or senior
securities for the reasons given above, we may at times be dependent on the issuance of equity as a financing source. If we raise additional funds by issuing more common stock, the percentage ownership of our common stockholders at the time of the
issuance would decrease and our existing common stockholders may experience dilution. In addition, under the 1940 Act, we will generally not be able to issue additional shares of our common stock at a price below NAV per common share to purchasers,
other than to our existing common stockholders through a rights offering, without first obtaining the approval of our stockholders and our independent directors. If we were to sell shares of our common stock below our then current NAV per common
share, as we did at times during March 2018 under the at-the-market program, and in other offerings in May 2017, March 2015, and October 2012, such sales would result in
an immediate dilution to the NAV per common share. This dilution would occur as a result of the sale of common shares at a price below the then current NAV per share of our common stock and a proportionately greater decrease in a common
stockholders interest in our earnings and assets and voting percentage than the increase in our assets resulting from such issuance. For example, if we issue and sell an additional 10% of our common stock at a 5% discount from NAV, a common
stockholder who does not participate in that offering for its proportionate interest will suffer NAV dilution of up to 0.5% or $5 per $1,000 of NAV. This imposes constraints on our ability to raise capital when our common stock is trading below NAV
per common share, as it generally has for the last several years. As noted above, the 1940 Act prohibits the issuance of multiple classes of senior securities that are stock. As a result, we would be prohibited from issuing convertible preferred
stock to the extent that such a security was deemed to be a separate class of stock from our outstanding mandatorily redeemable preferred stock.
We financed certain of our investments with borrowed money and capital from the issuance of senior securities, which will magnify the potential for gain or
loss on amounts invested and may increase the risk of investing in us.
The use of leverage, including through the issuance of senior securities that
are debt or stock, magnifies the potential for gain or loss on amounts invested. We have incurred leverage in the past and currently incur leverage through the Credit Facility, the 2026 Notes and shares of our mandatorily redeemable preferred stock
and, from time to time, may incur additional leverage to the extent permitted under the 1940 Act. The use of leverage is generally considered a speculative investment technique and increases the risks associated with investing in our securities. In
the future, we may borrow from, and issue senior securities to, banks and other lenders. Holders of these senior securities will have fixed dollar claims on our assets that are superior to the claims of our common stockholders, and we would expect
such holders to seek recovery against our assets in the event of a default.
33
Table of Contents
The following table illustrates the effect of leverage on returns from an investment in our common stock
assuming various annual returns on our portfolio, net of expenses. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing in the table below.
Assumed Return on Our Portfolio
(Net of Expenses)
(10)%
(5)%
0%
5%
10%
Corresponding return to common
stockholder (A)
(20.38
)%
(11.96
)%
(3.54
)%
4.88
%
13.30
%
(A)
The hypothetical return to common stockholders is calculated by multiplying our total assets as of
March 31, 2021 by the assumed rates of return and subtracting all interest on our debt and dividends on our mandatorily redeemable preferred stock expected to be paid or declared during the twelve months following March 31, 2021, and then
dividing the resulting difference by our total net assets attributable to common stock as of March 31, 2021. Based on $643.7 million in total assets, $22.4 million in borrowings outstanding on the Credit Facility, at cost,
127.9 million of 2026 Notes, at cost, $5.1 million in a secured borrowing, $ $94.4 million in aggregate liquidation preference of Series E Term Preferred Stock, and $382.4 million in net assets as of March 31, 2021.
Based on an aggregate outstanding indebtedness of $155.4 million, at cost, as of March 31, 2021, the effective annual cash
interest rate of 4.8% as of that date, and aggregate liquidation preference of our mandatorily redeemable preferred stock of $94.4 million with a weighted-average dividend rate of 6.4%, our investment portfolio at fair value would have to
produce an annual return of at least 2.1% to cover annual interest payments on the outstanding debt and dividends on our mandatorily redeemable preferred stock.
Risks Related to Our Regulation and Structure
We will be subject to corporate-level tax if we are unable to satisfy the Code requirements for RIC qualification.
To maintain our qualification as a RIC, we must maintain our status as a BDC and meet annual distribution, income source, and asset diversification
requirements. The annual distribution requirement is satisfied if we distribute at least 90% of our Investment Company Taxable Income to our stockholders on an annual basis. Because we use leverage, we are subject to certain asset coverage ratio
requirements under the 1940 Act and could, under certain circumstances, be restricted from making distributions necessary to qualify as a RIC. Warrants we may receive with respect to debt investments generally create original issue discount
(OID), which we must recognize as ordinary income over the term of the debt investment. Similarly, PIK interest which is accrued generally over the term of the debt investment but not paid in cash, is recognized as ordinary income. Both
OID and PIK interest will increase the amounts we are required to distribute to maintain our RIC status. Because such OIDs and PIK interest will not produce distributable cash for us at the same time as we are required to make distributions, we will
need to use cash from other sources to satisfy such distribution requirements. As of March 31, 2021, we did not have investments with OID or a PIK feature. Additionally, we must meet asset diversification and income source requirements at the
end of each calendar quarter. If we fail to meet these tests, we may need to quickly dispose of certain investments to prevent the loss of RIC status. Since most of our investments will be illiquid, such dispositions, if even possible, may not be
made at prices advantageous to us and may result in substantial losses. If we fail to qualify as a RIC as of a calendar quarter or annually for any reason and become fully subject to U.S. federal corporate income tax, the resulting corporate taxes
could substantially reduce our net assets, the amount of income available for distribution, and the actual amount distributed. Such a failure would have a material adverse effect on us and our common stock. Refer to Business Material
U.S. Federal Income Tax Considerations RIC Status for additional information regarding asset coverage ratio and RIC requirements.
Some
of our debt investments may include success fees that would generally generate payments to us upon a change of control. Because the satisfaction of these success fees, and the ultimate payment of these fees, is uncertain and highly contingent, we
generally only recognize them as income when the payment is received.
34
Table of Contents
Success fee amounts are characterized as ordinary income for tax purposes and, as a result, we are required to distribute such amounts to our stockholders to maintain our RIC status.
If we do not invest a sufficient portion of our assets in qualifying assets, we could fail to qualify as a BDC under the 1940 Act or be
precluded from investing according to our current business strategy.
As a BDC, we may not acquire any assets other than qualifying assets
unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets, exclusive of Operating Assets, are qualifying assets, as defined in Section 55(a) of the 1940 Act.
We believe that most of the investments that we may acquire in the future will constitute qualifying assets. However, we may be precluded from investing in
what we believe to be attractive investments if such investments are not qualifying assets for purposes of the 1940 Act. If we do not invest a sufficient portion of our assets in qualifying assets, we could violate the 1940 Act provisions applicable
to BDCs. As a result of such violation, specific rules under the 1940 Act could prevent us, for example, from making follow-on investments in existing portfolio companies (which could result in the dilution of
our position) or could require us to dispose of investments at inappropriate times to come into compliance with the 1940 Act. If we need to dispose of such investments quickly, it could be difficult to dispose of such investments on favorable terms.
We may not be able to find a buyer for such investments and, even if we do find a buyer, we may have to sell the investments at a substantial loss. Any such outcomes would have a material adverse effect on our business, financial condition, results
of operations and cash flows.
If we do not maintain our status as a BDC, we would be subject to regulation as a registered
closed-end investment company under the 1940 Act. As a registered closed-end investment company, we would be subject to substantially more regulatory restrictions under
the 1940 Act, which would significantly decrease our operating flexibility. Refer to Business Regulation as a BDC Qualifying Assets for additional information regarding qualifying assets.
Provisions of the Delaware General Corporation Law and of our certificate of incorporation and bylaws could restrict a change in control and have an
adverse impact on the price of our common stock.
We are subject to provisions of the Delaware General Corporation Law that, in general, prohibit any
business combination with a beneficial owner of 15% or more of our common stock for three years unless the holders acquisition of our stock was either approved in advance by our Board of Directors or ratified by our Board of Directors and
stockholders owning two-thirds of our outstanding stock not owned by the acquiring holder. Although we believe these provisions collectively provide for an opportunity to receive higher bids by requiring
potential acquirers to negotiate with our Board of Directors, they would apply even if the offer may be considered beneficial by some stockholders.
We
have also adopted other measures that may make it difficult for a third party to obtain control of us, including provisions of our certificate of incorporation classifying our Board of Directors in three classes serving staggered three-year terms,
and provisions of our certificate of incorporation authorizing our Board of Directors to induce the issuance of additional shares of our stock. These provisions, as well as other provisions of our certificate of incorporation and bylaws, may delay,
defer, or prevent a transaction or a change in control that might otherwise be in the best interests of our stockholders.
35
Table of Contents
We may not be permitted to declare a dividend or make any distribution to stockholders or repurchase
shares until such time as we satisfy the asset coverage tests under the provisions of the 1940 Act that apply to BDCs. As a BDC, we have the ability to issue senior securities only in amounts such that our asset coverage, as defined in the 1940 Act,
equals at least 150% after each issuance of senior securities. If the value of our assets declines, we may be unable to satisfy this test. If that happens, we may be required to sell a portion of our investments and, depending on the nature of our
leverage, repay a portion of our debt at a time when such sales and/or repayments may be disadvantageous.
Regulations governing our operation as a BDC
and RIC will affect our ability to raise, and the way in which we raise, additional capital or borrow for investment purposes, which may have a negative effect on our growth. As a result of the annual distribution requirement to qualify as a RIC, we
may need to periodically access the capital markets to raise cash to fund new investments. We may issue senior securities representing indebtedness, including borrowing money from banks or other financial institutions, or senior securities that are
stock, such as our Series E Term Preferred Stock, only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 150% after each such incurrence or issuance. Further, we may not be permitted to declare a dividend or make
any distribution to our outstanding stockholders or repurchase shares until such time as we satisfy this test. Our ability to issue different types of securities is also limited. Compliance with these requirements may unfavorably limit our
investment opportunities and reduce our ability in comparison to other companies to profit from favorable spreads between the rates at which we can borrow and the rates at which we can lend. As a BDC, therefore, we intend to continuously issue
equity at a rate more frequent than our privately owned competitors, which may lead to greater stockholder dilution. We have incurred leverage to generate capital to make additional investments. If the value of our assets declines, we may be unable
to satisfy the asset coverage test under the 1940 Act, which could prohibit us from paying distributions and could prevent us from qualifying as a RIC. If we cannot satisfy the asset coverage test, we may be required to sell a portion of our
investments and, depending on the nature of our debt financing, repay a portion of our indebtedness at a time when such sales and repayments may be disadvantageous. Such events, if they were to occur, could have a significant adverse effect on our
business, financial condition, results of operations, and cash flows.
Risks Related to Our External Management
We are dependent upon our key management personnel and the key management personnel of the Adviser, particularly David Gladstone, David Dullum and Terry Lee
Brubaker, and on the continued operations of the Adviser, for our future success.
We have no employees. Our chief executive officer, chief operating
officer, chief financial officer and treasurer, chief valuation officer, and the employees of the Adviser do not spend all of their time managing our activities and our investment portfolio. We are particularly dependent upon David Gladstone, David
Dullum and Terry Lee Brubaker for their experience, skills, and networks. Our executive officers and the employees of the Adviser allocate some, and in some cases a material portion, of their time to businesses and activities that are not related to
our business. We have no separate facilities and are completely reliant on the Adviser, which has significant discretion as to the implementation and execution of our business strategies and risk management practices. We are subject to the risk of
discontinuation of the Advisers operations or termination of the Advisory Agreement and the risk that, upon such event, no suitable replacement will be found. We believe that our success depends to a significant extent upon the Adviser and
that discontinuation of its operations or the loss of its key management personnel could have a material adverse effect on our ability to achieve our investment objectives.
Our success depends on the Advisers ability to attract and retain qualified personnel in a competitive environment.
The Adviser experiences competition in attracting and retaining qualified personnel, particularly investment professionals and senior executives, and we may be
unable to maintain or grow our business if we cannot attract and retain such personnel. The Advisers ability to attract and retain personnel with the requisite credentials, experience and skills depends on several factors including, its
ability to offer competitive wages, benefits and
36
Table of Contents
professional growth opportunities. The Adviser competes with investment funds (such as private equity funds and mezzanine funds) and traditional financial services companies for qualified
personnel, many of which have greater resources than us. Searches for qualified personnel may divert managements time from the operation of our business. Strain on the existing personnel resources of the Adviser, in the event that it is
unable to attract experienced investment professionals and senior executives, could have a material adverse effect on our business.
The Adviser can
resign on 60 days notice, and we may not be able to find a suitable replacement within that time, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations.
The Adviser has the right to resign under the Advisory Agreement at any time upon not less than 60 days written notice, whether we have found a
replacement or not. If the Adviser resigns, we may not be able to find a new investment adviser or hire internal management with similar expertise and ability to provide the same or equivalent services on acceptable terms within 60 days, or at all.
If we are unable to do so quickly, our operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions are likely to be adversely affected and the market price
of our common stock may decline. In addition, the coordination of our internal management and investment activities is likely to suffer if we are unable to identify and reach an agreement with a single institution or group of executives having the
expertise possessed by the Adviser and its affiliates. Even if we are able to retain comparable management, whether internal or external, the integration of such management and their lack of familiarity with our investment objectives may result in
additional costs and time delays that may adversely affect our business, financial condition, results of operations and cash flows.
The Advisers
liability is limited under the Advisory Agreement, and we are required to indemnify our investment adviser against certain liabilities, which may lead the Adviser to act in a riskier manner on our behalf than it would when acting for its own
account.
The Adviser has not assumed any responsibility to us other than to render the services described in the Advisory Agreement, and it will not
be responsible for any action of our Board of Directors in declining to follow the Advisers advice or recommendations. Pursuant to the Advisory Agreement, the Adviser and its officers, managers, partners, agents, employees, controlling
persons, members and any other person or entity affiliated with the Adviser will not be liable to us for their acts under the Advisory Agreement, absent willful misfeasance, bad faith or gross negligence in the performance of their duties or by
reason of the reckless disregard of their duties and obligations under the Advisory Agreement. We have agreed to indemnify, defend and protect the Adviser and its officers, managers, partners, agents, employees, controlling persons, members and any
other person or entity affiliated with the Adviser with respect to all damages, liabilities, costs and expenses arising out of or otherwise based upon the performance of any of the Advisers duties or obligations under the Advisory Agreement or
otherwise as an investment adviser for us, and not arising out of willful misfeasance, bad faith or gross negligence in the performance of their duties or by reason of the reckless disregard of their duties and obligations under the Advisory
Agreement. These protections may lead the Adviser to act in a riskier manner when acting on our behalf than it would when acting for its own account.
Our incentive fee may induce the Adviser to make certain investments, including speculative investments.
The management compensation structure that has been implemented under the Advisory Agreement may cause the Adviser to invest in high-risk investments or take
other investment risks. In addition to its management fee, the Adviser is entitled under the Advisory Agreement to receive incentive compensation based in part upon our achievement of specified levels of income. In evaluating investments and other
management strategies, the opportunity to earn incentive compensation based on net investment income may lead the Adviser to place undue emphasis on the maximization of net investment income at the expense of other criteria, such as preservation of
capital, maintaining sufficient liquidity, or management of credit risk or market risk, to achieve higher incentive compensation. Investments with higher yield potential are generally riskier or more speculative. This could result in increased risk
to the value of our investment portfolio.
37
Table of Contents
We may be obligated to pay the Adviser incentive compensation even if we incur a net decrease in net
assets.
The Advisory Agreement entitles the Adviser to incentive compensation for each fiscal quarter in an amount equal to a percentage of the
excess of our net investment income for that quarter (before deducting the incentive fee) above a threshold return of 1.75% of our net assets, as adjusted, for that quarter. When calculating our incentive fee, our
pre-incentive fee net investment income excludes realized losses and unrealized depreciation that we may incur in the fiscal quarter, even if such losses or depreciation result in a net decrease in net assets
on our statement of operations for that quarter. Thus, we may be required to pay the Adviser incentive compensation for a fiscal quarter even if there is a decline in the value of our portfolio or we incur a net realized or unrealized loss for that
quarter. For additional information on incentive compensation under the Advisory Agreement with the Adviser, see Business Investment Advisory and Management Agreement .
We may be required to pay the Adviser incentive compensation on income accrued, but not yet received in cash.
The part of the incentive fee payable by us that relates to our net investment income is computed and paid on income that may include income that has been
accrued but not yet received in cash, such as debt instruments with PIK interest. If a portfolio company defaults on a loan, it is possible that such accrued interest previously used in the calculation of the incentive fee will become uncollectible.
Consequently, we may make incentive fee payments on income accruals that we may not collect in the future and with respect to which we do not have a clawback right against the Adviser.
The Advisers failure to identify and invest in securities that meet our investment criteria or perform its responsibilities under the Advisory
Agreement would likely adversely affect our ability for future growth.
Our ability to achieve our investment objectives will depend on our ability to
grow, which in turn will depend on the Advisers ability to identify and invest in securities that meet our investment criteria. Accomplishing this result on a cost-effective basis will be largely a function of the Advisers structuring of
the investment process, its ability to provide competent and efficient services to us, and our access to financing on acceptable terms. The Advisers senior management team has substantial responsibilities under the Advisory Agreement. To grow,
the Adviser will need to hire, train, supervise, and manage new employees successfully. Any failure to manage our future growth effectively would likely have a material adverse effect on our business, financial condition, results of operations, and
cash flows.
There are significant potential conflicts of interest, including with the Adviser, which could impact our investment returns.
Our executive officers and directors, and the officers and directors of the Adviser, serve or may serve as officers, directors, or principals of entities that
operate in the same or a related line of business as we do or of investment funds managed by our affiliates. Accordingly, they may have obligations to investors in those entities, the fulfillment of which might not be in our or our
stockholders best interests. For example, Mr. Gladstone, our chairman and chief executive officer, is the chairman of the board and chief executive officer of the Adviser and Administrator, and the Affiliated Public Funds. In addition,
Mr. Brubaker, our vice chairman and chief operating officer, is the vice chairman and chief operating officer of the Adviser and Administrator, and the Affiliated Public Funds. Mr. Dullum, our president, is an executive managing director
of the Adviser. While portfolio managers and the officers and other employees of the Adviser will devote as much time to the management of us as appropriate to enable the Adviser to perform its duties in accordance with the Advisory Agreement, the
portfolio managers and other of the Advisers officers may have conflicts in allocating their time and services among us, on the one hand, and other investment vehicles managed by the Adviser, on the other hand. These activities could be viewed
as creating a conflict of interest insofar as the time and effort of the portfolio managers and the officers and employees of the Adviser will not be devoted exclusively to our business but will instead be allocated between our business and the
management of these other investment vehicles. Moreover, the Adviser may establish or sponsor other investment vehicles which from time to time may have potentially overlapping
38
Table of Contents
investment objectives with ours and accordingly may invest in, whether principally or secondarily, asset classes we target. While the Adviser generally has broad authority to make investments on
behalf of the investment vehicles that it advises, the Adviser has adopted investment allocation procedures to address these potential conflicts and intends to direct investment opportunities to the Company or the Affiliated Public Fund with the
investment strategy that most closely fits the investment opportunity. Nevertheless, the management of the Adviser may face conflicts in the allocation of investment opportunities to other entities it manages. As a result, it is possible that we may
not be given the opportunity to participate in certain investments made by other funds managed by the Adviser.
In certain circumstances, we may make
investments in a portfolio company in which one of our affiliates has or will have an investment, subject to satisfaction of any regulatory restrictions and, where required, the prior approval of our Board of Directors. As of March 31, 2021,
our Board of Directors has approved the following types of transactions:
Our affiliate, Gladstone Commercial, may, under certain circumstances, lease property to portfolio companies that
we do not control. We may pursue such transactions only if (i) the portfolio company is not controlled by us or any of our affiliates, (ii) the portfolio company satisfies the tenant underwriting criteria of Gladstone Commercial, and
(iii) the transaction is approved by a majority of our independent directors and a majority of the independent directors of Gladstone Commercial. We expect that any such negotiations between Gladstone Commercial and our portfolio companies
would result in lease terms consistent with the terms that the portfolio companies would be likely to receive were they not portfolio companies of ours.
We may invest simultaneously with our affiliate Gladstone Capital in senior loans in the broadly syndicated
market whereby neither we nor any affiliate has the ability to dictate the terms of the loans.
Pursuant to the Co-Investment Order, we may 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.
Certain of our officers, who are also officers of the Adviser, may from time to time serve as directors of certain of our portfolio
companies. If an officer serves in such capacity for one of our portfolio companies, such officer will owe fiduciary duties to stockholders of the portfolio company, which duties may from time to time conflict with the interests of our stockholders.
In the course of our investing activities, we will pay management and incentive fees to the Adviser and will reimburse the Administrator for certain
expenses it incurs. As a result, investors in our common stock will invest on a gross basis and receive distributions on a net basis after expenses, resulting in, among other things, a lower rate of return than one might
achieve through our investors themselves making direct investments. As a result of this arrangement, there may be times when the management team of the Adviser has interests that differ from those of our stockholders, giving rise to a conflict. In
addition, as a BDC, we make available significant managerial assistance to our portfolio companies and provide other services to such portfolio companies. While neither we nor the Adviser currently receive fees in connection with managerial
assistance, the Adviser and Gladstone Securities have, at various times, provided other services to certain of our portfolio companies and received fees for services other than managerial assistance as discussed in Business Ongoing
Management of Investment Portfolio Company Relationships Managerial Assistance and Services.
The Adviser is not obligated to provide
credits of the base management fee or incentive fees, which could negatively impact our earnings and our ability to maintain our current level of distributions to our stockholders.
The Advisory Agreement provides for a base management fee, based on our gross assets, and an incentive fee, that is based on our income and capital gains. Our
Board of Directors has accepted in the past and may accept in
39
Table of Contents
the future non-contractual, unconditional, and irrevocable credits to reduce the annual 2.0% base management fee or the incentive fee, on a quarterly or
annual basis. Any fees credited may not be recouped by the Adviser in the future. However, the Adviser is not required to issue these or other credits of fees under the Advisory Agreement. If the Adviser does not issue these credits in the future,
it could negatively impact our earnings and may compromise our ability to maintain our current level of distributions to our stockholders, which could have a material adverse impact on our common stock price.
Our business model is dependent upon developing and sustaining strong referral relationships with investment bankers, business brokers and other
intermediaries and any change in our referral relationships may impact our business plan.
We are dependent upon informal relationships with investment
bankers, business brokers and traditional lending institutions to provide us with deal flow. If we fail to maintain our relationship with such funds or institutions, or if we fail to establish strong referral relationships with other funds, we will
not be able to grow our portfolio of investments and fully execute our business plan.
Our base management fee may induce the Adviser to incur
leverage.
The fact that our base management fee is payable based upon our gross assets, which would include any investments made with proceeds of
borrowings, may encourage the Adviser to use leverage to make additional investments. Under certain circumstances, the use of increased leverage may increase the likelihood of default, which would disfavor holders of our securities. Given the
subjective nature of the investment decisions made by the Adviser on our behalf, we will not be able to monitor this potential conflict of interest.
Risks Related to an Investment in Our Securities
There is a risk that you may not receive distributions or that distributions may not grow over time.
Our current intention is to distribute up to 100% of our Investment Company Taxable Income to our stockholders by paying monthly distributions. We may retain
some or all of our net realized long-term capital gains, if any, and designate them as deemed distributions to supplement our equity capital and support the growth of our portfolio, although our Board of Directors may determine to distribute these
net realized long-term capital gains to our stockholders in cash. In addition, the Credit Facility restricts the amount of distributions we are permitted to make annually. We cannot assure investors that we will achieve investment results or
maintain a tax status that will allow or require any specified level of cash distributions.
Investing in our securities may involve an above average
degree of risk.
The investments we make in accordance with our investment objectives may result in a higher amount of risk than alternative investment
options and a higher risk of volatility or loss of principal. Our investments in portfolio companies may be highly speculative, and therefore, an investment in our securities may not be suitable for someone with lower risk tolerance.
Distributions to our common stockholders have included and may in the future include a return of capital.
Our Board of Directors declares monthly common distributions each quarter based on estimates of Investment Company Taxable Income and capital gains for each
fiscal year, which may differ, and in the past have differed, from actual results. Because our common distributions are based on estimates of Investment Company Taxable Income and capital gains that may differ from actual results, future common
distributions payable to our common stockholders may include a return of capital. To the extent that we distribute amounts that exceed our accumulated earnings and profits, these distributions constitute a return of capital to the extent of the
common stockholders adjusted tax basis in its shares of our common stock. A return of capital represents a return of a
40
Table of Contents
common stockholders original investment in shares of our common stock and should not be confused with a distribution from earnings and profits. Although return of capital distributions may
not be taxable, such distributions may increase an investors tax liability for capital gains upon the sale of our common stock by reducing the investors tax basis in its shares of our common stock. Such returns of capital reduce our
asset base and also adversely impact our ability to raise debt capital as a result of the leverage restrictions under the 1940 Act, which could have a material adverse impact on our ability to make new investments.
Common shares of closed-end investment companies frequently trade at a discount to NAV.
Shares of closed-end investment companies frequently trade at a discount to NAV per common share. Since our inception,
our common stock has at times traded above NAV per share and at times below NAV per share. During the past year, our common stock has at times traded significantly below NAV per share. This characteristic of shares of
closed-end investment companies is separate and distinct from the risk that our NAV per share will decline. As with any stock, the price of our common shares will fluctuate with market conditions and other
factors. If common shares are sold, the price received may be more or less than the original investment. Whether investors will realize gains or losses upon the sale of our shares will not depend directly upon our NAV, but will depend upon the
market price of the shares at the time of sale. Since the market price of our common shares will be affected by such factors as the relative demand for and supply of the shares in the market, general market and economic conditions and other factors
beyond our control, we cannot predict whether the common shares will trade at, below or above our NAV per share.
Under the 1940 Act, we are generally not
able to issue additional shares of our common stock at a price below NAV per share to purchasers other than our existing common stockholders through a rights offering without first obtaining the approval of our stockholders and our independent
directors. Additionally, at times when our common stock is trading below its NAV per share, our dividend yield may exceed the weighted-average returns that we would expect to realize on new investments that would be made with the proceeds from the
sale of such stock, making it unlikely that we would determine to issue additional common shares in such circumstances. Thus, for as long as our common stock may trade below NAV per share, we generally will be subject to significant constraints on
our ability to raise capital through the issuance of common stock. Additionally, an extended period of time in which we are unable to raise capital may restrict our ability to grow and adversely impact our ability to increase or maintain our
distributions.
Common stockholders may incur dilution if we sell shares of our common stock in one or more offerings at prices below the then current
NAV per share.
At our most recent annual meeting of stockholders on August 20, 2020, our stockholders approved a proposal designed to allow us to
sell shares of our common stock below the then current NAV per share in one or more offerings for a period of one year from the date of such approval, subject to certain conditions (including, that the number of common shares issued and sold
pursuant to such authority does not exceed 25% of our then outstanding common stock immediately prior to each such sale).
With
this and similar previous approvals from our stockholders, we exercised this right with Board of Director approval in March and April 2018 for certain sales under the
at-the-market program (Refer to Liquidity and Capital Resources Equity Common Stock for further details of sales under our at-the-market program.). With prior approval from our stockholders and our Board of Directors, we also issued shares of common stock below our then current NAV per share in
public offerings in May and June of 2017, March and April of 2015, and in October 2012 with a net dilutive effect of such issuances, net of discounts, commissions and offering costs borne by us, of $0.07, $0.29 and $0.39, respectively, per share of
common stock.
At the upcoming annual stockholders meeting to be held in August 2021, we expect that our stockholders will again be asked to vote in favor
of renewing this proposal for another year. During the past year, our common stock has frequently traded, and at times significantly, below NAV per share. Any decision to sell shares of our
41
Table of Contents
common stock below the then current NAV per share of our common stock would be subject to the determination by our Board of Directors that such issuance is in our and our stockholders best
interests.
If we were to sell shares of our common stock below NAV per share, such sales would result in an immediate dilution to the NAV per share. This
dilution would occur as a result of the sale of shares at a price below the then current NAV per share of our common stock and a proportionately greater decrease in a common stockholders interest in our earnings and assets and voting interest
in us than the increase in our assets resulting from such issuance. The greater the difference between the sale price and the NAV per share at the time of the offering, the more significant the dilutive impact would be. Because the number of shares
of common stock that could be so issued and the timing of any issuance is not currently known, the actual dilutive effect, if any, cannot be currently predicted. However, if, for example, we sold an additional 10% of our common stock at a 5%
discount from NAV, an existing common stockholder who did not participate in that offering for its proportionate interest would suffer NAV dilution of up to 0.5% or $5 per $1,000 of NAV.
If we fail to pay dividends on our mandatorily redeemable preferred stock for two years, the holders of our preferred stock will be entitled to elect a
majority of our directors.
The terms of our series of mandatorily redeemable preferred stock provide for annual dividends of approximately $1.59 per
outstanding share of our Series E Term Preferred Stock. In accordance with the 1940 Act and the terms of our series of mandatorily redeemable term preferred stock, if dividends thereon are unpaid in an amount equal to at least two years of
dividends, the holders of our preferred stock will be entitled to elect a majority of our Board of Directors.
Holders of our debt or mandatorily
redeemable preferred stock have liquidation and other rights that are senior to the rights of the holders of our common stock. Any future issuance of debt or additional shares of preferred stock could adversely affect the market price
of our common stock.
We may in the future raise additional capital through the issuance of debt or additional shares of preferred stock. Our Board of
Directors is authorized to issue one or more classes or series of preferred stock (so long as such stock is issued in parity with our outstanding shares of mandatorily redeemable preferred stock in accordance with Section 18(c) of the 1940 Act)
from time to time without any action on the part of the stockholders, as it has done with respect to our outstanding series of mandatorily redeemable preferred stock. Our Board of Directors also has the power, without stockholder approval, to set
the terms of any such classes or series of preferred stock that may be issued, including voting rights, dividend rights and preferences over our common stock with respect to dividends or upon our dissolution, winding-up or liquidation, and other terms. Holders of our outstanding mandatorily redeemable preferred stock have, and holders of any future debt securities will have,
preference over our common stock with respect to the payment of dividends and upon our liquidation, dissolution or winding-up. This will reduce the amount of our assets, if any,
available for distribution to holders of our common stock. The decision to issue debt or preferred stock is dependent on market conditions and other factors that may be beyond our control. As a result, we cannot predict or estimate the
amount, timing or nature of our future issuances. Any such future issuance could reduce the market price of our common stock.
Additionally, if we issue
additional preferred stock with voting rights that dilute the voting power of our common stock, the rights of holders of our common stock or the market price of our common stock could be adversely affected.
Risks Related to Our Mandatorily Redeemable Preferred Stock
An active trading market for the mandatorily redeemable preferred stock may not exist or continue, which could adversely affect the market price of the
mandatorily redeemable preferred stock or a holders ability to sell its shares.
Our Series E Term Preferred Stock is listed on Nasdaq. However,
we cannot provide any assurances that an active trading market for the mandatorily redeemable preferred stock will exist in the future or that stockholders
42
Table of Contents
will be able to sell their shares of mandatorily redeemable preferred stock. Even if an active trading market does exist, shares of the mandatorily redeemable preferred stock may trade at a
discount from the liquidation preference for such shares depending on prevailing interest rates, the market for similar securities, general economic conditions, our issuance of debt or preferred equity securities and our financial condition, results
of operation and prospects. To the extent an active trading market does not exist, the liquidity and trading price for shares of the mandatorily redeemable preferred stock may be harmed. Accordingly, holders may be required to bear the financial
risk of an investment in the mandatorily redeemable preferred stock for an indefinite period of time.
An investment in preferred stock with a fixed
interest rate bears interest rate risk.
Our series of mandatorily redeemable preferred stock pays dividends at a fixed dividend rate. Prices of fixed
income investments vary inversely with changes in market yields. The market yields on securities comparable to our mandatorily redeemable preferred stock may increase, which would likely result in a decline in the secondary market price of the
mandatorily redeemable preferred stock prior to the mandatory redemption date for that series of mandatorily redeemable preferred stock.
The
mandatorily redeemable preferred stock is not rated.
Our series of mandatorily redeemable preferred stock is not rated by any rating agency. Unrated
securities usually trade at a discount to similar, rated securities. As a result, the series of mandatorily redeemable preferred stock may trade at prices that are lower than they might otherwise trade if rated by a rating agency.
Our mandatorily redeemable preferred stock bears a risk of early redemption by us.
We may voluntarily redeem some or all of the Series E Term Preferred Stock at any time. We also may be forced to redeem some or all of the outstanding
shares of mandatorily redeemable preferred stock to meet regulatory requirements or the asset coverage requirements of such shares. We are also required to redeem all of the mandatorily redeemable preferred stock upon certain change of control
transactions. Any such redemption may occur at a time that is unfavorable to holders of the mandatorily redeemable preferred stock. We may have an incentive to redeem the mandatorily redeemable preferred stock voluntarily before the mandatory
redemption date for such series if market conditions allow us to issue other preferred stock or debt securities at a rate that is lower than the dividend rate on such series of mandatorily redeemable preferred stock or for other reasons. If we
redeem shares of the mandatorily redeemable preferred stock before the mandatory redemption date for such series of mandatorily redeemable preferred stock, the holders of such redeemed shares face the risk that the return on an investment purchased
with proceeds from such redemption may be lower than the return previously obtained from the investment in the mandatorily redeemable preferred stock.
Claims of holders of the mandatorily redeemable preferred stock will be subject to a risk of subordination relative to holders of our debt instruments.
While holders of the mandatorily redeemable preferred stock will have equal liquidation rights to the holder of any other outstanding series of our
mandatorily redeemable preferred stock, such holders will be subordinated to the rights of holders of our current and any future indebtedness, including the Credit Facility and the 2026 Notes. Even though the mandatorily redeemable preferred stock
is classified as a liability for purposes of GAAP and considered senior securities under the 1940 Act, the mandatorily redeemable preferred stock are not debt instruments. Therefore, dividends, distributions and other payments to holders of
mandatorily redeemable preferred stock in liquidation or otherwise may be subject to prior payments due to the holders of our indebtedness. In addition, under some circumstances the 1940 Act may provide debt holders with voting rights that are
superior to the voting rights of holders of the mandatorily redeemable preferred stock.
43
Table of Contents
Holders of the mandatorily redeemable preferred stock will bear dividend risk.
We may be unable to pay dividends on the series of mandatorily redeemable preferred stock under some circumstances. The terms of our indebtedness, including
the Credit Facility and the 2026 Notes, preclude the payment of dividends in respect of equity securities, including the mandatorily redeemable preferred stock, under certain conditions.
There is a risk of delay in our redemption of the mandatorily redeemable preferred stock, and we may fail to redeem such securities as required by their
terms.
We generally make investments in private companies whose securities are not traded in any public market. Substantially all of the investments
we presently hold and the investments we expect to acquire in the future are, and will be, subject to legal and other restrictions on resale and will otherwise be less liquid than publicly traded securities. The illiquidity of our investments may
make it difficult for us to obtain cash equal to the value at which we record our investments quickly if a need arises. If we are unable to obtain sufficient liquidity prior to the mandatory redemption date or any other date on which we are required
by law or the terms of a series of mandatorily redeemable preferred stock to redeem shares of such series, we may be forced to engage in a partial redemption or to delay a required redemption. If such a partial redemption or delay were to occur, the
market price of the mandatorily redeemable preferred stock might be adversely affected.
Risks Related to the 2026 Notes
The 2026 Notes are unsecured and therefore are effectively subordinated to any secured indebtedness we may incur in the future and will rank pari passu
with, or equal to, all outstanding and future unsecured indebtedness issued by us and our general liabilities (total liabilities, less debt).
The 2026
Notes are not secured by any of our assets or any of the assets of our subsidiaries. As a result, the 2026 Notes are effectively subordinated to any secured indebtedness we may incur in the future (or any indebtedness that is initially unsecured to
which we subsequently grant security) to the extent of the value of the assets securing such indebtedness. In any liquidation, dissolution, bankruptcy or other similar proceeding, the holders of any of our existing or future secured indebtedness and
the secured indebtedness of our subsidiaries may assert rights against the assets pledged to secure that indebtedness to receive full payment of their indebtedness before the assets may be used to pay other creditors, including the holders of the
2026 Notes. In addition, the 2026 Notes will rank pari passu with, or equal to, all outstanding and future unsecured indebtedness issued by us and our general liabilities (total liabilities, less debt).
The 2026 Notes are structurally subordinated to the indebtedness and other liabilities of our subsidiaries.
The 2026 Notes are obligations exclusively of the Company and not of any of our subsidiaries. None of our subsidiaries is a guarantor of the 2026 Notes and the
2026 Notes are not required to be guaranteed by any subsidiaries we may acquire or create in the future. Except to the extent we are a creditor with recognized claims against our subsidiaries, all claims of creditors of our subsidiaries will have
priority over our equity interests in such subsidiaries (and therefore the claims of our creditors, including holders of the 2026 Notes) with respect to the assets of such subsidiaries. Even if we are recognized as a creditor of one or more of our
subsidiaries, our claims would still be effectively subordinated to any security interests in the assets of any such subsidiary and to any indebtedness or other liabilities of any such subsidiary senior to our claims. Consequently, the 2026 Notes
are structurally subordinated to all indebtedness and other liabilities of any of our subsidiaries and any subsidiaries that we may in the future acquire or establish. Our wholly-owned subsidiary, Gladstone Business Investment, is the obligor under
our Credit Facility, which is structurally senior to the 2026 Notes. In addition, our subsidiaries may incur substantial additional indebtedness in the future, all of which would be structurally senior to the 2026 Notes.
44
Table of Contents
The indenture under which the 2026 Notes were issued contains limited protection for holders of the 2026
Notes.
The indenture under which the 2026 Notes were issued offers limited protection to holders of the 2026 Notes. The terms of the indenture and the
2026 Notes do not restrict our or any of our subsidiaries ability to engage in, or otherwise be a party to, a variety of corporate transactions, circumstances or events that could have an adverse impact on your investment in the 2026 Notes. In
particular, the terms of the indenture and the 2026 Notes do not place any restrictions on our or our subsidiaries ability to:
issue securities or otherwise incur additional indebtedness or other obligations, including (1) any
indebtedness or other obligations that would be equal in right of payment to the 2026 Notes, (2) any indebtedness or other obligations that would be secured and therefore rank effectively senior in right of payment to the 2026 Notes to the
extent of the values of the assets securing such debt, (3) indebtedness of ours that is guaranteed by one or more of our subsidiaries and which therefore is structurally senior to the 2026 Notes and (4) securities, indebtedness or
obligations issued or incurred by our subsidiaries that would be senior to our equity interests in our subsidiaries and therefore rank structurally senior to the 2026 Notes with respect to the assets of our subsidiaries, in each case other than an
incurrence of indebtedness or other obligation that would cause a violation of Section 18(a)(1)(A) as modified by Section 61(a)(2) of the 1940 Act or any successor provisions, whether or not we continue to be subject to such provisions of
the 1940 Act, which generally prohibit us incurring additional debt or issuing additional debt or preferred securities, unless our asset coverage, as defined in the 1940 Act, equals at least 150% after such incurrence or issuance;
pay dividends on, or purchase or redeem or make any payments in respect of, capital stock or other securities
ranking junior in right of payment to the 2026 Notes, including our preferred stock and any subordinated indebtedness, in each case other than dividends, purchases, redemptions or payments that would cause our asset coverage to fall below the
threshold specified in Section 18(a)(1)(B) as modified by Section 61(a)(2) of the 1940 Act or any successor provisions thereto, whether or not we are subject to such provisions of the 1940 Act, giving effect to any no-action relief granted by the SEC to another BDC and upon which we may reasonably rely (or to us if we determine to seek such similar
SEC no-action or other relief) permitting the BDC to declare any cash dividend or distribution notwithstanding the prohibition contained in Section 18(a)(1)(B) as modified by
Section 61(a)(2) of the 1940 Act to maintain the BDCs status as a RIC under Subchapter M of the Code;
sell assets (other than certain limited restrictions on our ability to consolidate, merge or sell all or
substantially all of our assets);
enter into transactions with affiliates;
create liens (including liens on the shares of our subsidiaries) or enter into sale and leaseback transactions;
make investments; or
create restrictions on the payment of dividends or other amounts to us from our subsidiaries.
In addition, the indenture and the 2026 Notes do not require us to make an offer to purchase the 2026 Notes in connection with a change
of control or any other event.
Furthermore, the terms of the indenture and the 2026 Notes do not protect holders of the 2026 Notes in the event that we
experience changes (including significant adverse changes) in our financial condition, results of operations or credit ratings, if any, as they do not require that we or our subsidiaries adhere to any financial tests or ratios or specified levels of
net worth, revenues, income, cash flow, or liquidity.
Our ability to recapitalize, incur additional debt (including additional debt that matures prior to
the maturity of the 2026 Notes) and take a number of other actions that are not limited by the terms of the 2026 Notes may have important consequences for you as a holder of the 2026 Notes, including making it more difficult for us to satisfy our
obligations with respect to the 2026 Notes or negatively affecting the trading value of the 2026 Notes.
45
Table of Contents
Other debt we issue or incur in the future could contain more protections for its holders than the indenture
and the 2026 Notes, including additional covenants and events of default. The issuance or incurrence of any such debt with incremental protections could affect the market for, trading levels, and prices of the 2026 Notes.
An active trading market for the 2026 Notes may not exist, which could limit your ability to sell the 2026 Notes or affect the market price of the 2026
Notes.
An active trading market for the 2026 Notes may not exist in the future and holders may not be able to sell their 2026 Notes. Even if an active
trading market does exist, the 2026 Notes may trade at a discount from their initial offering price depending on prevailing interest rates, the market for similar securities, our credit ratings, if any, general economic conditions, our financial
condition, performance and prospects and other factors. To the extent an active trading market does not exist, the liquidity and trading price for the 2026 Notes may be harmed. Accordingly, holders of the 2026 Notes may be required to bear the
financial risk of an investment in the 2026 Notes for an indefinite period of time.
If we default on our obligations to pay our other indebtedness, we
may not be able to make payments on the 2026 Notes.
Any default under the agreements governing our indebtedness, including a default under the Credit
Facility or other indebtedness to which we may be a party, that is not waived by the required lenders or holders, and the remedies sought by the holders of such indebtedness could make us unable to pay principal, premium, if any, and interest on the
2026 Notes and substantially decrease the market value of the 2026 Notes. If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on
our indebtedness, or if we otherwise fail to comply with the various covenants, including financial and operating covenants, in the instruments governing our indebtedness, we could be in default under the terms of the agreements governing such
indebtedness, including the 2026 Notes. In the event of such default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under the
Credit Facility or other debt we may incur in the future could elect to terminate their commitments, cease making further loans and institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation. If our
operating performance declines, we may in the future need to refinance or restructure our debt, including the 2026 Notes, sell assets, reduce or delay capital investments, seek to raise additional capital or seek to obtain waivers from the required
lenders under the Credit Facility or other debt that we may incur in the future to avoid being in default. If we are unable to implement one or more of these alternatives, we may not be able to meet our payment obligations under the 2026 Notes or
our other debt. If we breach our covenants under the Credit Facility or other debt and seek a waiver, we may not be able to obtain a waiver from the required lenders or holders. If this occurs, we would be in default under the Credit Facility or
other debt, the lenders or holders could exercise their rights as described above, and we could be forced into bankruptcy or liquidation. If we are unable to repay debt, lenders having secured obligations, including the lenders under the Credit
Facility, could proceed against the collateral securing the debt. Because the Credit Facility has, and any future credit facilities will likely have, customary cross-default provisions, if the indebtedness under the 2026 Notes or the Credit Facility
or under any future credit facility is accelerated, we may be unable to repay or finance the amounts due.
We may choose to redeem the 2026 Notes when
prevailing interest rates are relatively low.
On or after May 1, 2023, we may choose to redeem the 2026 Notes from time to time, especially if
prevailing interest rates are lower than the rate borne by the 2026 Notes. If prevailing rates are lower at the time of redemption, and we redeem the 2026 Notes, you likely would not be able to reinvest the redemption proceeds in a comparable
security at an effective interest rate as high as the interest rate on the 2026 Notes being redeemed. Our redemption right also may adversely impact your ability to sell the 2026 Notes as the optional redemption date or period approaches.
46
Table of Contents
A downgrade, suspension or withdrawal of any credit rating assigned by a rating agency to us or the 2026
Notes could cause the liquidity or market value of the 2026 Notes to decline significantly.
Any credit rating is an assessment by the assigning rating
agency of our ability to pay our debts when due. Consequently, real or anticipated changes in any credit ratings will generally affect the market value of the 2026 Notes. These credit ratings may not reflect the potential impact of risks relating to
the structure or marketing of the 2026 Notes. Credit ratings are not a recommendation to buy, sell or hold any security, and may be revised or withdrawn at any time by the issuing organization in its sole discretion. There can be no assurance that
any credit ratings will remain for any given period of time or that such credit ratings will not be lowered or withdrawn entirely by the rating agencies if in their judgment future circumstances relating to the basis of the credit ratings, such as
adverse changes in our Company, so warrant.
General Risks Factors
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.
Maintaining our network security is of critical importance because our systems store highly confidential financial models and portfolio company information.
Although we have implemented, and will continue to implement, security measures, our technology platform may be vulnerable to intrusion, computer viruses or similar disruptive problems caused by cyber-attacks. A cyber incident is considered to be
any adverse event that threatens the confidentiality, integrity or availability of our information resources or those of our portfolio companies. These incidents may be an intentional attack or an unintentional event and could involve gaining
unauthorized access to our information systems or those of our portfolio companies for purposes of misappropriating assets, stealing confidential information, corrupting data or causing operational disruption. The result of these incidents may
include disrupted operations, misstated or unreliable financial data, liability for stolen assets or information, increased cybersecurity protection and insurance costs, litigation and damage to our business relationships or those of our portfolio
companies. As our and our portfolio companies reliance on technology has increased, so have the risks posed to our information systems, both internal and those provided to us by third-party service providers, and the information systems of our
portfolio companies. We have implemented processes, procedures and internal controls to help mitigate cybersecurity risks and cyber intrusions, but these measures, as well as our increased awareness of the nature and extent of a risk of a cyber
incident, do not guarantee that a cyber incident will not occur and/or that our financial results, operations or confidential information will not be negatively impacted by such an incident. In addition, any such incident, disruption or other loss
of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, and regulatory penalties, disrupt our operations, and damage our and our Advisers reputations, resulting in a
loss of confidence in our services and our Advisers services, which could adversely affect our business.
47
Table of Contents
We are dependent on information systems and systems failures could significantly disrupt our business,
which may, in turn, negatively affect the market price of our common stock and our ability to pay dividends.
Our business is dependent on our and
third parties communications and information systems. Any failure or interruption of those systems, including as a result of the termination of an agreement with any third-party service providers, could cause delays or other problems in our
activities. Our financial, accounting, data processing, backup or other operating systems and facilities may fail to operate properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially
beyond our control and adversely affect our business. There could be:
sudden electrical or telecommunications outages;
natural disasters such as earthquakes, tornadoes and hurricanes;
disease pandemics;
events arising from local or larger scale political or social matters, including terrorist acts; and
cyber-attacks.
These events, in turn, could have a material adverse effect on our operating results and negatively affect the market price of our common stock and our
ability to pay dividends to our stockholders.
Changes in laws or regulations governing our operations, or changes in the interpretation thereof, and
any failure by us to comply with laws or regulations governing our operations may adversely affect our business.
We, and our portfolio companies, are
subject to regulation by laws at the local, state and federal levels. These laws and regulations, as well as their interpretation, may be changed from time to time. Accordingly, any change in these laws or regulations, or their interpretation, or
any failure by us or our portfolio companies to comply with these laws or regulations may adversely affect our business. Refer to BusinessMaterial U.S. Federal Income Tax Considerations RIC Status and
Business Regulation as a BDC for additional information regarding the regulations to which we are subject.
We may experience
fluctuations in our quarterly and annual operating results.
We may experience fluctuations in our quarterly and annual operating results due to a
number of factors, including, among others, variations in our investment income, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, rapidly changing valuation of our portfolio
companies, placing and removing investments on non-accrual status, the degree to which we encounter competition in our markets, the ability to sell investments at attractive terms, the ability to fund and
close suitable investments, and general economic conditions, including the impacts of inflation or the current COVID-19 pandemic. The majority of our portfolio companies are in industries that are directly
impacted by inflation, such as manufacturing and consumer goods and services. Our portfolio companies may not be able to pass on to customers increases in their costs of production which could greatly affect their operating results, impacting their
ability to service and repay our loans. In addition, any potential future decreases in our portfolio companies operating results due to inflation could adversely impact the fair value of those investments. Any decreases in the fair value of
our investments could result in future realized and unrealized losses and therefore reduce our net assets. As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods.
48
Table of Contents
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
PROPERTIES
We do not own any real estate or other physical properties material to our operations. The Adviser is the current leaseholder of all properties in which we
operate. We occupy these premises pursuant to our Advisory and Administration Agreements with the Adviser and Administrator, respectively.