Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of our financial condition and results of operations should be read in conjunction with our accompanying Consolidated Financial Statements and the notes thereto contained elsewhere in this Annual Report. Historical financial condition and results of operations and percentage relationships among any amounts in the financial statements are not necessarily indicative of financial condition, results of operations or percentage relationships for any future periods. Except per share amounts, dollar amounts included herein are in thousands unless otherwise indicated.
OVERVIEW
General
We were incorporated under the General Corporation Law of the State of Delaware on February 18, 2005. We operate as an externally managed, closed-end, non-diversified management investment company and have elected to be treated as a BDC under the 1940 Act. For U.S. federal income tax purposes, we have elected to be treated as a RIC under Subchapter M of the Code. To continue to qualify as a RIC for U.S. federal income tax purposes and obtain favorable RIC tax treatment, we must meet certain requirements, including certain minimum distribution requirements.
We were established for the purpose of investing in debt and equity securities of established private businesses operating in the U.S. Our investment objectives are to: (i) achieve and grow current income by investing in debt securities of established businesses that we believe will provide stable earnings and cash flow to pay expenses, make principal and interest payments on our outstanding indebtedness, and make distributions to our stockholders that grow over time; and (ii) provide our stockholders with long-term capital appreciation in the value of our assets by investing in equity securities of established businesses, generally, in combination with the aforementioned debt securities, that we believe can grow over time to permit us to sell our equity investments for capital gains. To achieve our objectives, our investment strategy is to invest in several categories of debt and equity securities, with individual investments generally totaling up to $75 million, although investment size may vary, depending upon our total assets or available capital at the time of investment. We expect that our investment portfolio over time will consist of approximately 75% in debt investments and 25% in equity investments, at cost. As of March 31, 2024, our investment portfolio was comprised of 77.0% in debt investments and 23.0% in equity investments, at cost.
We focus on investing in Lower Middle Market businesses in the U.S. that meet certain criteria, including: the sustainability of the business’ free cash flow and its ability to grow it over time, adequate assets for loan collateral, experienced management teams with a significant ownership interest in the portfolio company, reasonable capitalization of the portfolio company, including an ample equity contribution or cushion based on prevailing enterprise valuation multiples, and the potential to realize appreciation and gain liquidity in our equity position, if any. We anticipate that liquidity in our equity position will be achieved through a merger or acquisition of the portfolio company, a public offering of the portfolio company’s stock or, to a lesser extent, by exercising our right to require the portfolio company to repurchase our warrants, though there can be no assurance that we will always have these rights. We invest in portfolio companies that seek funds for management buyouts and/or growth capital to finance acquisitions, recapitalize or, to a lesser extent, refinance their existing debt facilities. We seek to avoid investing in high-risk, early-stage enterprises. Our targeted portfolio companies are generally considered too small for the larger capital marketplace.
We invest by ourselves or jointly with other funds and/or management of the portfolio company, depending on the opportunity, and have opportunistically made several co-investments with Gladstone Capital pursuant to the Co-Investment Order. We believe the Co-Investment Order has enhanced and will continue to enhance our ability to further our investment objectives and strategies. If we are participating in an investment with one or more co-investors, whether or not an affiliate of ours, our investment is likely to be smaller than if we were investing alone.
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Business
Portfolio and Investment Activity
While the business environment remains competitive, we continue to see new investment opportunities consistent with our investment strategy of providing a combination of debt and equity in support of management and independent sponsor-led buyouts of Lower Middle Market companies in the U.S. During the year ended March 31, 2024, we invested in two new portfolio companies and exited three portfolio companies. From our initial public offering in June 2005 through March 31, 2024, we have invested in 58 companies, excluding investments in syndicated loans, for a total of approximately $1.7 billion, before giving effect to principal repayments and divestitures.
The majority of the debt securities in our portfolio have a success fee component, which enhances the yield on our debt investments. Unlike PIK income, we generally do not recognize success fees as income until payment has been received. Due to the contingent nature of success fees, there are no guarantees that we will be able to collect any or all of these success fees or know the timing of any such collections. As a result, as of March 31, 2024, we had unrecognized, contractual success fees of $44.9 million, or $1.23 per common share. Consistent with GAAP, we generally have not recognized success fee receivables and related income in our accompanying Consolidated Financial Statements until earned.
From inception through March 31, 2024 , we exited our investments in 31 portfolio companies that we acquired under our buyout strategy (which excludes investments in syndicated loans). In the aggregate, these sales have generated $290.2 million in net realized gains and $41.8 million in other income upon exit, for a total increase to our net assets of $332.0 million. We believe, in aggregate, these transactions were equity-oriented investment successes and exemplify our investment strategy of striving to achieve returns through current income on the debt portion of our investments and capital gains from the equity portion. The 31 liquidity events have offset any realized losses since inception, which were primarily incurred during the 2008-2009 recession in connection with the sale of performing syndicated loans at a realized loss to pay off a former lender. The successful exits, in part, enabled us to increase the monthly distribution by 100.0% from March 2011 through March 31, 2024 and allowed us to declare and pay 22 supplemental distributions to common stockholders through March 31, 2024 .
Capital Raising
We have been able to meet our capital needs through extensions of and increases to the Credit Facility and by accessing the capital markets in the form of public offerings of unsecured notes, as well as common and preferred stock. We have successfully extended the Credit Facility’s revolving period multiple times, most recently to October 2026, and currently have a total commitment amount of $200.0 million (with a potential total commitment of $300.0 million through additional commitments from new or existing lenders). During the year ended March 31, 2024, we issued the 8.00% 2028 Notes for gross proceeds of $74.8 million and sold 3,097,162 shares of our common stock under our "at-the-market" program (the "Common Stock ATM Program") for gross proceeds of approximately $44.5 million. During the year ended March 31, 2023, we sold 386,482 shares of our common stock under our Common Stock ATM Program for gross proceeds of approximately $5.5 million. Refer to “ Liquidity and Capital Resources.”
Although we have been able to access the capital markets historically, market conditions may continue to affect the trading price of our common stock and thus our ability to finance new investments through the issuance of common equity. On March 31, 2024, the closing market price of our common stock was $ 14.23 per share, representing a 6.0 % premium to our NAV of $ 13.43 per share as of March 31, 2024. When our common stock trades below NAV, our ability to issue additional equity is constrained by provisions of the 1940 Act, which generally prohibits the issuance and sale of our common stock at an issuance price below the then current NAV per share without stockholder approval, other than through sales to our then existing stockholders pursuant to a rights offering.
Regulatory Compliance
Our ability to seek external debt financing, to the extent that it is available under current market conditions, is further subject to the asset coverage limitations of the 1940 Act, which require us to have asset coverage (as defined in Sections 18 and 61 of the 1940 Act) of at least 150% on each of our senior securities representing indebtedness and our senior securities that are stock.
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On April 10, 2018, our Board of Directors, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) thereof, approved the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, our asset coverage requirements for senior securities changed from 200% to 150%, effective as of April 10, 2019, one year after the date of the Board of Directors’ approval.
As of March 31, 2024, our asset coverage ratio on our senior securities representing indebtedness was 219.0%.
Investment Highlights
Investment Activity
During the fiscal year ended March 31, 2024, the following significant transactions occurred:
• In May 2023, we invested $15.3 million in a new portfolio company, Home Concepts Acquisition, Inc. ("Home Concepts"), in the form of $12.0 million of secured first lien debt and $3.3 million of preferred equity. Home Concepts, headquartered in Santa Barbara, California, is a leading home improvement advertising publication focusing on connecting homeowners to high-quality residential repair and remodeling businesses.
• In June 2023, we recapitalized our existing investment in Old World and invested an additional $2.5 million in the form of secured first lien debt. In connection with this investment, we received proceeds of $2.2 million, of which $1.9 million was recognized as dividend income and $0.3 million was recognized as a realized gain.
• In June 2023, we invested an additional $30.0 million in the form of $25.0 million of secured second lien debt and $5.0 million of common equity in Nth Degree Investment Group, LLC to fund an add-on acquisition.
• In June 2023, we received a $1.5 million escrow settlement in connection with our December 2021 exit of SOG Specialty Knives & Tools, LLC, of which $0.6 million was recognized as a return of cost basis and $0.9 million as a realized gain. As a result of the escrow release, there are no remaining assets held by Gladstone SOG Investments, Inc.
• In August 2023, we invested an additional $18.7 million in the form of secured first lien debt in Nocturne to fund an add-on acquisition.
• In September 2023, we invested $46.0 million in a new portfolio company, The E3 Company, LLC ("E3"), in the form of $34.8 million of secured first lien debt and $11.2 million of preferred equity. E3, headquartered in Kilgore, Texas, is a market leader in advanced pressure management solutions for oil and gas well completions.
• In October 2023, we invested an additional $64.7 million in the form of $39.0 million of secured second lien debt and $25.7 million of common equity in SFEG to fund an add-on acquisition. In connection with the investment, our existing preferred equity, with a cost basis of $4.8 million, was converted to common equity.
• In October 2023, we exited our investment in Counsel Press, Inc. ("Counsel Press"), which resulted in success fee income of $1.4 million, a realized gain of $43.5 million and the repayment of our debt investment of $27.5 million at par.
• In March 2024, we recognized a $14.7 million realized loss on our preferred and common equity investments and the related first and second lien debt investments in The Mountain Corporation (“The Mountain”) upon the liquidation and dissolution of The Mountain.
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Recent Developments
Distributions and Dividends
In April 2024, our Board of Directors declared the following monthly cash distributions to common stockholders:
Record Date Payment Date Distribution per Common Share
April 19, 2024 April 30, 2024 $ 0.080
May 17, 2024 May 31, 2024 0.080
June 19, 2024 June 28, 2024 0.080
Total for the Quarter: $ 0.240
Impact of Inflation
We believe the effects of inflation on our historical results of operations and financial condition have not been significant. During the year ended March 31, 2024, general inflationary pressures and certain commodity price volatility have impacted certain of our portfolio companies to varying degrees; however, the broad based impact of these pricing changes have largely been mitigated by price adjustments without adverse sales implications, and thus, have not materially impacted our portfolio companies’ ability to service their indebtedness, including our loans. Notwithstanding the results to date, we expect that the cumulative effect of these inflationary pressures may impact the profit margins or sales of certain portfolio companies and their ability to service their debts. We continue to monitor the current inflationary environment to anticipate any impact on our portfolio companies, including their ability to pay interest on our loans. We cannot assure you that our results of operations and financial condition or that of our portfolio companies will not be materially impacted by inflation in the future. Refer to “Risk Factors — Risks Related to the Economy — We may experience fluctuations in our quarterly and annual results based on the impact of inflation in the U.S.”
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RESULTS OF OPERATIONS
Comparison of the Fiscal Year Ended March 31, 2024 to the Fiscal Year Ended March 31, 2023
For the Fiscal Years Ended March 31,
2024 2023 $ Change % Change
INVESTMENT INCOME
Interest income $ 81,794 $ 60,276 $ 21,518 35.7 %
Dividend and success fee income 5,512 21,267 (15,755) (74.1) %
Total investment income 87,306 81,543 5,763 7.1 %
EXPENSES
Base management fee 17,500 14,798 2,702 18.3 %
Loan servicing fee 9,118 7,880 1,238 15.7 %
Incentive fee 21,047 8,880 12,167 137.0 %
Administration fee 1,789 1,811 (22) (1.2) %
Interest expense 24,121 15,877 8,244 51.9 %
Amortization of deferred financing costs and discounts 2,305 1,802 503 27.9 %
Other 4,363 5,186 (823) (15.9) %
Expenses before credits from Adviser 80,243 56,234 24,009 42.7 %
Credits to fees from Adviser (14,714) (11,691) (3,023) 25.9 %
Total expenses, net of credits to fees 65,529 44,543 20,986 47.1 %
NET INVESTMENT INCOME 21,777 37,000 (15,223) (41.1) %
REALIZED AND UNREALIZED GAIN (LOSS), NET OF TAXES
Net realized gain on investments 30,256 10,753 19,503 181.4 %
Net unrealized appreciation (depreciation) of investments 33,301 (12,235) 45,536 NM
Net unrealized (appreciation) depreciation of other (29) 29 (58) NM
Net realized and unrealized gain (loss), net of taxes on deemed distribution of long-term capital gains 63,528 (1,453) 64,981 NM
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 85,305 $ 35,547 $ 49,758 140.0 %
WEIGHTED-AVERAGE SHARES OF COMMON STOCK OUTSTANDING
Basic and diluted 34,466,724 33,311,785 1,154,939 3.5 %
BASIC AND DILUTED PER COMMON SHARE:
Net investment income $ 0.63 $ 1.11 $ (0.48) (43.2) %
Net increase in net assets resulting from operations $ 2.47 $ 1.07 $ 1.40 130.8 %
NM = Not Meaningful
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Investment Income
Total investment income increased $5.8 million, or 7.1%, for the year ended March 31, 2024, as compared to the prior year. This increase was primarily due to an increase in interest income, partially offset by a decrease in dividend and success fee income.
Interest income from our investments in debt securities increased $21.5 million, or 35.7%, for the year ended March 31, 2024, as compared to the prior year . Generally, the level of interest income from investments is directly related to the weighted-average principal balance of our interest-bearing investment portfolio outstanding during the period, multiplied by the weighted-average yield.
The weighted-average principal balance of our interest-bearing investment portfolio during the year ended March 31, 2024 was $560.8 million, compared to $464.4 million during the prior year. This increase was primarily due to $158.8 million of follow-on debt investments to existing portfolio companies, the origination of $85.8 million of new debt investments, and $14.9 million of loans placed back on accrual status, partially offset by the pay-off, restructuring, or write-off of $37.4 million of debt investments and $9.2 million of existing loans placed on non-accrual status after March 31, 2022, and their respective impact on the weighted-average principal balance when considering the timing of new investments, pay-offs, restructurings, write-offs, and accrual status changes, as applicable.
The weighted-average yield on our interest-bearing investments, excluding cash and cash equivalents and receipts recorded as other income, was 14.4% and 13.0% for the years ended March 31, 2024 and 2023, respectively. The weighted-average yield may vary from period to period, based on the current stated interest rate on interest-bearing investments, coupled with any collection of past due interest during the period. During the years ended March 31, 2024 and 2023, we had no collections of past due interest.
As of March 31, 2024, our loans to Edge Adhesives Holdings, Inc. ("Edge") and J.R. Hobbs Co. - Atlanta, LLC ("J.R. Hobbs") were on non-accrual status, with an aggregate debt cost basis of $59.1 million. As of March 31, 2023, our loans to Edge, J.R. Hobbs, and The Mountain were on non-accrual status, with an aggregate debt cost basis of $66.9 million.
Dividend and success fee income for the year ended March 31, 2024 decreased $15.8 million, or 74.1%, as compared to the prior year. During the year ended March 31, 2024, dividend and success fee income consisted of $3.6 million of success fee income and $1.9 million of dividend income. During the year ended March 31, 2023, dividend and success fee income consisted of $10.9 million of dividend income and $10.4 million of success fee income.
As of March 31, 2024, SFEG represented 10.1% of the total investment portfolio at fair value. As of March 31, 2023, no single investment represented greater than 10% of our total investment portfolio at fair value.
Expenses
Total expenses, net of any non-contractual, unconditional, and irrevocable credits from the Adviser, increased $21.0 million, or 47.1%, for the year ended March 31, 2024, as compared to the prior year, primarily due to increases in the capital gains-based incentive fee, interest expense and base management fee, partially offset by an increase in credits to fees from Adviser, and a decrease in income-based incentive fee.
In accordance with GAAP, we recorded a capital gains-based incentive fee of $12.7 million during the year ended March 31, 2024, compared to reversal of capital gains-based incentive fee of $0.3 million during the year ended March 31, 2023. The capital gains-based incentive fee is a result of the net impact of net realized gains (losses) and net unrealized appreciation (depreciation) on investments during the respective periods. The income-based incentive fee for the year ended March 31, 2024 decreased $0.8 million, or 9.2%, as compared to the prior year, due to the increase in net assets, which increases the pre-incentive fee net investment income required to meet the hurdle rate, and the decrease in pre-incentive fee net investment income.
Base management fee for the year ended March 31, 2024 increased $2.7 million, or 18.3%, as compared to the prior year, primarily due to the increase in the average total assets subject to the base management fee as a result of a net increase in additional investments at cost and an increase in the fair value of investments.
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The base management fee, loan servicing fee, incentive fee, and their related non-contractual, unconditional, and irrevocable credits are computed quarterly, as described under “ Transactions with the Adviser ” in Note 4 – Related Party Transactions in the accompanying Notes to Consolidated Financial Statements and are summarized in the following table:
Year Ended March 31,
2024 2023
Average total assets subject to base management fee (A)
$ 875,000 $ 739,900
Multiplied by annual base management fee of 2.0%
2.0 % 2.0 %
Base management fee (B)
17,500 14,798
Credits to fees from Adviser - other (B)
(5,596) (3,811)
Net base management fee
$ 11,904 $ 10,987
Loan servicing fee (B)
$ 9,118 $ 7,880
Credits to base management fee - loan servicing fee (B)
(9,118) (7,880)
Net loan servicing fee $ — $ —
Incentive fee – income-based $ 8,336 $ 9,176
Incentive fee – capital gains-based (C)
12,711 (296)
Total incentive fee (B)
21,047 8,880
Credits to fees from Adviser - other (B)
— —
Net total incentive fee $ 21,047 $ 8,880
(A) Average total assets subject to the base management fee is defined in the Advisory Agreement as total assets, including investments made with proceeds of borrowings, less any uninvested cash or cash equivalents resulting from borrowings, valued at the end of the applicable quarters within the respective periods and adjusted appropriately for any share issuances or repurchases during the periods.
(B) Reflected as a line item on our accompanying Consolidated Statement of Operations .
(C) The capital gains-based incentive fees are recorded in accordance with GAAP and do not necessarily reflect amounts contractually due under the terms of the Advisory Agreement.
Interest expense increased $8.2 million, or 51.9%, during the year ended March 31, 2024, as compared to the prior year, primarily due to the issuance of the 8.00% 2028 Notes in May 2023 and increased borrowings on the Credit Facility, partially offset by a decrease in the effective interest rate. The weighted-average balance outstanding on the Credit Facility during the year ended March 31, 2024 was $61.0 million, as compared to $16.2 million in the prior year. The effective interest rate on the Credit Facility, excluding the impact of deferred financing costs, during the year ended March 31, 2024 was 10.1%, as compared to 17.3% in the prior year. This decrease in the effective interest rate on the Credit Facility was primarily a result of a decrease in unused commitment fees, partially offset by an increase in interest rates on the drawn portion of the Credit Facility.
Other expenses decreased $0.8 million, or 15.9%, during the year ended March 31, 2024, as compared to the prior year, primarily due to a decrease in professional expenses and bad debt expense.
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Realized and Unrealized Gain (Loss)
The realized gains (losses) and unrealized appreciation (depreciation) across our investments for the years ended March 31, 2024 and 2023 were as follows:
Year Ended March 31, 2024
Portfolio Company Realized
Gain (Loss) on Investments Unrealized
Appreciation
(Depreciation) Reversal of
Unrealized
(Appreciation)
Depreciation Net Gain
(Loss)
Nth Degree Investment Group, LLC $ — $ 31,199 $ — $ 31,199
Counsel Press, Inc. 43,459 22,676 (43,566) 22,569
Brunswick Bowling Products, Inc. — 14,789 — 14,789
Educators Resource, Inc. — 12,193 — 12,193
Mason West, LLC — 8,819 — 8,819
SFEG Holdings, Inc. — 7,812 — 7,812
Galaxy Technologies Holdings, Inc. — 6,849 — 6,849
The E3 Company, LLC — 5,189 — 5,189
Utah Pacific Bridge & Steel, Ltd. — 4,539 — 4,539
Ginsey Home Solutions, Inc. — 2,415 — 2,415
The Maids International, LLC — 2,226 — 2,226
Gladstone SOG Investments, Inc. 882 — (93) 789
The Mountain Corporation (14,650) — 14,650 —
Diligent Delivery Systems — (1,207) — (1,207)
Edge Adhesives Holdings, Inc. — (1,350) — (1,350)
Home Concepts Acquisition, Inc. — (2,037) — (2,037)
Old World Christmas, Inc. 273 (3,352) — (3,079)
Nocturne Luxury Villas, Inc. — (3,998) — (3,998)
PSI Molded Plastics, Inc. — (4,529) — (4,529)
Schylling, Inc. — (7,553) — (7,553)
ImageWorks Display and Marketing Group, Inc. — (8,319) — (8,319)
B+T Group Acquisition, Inc. — (10,921) — (10,921)
Horizon Facilities Services, Inc. — (12,344) — (12,344)
Other, net (<$1.0 million, net ) 292 (786) — (494)
Total $ 30,256 $ 62,310 $ (29,009) $ 63,557
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Year Ended March 31, 2023
Portfolio Company Realized
Gain (Loss) on Investments Unrealized
Appreciation
(Depreciation) Reversal of
Unrealized
(Appreciation)
Depreciation Net Gain
(Loss)
Nth Degree Investment Group, LLC $ — $ 14,732 $ — $ 14,732
Brunswick Bowling Products, Inc. — 12,484 — 12,484
Old World Christmas, Inc. 13,371 (3,852) — 9,519
Horizon Facilities Services, Inc. 2,218 4,618 — 6,836
Nocturne Luxury Villas, Inc. — 6,040 — 6,040
SFEG Holdings, Inc. — 5,485 — 5,485
Mason West, LLC — 3,387 — 3,387
Counsel Press, Inc. — 2,511 — 2,511
Utah Pacific Bridge & Steel, Ltd. — 1,748 — 1,748
Dema/Mai Holdings, Inc. — 1,321 — 1,321
Schylling, Inc. — 1,102 — 1,102
PSI Molded Plastics, Inc. — (1,726) — (1,726)
Educators Resource, Inc. — (1,807) — (1,807)
Galaxy Technologies Holdings, Inc. — (3,481) — (3,481)
Ginsey Home Solutions, Inc. — (4,787) — (4,787)
Edge Adhesives Holdings, Inc. — (4,817) — (4,817)
ImageWorks Display and Marketing Group, Inc. — (5,479) — (5,479)
The Mountain Corporation (10,000) (5,590) 10,000 (5,590)
Bassett Creek Services, Inc. 5,188 — (12,250) (7,062)
B+T Group Acquisition, Inc. — (13,480) — (13,480)
J.R. Hobbs Co. - Atlanta, LLC — (18,510) — (18,510)
Other, net (<$1.0 million, net ) (24) 130 (14) 92
Total $ 10,753 $ (9,971) $ (2,264) $ (1,482)
Net Realized Gain (Loss) on Investments
During the year ended March 31, 2024, we recorded net realized gains on investments of $30.3 million, primarily due to a $43.5 million realized gain from the exit of Counsel Press, $1.2 million of realized gains related to certain prior period exits and $0.3 million of realized gain from the recapitalization of Old World. These amounts were partially offset by the $14.7 million realized loss recognized from the dissolution and liquidation of The Mountain.
During the year ended March 31, 2023, we recorded net realized gains on investments of $10.8 million, primarily due to a $13.4 million realized gain from the recapitalization of Old World, $5.2 million of realized gains from the exit of Bassett Creek Services, Inc., and a $2.2 million realized gain from the recapitalization of Horizon Facilities Services, Inc. These amounts were partially offset by the $10.0 million realized loss recognized in conjunction with the replacement of our existing investment in The Mountain.
Net Unrealized Appreciation (Depreciation) of Investments
Net unrealized appreciation of investments of $33.3 million for the year ended March 31, 2024 was primarily due to the net unrealized appreciation across our portfolio, as well as the reversal of unrealized depreciation of our investment in The Mountain upon its exit. These amounts were partially offset by the reversal of unrealized appreciation of our investment in Counsel Press upon its exit. The net appreciation was driven primarily by increased performance of certain of our portfolio companies, partially offset by decreased comparable transaction multiples used to estimate the fair value of certain of our portfolio companies.
Net unrealized appreciation of investments of $12.2 million for the year ended March 31, 2023 was primarily due to the net unrealized depreciation across our portfolio, as well as the reversal of unrealized appreciation of our investment in Bassett Creek upon its exit, partially offset by the reversal of unrealized depreciation of our investment in The Mountain upon the replacement of our existing investment. The net depreciation was driven primarily by decreased performance of certain of our other portfolio companies and decreased comparable transaction multiples used to estimate the fair value of certain of our portfolio companies. These decreases were partially offset by increased performance of certain of our portfolio
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companies, driven partially by the reversal of the impact of COVID-19 on certain of our portfolio companies and the markets in which they operate.
Across our entire investment portfolio, we recorded $35.8 million of net unrealized appreciation on our equity investments and $2.5 million of net unrealized depreciation on our debt investments for the year ended March 31, 2024. As of March 31, 2024, the fair value of our investment portfolio was more than our cost basis by $66.2 million, compared to March 31, 2023, when the fair value of our investment portfolio was more than our cost basis by $32.9 million. This resulted in net unrealized appreciation of $33.3 million for the year ended March 31, 2024. Our entire portfolio was fair valued at 107.8% of cost as of March 31, 2024.
The comparison of the fiscal year ended March 31, 2023 to the fiscal year ended March 31, 2022 can be found in our Annual Report on Form 10-K for the fiscal year ended March 31, 2023 located within Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations .
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities
Cash inflows from operating activities are primarily generated from cash collections of interest and other income from our portfolio companies, as well as from cash proceeds received from repayments of debt investments and from sales of equity investments. These cash collections are principally used to fund new investments, pay distributions to our common stockholders, make interest payments on our Credit Facility, 5.00% 2026 Notes, 4.875% 2028 Notes and 8.00% 2028 Notes, pay management and incentive fees to the Adviser and other operating expenses. We may also use cash inflows from operating activities to repay outstanding borrowings under the Credit Facility.
Net cash used in operating activities for the year ended March 31, 2024 was $69.9 million, as compared to net cash used in operating activities of $4.5 million for the year ended March 31, 2023. This change was primarily due to an increase in purchases of investments, partially offset by a decrease in the aggregate net proceeds from the sale and recapitalization of investments and principal repayments of investments.
Purchases of investments totaled $183.9 million during the year ended March 31, 2024, compared to $133.8 million during the year ended March 31, 2023. Net proceeds from the sale and recapitalization of investments and principal repayments of investments totaled $80.2 million during the year ended March 31, 2024, compared to $87.8 million during the year ended March 31, 2023.
Net cash used in operating activities for the year ended March 31, 2023 was $4.5 million , as compared to net cash provided by operating activities of $36.6 million for the year ended March 31, 2022. This change was primarily due to an increase in purchases of investments, partially offset by a decrease in the aggregate net proceeds from the sale and recapitalization of investments and principal repayments of investments.
Purchases of investments totaled $133.8 million during the year ended March 31, 2023 , compared to $92.7 million during the year ended March 31, 2022. Net proceeds from the sale and recapitalization of investments and principal repayments totaled $87.8 million during the year ended March 31, 2023 , compared to $101.4 million during the year ended March 31, 2022.
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As of March 31, 2024, we had equity investments in and/or loans to 24 companies with an aggregate cost basis of $854.3 million. As of March 31, 2023, we had equity investments in and/or loans to 25 companies with an aggregate cost basis of $720.6 million. The following table summarizes our total portfolio investment activity for the years ended March 31, 2024 and 2023:
Years Ended March 31,
2024 2023
Beginning investment portfolio, at fair value $ 753,543 $ 714,396
New investments 61,258 60,050
Disbursements to existing portfolio companies 122,666 73,706
Unscheduled principal repayments (A)
(28,000) (57,398)
Net proceeds from sales of investments (52,228) (35,533)
Net realized gain on investments 29,964 10,545
Net unrealized appreciation (depreciation) of investments 62,310 (9,971)
Reversal of net unrealized appreciation of investments (29,009) (2,264)
Amortization of premiums, discounts, and acquisition costs, net — 12
Ending investment portfolio, at fair value $ 920,504 $ 753,543
(A) The year ended March 31, 2023 includes $5.1 million of non-cash principal repayments related to the August 2022 refinancing at Ginsey.
The following table summarizes the contractual principal repayment and maturity of our investment portfolio by fiscal year, assuming no voluntary prepayments, as of March 31, 2024:
Amount
For the fiscal years ending March 31:
2025 $ 72,770
2026 236,193
2027 185,776
2028 38,250
2029 100,394
Thereafter 25,000
Total contractual repayments $ 658,383
Investments in equity securities 195,907
Total cost basis of investments held as of March 31, 2024: $ 854,290
Financing Activities
Net cash provided by financing activities for the year ended March 31, 2024 was $69.9 million, which consisted primarily of $74.8 million of gross proceeds from the issuance of the 8.00% 2028 Notes, $43.9 million of proceeds from the issuance of common stock under the Common Stock ATM Program, net of expenses and shelf offering registration costs, and $31.8 million of net borrowings on our Credit Facility, partially offset by $76.1 million in distributions to common stockholders and $4.5 million of deferred financing and offering costs.
Net cash used in financing activities for the year ended March 31, 2023 was $6.7 million, which consisted primarily of $47.1 million in distributions to common stockholders and $0.3 million of deferred financing and offering costs, partially offset by $35.2 million of net borrowings on our Credit Facility and $5.4 million of proceeds from the issuance of common stock under the Common Stock ATM Program, net expenses and shelf registration offering costs.
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Distributions and Dividends to Stockholders
Common Stock Distributions
To qualify to be taxed as a RIC and thus avoid corporate level federal income tax on the income we distribute to our stockholders, we are required, among other requirements, to distribute to our stockholders on an annual basis at least 90% of our Investment Company Taxable Income, determined without regard to the dividends paid deduction. Additionally, the Credit Facility generally restricts the amount of distributions to stockholders that we can pay out to be no greater than the sum of certain amounts, including our net investment income, plus net capital gains, plus amounts elected by the Company to be considered as having been paid during the prior fiscal year in accordance with Section 855(a) of the Code. In accordance with these requirements, our Board of Directors declared, and we paid, monthly cash distributions of $0.08 per common share for each of the twelve months from April 2023 through March 2024, and supplemental distributions of $0.12 per common share in June, September, and November 2023 and $0.88 per common share in December 2023. See also “ Recent Developments - Distributions and Dividends ” for a discussion of cash distributions to common stockholders declared by our Board of Directors in April 2024.
For each of the fiscal years ended March 31, 2024 and 2023, Investment Company Taxable Income exceeded distributions declared and paid, and, in accordance with Section 855(a) of the Code, we elected to treat $18.7 million and $21.4 million, respectively, of the first distributions paid subsequent to fiscal year-end as having been paid in the prior year. In addition, for each of the fiscal years ended March 31, 2024 and 2023, net capital gains exceeded distributions declared and paid, and, in accordance with Section 855(a) of the Code, we elected to treat $1.4 million and $10.6 million, respectively, of the first distributions paid subsequent to fiscal year-end as having been paid in the prior year. For the year ended March 31, 2024, we recorded $0.8 million of net adjustments for estimated permanent book-tax differences to reflect tax character, which increased Overdistributed net investment income and decreased Accumulated net realized gain in excess of distributions and Capital in excess of par value. For the year ended March 31, 2023, we recorded $1.6 million of net adjustments for estimated permanent book-tax differences to reflect tax character, which decreased Capital in excess of par value and increased Overdistributed net investment income and Accumulated net realized gain in excess of distributions.
Preferred Stock Dividends
Our Board of Directors declared and we paid monthly cash dividends of $0.1328125 per share to holders of our Series E Term Preferred Stock per month from April 2021 through July 2021 and $0.07968750 per share of our Series E Term Preferred Stock for the period from August 1, 2021 up to, but excluding, the redemption date of August 19, 2021. In accordance with GAAP, we treated these monthly dividends as an operating expense.
Dividend Reinvestment Plan
Our common stockholders who hold their shares through our transfer agent, Computershare, Inc. (“Computershare”), have the option to participate in a dividend reinvestment plan offered by Computershare, as the plan agent. This is an “opt in” dividend reinvestment plan, meaning that common stockholders may elect to have their cash distributions automatically reinvested in additional shares of our common stock. Common stockholders who do not make such election will receive their distributions in cash. Any distributions reinvested under the plan will be taxable to a common stockholder to the same extent, and with the same character, as if the common stockholder had received the distribution in cash. The common stockholder generally will have an adjusted basis in the additional common shares purchased through the plan equal to the dollar amount that would have been received if the U.S. stockholder had received the dividend or distribution in cash. The additional common shares will have a new holding period commencing on the day following the date on which the shares are credited to the common stockholder’s account. Computershare purchases shares in the open market in connection with the obligations under the plan.
Registration Statement
On February 28, 2024, we filed a registration statement on Form N-2 (File No. 333-277452), which the SEC declared effective on April 18, 2024. The registration statement permits us to issue, through one or more transactions, up to an aggregate of $450.0 million in securities, consisting of common stock, preferred stock, subscription rights, debt securities, and warrants to purchase common stock, preferred stock, or debt securities, including through concurrent, separate offerings of such securities. As of the date of this report, we have the ability to issue up to $450.0 million of securities under the registration statement.
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On September 3, 2021, we filed a registration statement on Form N-2 (File No. 333-259302), which the SEC declared effective on October 15, 2021. The registration statement permited us to issue, through one or more transactions, up to an aggregate of $300.0 million in securities, consisting of common stock, preferred stock, subscription rights, debt securities, and warrants to purchase common stock, preferred stock, or debt securities, including through concurrent, separate offerings of such securities. As of March 31, 2024, we had the ability to issue up to $175.3 million of the securities registered under the registration statement. This registration statement was terminated on April 18, 2024.
Equity
Common Stock
In August 2022, we entered into equity distribution agreements with Oppenheimer & Co. and Virtu Americas LLC (each a “Sales Agent”), under which we have the ability to issue and sell shares of our common stock, from time to time, through the Sales Agents, up to an aggregate offering price of $50.0 million in our Common Stock ATM Program. In August 2023, we entered into an equity distribution agreement with B. Riley Securities, Inc. and entered into amendments to the agreements with Oppenheimer & Co. Inc. and Virtu Americas LLC in order to add B. Riley Securities, Inc. as a Sales Agent for the Common Stock ATM Program. As of March 31, 2024, we had no remaining capacity under the Common Stock ATM Program.
During the year ended March 31, 2024, we sold 3,097,162 shares of our common stock under the Common Stock ATM Program at a weighted-average gross price of $14.37 per share and raised approximately $44.5 million of gross proceeds. The weighted-average net price per share, after deducting commissions and offering costs borne by us, was $14.12 and resulted in total net proceeds of approximately $43.7 million. These sales were above our then current NAV per share.
During the year ended March 31, 2023, we sold 386,482 shares of our common stock under the Common Stock ATM Program at a weighted-average gross price of $14.21 per share and raised approximately $5.5 million of gross proceeds. The weighted-average net price per share, after deducting commissions and offering costs borne by us, was $14.01 and resulted in total net proceeds of approximately $5.4 million. These sales were above our then current NAV per share.
We anticipate issuing equity securities to obtain additional capital in the future. However, we cannot determine the timing or terms of any future equity issuances or whether we will be able to issue equity on terms favorable to us, or at all. When our common stock is trading at a price below NAV per share, the 1940 Act places regulatory constraints on our ability to obtain additional capital by issuing common stock. Generally, the 1940 Act provides that we may not issue and sell our common stock at a price below our NAV per common share, other than to our then existing common stockholders pursuant to a rights offering, without first obtaining approval from our stockholders and our independent directors and meeting other stated requirements. On March 31, 2024, the closing market price of our common stock was $14.23 per share, representing a 6.0% premium to our NAV of $13.43 per share as of March 31, 2024.
Revolving Line of Credit
On February 5, 2024, we, through our wholly-owned subsidiary, Business Investment, entered into Amendment No. 9 to the Credit Facility with KeyBank National Association ("KeyBank"), as administrative agent, joint lead arranger and lender, Fifth Third Bank as managing agent, joint lead arranger and lender, the Adviser, as servicer, and certain other lenders party thereto. The Credit Facility was amended to increase the size from $135.0 million to $200.0 million and update certain existing terms. The Credit Facility continues to include customary terms, covenants, events of default and constraints on borrowing availability based on collateral tests for a credit facility of its size and nature.
Previously, on October 30, 2023, we, through our wholly-owned subsidiary, Business Investment, entered into Amendment No. 8 to the Credit Facility with KeyBank, as administrative agent, lead arranger, managing agent and lender, the Adviser, as servicer, and certain other lenders party thereto. Among other things, the revolving period was extended to October 30, 2026, and if not renewed or extended by such date, all principal and interest will be due and payable by October 30, 2028 (two years after the revolving period end date). Advances under the Credit Facility generally bear interest at 30-day Term SOFR, subject to a floor of 0.35%, plus 3.15% per annum until October 30, 2026, with the margin then increasing to 3.40% for the period from October 30, 2026 to October 30, 2027, and increasing further to 3.65% thereafter with a SOFR credit spread adjustment of 10 basis points. The Credit Facility has an unused commitment fee on the daily unused commitment amount of 0.50% per annum if the daily unused commitment amount is less than or equal to 50% of the total commitment amount, 0.75% per annum if the daily unused commitment amount is greater than 50% but less than or equal to 65% of the
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total commitment amount, and 1.00% per annum if the daily unused commitment amount is greater than 65% of the total commitment amount. The size of the Credit Facility was reduced from $180.0 million to $135.0 million.
Previously, on April 10, 2023, we, through our wholly-owned subsidiary, Business Investment, entered into Amendment No. 7 to the Credit Facility with KeyBank as administrative agent, lead arranger, managing agent and lender, the Adviser, as servicer, and certain other lenders party thereto. The reference rate was updated from LIBOR to Term SOFR plus an 11 basis point credit spread adjustment.
At March 31, 2024, we had $67.0 million of borrowings outstanding on the Credit Facility and as of the date of this report, we had $65.1 million outstanding under the Credit Facility.
Interest is payable monthly during the term of the Credit Facility. Available borrowings are subject to various constraints and applicable advance rates, which are generally based on the size, characteristics, and quality of the collateral pledged by Business Investment. The Credit Facility also requires that any interest and principal payments on pledged loans be remitted directly by the borrower into a lockbox account with KeyBank. KeyBank is also the trustee of the account and generally remits the collected funds to us once a month.
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 policies 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 required in the borrowing base. Additionally, the Credit Facility contains a performance guaranty that requires the Company to maintain (i) a minimum net worth (defined in our Credit Facility to include any outstanding mandatorily redeemable 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 $ 348.7 million as of March 31, 2024, (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, 2024, and as defined in the performance guaranty of the Credit Facility, we had a net worth of $ 822.4 million, asset coverage on our senior securities representing indebtedness of 219.0 %, calculated in compliance 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, 2024, we had availability, after adjustments for various constraints based on collateral quality, of $ 133.0 million under the Credit Facility and were in compliance with all covenants under the Credit Facility.
Notes Payable
5.00% Notes due 2026
In March 2021, we completed a public offering of the 5.00% 2026 Notes with an aggregate principal amount of $127.9 million, which resulted in net proceeds of approximately $123.8 million after deducting underwriting discounts, commissions and offering costs borne by us. The 5.00% 2026 Notes are traded under the ticker symbol “GAINN” on Nasdaq. The 5.00% 2026 Notes will mature on May 1, 2026 and may be redeemed in whole or in part at any time or from time to time at the Company’s option. The 5.00% 2026 Notes bear interest at a rate of 5.00% per year (which equates to $6.4 million per year), payable quarterly in arrears.
The indenture relating to the 5.00% 2026 Notes contains certain covenants, including (i) an inability to incur additional debt or issue additional debt or preferred securities unless the Company’s asset coverage meets the threshold specified in the 1940 Act after such borrowing, (ii) an inability to declare any dividend or distribution (except a dividend payable in our stock) on a class of our capital stock or to purchase shares of our capital stock unless the Company’s asset coverage meets the threshold specified in the 1940 Act at the time of (and giving effect to) such declaration or purchase, and (iii) if, at any time, we are not subject to the reporting requirements of the Exchange Act, we will provide the holders of the 5.00% 2026
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Notes, as applicable, and the trustee with audited annual consolidated financial statements and unaudited interim consolidated financial statements.
The 5.00% 2026 Notes are recorded at the aggregate principal amount, less underwriting discounts, commissions, and offering costs, on our accompanying Consolidated Statements of Assets and Liabilities . Total underwriting discounts, commissions, and offering costs related to this offering were $4.1 million, which have been recorded as discounts to the aggregate principal amount on our accompanying Consolidated Statements of Assets and Liabilities and are being amortized over the period ending May 1, 2026, the maturity date.
4.875% Notes due 2028
In August 2021, we completed a public offering of the 4.875% 2028 Notes with an aggregate principal amount of $134.6 million, which resulted in net proceeds of approximately $131.3 million after deducting underwriting discounts, commissions and offering costs borne by us. The 4.875% 2028 Notes are traded under the ticker symbol “GAINZ” on Nasdaq. The 4.875% 2028 Notes will mature on November 1, 2028 and may be redeemed in whole or in part at any time or from time to time at the Company’s option. The 4.875% 2028 Notes bear interest at a rate of 4.875% per year (which equates to $6.6 million per year), payable quarterly in arrears.
The indenture relating to the 4.875% 2028 Notes contains certain covenants, including (i) an inability to incur additional debt or issue additional debt or preferred securities unless the Company’s asset coverage meets the threshold specified in the 1940 Act after such borrowing, (ii) an inability to declare any dividend or distribution (except a dividend payable in our stock) on a class of our capital stock or to purchase shares of our capital stock unless the Company’s asset coverage meets the threshold specified in the 1940 Act at the time of (and giving effect to) such declaration or purchase, and (iii) if, at any time, we are not subject to the reporting requirements of the Exchange Act, we will provide the holders of the 4.875% 2028 Notes, as applicable, and the trustee with audited annual consolidated financial statements and unaudited interim consolidated financial statements.
The 4.875% 2028 Notes are recorded at the aggregate principal amount, less underwriting discounts, commissions, and offering costs, on our accompanying Consolidated Statements of Assets and Liabilities . Total underwriting discounts, commissions, and offering costs related to this offering were $3.3 million , which have been recorded as discounts to the aggregate principal amount on our accompanying Consolidated Statements of Assets and Liabilities and are being amortized over the period ending November 1, 2028, the maturity date.
8.00% Notes due 2028
In May 2023, we completed a public offering of the 8.00% 2028 Notes with an aggregate principal amount of $74.8 million, which resulted in net proceeds of approximately $72.3 million after deducting underwriting discounts, commissions and offering costs borne by us. The 8.00% 2028 Notes are traded under the ticker symbol “GAINL” on Nasdaq. The 8.00% 2028 Notes will mature on August 1, 2028 and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after August 1, 2025. The 8.00% 2028 Notes bear interest at a rate of 8.00% per year (which equates to $6.0 million per year), payable quarterly in arrears.
The indenture relating to the 8.00% 2028 Notes contains certain covenants, including (i) an inability to incur additional debt or issue additional debt or preferred securities unless the Company’s asset coverage meets the threshold specified in the 1940 Act after such borrowing, (ii) an inability to declare any dividend or distribution (except a dividend payable in our stock) on a class of our capital stock or to purchase shares of our capital stock unless the Company’s asset coverage meets the threshold specified in the 1940 Act at the time of (and giving effect to) such declaration or purchase, and (iii) if, at any time, we are not subject to the reporting requirements of the Exchange Act, we will provide the holders of the 8.00% 2028 Notes and the trustee with audited annual consolidated financial statements and unaudited interim consolidated financial statements.
The 8.00% 2028 Notes are recorded at the aggregate principal amount, less underwriting discounts, commissions, and offering costs, on our accompanying Consolidated Statements of Assets and Liabilities . Total underwriting discounts, commissions, and offering costs related to this offering were $2.5 million, which have been recorded as discounts to the aggregate principal amount on our accompanying Consolidated Statements of Assets and Liabilities and are being amortized over the period ending August 1, 2028, the maturity date.
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OFF-BALANCE SHEET ARRANGEMENTS
Unlike PIK income, we generally do not recognize success fees as income until payment has been received. Due to the contingent nature of success fees, there are no guarantees that we will be able to collect any or all of these success fees or know the timing of any such collections. As a result, as of March 31, 2024 and 2023, we had unrecognized, contractual off-balance sheet success fee receivables of $44.9 million and $53.6 million (or approximately $1.23 and $1.60 per common share), respectively, on our debt investments. Consistent with GAAP, we have not recognized success fee receivables and related income in our accompanying Consolidated Financial Statements until earned.
CONTRACTUAL OBLIGATIONS
We have line of credit commitments to certain of our portfolio companies that have not been fully drawn. Since these line of credit commitments have expiration dates and we expect many will never be fully drawn, the total line of credit commitment amounts do not necessarily represent future cash requirements. We estimate the fair value of the combined unused line of credit commitments as of March 31, 2024 to be insignificant.
The following table shows our contractual obligations as of March 31, 2024, at cost:
Payments Due by Period
Contractual Obligations (A)
Total Less than
1 Year 1-3 Years 3-5 Years More than
5 Years
Credit Facility (B)
$ 67,000 $ — $ — $ 67,000 $ —
Notes payable 337,238 — 127,938 209,300 —
Interest payments on obligations (C)
102,725 26,112 46,431 30,182 —
Total $ 506,963 $ 26,112 $ 174,369 $ 306,482 $ —
(A) Excludes unused line of credit commitments to our portfolio companies in the aggregate principal amount of $2.4 million.
(B) Principal balance of borrowings outstanding under the Credit Facility, based on the maturity date following the current contractual revolving period end date.
(C) Includes interest payments due on the Credit Facility, 5.00% 2026 Notes, 4.875% 2028 Notes, and 8.00% 2028 Notes, as applicable. The amount of interest payments calculated for purposes of this table was based upon rates and outstanding balances as of March 31, 2024.
Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the reported consolidated amounts of assets and liabilities, including disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the period reported. Actual results could differ materially from those estimates under different assumptions or conditions. We have identified our investment valuation policy (which has been approved by our Board of Directors) as our most critical accounting policy, which is described in Note 2— Summary of Significant Accounting Policies in the accompanying Notes to Consolidated Financial Statements included elsewhere in this Annual Report. Additionally, refer to Note 3 — Investments in the accompanying Notes to Consolidated Financial Statements included elsewhere in this Annual Report for additional information regarding fair value measurements and our application of Financial Accounting Standards Board Accounting Standards Codification Topic 820, “ Fair Value Measurements and Disclosures.” We have also identified our revenue recognition policy as a critical accounting policy, which is described in Note 2— Summary of Significant Accounting Policies in the accompanying Notes to Consolidated Financial Statements included elsewhere in this Annual Report.
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Investment Valuation
Credit Monitoring and Risk Rating
The Adviser monitors a wide variety of key credit statistics that provide information regarding our portfolio companies to help us assess credit quality and portfolio performance and, in some instances, are used as inputs in our valuation techniques. Generally, we, through the Adviser, participate in periodic board meetings of our portfolio companies in which we hold board seats and also require them to provide annual audited and monthly unaudited financial statements. Using these statements or comparable information and board discussions, the Adviser calculates and evaluates certain credit statistics.
The Adviser risk rates all of our investments in debt securities. The Adviser does not risk rate equity securities. For loans that have been rated by a SEC-registered Nationally Recognized Statistical Rating Organization (“NRSRO”), the Adviser generally uses the average of two corporate level NRSRO’s risk ratings for such security. For all other debt securities, the Adviser uses a proprietary risk rating system. While the Adviser seeks to mirror the NRSRO systems, we cannot provide any assurance that the Adviser’s risk rating system will provide the same risk rating as an NRSRO for these securities. The Adviser’s risk rating system is used to estimate the probability of default on debt securities and the expected loss, if there is a default. The Adviser’s risk rating system uses a scale of 0 to >10, with >10 being the lowest probability of default. It is the Adviser’s understanding that most debt securities of Lower Middle Market companies do not exceed the grade of BBB on an NRSRO scale, so there would be no debt securities in the Lower Middle Market that would meet the definition of AAA, AA or A. Therefore, the Adviser’s scale begins with the designation >10 as the best risk rating which may be equivalent to a BBB from an NRSRO; however, no assurance can be given that a >10 on the Adviser’s scale is equal to a BBB or Baa2 on an NRSRO scale. The Adviser’s risk rating system covers both qualitative and quantitative aspects of the business and the securities we hold.
The following table reflects risk ratings for all loans in our portfolio as of March 31, 2024 and 2023:
As of March 31,
Rating 2024 2023
Highest 9.0 9.0
Average 6.6 6.4
Weighted-average 6.9 7.3
Lowest 3.0 1.0
Tax Status
We intend to continue to maintain our qualification as a RIC under Subchapter M of the Code for U.S. federal income tax purposes. As a RIC, we generally are not subject to U.S. federal income tax on the portion of our taxable income and gains distributed to our stockholders. To maintain our qualification as a RIC, we must maintain our status as a BDC and meet certain source-of-income and asset diversification requirements. In addition, to qualify to be taxed as a RIC, we must distribute to stockholders at least 90% of our Investment Company Taxable Income, determined without regard to the dividends paid deduction. Our policy generally is to make distributions to our stockholders in an amount up to 100% of Investment Company Taxable Income. We may retain some or all of our net long-term capital gains, if any, and designate them as deemed distributions, or distribute such gains to stockholders in cash. See “Business — Material U.S. Federal Income Tax Considerations” and “ — Liquidity and Capital Resources — Distributions and Dividends to Stockholders . ”
In an effort to limit federal excise taxes, we have to distribute to stockholders, during each calendar year, an amount close to the sum of: (1) 98% of our ordinary income for the calendar year, (2) 98.2% of our net capital gains (both long-term and short-term), if any, for the one-year period ending on October 31 of the calendar year, and (3) any income realized, but not distributed, in the preceding period (to the extent that income tax was not imposed on such amounts), less certain reductions, as applicable. Under the RIC Modernization Act, we are permitted to carryforward any capital losses that we may incur for an unlimited period, and such capital loss carryforwards will retain their character as either short-term or long-term capital losses. Our capital loss carryforward balance was $0 as of March 31, 2024 and 2023 .
Recent Accounting Pronouncements
Refer to Note 2 — Summary of Significant Accounting Policies in the accompanying Notes to Consolidated Financial Statements included elsewhere in this Annual Report for a description of recent accounting pronouncements.
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