What changed in this filing

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Item 1. Business

2021-03-04 compared with 2020-03-03 · 175 added, 124 removed, 665 unchanged (31% of the section changed)

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and “Stellus Capital Management” refers to our investment adviser and administrator, Stellus Capital Management, LLC.

We are an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a business development company, or “BDC”, under the Investment Company Act of 1940, or the “1940 Act.” We were organized as a Maryland corporation on May 8, 2012, and formally commenced operations on November 7, 2012.

We originate and invest primarily in private middle-market companies (typically those with $5 million to $50 million of EBITDA (earnings before interest, taxes, depreciation and amortization)) through first lien (including unitranche), second lien, and unsecured debt financing, often with corresponding equity co-investments.

We are an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”).

We were organized as a Maryland corporation on May 8, 2012, and formally commenced operations on November 7, 2012.

We originate and invest primarily in private middle-market companies (typically those with $5.0 million to $50.0 million of EBITDA (earnings before interest, taxes, depreciation and amortization)) through first lien, unitranche, second lien, and unsecured debt financing, often with corresponding equity co-investments.

Unitranche structures may combine characteristics of first lien senior secured as well as second lien and/or subordinated loans and our unitranche loans will expose us to the risks associated with second lien and subordinated loans to the extent we invest in the “last-out” tranche.

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capitalizing upon the experience and resources of the Stellus Capital Management investment team to monitor our investments.

We previously received an exemptive order (the “Prior Order”) from the SEC to co-invest with private funds managed by Stellus Capital Management where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC).

We previously received an exemptive order (the “Prior Order”) from the Securities and Exchange Commission (the “SEC”) to co-invest with private funds managed by Stellus Capital Management where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC).

On December 18, 2018, we received a new exemptive order (the “Order”) that supersedes the Prior Order and permits us greater flexibility to enter into co-investment transactions.

The Order expands on the Prior Order and allows us to co-invest with additional types of private funds, other BDCs, and registered investment companies managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management, subject to the conditions included therein.

the proposed transaction, including the consideration to be paid, are reasonable and fair to the Company and its stockholders and do not involve overreaching of the Company or its stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of the Company’s stockholders and is consistent with its investment objectives and strategies.

Pursuant to the Order, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our directors who are not “interested persons,” as such term is defined in Section 2(a)(19)

of the 1940 Act (the “independent directors”) must make certain conclusions in connection with a co-investment transaction, including (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to the Company and its stockholders and do not involve overreaching of the Company or its stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of the Company’s stockholders and is consistent with its investment objectives and strategies.

We co-invest, subject to the conditions in the Order, with private credit funds managed by Stellus Capital Management that have an investment strategy that is similar or identical to our investment strategy, and the we may co-invest with other BDCs and registered investment companies managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management in the future.

We believe that such co-investments may afford it additional investment opportunities and an ability to achieve greater diversification.

We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification.

Additionally, pursuant to an exemptive order applicable to all BDCs that was issued by the SEC on April 8, 2020, we were able, through December 31, 2020, and subject to the satisfaction of certain conditions, co-invest in our existing portfolio companies with the private funds, other BDCs, and registered investment companies covered by the Order (the “Affiliated Funds”), even if such Affiliated Funds have not previously invested in such existing portfolio company.

Without this order, these Affiliated Funds would not have been able to participate in such co-investments with us unless the Affiliated Funds had previously acquired securities of the portfolio company in a co-investment transaction with us.

As a BDC, we are required to comply with certain regulatory requirements.

Prior to June 28, 2018, we were only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, was equal to at least 200% after giving effect to such leverage.

For instance, as a BDC, we may not acquire any assets other than “qualifying assets” specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our total assets are qualifying assets.

Qualifying assets include investments in “eligible portfolio companies.” Under the relevant SEC rules, the term “eligible portfolio company” includes all private operating companies, operating companies whose securities are not listed on a national securities exchange, and certain public operating companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250.0 million, in each case organized and with their principal of business in the United States.

We have elected to be treated for U.S.

federal income tax purposes as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”).

To maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements.

As of December 31, 2020, we were in compliance with the RIC requirements.

As a RIC, we generally will not have to pay corporate-level U.S.

federal income taxes on any income we timely distribute to our stockholders.

On March 23, 2018, the Small Business Credit Availability Act (the “SBCAA”) was signed into law, which included various changes to regulations under the federal securities laws that impact BDCs.

The SBCAA included changes to the 1940 Act to allow BDCs to decrease their asset coverage requirement to 150% from 200% under certain circumstances.

On April 4, 2018, our board of directors, or the “Board”, including a “required majority” (as such term is defined in Section 57(o) of the Investment Company Act of 1940, as amended (the “1940 Act”)) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act.

The Board also approved the submission of a proposal to approve the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act, which was approved by stockholders at the Company’s 2018 annual meeting of stockholders.

As a result, the asset coverage ratio test applicable to the Company was decreased from 200% to 150%, effective June 28, 2018.

In other words, prior to the enactment of the SBCAA, a BDC could borrow $1.00 for investment purposes for every $1.00 of investor equity.

Now, for those BDCs that satisfy the Act’s approval and disclosure requirements, the BDC can borrow $2.00 for investment purposes for every $1.00 of investor equity.

On April 4, 2018, our board of directors (the “Board”), including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act.

At our 2018 annual meeting of stockholders our stockholders also approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act.

As a result, the asset coverage ratio applicable to us was decreased from 200% to 150%, effective June 29, 2018 and we can now borrow $2.00 for investment purposes for every $1.00 of investor equity.

As of December 31, 2020, our asset coverage ratio was 223%.

The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing.

We have elected and intend to qualify annually to be treated for federal income tax purposes as a regulated investment company, or “RIC,” under Subchapter M of the Internal Revenue Code, or the Code.

So long as we maintain our qualification as a RIC, we will not be taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to stockholders as dividends on a timely basis.

Our principal executive office is currently located at 4400 Post Oak Parkway, Suite 2200, Houston, TX 77027, and our telephone number is (713) 292-5400.

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SBIC Licenses

Two of our wholly owned subsidiaries (the “SBIC subsidiaries”) hold a license to operate as small business investment companies, or SBICs.

Current SBA regulations allow an SBIC to obtain leverage by issuing debentures guaranteed by the SBA up to a maximum of $175 million under current SBIC regulations, subject to required capitalization of the SBIC subsidiary, SBA approval, and other requirements.

Two of our wholly owned subsidiaries (the “SBIC subsidiaries”) hold a license to operate as small business investment companies (“SBICs”).

Current Small Business Administration (“SBA”) regulations allow an SBIC to obtain leverage by issuing debentures guaranteed by the SBA up to a maximum of $175.0 million under current SBIC regulations, subject to required capitalization of the SBIC subsidiary, SBA approval, and other requirements.

SBA-guaranteed debentures have fixed interest rates that equal prevailing 10-year Treasury Note rates plus a market spread and have a maturity of ten years with interest payable semi-annually.

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We have obtained exemptive relief from the SEC to permit us to exclude the debt of the SBIC subsidiaries guaranteed by the SBA from our asset coverage test under the 1940 Act.

The exemptive relief provides us

with increased flexibility under the asset coverage test by permitting us to borrow up to $325,000,000 more than we would otherwise be able to absent the receipt of this exemptive relief.

The exemptive relief provides us with increased flexibility under the asset coverage test by permitting us to borrow up to $325.0 million more than we would otherwise be able to absent the receipt of this exemptive relief.

COVID-19 Pandemic

On March 11, 2020 the World Health Organization declared COVID-19 a pandemic and recommended containment and mitigation measures worldwide.

Since then, the COVID-19 pandemic has severely impacted global economic activity and caused significant volatility in financial markets.

The global impact of the outbreak has been rapidly evolving and many countries, including the United States, have reacted by instituting quarantines, mandating business and school closures and restricting travel.

Such actions created and continue to create disruption in global supply chains and are adversely impacting several industries.

While several countries, as well as certain states in the United States, have begun to lift public health restrictions with the view to reopening their economies, recurring COVID-19 outbreaks have led to the re-introduction of such restrictions in certain states in the United States and globally and could continue to lead to the re-introduction of such restrictions elsewhere.

The COVID-19 pandemic could have a continued adverse impact on economic and market conditions and trigger a period of global economic slowdown.

The COVID-19 pandemic presents material uncertainty and risks with respect to the underlying value of our portfolio companies and with respect to our business, financial condition, results of operations, and cash flows, such as the potential negative impact to financing arrangements, increased costs of operations, changes in law and/or regulation, and uncertainty regarding government and regulatory policy.

All partners and employees of Stellus Capital Management have been primarily operating remotely since March 16, 2020 without disruption to its operations and are prepared to continue working remotely as long as is necessary for the health and safety of all personnel.

Our COVID-19 response

Since the onset of the COVID-19 pandemic, we have been in regular contact with all of our portfolio companies and/or their sponsors to assess among other things their ability to function in the new environment.

Discussions have addressed the portfolio companies’ liquidity position, expected covenant compliance, and the health of their workforce and customers.

Financial impact

We will continue to closely monitor the financial condition of our portfolio companies as part of our efforts to mitigate the impact of the COVID-19 pandemic.

Historical information may be relatively less significant.

Summary Risk Factors

Investing in our securities involves a high degree of risk.

You should carefully consider the information in “Item 1A.

Risk Factors”, including, but not limited to, the following risks:

Political, social and economic uncertainty, including uncertainty related to the COVID-19 pandemic, creates and exacerbates risks.

We are dependent upon key personnel of Stellus Capital Management for our future success.

If Stellus Capital Management were to lose any of its key personnel, our ability to achieve our investment objective could be significantly harmed.

Our business model depends to a significant extent upon strong referral relationships.

Any inability of Stellus Capital Management to maintain or develop these relationships, or the failure of these relationships to generate investment opportunities, could adversely affect our business.

Our incentive fee may induce Stellus Capital Management to make speculative investments.

We may be obligated to pay Stellus Capital Management incentive compensation even if we incur a loss and may pay more than 20.0% of our net capital gains because we cannot recover payments made in previous years.

We will be subject to corporate-level income tax and may default under our revolving credit facility if we are unable to maintain our tax treatment as a RIC under Subchapter M of the Code.

We may have difficulty paying our required distributions if we recognize income before, or without, receiving cash representing such income.

Because we finance our investments with borrowed money, the potential for gain or loss on amounts invested in us is magnified and may increase the risk of investing in us.

Substantially all of our assets are subject to security interests under the Credit Facility or claims of the SBA with respect to SBA-guaranteed debentures we may issue and, if we default on our obligations thereunder, we may suffer adverse consequences, including foreclosure on our assets.

The current period of capital markets disruption and economic uncertainty may make it difficult to extend the maturity of, or refinance, our existing indebtedness or obtain new indebtedness and any failure to do so could have a material adverse effect on our business, financial condition or results of operations.

Most of our portfolio investments are recorded at fair value as determined in good faith by our Board and, as a result, there may be uncertainty as to the value of our portfolio investments

If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud.

As a result, stockholders could lose confidence in our financial and other public reporting, which would harm our business and the trading price of our common stock.

Any failure to comply with SBA regulations could have an adverse effect on our SBIC subsidiaries’ operations.

Because we intend to distribute substantially all of our income to our stockholders to obtain and maintain our status as a RIC, we will continue to need additional capital to finance our growth.

If additional funds are unavailable or not available on favorable terms, our ability to grow may be impaired.

The time and resources that Stellus Capital Management devote to us may be diverted, and we may face additional competition due to the fact that Stellus Capital Management and its affiliates are not prohibited from raising money for, or managing, another entity that makes the same types of investments that we target.

If we do not invest a sufficient portion of our assets in qualifying assets, we could violate the 1940 Act provisions applicable to BDCs or be precluded from investing according to our current business strategy.

The failure in cyber security systems, as well as the occurrence of events unanticipated in our disaster recovery systems and management continuity planning could impair our ability to conduct business effectively.

Our investments in private and middle-market portfolio companies are risky, and we could lose all or part of our investment.

Price declines and illiquidity in the corporate debt markets may adversely affect the fair value of our portfolio investments, reducing our net asset value through increased net unrealized depreciation.

Because we generally do not hold controlling equity interests in our portfolio companies, we may not be able to exercise control over our portfolio companies or to prevent decisions by management of our portfolio companies that could decrease the value of our investments.

The interest rates of our floating-rate loans to our portfolio companies that extend beyond 2021 might be subject to change based on recent regulatory changes.

Portfolio Composition

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The weighted average yield on all of our debt investments as of December 31, 2020, was approximately 8.3%, of which approximately 7.8% was current cash interest.

The weighted average yield on all of our investments, including non-income producing equity positions, as of December 31, 2020 and December 31, 2019 was approximately 7.9% and 8.8%, respectively.

The weighted average yield of our debt investments is not the same as a return on investment for our stockholders but, rather, relates to a portion of our investment portfolio and is calculated before the payment of all of our and our subsidiaries’ fees and expenses.

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Stellus Capital Management

Stellus Capital Management manages our investment activities and is responsible for analyzing investment opportunities, conducting research and performing due diligence on potential investments, negotiating and structuring our investments, originating prospective investments and monitoring our investments and portfolio companies on an ongoing basis.

Stellus Capital Management manages our investment activities and is responsible for analyzing investment opportunities, conducting research and performing due diligence on potential investments,

negotiating and structuring our investments, originating prospective investments and monitoring our investments and portfolio companies on an ongoing basis.

The senior investment professionals of Stellus Capital Management have an average of over 31 years of investing, corporate finance, restructuring, consulting and accounting experience and have worked together at several companies.

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Shaw & Co., L.P.

and its associated investment funds

Shaw group”) with respect to an approximately $10.0 million investment portfolio at fair value (as of December 31, 2019) in middle-market companies pursuant to sub-advisory arrangements.

and its associated investment funds (the “D.E.

Shaw group”).

In addition to serving as our investment adviser and the sub-advisor to the D.

Shaw group as noted above, Stellus Capital Management currently manages private credit funds, some of which have an investment strategy that is similar or identical to our investment strategy, and energy private equity funds.

Shaw group as noted above, Stellus Capital Management currently manages private credit funds, some of which have an investment strategy that is similar or identical to our investment strategy.

We received the Order from the SEC, which permits us to co-invest with investment funds managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management, where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC).

We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification.

We will not co-invest with the energy private equity funds, as the energy private equity funds focus on equity-related investments only in the energy industry, and we focus on predominantly credit-related investments across many industries.

In addition, we will not co-invest with D.E.

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We believe that several factors render many U.S.

financial institutions ill-suited to lend to middle-market companies.

For example, based on the experience of Stellus Capital Management’s senior investment professionals, lending to middle-market companies in the United States (a) is generally more labor intensive than lending to larger companies due to the smaller size of each investment and the fragmented nature of the information available with respect to such companies,

(b) requires specialized due diligence and underwriting capabilities, and (c) may also require more extensive ongoing monitoring by the lender.

institutions ill-suited to lend to middle-market companies.

We believe that, through Stellus Capital Management, we have the experience and expertise to meet these specialized lending requirements.

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Stellus Capital Management has the expertise and ability to structure investments across all levels of a company’s capital structure.

Furthermore, we believe that current market conditions will allow us to structure attractively priced debt investments and may allow us to incorporate other return-enhancing mechanisms such as commitment fees, original issue discounts, early redemption premiums, payment-in-kind, or “PIK,” interest and various forms of equity securities.

Furthermore, we believe that current market conditions will allow us to structure attractively priced debt investments and may allow us to incorporate other return-enhancing mechanisms such as commitment fees, original issue discounts, early redemption premiums, PIK, interest and various forms of equity securities.

Resources of Stellus Capital Management Platform.

We have access to the resources and capabilities of Stellus Capital Management, which has 16 investment professionals, including Robert T.

Ladd, Dean D’Angelo, Joshua T.

Davis and Todd A.

Overbergen, who are supported by six managing directors, two vice presidents and three analysts.

Ladd, Dean D’Angelo, and Joshua T.

Davis, who are supported by five managing directors, two vice presidents and four analysts.

These individuals have developed long-term relationships with middle-market companies, management teams, financial sponsors, lending institutions and deal intermediaries by providing flexible financing throughout the capital structure.

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We also expect to benefit from Stellus Capital Management’s due diligence, credit analysis, origination and transaction execution experience and capabilities, including the support provided with respect to those functions by Mr.

Huskinson, who serves as our chief financial officer and chief compliance officer, and his staff of ten finance and operations professionals.

Huskinson, who serves as our Chief Financial Officer and Chief Compliance Officer, and his staff of nine finance and operations professionals.

Investment Strategy

The Stellus Capital Management senior investment professionals employ an opportunistic and flexible investing approach, combined with strong risk management processes, which we believe yields a highly diversified portfolio across companies, geographies, industries, and investment types.

We seek direct origination opportunities of first lien (including unitranche), second lien, and unsecured debt financing,

often with corresponding equity co-investments, in middle-market companies.

We seek direct origination opportunities of first lien (including unitranche), second lien, and unsecured debt financing, often with corresponding equity co-investments, in middle-market companies.

We believe that businesses in this size range often have limited access to public financial markets, and will benefit from Stellus Capital Management’s reliable lending approach.

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Further, many financial institutions and traditional lenders are faced with constrained balance sheets and are requiring existing borrowers to reduce leverage.

With an average of over 30 years of investing, corporate finance, restructuring, consulting and accounting experience, the senior investment professionals of Stellus Capital Management have demonstrated investment expertise throughout the balance sheet and in a variety of situations, including financial sponsor buyouts, growth capital, debt refinancings, balance sheet recapitalizations, rescue financings, distressed opportunities, and acquisition financings.

With an average of over 31 years of investing, corporate finance, restructuring, consulting and accounting experience, the senior investment professionals of Stellus Capital Management have demonstrated investment expertise throughout the balance sheet and in a variety of situations, including financial sponsor buyouts, growth capital, debt refinancing, balance sheet recapitalizations, rescue financings, distressed opportunities, and acquisition financings.

Our investment philosophy emphasizes capital preservation through superior credit selection and risk mitigation.

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As access to investment opportunities is highly relationship-driven, the senior investment team and other investment professionals of Stellus Capital Management spend considerable time developing and maintaining contacts with key deal sources, including private equity firms, investment banks and senior lenders.

The senior investment team and other investment professionals of Stellus Capital Management have been actively investing in the middle-market for more than a decade and have focused on extensive calling and marketing efforts via speaking engagements, sponsorships, industry events and referrals to broaden their relationship network.

relationship network.

Existing relationships are constantly cultivated through transactional work and other personal contacts.

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We believe that, over the past decade, the senior investment team and other investment professionals of Stellus Capital Management have built a reputation as a thoughtful and disciplined provider of capital to middle-market companies and a preferred financing source for private equity sponsors and management teams.

We believe these factors give Stellus Capital Management a competitive advantage in sourcing investment opportunities, which are used for our benefit.

We believe these factors give Stellus Capital Management a competitive advantage in sourcing investment opportunities, which are put to use for our benefit.

Investment Structuring

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Secured debt, including first lien (including unitranche) and second lien financing, has liens on the assets of the borrower that serve as collateral in support of the repayment of such loans.

First Lien Debt First lien debt is structured with first-priority liens on the assets of the borrower that serve as collateral in support of the repayment of such loans.

First lien loans may provide for moderate loan amortization in the early years of the loan, with most of the amortization deferred until loan maturity.

Unitranche Debt Unitranche debt typically is structured as first lien loans that combine both senior and junior debt with lenders agreeing separately to an order of priority among them.

First Lien Debt.

First lien debt is structured with first-priority liens on the assets of the borrower that serve as collateral in support of the repayment of such loans.

First lien loans may provide for moderate loan amortization in the early years of the loan, with the majority of the amortization deferred until loan maturity.

Unitranche Debt.

Unitranche debt typically is structured as first lien loans that combine both senior and junior debt with lenders agreeing separately to an order of priority among them.

To the extent that we invest in the “last out” tranche of a unitranche facility, our unitranche investments will have certain risk characteristics of second lien debt.

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In some cases, we will be the sole lender, or we together with our affiliates will be the sole lender, of unitranche debt, which can provide us with more influence interacting with a borrower in terms of monitoring and, if necessary, remediation in the event of underperformance.

Second Lien Debt Second lien debt is structured as junior, secured loans, with second priority liens on an issuer’s assets.

Second Lien Debt.

Second lien debt is structured as junior, secured loans, with second priority liens on an issuer’s assets.

These loans typically provide for moderate loan amortization in the initial years of the loan, with the majority of the amortization deferred until loan maturity.

Unsecured Debt

Unsecured debt, including senior unsecured and subordinated loans, is not be secured by any collateral and is effectively subordinated to the borrower’s secured indebtedness (to the extent of the collateral securing such indebtedness), including pursuant to one or more intercreditor agreements that we enter into with holders of a borrower’s senior debt.

Unsecured debt, including senior unsecured and subordinated loans, is not secured by any collateral and is effectively subordinated to the borrower’s secured indebtedness (to the extent of the collateral securing such indebtedness), including pursuant to one or more intercreditor agreements that we enter into with holders of a borrower’s senior debt.

Senior Unsecured Loans .

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The process involves several levels of review and is coordinated in an effort to identify risks in potential investments.

Stellus Capital Management applies its expertise to

screen our investment opportunities as described below.

Stellus Capital Management applies its expertise to screen our investment opportunities as described below.

This rigorous process, combined with our broad origination capabilities, has allowed the Stellus Capital Management team to be prudent in selecting opportunities in which to make an investment.

All potential investment opportunities undergo an initial informal review by Stellus Capital Management’s investment professionals.

Each potential investment opportunity that an investment professional determines merits consideration is presented and evaluated at a weekly meeting in which Stellus Capital Management’s senior investment professionals discuss the merits and risks of a potential investment opportunity as well as the due diligence process and the pricing and structure.

Each potential investment opportunity that an investment professional determines merits consideration is presented and evaluated at a weekly meeting during which Stellus Capital Management’s senior investment professionals discuss the merits and risks of a potential investment opportunity as well as the due diligence process and the pricing and structure.

If Stellus Capital Management’s senior investment professionals believe an investment opportunity merits further review, the investment opportunity is assigned a deal team and the deal team prepares and presents to the investment committee for initial review a prescreen memorandum that generally describes the potential transaction and includes a description of the risks, due diligence process and proposed structure and pricing for the proposed investment opportunity.

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The credit approval memorandum updates the prescreen memorandum with more deal specific detail, including an update to the diligence process and any changes in the structure and pricing of the proposed investment.

Upon unanimous approval by the investment committee of the proposed investment as presented in the credit approval memorandum, Stellus Capital Management’s Chief Investment Officer reviews any amendments before finalizing and closing negotiations with the prospective portfolio company.

Investment Committee

Each new investment opportunity must be unanimously approved by Stellus Capital Management’s investment committee.

Follow-on investments in existing portfolio companies also require the investment committee’s unanimous approval.

The purpose of Stellus Capital Management’s investment committee is to evaluate and approve all of our investments, subject at all times to the oversight of our Board.

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The investment committee serves to provide investment consistency and adherence to our core investment philosophy and policies.

Each new investment opportunity must be unanimously approved by Stellus Capital Management’s investment committee.

Follow-on investments in existing portfolio companies also require the investment committee’s unanimous approval.

Stellus Capital Management’s Chief Investment Officer, Robert T.

Ladd, reviews any amendments before finalizing and closing negotiations with the prospective portfolio company.

The investment committee also determines appropriate investment sizing and suggests ongoing monitoring requirements.

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Potential transactions and deal flow are reviewed on a regular basis.

Members of the investment team are encouraged to share information and views on credits with the investment committee early in their analysis.

Members of the investment team are encouraged to share information and views on credits with the investment committee

early in their analysis.

We believe this process improves the quality of the analysis and assists the deal team members to work more efficiently.

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Monitoring Investments

In most cases, we do not have board influence over portfolio companies.

In some instances, Stellus Capital Management’s senior investment professionals may obtain board representation or observation

rights in conjunction with our investments.

In most cases, we do not have board influence over our portfolio companies.

In some instances, Stellus Capital Management’s senior investment professionals may obtain board representation or observation rights in conjunction with our investments.

Stellus Capital Management takes an active approach in monitoring all investments, including reviews of financial performance on at least a quarterly basis and regular discussions with management.

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In addition, pursuant to our valuation policy, the valuation of each portfolio investment for which a market quotation is not readily available is reviewed by our independent third-party valuation firm at least twice annually.

In addition, portfolio investments that are not publicly traded or whose market price is not readily available are valued at fair value as determined in good faith by our Board based on the input of our management and audit committee.

As part of the monitoring process, Stellus Capital Management also tracks developments in the broader marketplace.

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Investments for which market quotations are readily available may be valued at such market quotations.

Debt and equity securities that are not publicly traded or whose market price is not readily available are valued at fair value as determined in good faith by our Board based on the input of our management and audit committee.

In addition, our Board retains one or more independent valuation firms to review at least twice annually, the valuation of each portfolio investment for which a market quotation is not readily available.

We also have adopted Accounting Standards Board Accounting Standards Codification 820, Fair Value Measurements and Disclosures , or “ASC 820.” This accounting statement requires us to assume that the portfolio investment is assumed to be sold in the principal market to market participants, or in the absence of a principal market, the most advantageous market, which may be a hypothetical market.

We also have adopted Accounting Standards Board Accounting Standards Codification 820, Fair Value Measurements and Disclosures (“ASC 820”).

This accounting statement requires us to assume that the portfolio investment is assumed to be sold in the principal market to market participants, or in the absence of a principal market, the most advantageous market, which may be a hypothetical market.

Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact.

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Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the investments may differ materially from the values that would have been used had a readily available market value existed for such investments.

In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different from the valuations currently assigned.

In addition, changes in the market

environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different from the valuations currently assigned.

With respect to investments for which market quotations are not readily available, our Board undertakes a multi-step valuation process each quarter, as described below:

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the audit committee of our board of directors then reviews these preliminary valuations;

the Board then discusses the valuations and determines the fair value of each investment in our portfolio in good faith, based on the input of Stellus Capital Management, the independent valuation firm and the audit committee.

the Board then discusses the valuations and determines the fair value of each investment in our portfolio in good faith, based on the input of Stellus Capital Management’s investment professionals, the independent valuation firm and the audit committee.

In following these approaches, the types of factors that are taken into account in fair value pricing our investments include, as relevant, but are not limited to:

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We may receive fees for these services and will reimburse Stellus Capital Management or an affiliate of Stellus Capital Management for its allocated costs in providing such assistance, subject to the review by our Board, including our independent directors.

Our primary competitors in providing financing to middle-market companies include public and private funds, other BDCs, commercial and investment banks, commercial financing companies and, to the

extent they provide an alternative form of financing, private equity and hedge funds.

Our primary competitors in providing financing to middle-market companies include public and private funds, other BDCs, commercial and investment banks, commercial financing companies and, to the extent they provide an alternative form of financing, private equity and hedge funds.

Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do.

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Management Agreements

Stellus Capital Management serves as our investment adviser and is registered as an investment adviser under the Investment Advisers Act of 1940, as amended, or the “Advisers Act.” In addition, Stellus Capital Management serves as our administrator.

Stellus Capital Management serves as our investment adviser and is registered as an investment adviser under the Investment Advisers Act of 1940, as amended (the “Advisers Act”).

In addition, Stellus Capital Management serves as our administrator.

Investment Advisory Agreement

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The base management fee is calculated at an annual rate of 1.75% of our gross assets, including assets purchased with borrowed funds or other forms of leverage (including preferred stock, public and private debt issuances, derivative instruments, repurchase agreements and other similar instruments or arrangements) and excluding cash and cash equivalents.

For services rendered under the investment advisory agreement,

the base management fee is payable quarterly in arrears.

For services rendered under the investment advisory agreement, the base management fee is payable quarterly in arrears.

The base management fee is calculated based on the average value of our gross assets, excluding cash and cash equivalents, at the end of the two most recently completed calendar quarters.

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Any reversal of such amounts would reduce net income for the quarter by the net amount of the reversal (after taking into account the reversal of incentive fees payable) and would result in a reduction and possible elimination of the incentive fees for such quarter.

There is no accumulation of amounts on the hurdle rate from quarter to quarter, and accordingly there is no clawback of amounts previously paid if subsequent quarters are below the quarterly hurdle, and there is no delay of payment if

prior quarters are below the quarterly hurdle.

Stellus Capital Management has agreed to permanently waive any interest accrued on the portion of the incentive fee attributable to deferred interest (such as PIK interest or OID).

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As illustrated in Year 3 of Alternative 1 above, if a portfolio company were to be wound up on a date other than its fiscal year end of any year, it may have paid aggregate capital gains incentive fees that are more than the amount of such fees that would be payable if such portfolio company had been wound up on its fiscal year end of such year.

As noted above, it is possible that the cumulative aggregate capital gains fee received by Stellus Capital

Management ($0.70 million) is effectively greater than $0.45 million (20.0% of cumulative aggregate realized capital gains less net realized capital losses or net unrealized depreciation ($2.25 million)).

As noted above, it is possible that the cumulative aggregate capital gains fee received by Stellus Capital Management ($0.70 million) is effectively greater than $0.45 million (20.0% of cumulative aggregate realized capital gains less net realized capital losses or net unrealized depreciation ($2.25 million)).

Payment of Our Expenses

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Duration and Termination

Unless terminated earlier as described below, the investment advisory agreement will continue in effect from year to year if approved annually by our Board or by the affirmative vote of the holders of a majority of our outstanding voting securities, and, in either case, if also approved by a majority of our directors who are not “interested persons.” The investment advisory agreement automatically terminates in the event of its assignment, as defined in the 1940 Act, by Stellus Capital Management and may be terminated by either party without penalty upon 60 days’ written notice to the other.

The holders of a majority of our outstanding voting securities may also terminate the investment advisory agreement without penalty upon

60 days’ written notice.

“Risk Factors — Risks Relating to our Business and Structure.” We are dependent upon key personnel of Stellus Capital Management for our future success.

The investment advisory agreement automatically terminates in the event of its assignment, as defined in the 1940 Act, by Stellus Capital Management and may be terminated by either party without penalty upon 60 days’ written notice to the other.

The holders of a majority of our outstanding voting securities may also terminate the investment advisory agreement without penalty upon 60 days’ written notice.

“Risk Factors — Risks Relating to our Business and Structure” in this Annual Report on Form 10-K.

We are dependent upon key personnel of Stellus Capital Management for our future success.

If Stellus Capital Management were to lose any of its key personnel, our ability to achieve our investment objective could be significantly harmed.

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Our Board also considered Stellus Capital Management’s personnel and their prior experience in connection with the types of investments made by us, including such personnel’s corporate relationships and relationships with private equity firms, investment banks, restructuring advisors, law firms, boutique advisory firms and distressed/specialty lenders.

In addition, our Board considered the other terms and conditions of the investment advisory agreement, including the fact that we could terminate the investment advisory agreement without penalty upon 60 days’ notice to Stellus Capital Management.

As a result, our Board determined that the substantive terms of the investment advisory agreement (other than the fees payable thereunder, which our Board reviewed separately), including the services to be provided, are similar to those of comparable BDCs described in the available market data and in the best interests of our stockholders.

Moreover, our Board concluded that although the substantive terms of the Investment Advisory Agreement, including the services to be provided, are generally the same as those of comparable BDCs described in the market data then available, it would be difficult to obtain similar services from other third-party

service providers in light of the nature, quality and extent of the advisory and other services provided to us by Stellus Capital Management.

In addition, our Board considered the other terms and conditions of the investment advisory agreement,

including the fact that we have the ability to terminate the investment advisory agreement without penalty upon 60 days’ notice to Stellus Capital Management.

As a result, our Board determined that the substantive terms of the investment advisory agreement (other than the fees payable thereunder, which our Board reviewed separately), including the services to be provided, are similar to those of comparable externally managed BDCs described in the available market data and in the best interests of our stockholders.

Moreover, our Board concluded that although the substantive terms of the investment advisory agreement, including the services to be provided, are generally the same as those of comparable externally managed BDCs described in the market data then available, it would be difficult to obtain similar services from other third-party service providers in light of the nature, quality and extent of the advisory and other services provided to us by Stellus Capital Management.

Projected Costs of the Services Provided to the Company.

Our Board considered (i) comparative data based on publicly available information with respect to services rendered and the advisory fees (including the base management fee and incentive fees) of other externally managed BDCs that invest in similar securities, our total expenses, and expense ratios compared to other BDCs of similar size and with similar investment objectives and (ii) the administrative services that Stellus Capital Management will provide to us at cost pursuant to the administration agreement.

Based upon its review, our Board concluded that the fees to be paid under the investment advisory agreement are generally comparable to or more favorable than those payable under agreements of comparable BDCs and reasonable in relation to the services expected to be provided by Stellus Capital Management.

Our Board considered (i) comparative data based on publicly available information with respect to services rendered and the advisory fees (including the base management fee and incentive fees) of other externally managed BDCs that invest in similar securities, our total expenses, and expense ratios compared to other externally managed BDCs of similar size and with similar investment objectives and (ii) the administrative services that Stellus Capital Management will provide to us at cost pursuant to the administration agreement.

Based upon its review, our Board concluded that the fees to be paid under the investment advisory agreement are generally comparable to or more favorable than those payable under agreements of comparable externally managed BDCs and reasonable in relation to the services expected to be provided by Stellus Capital Management.

Projected Profitability of Stellus Capital Management.

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Our Board considered the extent to which economies of scale would be realized as the Company grows, and whether the fees payable under the investment advisory agreement reflect these economies of scale for the benefit of our stockholders.

Considering such information, our Board determined that the advisory fee structure under the investment advisory agreement was reasonable with respect to any economies of scale that may be realized as the Company grows.

Taking into account such information, our Board determined that the advisory fee structure under the investment advisory agreement was reasonable with respect to any economies of scale that may be realized as the Company grows.

Limited Potential for Additional Benefits Derived by Stellus Capital Management.

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In considering the factors discussed above, individual directors may have given different weights to different factors.

Based on the information reviewed and the discussions, the Board, including a majority of the non-interested directors, concluded that the investment management fee rates and terms are reasonable in relation to the services to be provided and approved the investment advisory agreement as being in the best interests of our stockholders.

Based on the information reviewed and the discussions, the Board, including a majority of the independent directors, concluded that the investment management fee rates and terms are reasonable in

relation to the services to be provided and approved the investment advisory agreement as being in the best interests of our stockholders.

Administration Agreement

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Stellus Capital Management also performs, or oversees the performance of, our required administrative services, which include being responsible for the financial and other records that we are required to maintain and preparing reports to our stockholders and reports and other materials filed with the SEC.

other materials to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others.

In addition, Stellus Capital Management assists us in determining and publishing our net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports and other materials to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others.

Under the administration agreement, Stellus Capital Management also provides managerial assistance on our behalf to those portfolio companies that have accepted our offer to provide such assistance.

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The information on our website is not incorporated by reference in this Annual Report on Form 10-K.

We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the SEC in accordance with the Securities Exchange Act of 1934, or the “Exchange Act.” These include our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K.

These include our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K.

We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC.

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We are a BDC under the 1940 Act that has elected to be treated as a RIC under the Code.

and requires that a majority of the directors be persons other than “interested persons,” as that term is defined in the 1940 Act.

The 1940 Act contains prohibitions and restrictions relating to transactions between BDCs and their affiliates (including any investment advisers), principal underwriters and affiliates of those affiliates or underwriters and requires that a majority of the directors be persons other than “interested persons,” as that term is defined in the 1940 Act.

In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC unless approved by a majority of our outstanding voting securities.

We may invest up to 100% of our assets in securities acquired directly from issuers in privately negotiated transactions.

With respect to such securities, we may, for the purpose of public resale, be deemed an “underwriter” as that term is defined in the Securities Act.

With respect to such securities, we may, for the purpose of public resale, be deemed an “underwriter” as that term is defined in the Securities Act of 1933, as amended.

Our intention is to not write (sell) or buy put or call options to manage risks associated with the publicly traded securities of our portfolio companies, except that we may enter into hedging transactions to manage the risks associated with interest rate fluctuations.

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Securities purchased in a private transaction from a U.S.

issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident to such a private transaction, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities, was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.

purchase of its securities, was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.

Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own 60% of the outstanding equity of the eligible portfolio company.

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Managerial Assistance to Portfolio Companies

To count portfolio securities as qualifying assets for the purpose of the 70% test, a BDC must either control the issuer of the securities or must offer to make available to the issuer of the securities significant managerial assistance.

In order to count portfolio securities as qualifying assets for the purpose of the 70% test, a BDC must either control the issuer of the securities or must offer to make available to the issuer of the securities significant managerial assistance.

However, when the BDC purchases securities in conjunction with one or more other persons acting together and one of the other persons in the group may make available such managerial assistance.

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Under the 1940 Act, a BDC is subject to restrictions on the amount of warrants, options, restricted stock or rights to purchase shares of capital stock that it may have outstanding at any time.

Under the 1940 Act, we may generally only offer warrants provided that (i) the warrants expire by their terms within ten years, (ii) the exercise or conversion price is not less than the current market value at the date of issuance, (iii) our stockholders authorize the proposal to issue such warrants, and our Board approves such issuance on the basis that the issuance is in the best interests of us and our stockholders and (iv) if the warrants are accompanied by other securities, the warrants are not separately transferable unless no class of such warrants and the securities accompanying them has been publicly distributed.

The 1940 Act also provides that the amount of our voting securities that would result from the exercise of all outstanding warrants, as well as options and rights, at the time of issuance may not exceed 25% of our outstanding voting securities.

The 1940 Act also provides

that the amount of our voting securities that would result from the exercise of all outstanding warrants, as well as options and rights, at the time of issuance may not exceed 25% of our outstanding voting securities.

In particular, the amount of capital stock that would result from the conversion or exercise of all outstanding warrants, options or rights to purchase capital stock cannot exceed 25% of the BDC’s total outstanding shares of capital stock.

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We may also borrow amounts up to 5% of the value of our total assets for temporary or emergency purposes without regard to asset coverage.

For a discussion of the risks

associated with leverage, see Item 1A.

For a discussion of the risks associated with leverage, see Item 1A.

“Risk Factors — Risks Relating to our Business and Structure — Regulations governing our operation as a BDC affect our ability to, and the way in which we, raise additional capital.

As a BDC, the necessity of raising additional capital may expose us to risks, including the typical risks associated with leverage.”

As a BDC, the necessity of raising additional capital may expose us to risks, including the typical risks associated with leverage” in this Annual Report on Form 10-K.

We are not generally able to issue and sell our common stock at a price below net asset value per share.

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The proxy voting policies and procedures of Stellus Capital Management are set out below.

The guidelines will be reviewed periodically by Stellus Capital Management and our directors who are not “interested persons,” and, accordingly, are subject to change.

The guidelines will be reviewed periodically by Stellus Capital Management and our independent directors and, accordingly, are subject to change.

Introduction .

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Stellus Capital Management reviews on a case-by-case basis each proposal submitted to a stockholder vote to determine its effect on the portfolio securities we hold.

In most cases Stellus Capital Management will vote in favor of proposals that Stellus Capital Management believes are likely to increase the value of the portfolio securities we hold.

In most cases Stellus Capital Management will vote in favor of proposals that Stellus Capital

Management believes are likely to increase the value of the portfolio securities we hold.

Although Stellus Capital Management will generally vote against proposals that may have a negative effect on our portfolio securities, Stellus Capital Management may vote for such a proposal if there exist compelling long-term reasons to do so.

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The proxy voting committee establishes proxy voting guidelines and procedures, oversees the internal proxy voting process, and reviews proxy voting issues.

To ensure that Stellus Capital Management’s vote is not the product of a conflict of interest, Stellus Capital Management requires that anyone involved in the decision-making process disclose to our Chief Compliance Officer any potential conflict that he or she is aware of and any contact that he or she has had with any interested party

regarding a proxy vote.

Where conflicts of interest may be present, Stellus Capital Management will disclose such conflicts to us, including our independent directors and may request guidance from us on how to vote such proxies.

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We and Stellus Capital Management are each required to adopt and implement written policies and procedures reasonably designed to prevent violation of relevant federal securities laws, review these policies and procedures annually for their adequacy and the effectiveness of their implementation, and designate a Chief Compliance Officer to be responsible for administering the policies and procedures.

In general, BDCs are prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our Board who are not interested persons and, in some cases, prior approval by the SEC.

The SEC has interpreted the BDC prohibition on transactions with affiliates to prohibit all “joint transactions” between entities that share a common investment adviser.

The staff of the SEC has granted no-action relief permitting purchases of a single class of privately placed securities provided that the adviser negotiates no term other than price and certain other conditions are met.

In addition, we previously received the Prior Order from the SEC to co-invest with private funds managed by Stellus Capital Management where doing so is consistent with our investment strategy as well as applicable law (including the terms and conditions of the exemptive order issued by the SEC).

On December 18, 2018, we received the Order, which supersedes the Prior Order and permits us greater flexibility to enter into co-investment transactions.

Pursuant to the Order, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our stockholders and is consistent with our investment objectives and

We co-invest, subject to the conditions included in the Order, with private credit funds managed by Stellus Capital Management that have an investment strategy that is similar to or identical to our investment strategy, and we may co-invest with other BDCs and registered investment companies managed by Stellus Capital Management or an adviser that is controlled, controlling, or under common control with Stellus Capital Management in the future.

We believe that such co-investments may afford us additional investment opportunities and an ability to achieve greater diversification.

Sarbanes-Oxley Act of 2002

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As a RIC, we generally do not have to pay corporate-level U.S.

federal income taxes on any net ordinary income or capital gains that we distribute to our stockholders as dividends.

federal income taxes on any net ordinary income or capital gains that we timely distribute to our stockholders as dividends.

To continue to maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below).

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We will not be subject to U.S.

federal income tax on the portion of our income we distribute to stockholders.

federal income tax on the portion of our income we timely distribute to stockholders.

We will be subject to U.S.

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We will be subject to a 4% nondeductible U.S.

federal excise tax on our undistributed income unless we distribute in a timely manner an amount at least equal to the sum of (a) 98% of our net ordinary income for each calendar year, (b) 98.2% of our capital gain net income for the one-year period ending December 31 (c) any income realized, but not distributed, in the preceding year and on which we paid no U.S.

federal excise tax on our undistributed income unless we distribute in a timely manner an amount at least equal to the sum of (a) 98% of our net ordinary income for each calendar year, (b) 98.2% of our capital gain net income for the one-year period ending December 31 (c) any ordinary income and capital gain net income that we recognized in preceding years, but were not distributed during such years and on which we paid no U.S.

federal income tax, or the Excise Tax Avoidance Requirement.

For this purpose, however, any net ordinary income or capital gain net income retained by us that is subject to corporate income tax for the tax year ending in that calendar year will be considered to have been distributed by year end (or earlier if estimated taxes are paid).

For this purpose, however, any net ordinary income or capital gain net income retained by us that is subject to corporate-level U.S.

federal income tax for the tax year ending in that calendar year will be considered to have been distributed by year end (or earlier if estimated taxes are paid).

In order to qualify as a RIC for U.S.

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continue to qualify as a BDC under the 1940 Act at all times during each year;

from interests in “qualified publicly traded partnerships” (which generally are partnerships that are traded on an established securities market or tradable on a secondary market, other than partnerships that derive 90% of their income from interest, dividends and other permitted RIC income), or the 90% Income Test;

derive in each taxable year at least 90% of our gross income from dividends, interest, payments with respect to certain securities loans, gains from the sale of stock or other securities, or other income derived with respect to our business of investing in such stock or securities, and net income derived from interests in “qualified publicly traded partnerships” (which generally are partnerships that are traded on an established securities market or tradable on a secondary market, other than partnerships that derive 90% of their income from interest, dividends and other permitted RIC income), or the 90% Income Test;

diversify our holdings so that at the end of each quarter of the taxable year:

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However, under the 1940 Act, we are not permitted in certain circumstances to make distributions to our stockholders while our debt obligations and other senior securities are outstanding unless certain “asset coverage” tests are met.

“Regulation as a Business Development Company — Senior Securities.” Moreover, our ability to dispose of assets to meet the Annual Distribution Requirement, the Excise Tax Avoidance Requirement or the Diversification Tests may be limited by (a) the illiquid nature of our portfolio and/or (b) other requirements relating to our qualifications as a RIC, including the Diversification Tests.

“Regulation as a Business Development Company — Senior Securities” in this Annual Report on Form 10-K.

Moreover, our ability to dispose of assets to meet the Annual Distribution Requirement, the Excise Tax Avoidance Requirement or the Diversification Tests may be limited by (a) the illiquid nature of our portfolio and/or (b) other requirements relating to our qualifications as a RIC, including the Diversification Tests.

If we dispose of assets in order to meet the Annual Distribution Requirement, the Excise Tax Avoidance Requirement or the Diversification Tests, we may make such dispositions at times that, from an investment standpoint, are not advantageous.

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We cannot assure you that the SBA will grant such waiver.

If the SBIC subsidiaries are unable to obtain a waiver, compliance with the SBA regulations may cause us to fail to maintain our tax treatment as a RIC, which would result in us becoming subject to corporate-level federal income tax.

federal income tax.

Certain of our investment practices may be subject to special and complex U.S.

the corporate dividends received deduction as ineligible for such treatment, (c) disallow, suspend or otherwise limit the allowance of certain losses or deductions, (d) convert lower-taxed long term capital gain into higher-taxed short-term capital gain or ordinary income, (e) convert an ordinary loss or a deduction into a capital loss (the deductibility of which is more limited), (f) cause us to recognize income or gain without a corresponding receipt of cash, (g) adversely affect the time as to when a purchase or sale of stock or securities is deemed to occur, (h) adversely alter the characterization of certain complex financial transactions and (i) produce income that will not be qualifying income for purposes of the 90% Income Test.

federal income tax provisions that may, among other things, (a) treat dividends that would otherwise constitute qualified dividend income as non-qualified dividend income, (b) treat dividends that would otherwise be eligible for the corporate dividends received deduction as ineligible for such treatment, (c) disallow, suspend or otherwise limit the allowance of certain losses or deductions, (d) convert lower-taxed long term capital gain into higher-taxed short-term capital gain or ordinary income, (e) convert an ordinary loss or a deduction into a capital loss (the deductibility of which is more limited), (f) cause us to recognize income or gain without a corresponding receipt of cash, (g) adversely affect the time as to when a purchase or sale of stock or securities is deemed to occur, (h) adversely alter the characterization of certain complex financial transactions and (i) produce income that will not be qualifying income for purposes of the 90% Income Test.

We intend to monitor our transactions and may make certain tax elections to mitigate the effect of these provisions and prevent our disqualification as a RIC.

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Some of the income and fees that we may recognize will not satisfy the 90% Income Test.

In order to ensure that such income and fees do not disqualify us as a RIC for a failure to satisfy the 90% Income Test, we may hold assets that generate such income and provide services that generate such fees indirectly through one or more entities treated as corporations for U.S.

corporations for U.S.

federal income tax purposes.

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federal corporate income tax on their earnings, which ultimately will reduce our return on such income and fees.

If we are unable to qualify for tax treatment as a RIC, and if certain remedial provisions are not available, we would be subject to tax on all of our taxable income at regular corporate rates.

If we are unable to qualify for tax treatment as a RIC, and if certain remedial provisions are not available, we would be subject to U.S.

federal income tax on all of our taxable income at regular corporate rates.

We would not be able to deduct distributions to stockholders, nor would they be required to be made.

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Regulation as a Small Business Investment Company

Our wholly owned subsidiaries’ SBIC licenses allow them to obtain leverage by issuing SBA-guaranteed debentures, subject to customary procedures.

Our wholly-owned subsidiaries’ SBIC licenses allow them to incur leverage by issuing SBA-guaranteed debentures, subject to customary procedures.

SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten-year maturity.

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Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses.

Under present SBA regulations, eligible small businesses include businesses that have a tangible net worth not exceeding $19.5 million and have average annual fully taxed net income not exceeding $6.5 million for the two most recent fiscal years.

Under present SBA regulations, eligible small businesses (together with their affiliates) include businesses that have a tangible net worth not exceeding $19.5 million and have average annual net income after U.S federal income taxes not exceeding $6.5 million (average annual net income to be computed without benefit of any carryover loss) for the two most recent fiscal years.

In addition, an SBIC must devote 25% of its investment activity to “smaller enterprises” as defined by the SBA.

A smaller enterprise is one that has a net worth not

exceeding $6 million and has average annual fully taxed net income not exceeding $2 million for the two most recent fiscal years.

SBA regulations also provide alternative size standard criteria to determine eligibility, which depend on the industry in which the business is engaged and are based on such factors as the number of employees and gross sales.

A smaller enterprise is a business (together with their affiliates) that has a net worth not exceeding $6.0 million and has average annual net income after U.S.

federal income taxes not exceeding $2.0 million (average annual net income to be computed without benefit of any carryover loss) for the two most recent fiscal years.

SBA regulations also provide alternative size standard criteria to determine eligibility of a small business or a smaller enterprise, which depend on the industry in which the business is engaged and are based on such factors as the number of employees and gross sales of the business and its affiliates.

According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory services.

SBA regulations currently limit the amount that an SBIC subsidiary may borrow to a maximum of $175.0 million, subject to SBA approval, with sufficient regulatory capital (as such term is defined in SBA regulations).

The amount of SBA-guaranteed debentures that affiliated SBIC funds can have outstanding is $350.0 million.

The SBA generally prohibits an SBIC from providing financing to small businesses with certain characteristics, such as relending or businesses with the majority of their employees located outside the United States, and business engaged in certain prohibited industries, such as project finance, real estate, farmland, financial intermediaries or “passive” (i.e.

non-operating) businesses.

Without prior SBA approval, an SBIC may not provide financing or a commitment to a small business in an amount equal to more than approximately 30.0% of the SBIC’s regulatory capital in any one company and its affiliates.

SBA regulations currently limit the amount that an SBIC subsidiary may borrow to a maximum of $175.0 million with at least $87.5 million in regulatory capital (as defined in the SBA regulations), subject to SBA approval.

The maximum leverage available to a “family” of SBIC affiliated funds is $350.0 million, subject to SBA approval.

As of December 31, 2020, our SBIC I subsidiary had $75.0 million in regulatory capital and $150.0 million in SBA-guaranteed debentures outstanding, which approximated their fair value.

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The SBA restricts the ability of SBICs to repurchase their capital stock.

SBA regulations also include restrictions on a “change of control” or transfer of an SBIC and require that SBICs invest idle funds in accordance with SBA regulations.

The SBA restricts the ability of an SBIC to provide financing to an “associate” as defined in the SBA regulations, without prior written approval from the SBA.

SBA regulations also prohibit, without prior SBA approval, a “change of control” or “change in ownership” of transfer of an SBIC (as such terms are defined in the SBA regulations) and require that SBICs invest idle funds in accordance with SBA regulations.

In addition, our SBIC subsidiaries may also be limited in their ability to make distributions to us if they do not have sufficient capital, in accordance with SBA regulations.

Our SBIC subsidiaries are subject to regulation and oversight by the SBA, including requirements with respect to maintaining certain minimum financial ratios and other covenants.

Our SBIC subsidiaries are subject to regulation and oversight by the SBA, including, among other things, requirements with respect to maintaining certain minimum financial ratios and other covenants, a periodic examination by an SBA examiner, and the performance of a financial audit by an independent auditor.

Receipt of an SBIC license does not assure that our SBIC subsidiaries will receive SBA guaranteed debenture funding, which is dependent upon our SBIC subsidiaries continuing to be in compliance with SBA regulations and policies.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 1. Business