POS 8C

As filed with the Securities and Exchange Commission on December 23, 2019

Registration No. 333-218596

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM N-2

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

Pre-Effective Amendment No.

Post-Effective Amendment No. 4

 

 

Portman Ridge Finance Corporation

(Exact Name of Registrant as Specified in Charter)

 

 

650 Madison Avenue,

23rd Floor

New York, New York 10022

(212) 891-2880

(Address and Telephone Number of Principal Executive Offices)

Edward Goldthorpe

President and Chief Executive Officer

Portman Ridge Finance Corporation

650 Madison Avenue

23rd Floor

New York, New York 10022

(Name and Address of Agent for Service)

 

 

Copy to:

 

Rajib Chanda, Esq.
Simpson Thacher & Bartlett LLP
900 G Street, N.W.
Washington, DC 20001
Telephone: (202) 636-5500
Fax: (202) 636-5502

 

 

Approximate Date of Proposed Public Offering:

From time to time after the effective date of this Registration Statement.

If any securities being registered on this form will be offered on a delayed or continuous basis in reliance on Rule 415 under the Securities Act of 1933, other than securities offered in connection with a dividend reinvestment plan, check the following box.  ☒

It is proposed that this filing will become effective (check appropriate box)

 

 

when declared effective pursuant to Section 8(c)

CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933

 

 

 

Title of Securities Being Registered   Proposed Maximum
Aggregate Offering Price(1)
  Amount of
Registration Fee(7)

Common Stock, $0.01 par value per share(2)(3)

       

Preferred Stock, $0.01 par value per share(2)

       

Warrants(4)

       

Debt Securities(5)

       

Total

  $250,000,000(6)   $28,975

 

 

 

(1)

Estimated pursuant to Rule 457(o) under the Securities Act of 1933 (the “Securities Act”) solely for the purpose of determining the registration fee. Subject to Note 6 below, the proposed maximum offering price per security will be determined, from time to time, by the Registrant in connection with the sale by the Registrant of the securities registered under this Registration Statement.

(2)

Subject to Note 6 below, there is being registered hereunder an indeterminate number of shares of common stock or preferred stock as may be sold, from time to time.

(3)

Includes such indeterminate number of shares of common stock as may be issued, from time to time, upon conversion or exchange of other securities registered hereunder, to the extent any such securities are, by their terms, convertible or exchangeable for common stock.

(4)

Subject to Note 6 below, there is being registered hereunder an indeterminate number of warrants as may be sold, from time to time, representing rights to purchase common stock, preferred stock or debt securities.

(5)

Subject to Note 6 below, there is being registered hereunder an indeterminate number of debt securities as may be sold, from time to time. If any debt securities are issued at an original issue discount, then the offering price shall be in such greater principal amount as shall result in an aggregate price to investors not to exceed $250,000,000.

(6)

In no event will the aggregate offering price of all securities issued from time to time pursuant to this Registration Statement exceed $250,000,000.

(7)

Previously paid.

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT OF SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.

 

 

 


The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED December 23, 2019

Prospectus

$250,000,000

PORTMAN RIDGE

FINANCE CORPORATION

Common Stock

Preferred Stock

Warrants

Debt Securities

 

 

We are an externally managed, non-diversified closed-end investment company that is regulated as a BDC, under the Investment Company Act of 1940, as amended (the “1940 Act”). We have elected to be treated for U.S. federal income tax purposes as a RIC under the Internal Revenue Code of 1986, as amended (the “Code”) and intend to operate in a manner to maintain our RIC status.

We originate, structure, and invest in senior secured term loans and mezzanine debt primarily in privately-held middle-market companies (the “Debt Securities Portfolio”). In addition, from time to time, we may invest in the equity securities of privately held middle-market companies.

On November 8, 2018, we entered into an agreement with LibreMax under which our wholly-owned subsidiary Commodore Holdings, LLC (“Commodore”) agreed to sell Katonah Debt Advisors, L.L.C. (“Katonah Debt Advisors”), Trimaran Advisors, L.L.C. (“Trimaran Advisors”), and Trimaran Advisors Management, L.L.C. (“Trimaran Advisors Management” and, together with Katonah Debt Advisors and Trimaran Advisors, the “Disposed Manager Affiliates”) to LibreMax for a cash purchase price of approximately $37.9 million (the “LibreMax Transaction”). In connection with the closing of the LibreMax Transaction on December 31, 2018, Commodore sold the Disposed Manager Affiliates, which manage collateralized loan obligation funds (“CLO Funds”), to LibreMax for a cash purchase price of approximately $37.9 million.

As of September 30, 2019, our remaining asset management subsidiaries (the “Asset Manager Affiliates”) were comprised of Commodore, Katonah Management Holdings, LLC, Katonah X Management LLC (“Katonah X Management”), Katonah 2007-1 Management, LLC (“Katonah 2007-I Management”) and KCAP Management, LLC. Commodore, Katonah X Management and Katonah 2007-1 Management have no operations and are expected to be liquidated in the normal course.

On December 14, 2018, we entered into the Externalization Agreement with BC Partners Advisors L.P. (“BCP”), an affiliate of BC Partners LLP (“BC Partners”), pursuant to which our management function would be externalized and Sierra Crest Investment Management LLC (the “Adviser”), an affiliate of BC Partners, would be appointed as our investment adviser, subject to our stockholders’ approval of the Investment Advisory Agreement between us and the Adviser (the “Externalization”). At a special meeting of our stockholders on February 19, 2019, the stockholders approved our Investment Advisory Agreement. As a result of the Externalization, we now operate as an externally managed BDC managed by the Sierra Crest.

On August 1, 2019, we and OHA Investment Corporation (“OHAI”) announced entry into a definitive agreement under which OHAI would merge with and into us (the “Merger”).

Approval by our stockholders is not required for the Merger, and OHAI stockholders approved the Merger on December 12, 2019. The Merger closed on December 18, 2019.


In our Debt Securities Portfolio, our investment objective is to generate current income and, to a lesser extent, capital appreciation from the investments in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies. We define the middle market as comprising companies with EBITDA of $10 million to $50 million and/or total debt of $25 million to $150 million. We primarily invest in first and second lien term loans which, because of their priority in a company’s capital structure, we expect will have lower default rates and higher rates of recovery of principal if there is a default and which we expect will create a stable stream of interest income. The investments in our Debt Securities Portfolio are all or predominantly below investment grade, and have speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal.

Our investment in debt and subordinated securities issued by CLO Funds (“CLO Fund Securities”) are primarily managed by our formerly wholly-owned asset management subsidiaries Trimaran Advisors and Trimaran Advisors Management, L.L.C. From time-to-time, we have also made investments in CLO Fund Securities managed by other asset managers. The CLO Funds typically invest in broadly syndicated loans, high-yield bonds and other credit instruments. Our investments in CLO Fund Securities are anticipated to provide it with recurring cash distributions.

We may offer from time to time shares of our common stock, preferred stock, debt securities or warrants representing rights to purchase shares of our common stock, preferred stock or debt securities, which we refer to collectively as the “securities”, in one or more offerings up to an aggregate amount of $250,000,000. Our securities may be offered at prices and on terms to be disclosed in one or more supplements to this prospectus. You should read this prospectus and the applicable prospectus supplement carefully before you invest in our securities.

Our securities may be offered directly to one or more purchasers through agents designated from time to time by us, or to or through underwriters or dealers. The prospectus supplement relating to the offering will identify any agents or underwriters involved in the sale of our securities, and will disclose any applicable purchase price, fee, commission or discount arrangement between us and our agents or underwriters or among our underwriters or the basis upon which such amount may be calculated. See “Plan of Distribution.” We may not sell any of our securities through agents, underwriters or dealers without delivery of this prospectus and a prospectus supplement describing the method and terms of the offering of such securities.

Our common stock is traded on The NASDAQ Global Select Market under the symbol “PTMN.” On December 20, 2019, the last reported sale price of a share of our common stock on The NASDAQ Global Select Market was $2.16. Our 6.125% notes due 2022 (“6.125% Notes Due 2022”) are traded on the NASDAQ Global Select Market under the symbol “KCAPL.” On December 20, 2019, the last reported price of our 6.125% Notes Due 2022, which have a par value of $25.00, was $25.18. We are required to determine net asset value per share of our common stock on a quarterly basis. The net asset value per share of our common stock at September 30, 2019 was $3.55.

Please read this prospectus and any accompanying prospectus supplement before investing and keep it for future reference. This prospectus and any accompanying prospectus supplement contain important information about us that a prospective investor should know before investing in our securities. We file annual, quarterly and current reports, proxy statements and other information about us with the Securities and Exchange Commission. This information is available free of charge by contacting us at 650 Madison Avenue, 23rd Floor, New York, New York 10022, by telephone at (212) 455-8300, or on our website at http://www.portmanridge.com. The information on our website is not incorporated by reference into this prospectus, and you should not consider that information to be part of this prospectus. The SEC also maintains a website at www.sec.gov that contains such information.

Shares of closed-end investment companies such as ours frequently trade at a discount to their net asset value. This risk is separate and distinct from the risk that our net asset value per share may decline. We cannot predict whether our common stock will trade above, at or below net asset value. The offering price per share of our common stock, less any underwriting commissions or discounts, will not be less than the net asset value per


share of our common stock at the time of the offering, except (i) with the requisite approval of our common stockholders or (ii) under such other circumstances as the Securities and Exchange Commission may permit. We did not seek stockholder authorization to issue common stock at a price below net asset value per share at our 2019 Annual Meeting of Stockholders, but we may seek such authorization at future Annual Meetings or Special Meetings of Stockholders. Sales of common stock at prices below net asset value per share dilute the interests of existing stockholders, have the effect of reducing our net asset value per share and may reduce our market price per share. See “Sales of Common Stock Below Net Asset Value” in this prospectus.

 

 

Investing in our securities is speculative and involves numerous risks, including the risks associated with the use of leverage. For more information regarding these risks, please see “Risk Factors” beginning on page 17 of this prospectus.

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or determined if either this prospectus or the accompanying prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

The date of this prospectus is                     , 2019.


ABOUT THIS PROSPECTUS

This prospectus is part of a registration statement that we have filed with the Securities and Exchange Commission, or SEC, using the “shelf” registration process. Under the shelf registration process, we may offer, from time to time, up to $250,000,000 of our securities on terms to be determined at the time of the offering. This prospectus provides you with a general description of the securities that we may offer. Each time we use this prospectus to offer securities, we will provide a prospectus supplement that will contain specific information about the terms of that offering. The prospectus supplement may also add, update or change information contained in this prospectus. Please carefully read this prospectus and any accompanying prospectus supplement together with the additional information described under “Risk Factors” and “Available Information” before you make an investment decision.

We have not authorized anyone to provide you with any information other than that contained in this prospectus or in any accompanying supplement to this prospectus. We take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. This prospectus and any accompanying prospectus supplement do not constitute an offer to sell or a solicitation of any offer to buy any security other than the registered securities to which they relate, nor do they constitute an offer to sell or a solicitation of an offer to buy any securities in any jurisdiction to any person to whom it is unlawful to make such an offer or solicitation in such jurisdiction. The information contained in this prospectus and any accompanying prospectus supplement is accurate as of the dates on their respective covers. Our financial condition, results of operations and prospects may change subsequent to such dates. To the extent required by law, we will amend or supplement the information contained in this prospectus and any accompanying prospectus supplement to reflect any material changes to such information subsequent to the date of this prospectus and any accompanying prospectus supplement and prior to the completion of any offering pursuant to this prospectus and any accompanying prospectus supplement.

 

i


TABLE OF CONTENTS

 

Prospectus Summary

     1  

The Offering

     10  

Fees and Expenses

     12  

Selected Financial and Other Data

     14  

Risk Factors

     17  

Forward-Looking Statements

     41  

Use of Proceeds

     42  

Price Range of Common Stock and Distributions

     43  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     46  

Unaudited Pro Forma Condensed Consolidated Financial Statements

     76  

Senior Securities Table

     98  

Business

     99  

Determination of Net Asset Value

     113  

Management

     132  

Certain Relationships and Related Transactions

     140  

Control Persons and Principal Shareholders

     141  

Sales of Common Stock Below Net Asset Value

     143  

Dividend Reinvestment Plan

     144  

Regulation

     145  

Certain U.S. Federal Income Tax Considerations

     149  

Description of Our Common Stock

     156  

Description of Our Preferred Stock

     160  

Description of Our Warrants

     161  

Description of Our Debt Securities

     163  

Plan of Distribution

     178  

Brokerage Allocation and Other Practices

     180  

Custodian, Transfer and Dividend Paying Agent and Registrar

     180  

Legal Matters

     180  

Independent Registered Public Accounting Firm

     180  

Available Information

     181  

Privacy Notice

     182  

Portman Ridge Finance Corporation, our logo and other trademarks of Portman Ridge Finance Corporation, mentioned in this prospectus are the property of Portman Ridge Finance Corporation. All other trademarks or trade names referred to in this prospectus are the property of their respective owners.

 

ii


PROSPECTUS SUMMARY

This summary highlights some of the information in this prospectus and may not contain all of the information that is important to you. You should read carefully the more detailed information set forth under “Risk Factors” and the other information included in this prospectus. In this prospectus, unless the context otherwise requires, the terms the “Company,” “Portman Ridge Finance,” “we,” “us” and “our” refer to Portman Ridge Finance Corporation in each case together with our wholly-owned portfolio companies Katonah Debt Advisors, L.L.C., Trimaran Advisors, L.L.C. and Trimaran Advisors Management, L.L.C. “Katonah Debt Advisors” refers to Katonah Debt Advisors, L.L.C. and related affiliates controlled by us. “Trimaran Advisors” refers to Trimaran Advisors, L.L.C. and related affiliates controlled by us. “Trimaran Advisors Management” refers to Trimaran Advisors Management, L.L.C.

Overview

We are an externally managed, non-diversified closed-end investment company that is regulated as a BDC, under the 1940 Act. We have elected to be treated for U.S. federal income tax purposes as a RIC under the Code and intend to operate in a manner to maintain our RIC status.

We originate, structure, and invest in senior secured term loans and mezzanine debt primarily in privately-held middle-market companies (the “Debt Securities Portfolio”). In addition, from time to time, we may invest in the equity securities of privately held middle-market companies.

On November 8, 2018, we entered into an agreement with LibreMax under which our wholly-owned subsidiary Commodore agreed to sell the Disposed Manager Affiliates to LibreMax for a cash purchase price of approximately $37.9 million (the “LibreMax Transaction”). In connection with the closing of the LibreMax Transaction on December 31, 2018, Commodore sold the Disposed Manager Affiliates, which manage CLO Funds, to LibreMax for a cash purchase price of approximately $37.9 million.

As of September 30, 2019, our remaining asset management subsidiaries (the “Asset Manager Affiliates”) were comprised of Commodore, Katonah Management Holdings, LLC, Katonah X Management LLC (“Katonah X Management”), Katonah 2007-1 Management, LLC (“Katonah 2007-I Management”) and KCAP Management, LLC. Commodore, Katonah X Management and Katonah 2007-1 Management have no operations and are expected to be liquidated in the normal course.

On December 14, 2018, we entered into the Externalization Agreement with BC Partners Advisors L.P. (“BCP”), an affiliate of BC Partners LLP (“BC Partners”), pursuant to which our management function would be externalized and Sierra Crest Investment Management LLC (the “Adviser”), an affiliate of BC Partners, would be appointed as our investment adviser, subject to our stockholders’ approval of the Investment Advisory Agreement. At a special meeting of our stockholders (the special meeting held on February 19, 2019), the stockholders approved our Investment Advisory Agreement. As a result of the Externalization, we now operate as an externally managed BDC managed by the Sierra Crest.

On August 1, 2019, we and OHA Investment Corporation (“OHAI”) announced entry into a definitive agreement under which OHAI would merge with and into the us.

In our Debt Securities Portfolio, our investment objective is to generate current income and, to a lesser extent, capital appreciation from the investments in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies. We define the middle market as comprising companies with EBITDA of $10 million to $50 million and/or total debt of $25 million to $150 million. We primarily invest in first and second lien term loans which, because of their priority in a company’s capital



 

1


structure, we expect will have lower default rates and higher rates of recovery of principal if there is a default and which we expect will create a stable stream of interest income. The investments in our debt securities portfolio are all or predominantly below investment grade, and have speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal.

Our investment in CLO Fund Securities are primarily managed by our formerly wholly-owned asset management subsidiaries Trimaran Advisors and Trimaran Advisors Management, L.L.C. From time-to-time, we have also made investments in CLO Fund Securities managed by other asset managers. The CLO Funds typically invest in broadly syndicated loans, high-yield bonds and other credit instruments. Our investments in CLO Fund Securities are anticipated to provide it with recurring cash distributions.

Subject to market conditions, we intend to grow our portfolio of assets by raising additional capital, including through the prudent use of leverage available to us. As a BDC, we are limited in the amount of leverage we can incur under the 1940 Act. Effective March 29, 2019, we are only allowed to borrow amounts such that its asset coverage, as defined in the 1940 Act, equals at least 150% after such borrowing. We will continue to be prohibited by the indentures governing our 2022 Notes from making distributions on our common stock if our asset coverage, as defined in the 1940 Act, falls below 200%.

As a BDC, we are subject to certain regulatory restrictions in making investments. For example, BDCs generally are not permitted to co-invest with certain affiliated entities in transactions originated by the BDC or its affiliates in the absence of an exemptive order from the SEC. However, BDCs are permitted to, and may, simultaneously co-invest in transactions where price is the only negotiated term. On October 23, 2018, the SEC issued an exemptive order to an affiliate of Sierra Crest that permits us to co-invest, subject to the satisfaction of certain conditions, in certain private placement transactions, with other funds managed by us or our affiliates, including BCP Special Opportunities Fund I LP, BCP Special Opportunities Fund II LP and any future funds that are advised by Sierra Crest or its affiliated investment advisers. Under the terms of the exemptive order, in order for us to participate in a co-investment transaction a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must conclude that (i) 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 with respect of us or our stockholders on the part of any person concerned, and (ii) the proposed transaction is consistent with the interests of our stockholders and is consistent with our investment objectives and strategies and certain criteria established by our Board of Directors.

We have elected to be treated for U.S. federal income tax purposes as a RIC under the Code and intend to operate in a manner to maintain our RIC status. As a RIC, we intend to distribute to our stockholders substantially all of our net ordinary taxable income and the excess of realized net short-term capital gains over realized net long-term capital losses, if any, for each taxable year. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any income that we timely distribute to our stockholders.

Our common stock is traded on The NASDAQ Global Select Market under the symbol “PTMN.” On December 20, 2019, the last reported sale price of a share of our common stock on The NASDAQ Global Select Market was $2.16. Our 6.125% notes due 2022 (“6.125% Notes Due 2022”) are traded on the NASDAQ Global Select Market under the symbol “KCAPL.” On December 20, 2019, the last reported price of our 6.125% Notes Due 2022, which have a par value of $25.00, was $25.18. We are required to determine net asset value per share of our common stock on a quarterly basis. The net asset value per share of our common stock at September 30, 2019 was $3.55.



 

2


Investment Portfolio

Our investment portfolio generates investment income, which is generally used to pay principal and interest on our borrowings, operating expenses, and to fund our distributions to our stockholders. Our investment portfolio consists primarily of its debt securities portfolio and investments in CLO Fund Securities.

Debt Securities Portfolio. We target privately-held middle-market companies that have strong historical cash flows, experienced management teams and identifiable and defendable market positions in industries with positive dynamics. We generally targets companies that generate positive cash flows because we look to cash flows as the primary source for servicing debt.

We employ a disciplined approach in the selection and monitoring of our investments. Generally, we target investments that will generate a current return through interest income to provide for stability in our shareholder distributions and place less reliance on realized capital gains from our investments. Our investment philosophy is focused on preserving capital with an appropriate return profile relative to risk. Our investment due diligence and selection generally focuses on an underlying issuer’s net cash flow after capital expenditures to service our debt rather than on multiples of net income, valuations or other broad benchmarks which frequently miss the nuances of an issuer’s business and prospective financial performance. We also generally avoid concentrations in any one industry or issuer. We manage risk by following our internal credit policies and procedures.

When we extend senior and junior secured term loans, we will generally take a security interest in the available assets of the portfolio company, including the equity interests of our subsidiaries, which we expect to help mitigate the risk that it will not be repaid. Nonetheless, there is a possibility that our lien could be subordinated to claims of other creditors. Structurally, mezzanine debt ranks subordinate in priority of payment to senior term loans and is often unsecured. Relative to equity, mezzanine debt ranks senior to common and preferred equity in a borrower’s capital structure. Typically, mezzanine debt has elements of both debt and equity instruments, offering the fixed returns in the form of interest payments associated with a loan, while providing an opportunity to participate in the capital appreciation of a borrower, if any, through an equity interest that is typically in the form of equity purchased at the time the mezzanine loan is originated or warrants to purchase equity at a future date at a fixed cost. Mezzanine debt generally earns a higher return than senior secured debt due to its higher risk profile and usually less restrictive covenants. The warrants associated with mezzanine debt are typically detachable, which allows lenders to receive repayment of their principal on an agreed amortization schedule while retaining an equity interest in the borrower. Mezzanine debt also may include a “put” feature, which permits the holder to sell its equity interest back to the borrower at a price determined through an agreed formula.

Below are summary attributes for our debt securities portfolio as of September 30, 2019:

 

   

represented approximately 61% of total investment portfolio;

 

   

contained credit instruments issued by corporate borrowers;

 

   

primarily comprised of senior secured and junior secured loans (60% and 40% of Debt Securities Portfolio, respectively);

 

   

spread across 21 different industries and 51 different entities;

 

   

average par balance per investment of approximately $3.3 million;

 

   

six investments were on non-accrual status; and

 

   

the weighted average contractual interest rate on our loans and debt securities was approximately 9.4%, and the weighted average contractual interest rate on our loans and debt securities, excluding non-accrual investments, was approximately 9.0%.



 

3


Our debt securities portfolio investments generally average between $1 million to $20 million, although particular investments may be larger or smaller. The size of individual investments will vary according to their priority in a company’s capital structure, with larger investments in more secure positions in an effort to maximize capital preservation. The size of our investments and maturity dates may vary as follows:

 

   

senior secured term loans from $2 million to $20 million maturing in five to seven years;

 

   

second lien term loans from $5 million to $15 million maturing in six to eight years;

 

   

senior unsecured loans from $5 million to $23 million maturing in six to eight years;

 

   

mezzanine loans from $5 million to $23 million maturing in seven to ten years; and

 

   

equity investments from $1 million to $5 million.

Investment in the Joint Venture. During the third quarter of 2017, Freedom 3 Opportunities LLC (“Freedom 3 Opportunities”), an affiliate of Freedom 3 Capital LLC, entered into an agreement with us to create KCAP Freedom 3 LLC (the “Joint Venture”). Freedom 3 Opportunities contributed approximately $37 million and $25 million with us, respectively, in assets to the Joint Venture, which in turn used the assets to capitalize a new fund, KCAP F3C Senior Funding, L.L.C. (the “Fund”) managed by KCAP Management, LLC, our Surviving Asset Manager Affiliate. In addition, we used cash on hand and borrowings under a credit facility to purchase approximately $184 million of primarily middle-market loans from us and we used the proceeds from such sale to redeem approximately $147 million in debt issued by KCAP Senior Funding I, LLC (“KCAP Senior Funding”). We invest primarily in middle-market loans and the Joint Venture partners may source middle-market loans from time-to-time for us.

During the fourth quarter of 2017, we were refinanced through the issuance of senior and subordinated notes. The Joint Venture purchased 100% of the subordinated notes issued by us. In connection with the refinancing, the Joint Venture made a cash distribution to us of approximately $12.6 million. Approximately $11.8 million of this distribution was a reduction in the cost basis of our investment in the Joint Venture. The final determination of the tax attributes of distributions from the Joint Venture is made on an annual (full calendar year) basis at the end of the year, therefore, any estimate of tax attributes of distributions made on an interim basis may not be representative of the actual tax attributes of distributions for the full year.

We own a 60% equity investment in the Joint Venture. The Joint Venture is structured as an unconsolidated Delaware limited liability company. All portfolio and other material decisions regarding the Joint Venture must be submitted to our board of managers, which is comprised of four members, two of whom were selected by us and two of whom were selected by Freedom 3 Opportunities, and must be approved by at least one member appointed by us and one appointed by Freedom 3 Opportunities. In addition, certain matters may be approved by the Joint Venture’s investment committee, which is comprised of one member appointed by us and one member appointed by Freedom 3 Opportunities.

We have determined that the Joint Venture is an investment company under ASC 946, however, in accordance with such guidance; we will generally not consolidate our investment in a company other than a wholly owned investment company subsidiary or a controlled operating company whose business consists of providing services to us. We do not consolidate our interest in the Joint Venture because we do not control the Joint Venture due to allocation of the voting rights among the Joint Venture partners.

CLO Fund Securities. Our investments in CLO Fund Securities are primarily made up of minority investments in the subordinated securities or preferred stock of CLO Funds managed by the Disposed Manager Affiliates.



 

4


Below are summary attributes for our CLO Fund Securities, as of and for the nine-months ended September 30, 2019, unless otherwise specified:

 

   

CLO Fund Securities represented approximately 13% of total investment portfolio at September 30, 2018;

 

   

all of the CLO Fund Securities Portfolio represented investments in subordinated securities or equity securities issued by CLO Funds;

 

   

all CLO Funds invested primarily in credit instruments issued by corporate borrowers;

 

   

U.S. GAAP basis investment income of $5.1 million; cash distributions received of approximately $5.9 million (approximately $5.9 million taxable distributable income, no tax return of capital).

RISK FACTORS

Investing in us involves significant risks. The following is a summary of certain risks that you should carefully consider before investing in us. For a further discussion of these risk factors, please see “Risk Factors” beginning on page 17.

Risks Related to Economic Conditions

 

   

Economic recessions or downturns may have a material adverse effect on our business, financial condition and results of operations, and could impair the ability of our portfolio companies to repay loans.

 

   

Capital markets may experience periods of disruption and instability and we cannot predict when these conditions will occur. Such market conditions could materially and adversely affect debt and equity capital markets in the United States and abroad, which could have a negative impact on our business, financial condition and results of operations.

 

   

The United Kingdom referendum decision to leave the European Union may create significant risks and uncertainty for global markets and our investments.

 

   

Terrorist attacks, acts of war or natural disasters may affect any market for our Common Stock, impact the businesses in which we invest and harm our business, operating results and financial condition.

Risks Related to Our Business and Structure

 

   

Ineffective internal controls could impact our business and operating results.

 

   

Sierra Crest has limited prior experience managing a BDC or a RIC.

 

   

Sierra Crest and its affiliates, including our officers and some of our directors, face conflicts of interest caused by compensation arrangements with us and our affiliates, which could result in actions that are not in the best interests of our stockholders.

 

   

We may be obligated to pay Sierra Crest incentive compensation even if it incurs a net loss due to a decline in the value of our portfolio.

 

   

There may be conflicts of interest related to obligations that Sierra Crest’s senior management and investment team has to other clients.

 

   

The time and resources that individuals employed by Sierra Crest devote to us may be diverted and we may face additional competition due to the fact that individuals employed by Sierra Crest are not prohibited from raising money for or managing other entities that make the same types of investments that we target.



 

5


   

Our base management and incentive fees may induce Sierra Crest to make speculative investments or to incur leverage.

 

   

Sierra Crest relies on key personnel, the loss of any of whom could impair its ability to successfully manage us.

 

   

Sierra Crest may retain additional consultants, advisors and/or operating partners to provide services to us, and such additional personnel will perform similar functions and duties for other organizations which may give rise to conflicts of interest.

 

   

The compensation we pay to Sierra Crest was determined without independent assessment on our behalf, and these terms may be less advantageous to us than if such terms had been the subject of arm’s-length negotiations.

 

   

Sierra Crest’s influence on conducting our operations give it the ability to increase its fees, which may reduce the amount of cash flow available for distribution to our stockholders.

 

   

We operate in a highly competitive market for investment opportunities.

 

   

If Sierra Crest is unable to source investments effectively, we may be unable to achieve our investment objectives and provide returns to stockholders.

 

   

We may have difficulty paying distributions required to maintain our RIC status if we recognize income before or without receiving cash equal to such income.

 

   

Any unrealized losses we experience on our loan portfolio may be an indication of future realized losses, which could reduce our resources available to make distributions.

 

   

We may experience fluctuations in our quarterly and annual operating results and credit spreads.

 

   

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

 

   

We borrow money, which magnifies the potential for gain or loss on amounts invested and may increase the risk of investing in us.

 

   

Our indebtedness could adversely affect our financial health and our ability to respond to changes in our business.

 

   

Our Board of Directors has approved our ability to incur additional leverage as permitted by recent legislation.

 

   

We may default under the Revolving Credit Facility or any future borrowing facility we enter into or be unable to amend, repay or refinance any such facility on commercially reasonable terms, or at all, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

   

Provisions in the Revolving Credit Facility or any other future borrowing facility may limit our discretion in operating our business.

 

   

Because we intend to continue to distribute substantially all of our income and net realized capital gains to our stockholders, we will need additional capital to finance our growth.

 

   

We may from time to time expand our business through acquisitions, which could disrupt our business and harm our financial condition.

 

   

We may invest through joint ventures, partnerships or other special purpose vehicles and our investments through these vehicles may entail greater risks, or risks that we otherwise would not incur, if we otherwise made such investments directly.



 

6


   

Our Board of Directors may change our investment objective, operating policies and strategies without prior notice or stockholder approval.

 

   

Our businesses may be adversely affected by litigation and regulatory proceedings.

 

   

Regulations governing our operation as a BDC affect our ability to, and the way in which we raise, additional capital.

 

   

The application of the risk retention rules under Section 941 of the Dodd-Frank Act to CLOs may have broader effects on the CLO and loan markets in general, potentially resulting in fewer or less desirable investment opportunities for us.

 

   

If we do not invest a sufficient portion of our assets in Qualifying Assets, we could be precluded from investing according to our current business strategy.

 

   

Our ability to enter into transactions with our affiliates is restricted.

 

   

A failure on our part to maintain our status as a BDC would significantly reduce our operating flexibility.

 

   

Our business and operations could be negatively affected if we become subject to any securities litigation or stockholder activism, which could cause us to incur significant expense, hinder execution of investment strategy and impact our stock price.

 

   

We will be subject to corporate-level U.S. federal income taxes if we are unable to qualify as a RIC under Subchapter M of the Code.

Risks Associated with Our Information Technology Systems

 

   

Disruptions in current systems or difficulties in integrating new systems.

 

   

Internal and external cyber threats, as well as other disasters, could impair our ability to conduct business effectively.

Risks Related to Our Investments

 

   

Our investments may be risky, and you could lose all or part of your investment.

 

   

Our portfolio investments for which there is no readily available market, including our investment in our Asset Manager Affiliates, our Joint Venture and our investments in CLO Funds, are recorded at fair value as determined in good faith by our Board of Directors. As a result, there is uncertainty as to the value of these investments.

 

   

We are a non-diversified investment company within the meaning of the 1940 Act, and therefore we may invest a significant portion of our assets in a relatively small number of issuers, which subjects us to a risk of significant loss if any of these issuers defaults on its obligations under any of its debt instruments or as a result of a downturn in the particular industry.

 

   

Defaults by our portfolio companies could harm our operating results.

 

   

When we are a debt or minority equity investor in a portfolio company, which generally is the case, we may not be in a position to control the entity, and its management may make decisions that could decrease the value of our investment.

 

   

We may have limited access to information about privately held companies in which we invest.

 

   

Prepayments of our debt investments by our portfolio companies could negatively impact our operating results.



 

7


   

We may be unable to invest the net proceeds raised from offerings and repayments from investments on acceptable terms, which would harm our financial condition and operating results.

 

   

Our portfolio companies may incur debt that ranks equal with, or senior to, our investments in such companies.

 

   

Second priority liens on collateral securing loans that we make to our portfolio companies may be subject to control by senior creditors with first priority liens. If there is a default, the value of the collateral may not be sufficient to repay in full both the first priority creditors and us.

 

   

There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to lender liability claims.

 

   

Our investments in equity securities involve a substantial degree of risk.

 

   

The lack of liquidity in our investments may adversely affect our business.

 

   

Our investments in foreign securities may involve significant risks in addition to the risks inherent in U.S. investments.

 

   

The disposition of our investments may result in contingent liabilities.

 

   

We may not receive any return on our investment in the CLO Funds in which we have invested.

Risks Related to Our Investment Advisory Relationship with Sierra Crest

 

   

Sierra Crest selects our investments and our Stockholders have no input with respect to investment decisions.

 

   

We are dependent upon Sierra Crest for our future success.

 

   

The structure under our Investment Advisory Agreement may induce Sierra Crest to pursue speculative investments and incur leverage, which may not be in the best interests of our stockholders.

 

   

Sierra Crest’s liability is limited under our Investment Advisory Agreement, and we are required to indemnify Sierra Crest against certain liabilities, which may lead Sierra Crest to act in a riskier manner on our behalf than it would when acting for its own account.

 

   

Sierra Crest is able to resign upon 60 days’ written notice, and we may not be able to find a suitable replacement within that time, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations.

 

   

We may not replicate our historical performance, or the historical success of other investment vehicles advised by Sierra Crest.

Risks Relating to the Merger

 

   

Sales of shares of our Common Stock after the completion of the Merger may cause the market price of our Common Stock to decline.

 

   

We may be unable to realize the benefits anticipated by the Merger, including estimated cost savings, or it may take longer than anticipated to achieve such benefits.

 

   

If we sell investments acquired as a result of the Merger, it may result in capital gains and increase the incentive fees payable to Sierra Crest.



 

8


Our Corporate Information

Our principal executive offices are located at 650 Madison Avenue, 23rd Floor, New York, New York 10022, and our telephone number is (212) 891-2880. We maintain a website on the Internet at http://www.portmanridge.com. The information contained in our website is not incorporated by reference into this Prospectus. 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 (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. 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.



 

9


THE OFFERING

We may offer, from time to time, up to $250,000,000 of our securities, on terms to be determined at the time of the offering. Our securities may be offered at prices and on terms to be disclosed in one or more prospectus supplements.

Our securities may be offered directly to one or more purchasers by us or through agents designated from time to time by us, or to or through underwriters or dealers. The prospectus supplement relating to any offering will disclose the terms of the offering, including the name or names of any agents or underwriters involved in the sale of our securities by us, the purchase price, and any fee, commission or discount arrangement between us and our agents or underwriters or among our underwriters or the basis upon which such amount may be calculated. See “Plan of Distribution.” We may not sell any of our securities directly or through agents, underwriters or dealers without delivery of this prospectus and a prospectus supplement describing the method and terms of the offering of our securities.

Set forth below is additional information regarding any offering of our securities:

 

Use of Proceeds

We intend to use the net proceeds from the sale of our securities for investing in debt and equity securities, repayment of any outstanding indebtedness and other general corporate purposes, which may include investing in portfolio companies and CLO Fund Securities in accordance with our investment objective and strategies described elsewhere in this prospectus. The supplement to this prospectus relating to an offering will more fully identify the use of proceeds from such offering. See “Use of Proceeds.”

 

NASDAQ Global Select Market symbol

“PTMN”

 

Taxation

We have elected to be treated for U.S. federal income tax purposes as a RIC under Subchapter M of the Code and intend to operate in a manner to maintain our RIC tax treatment. Accordingly, we generally will not pay corporate-level U.S. federal income taxes on any net ordinary income or realized capital gains that we timely distribute to our shareholders as dividends. To maintain our RIC tax treatment, we must meet specified source-of-income and asset diversification requirements and distribute annually at least 90% of the sum of our investment company taxable income (generally, our net ordinary income and realized short-term capital gains in excess of realized net long-term capital losses, if any) and net tax-exempt income for each year.

 

  We intend to continue to distribute to our stockholders substantially all of our net ordinary income and realized net capital gains except for certain net long-term capital gains (which we may retain, pay applicable U.S. federal income taxes with respect thereto, and elect to treat as deemed distributions to our stockholders). See “Certain U.S. Federal Income Tax Considerations.”

 

Leverage

We have issued various types of debt, and in the future may borrow from, and/or issue additional senior securities (such as preferred or convertible debt securities or debt securities) to, banks and other



 

10


 

lenders and investors. Subject to prevailing market conditions, we intend to grow our portfolio of assets by raising additional capital, including through the prudent use of leverage available to us.

 

Trading

Shares of closed-end investment companies frequently trade at a discount to their net asset value. The risk that our shares may trade at a discount to our net asset value is separate and distinct from the risk that our net asset value per share may decline. We cannot predict whether our shares will trade above, at or below net asset value.

 

Sales of Common Stock Below Net Asset Value

The offering price per share of our common stock, less any underwriting commissions or discounts, will not be less than the net asset value per share of our common stock at the time of the offering, except (i) with the requisite approval of the Board of Directors and stockholders or (ii) under such other circumstances as the Securities and Exchange Commission may permit. In addition, we cannot issue shares of our common stock below net asset value unless our Board of Directors determines that it would be in our and our stockholders’ best interests to do so. We did not seek stockholder authorization to issue common stock at a price below net asset value per share at our 2019 Annual Meeting of Stockholders, but we may seek such authorization at future Annual Meetings or Special Meetings of Stockholders.

 

Dividend Reinvestment Plan

We have adopted an “opt out” dividend reinvestment plan.

 

Certain Anti-Takeover Measures

Our charter and bylaws, as well as certain statutes and regulations, contain provisions that may have the effect of discouraging a third party from making an acquisition proposal for us. This could delay or prevent a transaction that could give our stockholders the opportunity to realize a premium over the price for their securities.

 

Available Information

We are required to file annual, quarterly and current periodic reports, proxy statements and other information with the SEC. The SEC maintains an Internet website that contains reports, proxy and information statements and other information filed electronically by us with the SEC at http://www.sec.gov. See “Available Information.”

 

Risk Factors

Your investment in our securities involves a high degree of risk and should be considered highly speculative. See “Risk Factors” in this prospectus for a discussion of factors you should carefully consider before investing in our securities.


 

11


FEES AND EXPENSES

The following table is intended to assist you in understanding the costs and expenses that an investor in an offering will bear directly or indirectly. We caution you that some of the percentages indicated in the table below are estimates and may vary. Moreover, the information set forth below does not include any transaction costs and expenses that investors will incur in connection with an offering of our securities pursuant to this prospectus and the attached prospectus supplement for that offering. As a result, investors are urged to read the “Fees and Expenses” table contained in any corresponding prospectus supplement to fully understanding the actual transaction costs and expenses they will incur in connection with each such offering. Except where the context suggests otherwise, whenever this prospectus contains a reference to fees or expenses paid by “us” or that “we” will pay fees or expenses, stockholders will indirectly bear such fees or expenses as investors in the Company.

 

STOCKHOLDER TRANSACTION EXPENSES (as a percentage of the offering price)

  

Sales Load

     None (1) 

Offering Expenses

     None (1) 

Dividend Reinvestment Plan Fees

     None (2) 
  

 

 

 

Total Stockholder Transaction Expenses

     None  
  

 

 

 

ANNUAL EXPENSES (as a percentage of net assets attributable to common stock): (3)

  

Base management fees(4)

     1.79

Incentive fees(5)

     0.00

Interest Payments on Borrowed Funds

     4.99

Other Expenses(6)

     3.95
  

 

 

 

Acquired fund fees and expenses

     0.00
  

 

 

 

Total Annual Expenses(7)

     10.73
  

 

 

 

 

(1)

Purchases of shares of common stock of PTMN or OHAI on the secondary market are not subject to sales charges, but may be subject to brokerage commissions or other charges. The table does not include any sales load (underwriting discount or commission) that stockholders may have paid in connection with their purchase of shares of PTMN Common Stock or OHAI Common Stock in a prior underwritten offering or otherwise.

(2)

The estimated expenses associated with the respective distribution reinvestment plans are included in “Other expenses.”

(3)

“Consolidated net assets attributable to common stock” equals pro forma net assets at September 30, 2019. See “Unaudited Selected Pro Forma Consolidated Financial Data” for more information.

(4)

For the period from the date of our Investment Advisory Agreement (the “Effective Date”) through June 30, 2019, the end of the first calendar quarter after the Effective Date, our base management fee was calculated at an annual rate of 1.50% of our gross assets, excluding cash and cash equivalents, but including assets purchased with borrowed amounts, as of the end of such calendar quarter. Subsequently, the base management fee will be 1.50% of our average gross assets, excluding cash and cash equivalents, but including assets purchased with borrowed amounts, at the end of the two most recently completed calendar quarters; provided, however, that the base management fee will be 1.00% of our average gross assets, excluding cash and cash equivalents, but including assets purchased with borrowed amounts, that exceed the product of (i) 200% and (ii) the value of our net asset value at the end of the most recently completed calendar quarter.

(5)

PTMN’s incentive fee consists of two parts: (1) a portion based on our pre-incentive fee net investment income (the “Income-Based Fee”) and (2) a portion based on the net capital gains received on our portfolio of securities on a cumulative basis for each calendar year, net of all realized capital losses and all unrealized capital depreciation on a cumulative basis, in each case calculated from the Effective Date, less the aggregate amount of any previously paid capital gains Incentive Fee (the “Capital Gains Fee”). The Income-Based Fee will be 17.50% of pre-incentive fee net investment income with a 7.00% hurdle rate. The Capital Gains Fee will be 17.50%.

 

12


(6)

Other expenses include insurance, accounting, legal and auditing fees and state franchise taxes, as well as the reimbursement of the compensation of administrative personnel and fees payable to our directors who do not also serve in an executive officer capacity for us or Sierra Crest.

(7)

“Total annual expenses” as a percentage of consolidated net assets attributable to common stock are higher than the total annual expenses percentage would be for a company that is not leveraged. We borrow money to leverage and increase total assets. The SEC requires that the “Total annual expenses” percentage be calculated as a percentage of net assets (defined as total assets less indebtedness and before taking into account any incentive fees payable during the period), rather than the total assets, including assets that have been funded with borrowed monies.

(9)

This is based on the assumption that borrowings and interest costs after the Merger will remain the same as those costs prior to the Merger. We expect over time that as a result of additional investment purchases, and in turn, additional borrowings on the financing facilities after the Merger, the combined company’s interest payments on borrowed funds may be more than the amounts estimated in the Unaudited Pro Forma Combined Statement of Operations of the Merger and, accordingly, that estimated total expenses may be different than as reflected in the Unaudited Pro Forma Combined Statement of Operations of the Merger for the nine months ended September 30, 2019. However, the actual amount of leverage employed at any given time cannot be predicted.

Example

The following example demonstrates the projected dollar amount of total cumulative expenses over various periods with respect to a hypothetical investment in PTMN, OHAI or the combined company’s common stock following the Merger on a pro forma basis. In calculating the following expense amounts, we assumed that it would have no additional leverage and that its annual operating expenses would remain at the levels set forth in the tables above. Calculations for the pro forma combined company following the Merger assume that the Merger closed on September 30, 2019 and that the leverage and operating expenses remain at the levels set forth in the tables above. Transaction expenses related to the Merger are not included in the following examples.

 

     1 year      3 years      5 years      10 years  

You would pay the following expenses on a $1,000 investment:

           

Assuming a 5% annual return (assumes no return from net realized capital gains or net unrealized capital appreciation)

   $ 107      $ 304      $ 478      $ 834  

Assuming a 5% annual return (assumes return entirely from realized capital gains and thus subject to the capital gain incentive fee)

   $ 116      $ 326      $ 508      $ 870  

The foregoing tables are to assist you in understanding the various costs and expenses that an investor in our common stock will bear directly or indirectly. While the example assumes, as required by the SEC, a 5% annual return, our performance will vary and may result in a return greater or less than 5%. The incentive fee under our Investment Advisory Agreement, which, assuming a 5% annual return, would either not be payable or have an immaterial impact on the expense amounts shown above in the example where there is no return from net realized capital gains, and thus are not included in those examples. Under our Investment Advisory Agreement, no incentive fee would be payable if we have a 5% annual return with no capital gains, however, there would be incentive fees payable in the examples where the entire return is derived from realized capital gains. If sufficient returns are achieved on investments, including through the realization of capital gains, to trigger an incentive fee of a material amount, expenses, and returns to investors, would be higher. The example assumes that all dividends and other distributions are reinvested at net asset value. Under certain circumstances, reinvestment of dividends and other distributions under the relevant dividend reinvestment plan may occur at a price per share that differs from net asset value. See “Dividend Reinvestment Plan” for additional information regarding our dividend reinvestment plan.

The example and the expenses in the table above should not be considered a representation of our future expenses, and actual expenses may be greater or less than those shown.

 

13


SELECTED FINANCIAL AND OTHER DATA

The following selected consolidated financial data for us as of and for the years ended December 31, 2018, 2017, 2016, 2015 and 2014 is derived from our audited consolidated financial statements. The following selected financial data for the nine months ended September 30, 2019 and 2018 is derived from our unaudited consolidated financial statements. The data should be read in conjunction with our financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included in this prospectus. The historical data is not necessarily indicative of results to be expected for any future period.

The following selected consolidated financial data for OHAI as of and for the years ended December 31, 2018, 2017, 2016, 2015 and 2014 is derived from its audited consolidated financial statements. The following selected financial data for the nine months ended September 30, 2019 and 2018 is derived from our unaudited consolidated financial statements. The data should be read in conjunction with its financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included in this prospectus. The historical data is not necessarily indicative of results to be expected for any future period.

Portman Ridge Finance Corporation

 

    Nine Months
Ended
September 30,
2019
    Nine Months
Ended
September 30,
2018
    As of and
for the
Year Ended
December 31,
2018
    As of and
for the
Year Ended
December 31,
2017
    As of and
for the
Year Ended
December 31,
2016
    As of and
for the
Year Ended
December 31,
2015
    As of and
for the
Year Ended
December 31,
2014
 
    (In thousands, Except Share and Per Share Data)  

Income Statement Data:

             

Interest and related portfolio income:

             

Interest and Dividends

  $ 16,065     $ 17,578     $ 22,495     $ 26,363     $ 34,132     $ 39,812     $ 34,803  

Fees and other income

    183       185       245       491       669       367       935  

Dividends from Asset Manager Affiliates

    —         920       1,247       460       1,400       5,349       5,468  

Investment income – Joint Venture

    3,542       2,150       3,100       949       —         —         —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest and related portfolio income

    19,790       20,833       27,087       28,264       36,200       45,527       41,205  

Expenses:

             

Interest and amortization of debt issuance costs

    6,064       5,582       7,403       7,661       9,111       11,728       11,538  

Compensation

    3,689       3,217       4,013       4,571       4,104       3,844       4,952  

Other

    9,110       4,090       5,666       5,012       4,496       5,773       4,595  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    18,863       12,889       17,082       17,245       17,710       21,344       21,085  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Investment Income (Loss)

    927       7,944       10,004       11,019       18,490       24,183       20,121  

Realized and unrealized (losses) gains on investments:

             

Net realized (losses) gains

    (16,796     (306     (16,672     (11,021     (6,342     (6,647     (11,132

Net change in unrealized (losses) gains

    (147     (4,991     (2,904     3,390       (13,188     (36,170     6,046  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net (losses) gains

    (16,943     (5,297     (19,576     (7,631     (19,530     (42,817     (5,087
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (decrease) increase in net assets resulting from operations

  $ (16,016   $ 2,647     $ (9,572   $ 3,388     $ (1,040   $ (18,635   $ 15,034  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

14


    Nine Months
Ended
September 30,
2019
    Nine Months
Ended
September 30,
2018
    As of and
for the
Year Ended
December 31,
2018
    As of and
for the
Year Ended
December 31,
2017
    As of and
for the
Year Ended
December 31,
2016
    As of and
for the
Year Ended
December 31,
2015
    As of and
for the
Year Ended
December 31,
2014
 
    (In thousands, Except Share and Per Share Data)  

Per Share:

             

Earnings per common share – basic

  $ (0.43   $ 0.07     $ (0.26   $ 0.09     $ (0.03   $ (0.50   $ 0.44  

Earnings per common share – diluted

  $ (0.43   $ 0.07     $ (0.26   $ 0.09     $ (0.03   $ (0.50   $ 0.43  

Net investment income per share – basic

  $ 0.02     $ 0.21     $ 0.27     $ 0.30     $ 0.50     $ 0.65     $ 0.59  

Net investment income per share – diluted

  $ 0.02     $ 0.21     $ 0.27     $ 0.30     $ 0.50     $ 0.65     $ 0.58  

Distributions declared per common share

  $ 0.06     $ 0.10     $ 0.40     $ 0.46     $ 0.57     $ 0.78     $ 1.00  

Taxable Distributable Income per basic share

  $ 0.14     $ 0.24     $ 0.25     $ 0.16     $ 0.40     $ 0.63     $ 0.78  

Balance Sheet Data:

             

Investment assets at fair value

  $ 287,392     $ 273,485     $ 273,308     $ 311,956     $ 366,471     $ 409,570     $ 479,706  

Total assets

  $ 293,166     $ 279,739     $ 285,465     $ 319,809     $ 381,372     $ 421,205     $ 505,180  

Total debt outstanding

  $ 122,479     $ 103,736     $ 100,400     $ 101,413     $ 175,549     $ 201,104     $ 218,618  

Stockholders’ equity

  $ 132,723     $ 173,909     $ 158,021     $ 181,805     $ 194,925     $ 216,100     $ 255,317  

Net asset value per common share

  $ 3.55     $ 4.66     $ 4.23     $ 4.87     $ 5.24     $ 5.82     $ 6.94  

Common shares outstanding at end of period

    37,371,912       37,349,224       37,326,846       37,339,224       37,178,294       37,100,005       36,775,127  

Other Data:

             

Investments funded(1)

    106,627       75,551       118,159       227,723       75,725       130,955       235,905  

Principal collections related to investment repayments or sales(1)

    80,927       61,433       112,052       323,532       129,192       129,793       193,555  

Number of portfolio investments at end of year(1)

    85       84       86       77       125       130       141  

Weighted average interest rate on income producing debt investments(2)

    9.4     10.1     10.0     10.1     7.0     7.4     7.3

Weighted average interest rate on income producing debt investments (adjusted for non-accrual and partial non-accrual)(3)

    9.0     8.9     9.1     9.6     7.0     7.4     7.3

 

(1)

Does not include investments in time deposits or money markets.

(2)

Weighted average interest rate on income producing investments is calculated as the weighted average contractual interest rate on par outstanding balances for investments in loans, bonds, and mezzanine debt in our Debt Securities portfolio.

(3)

Weighted average interest rate of income producing investments (adjusted for non-accrual and partial non-accrual) is calculated as the weighted average contractual interest rate on par outstanding balances for investments in loans, bonds, and mezzanine debt in our Debt Securities portfolio, excluding contractual income on non-accrual and partial non-accrual investments.

 

15


OHA Investment Corporation

 

    

Nine Months Ended
September 30,

    Year ended December 31,  
     2019     2018     2018     2017     2016     2015     2014  
     (In Thousands, Except Per Share Data and Other Data)  

Income Statement Data

              

Total investment income

   $ 4,567     $ 6,796     $ 8,468     $ 10,272     $ 17,888     $ 22,049     $ 22,119  

Total operating expenses, net of incentive fee waiver(1)(4)

     5,758       6,123       7,760       9,222       11,378       12,008       18,812  

Net investment income, net of tax(1)(4)

     (1,206     628       671       1,028       6,503       9,969       3,198  

Net realized capital loss on investments

     629       (55,991     (55,952     (10,868     (27,011     (218     (12,430

Net unrealized appreciation (depreciation) on investments

     1,382       52,154       45,033       (21,268     (4,938     (40,973     (12,999

Net increase (decrease) in net assets resulting from operations(1)(4)

   $ 805     $ (3,209   $ (10,248   $ (31,108   $ (25,446   $ (31,222   $ (22,231

Per Share Data

              

Net investment income(1)(4)

   $ (0.06   $ 0.03     $ 0.03     $ 0.05     $ 0.32     $ 0.49     $ 0.16  

Net realized and unrealized gain (loss) on investments

     0.10       (0.19     (0.54     (1.59     (1.58     (2.03     (1.24

Net increase (decrease) in net assets resulting from operations(1)(4)

   $ 0.04     $ (0.16   $ (0.51   $ (1.54   $ (1.26   $ (1.54   $ (1.08

Dividends declared

   $ 0.06     $ 0.06     $ 0.08     $ 0.08     $ 0.24     $ 0.48     $ 0.64  

Net asset value per share(6)

   $ 1.76     $ 1.78     $ 1.78     $ 2.37     $ 3.99     $ 5.49     $ 7.48  

Balance Sheet Data

              

Total investments

   $ 72,403     $ 80,595     $ 80,595     $ 84,924     $ 145,002     $ 209,707     $ 206,763  

Portfolio investments at fair value

     62,404       65,606       65,606       64,930       105,005       174,710       176,163  

Cash and cash equivalents

     4,497       3,124       3,124       19,939       16,533       15,554       31,455  

Total assets

     78,009       84,777       84,777       106,148       162,898       228,477       242,175  

Total debt(2)

     30,000       29,000       29,000       36,000       40,500       72,000       52,000  

Total net assets

     35,504       35,909       35,909       47,771       80,493       110,780       154,164  

Other Data

              

Weighted average yield on portfolio investments(3), excluding non-yielding investments

     10.1     10.4     10.4     13.2     9.7     10.6     10.2

Weighted average yield on portfolio investments(4)

     5.3     7.4     5.5     5.8     8.1     9.6     9.2

Number of portfolio companies

     28       26       26       16       14       17       15  

Expense ratios (as a percentage of average net assets):

              

Interest expense and bank fees

     6.7     6.6     6.4     6.5     3.9     2.4     1.2

Management fees

     3.4     3.2     3.2     3.1     2.9     2.1     2.6

Incentive fees(5)

     0.2     —       —       0.1     0.3     0.7     —  

Costs related to strategic alternatives review

     3.9     0.2     0.2     —       —       —       3.4

Other operating expenses including provision for income taxes

     6.8     7.0     6.8     5.6     4.4     3.2     3.5

Total operating expenses including provision for income taxes

     21.0     17.0     16.6     15.3     11.5     8.4     10.7

 

(1)

Includes $0.3 million, $0.1 million and $6.0 million, or $0.01, $0.00 and $0.29 per share, in 2019, 2018 and 2014, respectively, of costs related to our review of strategic alternatives.

(2)

Excludes amounts borrowed on a temporary basis to purchase U.S. Treasury Bills and unamortized debt issuance costs.

(3)

Calculated on the total cost of the investment portfolio, excluding non-yielding investments, as of the end of the period, based on amortized cost and the expected income on portfolio investment.

(4)

Calculated on the total cost of the investment portfolio, including non-yielding investments, as of the end of the period, based on amortized cost and the expected income of the portfolio investment.

(5)

Incentive fees waived in 2017 were $89,000.

(6)

Totals may not sum due to rounding.

 

16


RISK FACTORS

Investing in our securities involves a high degree of risk. Before you invest in our securities, you should be aware of various significant risks, including those described below. You should carefully consider these risks, together with all of the other information included in this prospectus and any accompanying prospectus supplement, before you decide whether to make an investment in our securities. The risks set forth below are not the only risks we face. If any of the following risks occur, our business, financial condition and results of our operations could be materially adversely affected. In such case, you could lose all or part of your investment.

Risks Related to Economic Conditions

Economic recessions or downturns may have a material adverse effect on our business, financial condition and results of operations, and could impair the ability of its portfolio companies to repay loans.

Economic recessions or downturns may result in a prolonged period of market illiquidity which could have a material adverse effect on our business, financial condition and results of operations. Unfavorable economic conditions also could increase our funding costs, limit its access to the capital markets or result in a decision by lenders not to extend credit to us. These events could limit our investment originations, limit its ability to grow and negatively impact its operating results.

In the event of economic recessions and downturns, the financial results of middle-market companies, like those in which we invest, will likely experience deterioration, which could ultimately lead to difficulty in meeting debt service requirements and an increase in defaults. Additionally, the end markets for certain of our portfolio companies’ products and services would likely experience negative financial trends. The performances of certain of our portfolio companies have been, and may continue to be, negatively impacted by these economic or other conditions, which may ultimately result in our receipt of a reduced level of interest income from its portfolio companies and/or losses or charge-offs related to its investments, and, in turn, may adversely affect distributable income. Further, adverse economic conditions may decrease the value of collateral securing some of our loans and the value of its equity investments. As a result, we may need to modify the payment terms of its investments, including changes in PIK interest provisions and/or cash interest rates. These factors may result in our receipt of a reduced level of interest income from its portfolio companies and/or losses or charge-offs related to its investments, and, in turn, may adversely affect distributable income and have a material adverse effect on our results of operations.

Capital markets may experience periods of disruption and instability and we cannot predict when these conditions will occur. Such market conditions could materially and adversely affect debt and equity capital markets in the United States and abroad, which could have a negative impact on our business, financial condition and results of operations.

From time-to-time, capital markets may experience periods of disruption and instability. For example, from 2008 to 2009, the global capital markets were unstable as evidenced by the lack of liquidity in the debt capital markets, significant write-offs in the financial services sector, the repricing of credit risk in the broadly syndicated credit market and the failure of major financial institutions. Despite actions of the U.S. federal government and various foreign governments, these events contributed to worsening general economic conditions that materially and adversely impacted the broader financial and credit markets and reduced the availability of debt and equity capital for the market as a whole and financial services firms in particular. There have been more recent periods of volatility and there can be no assurance that adverse market conditions will not repeat themselves in the future. If similar adverse and volatile market conditions repeat in the future, us and other companies in the financial services sector may have to access, if available, alternative markets for debt and equity capital in order to grow.

 

17


Moreover, the reappearance of market conditions similar to those experienced from 2008 through 2009 for any substantial length of time or worsened market conditions, including as a result of U.S. government shutdowns or the perceived creditworthiness of the United States, could make it difficult for us to borrow money or to extend the maturity of or refinance any indebtedness it may have under similar terms and any failure to do so could have a material adverse effect on our business. Unfavorable economic conditions, including future recessions, also could increase our funding costs, limit its access to the capital markets or result in a decision by lenders not to extend credit to us. We may in the future have difficulty accessing debt and equity capital on attractive terms, or at all, and a severe disruption and instability in the global financial markets or deteriorations in credit and financing conditions may cause us to reduce the volume of loans we originate and/or fund, adversely affect the value of our portfolio investments or otherwise have a material adverse effect on our business, financial condition, results of operations and cash flows.

The United Kingdom referendum decision to leave the European Union may create significant risks and uncertainty for global markets and our investments.

The decision made in the United Kingdom referendum in June 2016 to leave the European Union has led to volatility in global financial markets, and in particular in the markets of the United Kingdom and across Europe, and may also lead to weakening in consumer, corporate and financial confidence in the United Kingdom and Europe. The process for the United Kingdom to exit the European Union, and the longer term economic, legal, political and social framework to be put in place between the United Kingdom and the European Union remain unclear and may to lead to ongoing political and economic uncertainty and periods of exacerbated volatility in both the United Kingdom and in wider European markets for some time. In particular, the decision made in the United Kingdom referendum may lead to a call for similar referenda in other European jurisdictions which may cause increased economic volatility and uncertainty in the European and global markets. This volatility and uncertainty may have an adverse effect on the economy generally and on the ability of us and our portfolio companies to execute our respective strategies and to receive attractive returns.

Terrorist attacks, acts of war or natural disasters may affect any market for our Common Stock, impact the businesses in which we invest and harm our business, operating results and financial condition.

Terrorist attacks, acts of war or natural disasters may disrupt our operations, as well as the operations of the businesses in which we invest. Such acts have created, and continue to create, economic and political uncertainties and have contributed to global economic instability. Further terrorist activities, military or security operations, or natural disasters could further weaken the domestic/global economies and create additional uncertainties, which may negatively impact the businesses in which we invest directly or indirectly and, in turn, could have a material adverse impact on our business, operating results and financial condition. Losses from terrorist attacks and natural disasters are generally uninsurable.

Risks Related to our Business and Structure

Ineffective internal controls could impact our business and operating results.

Our internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. If we fail to maintain the adequacy of its internal controls, including any failure to implement required new or improved controls, or if we experience difficulties in their implementation, its business and operating results could be harmed and we could fail to meet its financial reporting obligations.

 

18


Sierra Crest has limited prior experience managing a BDC or a RIC.

Sierra Crest has limited experience managing a BDC or a RIC and may not be able to successfully operate our business or achieve our investment objective. As a result, an investment in our Common Stock may entail more risk than the shares of common stock of a comparable company with a substantial operating history.

The 1940 Act and the Code impose numerous constraints on the operations of BDCs and RICs that do not apply to the other types of investment vehicles previously managed by Sierra Crest’s management team. For example, under the 1940 Act, BDCs are required to invest at least 70% of their total assets primarily in securities of qualifying U.S. private or thinly-traded public companies. Moreover, qualification for RIC tax treatment under Subchapter M of the Code requires, among other things, satisfaction of source-of-income, asset diversification and other requirements. The failure to comply with these provisions in a timely manner could prevent us from qualifying as a BDC or RIC or could force us to pay unexpected taxes and penalties, which could be material. Sierra Crest’s limited experience in managing a portfolio of assets under such constraints may hinder its ability to take advantage of attractive investment opportunities and, as a result, achieve our investment objective.

Sierra Crest and its affiliates, including our officers and some of our directors, face conflicts of interest caused by compensation arrangements with us and our affiliates, which could result in actions that are not in the best interests of our stockholders.

Sierra Crest and its affiliates will receive substantial fees from us in return for their services, including certain incentive fees based on the performance of our investments. These fees could influence the advice provided to us. Generally, the more equity we sell in private offerings and the greater the risk assumed by us with respect to our investments, the greater the potential for growth in our assets and profits, and, correlatively, the fees payable by us to Sierra Crest. These compensation arrangements could affect Sierra Crest or its affiliates’ judgment with respect to private offerings of equity and investments made by us, which allows Sierra Crest to earn increased asset management fees.

We may be obligated to pay Sierra Crest incentive compensation even if it incurs a net loss due to a decline in the value of our portfolio.

Our Investment Advisory Agreement entitles Sierra Crest to receive incentive compensation on income regardless of any capital losses. In such case, we may be required to pay Sierra Crest incentive compensation for a fiscal quarter even if there is a decline in the value of our portfolio or if we incur a net loss for that quarter.

Any incentive fee payable by us that relates to our net investment income may be computed and paid on income that may include interest that has been accrued, but not yet received, including original issue discount, which may arise if we receive fees in connection with the origination of a loan or possibly in other circumstances, or contractual PIK interest, which represents contractual interest added to the loan balance and due at the end of the loan term. To the extent we do not distribute accrued PIK interest, the deferral of PIK interest has the simultaneous effects of increasing the assets under management and increasing the base management fee at a compounding rate, while generating investment income and increasing the incentive fee at a compounding rate. In addition, the deferral of PIK interest would also increase the loan-to-value ratio at a compounding rate if the issuer’s assets do not increase in value, and investments with a deferred interest feature, such as PIK interest, may represent a higher credit risk than loans on which interest must be paid in full in cash on a regular basis.

For example, if a portfolio company defaults on a loan that is structured to provide accrued interest, it is possible that accrued interest previously included in the calculation of the incentive fee will become uncollectible. Sierra Crest is not under any obligation to reimburse us for any part of the incentive fee it received that was based on accrued income that we never received as a result of a default by an entity on the obligation that resulted in the accrual of such income, and such circumstances would result in us paying an incentive fee on income that we never received.

 

19


There may be conflicts of interest related to obligations that Sierra Crest’s senior management and investment team has to other clients.

The members of the senior management and investment team of Sierra Crest serve or may serve as officers, directors or principals of entities that operate in the same or a related line of business as us, or of investment funds managed by the same personnel. In serving in these multiple capacities, they may have obligations to other clients or investors in those entities, the fulfillment of which may not be in our best interests or in the best interest of our stockholders. Our investment objective may overlap with the investment objectives of such investment funds, accounts or other investment vehicles. In particular, we rely on Sierra Crest to manage our day-to-day activities and to implement our investment strategy. Sierra Crest and certain of its affiliates are presently, and plan in the future to continue to be, involved with activities that are unrelated to us. As a result of these activities, Sierra Crest, its officers and employees and certain of its affiliates will have conflicts of interest in allocating their time between us and other activities in which they are or may become involved, including the management of its affiliated funds. Sierra Crest and its officers and employees will devote only as much of its or their time to our business as Sierra Crest and its officers and employees, in their judgment, determine is reasonably required, which may be substantially less than their full time.

We rely, in part, on Sierra Crest to assist with identifying and executing upon investment opportunities and on our Board of Directors to review and approve the terms of our participation in co-investment transactions with Sierra Crest and its affiliates. Sierra Crest and its affiliates are not restricted from forming additional investment funds, entering into other investment advisory relationships or engaging in other business activities. These activities could be viewed as creating a conflict of interest in that the time and effort of the members of Sierra Crest, its affiliates and their officers and employees will not be devoted exclusively to our business, but will be allocated between us and such other business activities of Sierra Crest and its affiliates in a manner that Sierra Crest deems necessary and appropriate.

An affiliate of Sierra Crest manages BC Partners Lending Corporation, which is a BDC that will invest primarily in debt and equity of privately-held middle-market companies, similar to our targets for investment. Therefore, there may be certain investment opportunities that satisfy the investment criteria for BC Partners and us. BC Partners operates as a distinct and separate company and any investment in our Common Stock will not be an investment in BC Partners. In addition, certain of our executive officers serve in substantially similar capacities for BC Partners and three of our independent directors serve as independent directors of BC Partners.

The time and resources that individuals employed by Sierra Crest devote to us may be diverted and we may face additional competition due to the fact that individuals employed by Sierra Crest are not prohibited from raising money for or managing other entities that make the same types of investments that we target.

Neither Sierra Crest nor individuals employed by Sierra Crest are generally prohibited from raising capital for and managing other investment entities that make the same types of investments that we target. As a result, the time and resources that these individuals may devote to us may be diverted. In addition, we may compete with any such investment entity for the same investors and investment opportunities. On October 23, 2018, the SEC issued an order granting an application for exemptive relief to an affiliate of Sierra Crest that allows BDCs managed by Sierra Crest, including us, to co-invest, subject to the satisfaction of certain conditions, in certain private placement transactions, with other funds managed by Sierra Crest or its affiliates, including BCP Special Opportunities Fund I LP and BCP Special Opportunities Fund II LP and any future funds that are advised by Sierra Crest or its affiliated investment advisers. Affiliates of Sierra Crest, whose primary business includes the origination of investments, engage in investment advisory business with accounts that compete with us.

Our base management and incentive fees may induce Sierra Crest to make speculative investments or to incur leverage.

The incentive fee payable by us to Sierra Crest may create an incentive for Sierra Crest to make investments on our behalf that are risky or more speculative than would be the case in the absence of such compensation

 

20


arrangement. The way in which the incentive fee payable to Sierra Crest is determined may encourage Sierra Crest to use leverage to increase the leveraged return on our investment portfolio. The part of the management and incentive fees payable to Sierra Crest that relates to our net investment income is computed and paid on income that may include interest income that has been accrued but not yet received in cash, such as market discount, debt instruments with PIK interest, preferred stock with PIK dividends and zero coupon securities. This fee structure may be considered to involve a conflict of interest for Sierra Crest to the extent that it may encourage Sierra Crest to favor debt financings that provide for deferred interest, rather than current cash payments of interest.

In addition, the fact that our base management fee is payable based upon our gross assets, which would include any borrowings for investment purposes, may encourage Sierra Crest to use leverage to make additional investments. Under certain circumstances, the use of leverage may increase the likelihood of defaulting on our borrowings, which would disfavor holders of our Common Stock. Such a practice could result in us investing in more speculative securities than would otherwise be in our best interests, which could result in higher investment losses, particularly during cyclical economic downturns.

Sierra Crest relies on key personnel, the loss of any of whom could impair its ability to successfully manage us.

Our future success depends, to a significant extent, on the continued services of the officers and employees of Sierra Crest or its affiliates. The loss of services of one or more members of Sierra Crest’s management team, including members of our investment team, could adversely affect our financial condition, business and results of operations.

Sierra Crest may retain additional consultants, advisors and/or operating partners to provide services to us, and such additional personnel will perform similar functions and duties for other organizations which may give rise to conflicts of interest.

BC Partners may work with or alongside one or more consultants, advisors (including senior advisors and CEOs) and/or operating partners who are retained by BC Partners on a consultancy or retainer or other basis, to provide services to us and other entities sponsored by BC Partners including the sourcing of investments and other investment-related and support services. The functions undertaken by such persons with respect to us and any of its investments will not be exclusive and such persons may perform similar functions and duties for other organizations which may give rise to conflicts of interest. Such persons may also be appointed to the board of directors of companies and have other business interests which give rise to conflicts of interest with the interests of us or a portfolio entity of us. Stockholders should note that such persons may retain compensation that will not offset the base management fee payable to Sierra Crest, including that: (i) such persons are permitted to retain all directors’ fees, monitoring fees and other compensation received by them in respect of acting as a director or officer of, or providing other services to, a portfolio entity and such amounts shall not be credited against the base management fee; and (ii) certain of such persons may be paid a deal fee, a consultancy fee or other compensation where they are involved in a specific project relating to us, which fee will be paid either by us or, if applicable, the relevant portfolio entity.

The compensation we pay to Sierra Crest was determined without independent assessment on our behalf, and these terms may be less advantageous to us than if such terms had been the subject of arm’s-length negotiations.

The compensation we pay to Sierra Crest was not entered into on an arm’s-length basis with an unaffiliated third party. As a result, the form and amount of such compensation may be less favorable to us than they might have been had these been entered into through arm’s-length transactions with an unaffiliated third party.

 

21


Sierra Crest’s influence on conducting our operations gives it the ability to increase its fees, which may reduce the amount of cash flow available for distribution to our stockholders.

Sierra Crest is paid a base management fee calculated as a percentage of our gross assets and unrelated to net income or any other performance base or measure. Sierra Crest may advise us to consummate transactions or conduct its operations in a manner that, in Sierra Crest’s reasonable discretion, is in the best interests of our stockholders. These transactions, however, may increase the amount of fees paid to Sierra Crest. Sierra Crest’s ability to influence the base management fee paid to it by us could reduce the amount of cash flow available for distribution to our stockholders.

We operate in a highly competitive market for investment opportunities.

A large number of entities compete with us to make the types of investments that we make. We compete with other BDCs, as well as a number of investment funds, investment banks and other sources of financing, including traditional financial services companies, such as commercial banks and finance companies. Many of our competitors are substantially larger and have considerably greater financial, marketing and other resources than us. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. This may enable some of our competitors to make commercial loans with interest rates that are lower than the rates we typically offers. We may lose prospective portfolio investments if it does not match its competitors’ pricing, terms and structure. If we do match our competitors’ pricing, terms or structure, it may experience decreased net interest income. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments, establish more relationships and build their market shares. Furthermore, many of our potential competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a BDC. As a result of this competition, there can be no assurance that we will be able to identify and take advantage of attractive investment opportunities or that we will be able to fully invest our available capital. If we are not able to compete effectively, its business and financial condition and results of operations will be adversely affected.

If Sierra Crest is unable to source investments effectively, we may be unable to achieve its investment objectives and provide returns to stockholders.

Our ability to achieve its investment objective depends on Sierra Crest’s ability to identify, evaluate and invest in suitable companies that meet our investment criteria. Accomplishing this result on a cost-effective basis is largely a function of Sierra Crest’s marketing capabilities, its management of the investment process, its ability to provide efficient services and its access to financing sources on acceptable terms. Failure to source investments effectively could have a material adverse effect on our business, financial condition and results of operations.

We may have difficulty paying distributions required to maintain our RIC status if we recognize income before or without receiving cash equal to such income.

In accordance with the Code, we include in income certain amounts that we have not yet received in cash, such as non-cash PIK interest, which represents contractual interest added to the loan balance and due at the end of the loan term. The increases in loan balances as a result of contracted non-cash PIK arrangements are included in income for the period in which such non-cash PIK interest was received, which is often in advance of receiving cash payment, and are separately identified on our statements of cash flows. We also may be required to include in income certain other amounts that we will not receive in cash. Any warrants that we receive in connection with our debt investments generally are valued as part of the negotiation process with the particular portfolio company. As a result, a portion of the aggregate purchase price for the debt investments and warrants is allocated to the warrants that we receive. This generally results in the associated debt investment having “original issue discount” for tax purposes, which we must recognize as ordinary income as it accrues. This increases the amounts that we are required to distribute to maintain our qualification for tax treatment as a RIC. Because such

 

22


original issue discount income might exceed the amount of cash received in a given year with respect to such investment, we might need to obtain cash from other sources to satisfy such distribution requirements. Other features of the debt instruments that we hold may also cause such instruments to generate original issue discount.

Since, in certain cases, we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the annual distribution requirement necessary to maintain RIC tax treatment under the Code. Accordingly, we may have to sell some of our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity capital or forgo new investment opportunities for this purpose. If we are not able to obtain cash from other sources, we may fail to qualify for RIC tax treatment and thus become subject to corporate-level U.S. federal income tax. For additional discussion regarding the tax implication of a RIC, see “Certain U.S. Federal Income Tax Considerations.”

Any unrealized losses we experience on our loan portfolio may be an indication of future realized losses, which could reduce our resources available to make distributions.

As a BDC, we are required to carry our investments at market value or, if no market value is ascertainable, at the fair value as determined in good faith by our Board of Directors pursuant to a valuation methodology approved by our Board of Directors. Decreases in the market values or fair values of our investments will be recorded as unrealized losses. An unrealized loss in our loan portfolio could be an indication of a portfolio company’s inability to meet its repayment obligations with respect to the affected loans. This could result in realized losses in the future and ultimately in reductions of our resources available to pay dividends or interest and principal on our securities and could cause you to lose all or part of your investment.

We may experience fluctuations in our quarterly and annual operating results and credit spreads.

We could experience fluctuations in our quarterly and annual operating results due to a number of factors, some of which are beyond our control, including our ability to make investments in companies that meet our investment criteria, the interest rate payable on the debt securities we acquire (which could stem from the general level of interest rates, credit spreads, or both), the default rate on such securities, prepayment upon the triggering of covenants in our middle-market loans as well as our CLO Funds, our level of expenses, variations in and timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods.

We are exposed to risks associated with changes in interest rates and spreads.

Changes in interest rates may have a substantial negative impact on our investments, the value of its securities and its rate of return on invested capital. A reduction in the interest spreads on new investments could also have an adverse impact on our net interest income. An increase in interest rates could decrease the value of any investments we hold which earn fixed interest rates, including mezzanine securities and high-yield bonds, and also could increase its interest expense, thereby decreasing its net income. An increase in interest rates due to an increase in credit spreads, regardless of general interest rate fluctuations, could also negatively impact the value of any investments we hold in our portfolio.

In addition, an increase in interest rates available to investors could make an investment in our securities less attractive than alternative investments, a situation which could reduce the value of our securities. Conversely, a decrease in interest rates may have an adverse impact on our returns by requiring us to seek lower yields on our debt investments and by increasing the risk that our portfolio companies will prepay our debt investments, resulting in the need to redeploy capital at potentially lower rates. A decrease in market interest rates may also adversely impact our returns on idle funds, which would reduce our net investment income.

 

23


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

LIBOR, the London interbank offered rate, is the basic rate of interest used in lending between banks on the London interbank market and is widely used as a reference for setting the interest rate on loans globally. We typically use LIBOR as a reference rate in term loans that we extend to portfolio companies such that the interest due to us, pursuant to a term loan extended to a partner company, is calculated using LIBOR. Some of our term loan agreements with partner companies contain a stated minimum value for LIBOR.

In 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced the desire to phase out LIBOR by the end of 2021. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing U.S.-dollar LIBOR with the SOFR a new index calculated by short-term repurchase agreements, backed by Treasury securities. Although there have been a few issuances utilizing SOFR or the Sterling Over Night Index Average, an alternative reference rate that is based on transactions, it is unknown whether these alternative reference rates will attain market acceptance as replacements for LIBOR.

If LIBOR ceases to exist, we may need to renegotiate any credit agreements extending beyond 2021 with its prospective portfolio companies that utilize LIBOR as a factor in determining the interest rate. There is currently no definitive information regarding the future utilization of LIBOR or of any particular replacement rate. As such, the potential effect of any such event on our cost of capital and net investment income cannot yet be determined.

We borrow money, which magnifies the potential for gain or loss on amounts invested and may increase the risk of investing in us.

Borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increase the risks associated with investing in us. We have issued senior securities, and in the future may borrow from, or issue additional senior securities (such as preferred or convertible securities or debt securities) to, banks and other lenders and investors. Subject to prevailing market conditions, we intend to grow our portfolio of assets by raising additional capital, including through the prudent use of leverage available to us. Lenders and holders of such senior securities would have fixed dollar claims on our assets that are superior to the claims of our common stockholders. Leverage is generally considered a speculative investment technique. Any increase in our income in excess of interest payable on our outstanding indebtedness would cause our net income to increase more than it would have had we not incurred leverage, while any decrease in our income would cause net income to decline more sharply than it would have had we not incurred leverage. Such a decline could negatively affect our ability to make distributions to our stockholders and service our debt obligations. In addition, our common stockholders will bear the burden of any increase in our expenses as a result of leverage. There can be no assurance that our leveraging strategy will be successful.

Our outstanding indebtedness imposes, and additional debt we may incur in the future will likely impose, financial and operating covenants that restrict our business activities, including limitations that could hinder our ability to finance additional loans and investments or to make the distributions required to maintain our status as a RIC. A failure to add new debt facilities or issue additional debt securities or other evidences of indebtedness in lieu of or in addition to existing indebtedness could have a material adverse effect on our business, financial condition or results of operations.

The following table illustrates the effect of leverage on returns from an investment in our common stock as of September 30, 2019, assuming various annual returns, net of expenses. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing in the table below.

 

Assumed Return on our Portfolio (Net of Expenses)(1)

   -10%   -5%   0   5%    10%

Corresponding return to common stockholder(2)

   (28.7)%   (17.3)%   (5.9)%   5.5%    16.9%

 

24


 

(1)

The assumed portfolio return is required by SEC regulations and is not a prediction of, and does not represent, our projected or actual performance. Actual returns may be greater or less than those appearing in the table. Pursuant to SEC regulations, this table is calculated on a pro forma combined basis as of September 30, 2019. As a result, it has not been updated to take into account any changes in assets or leverage since such date.

(2)

Assumes $362 million in total assets, $155 million in debt outstanding and $158 million in net assets as of as of September 30, 2019 and a weighted average interest rate of 6.0% as of September 30, 2019.

Our indebtedness could adversely affect our financial health and our ability to respond to changes in our business.

With certain limited exceptions, we are only allowed to borrow amounts or issue senior securities such that our asset coverage, as defined in the 1940 Act, is at least 200% (or the 150% asset coverage ratio effective as of March 29, 2019) immediately after such borrowing or issuance. The amount of leverage that we employ in the future will depend on our management’s and our Board of Directors’ assessment of market and other factors at the time of any proposed borrowing. There is no assurance that a leveraging strategy will be successful. As a result of the level of our leverage:

 

   

Our exposure to risk of loss is greater if we incur debt or issue senior securities to finance investments because a decrease in the value of our investments has a greater negative impact on our equity returns and, therefore, the value of our business if we do not use leverage;

 

   

the decrease in our asset coverage ratio resulting from increased leverage and the covenants contained in documents governing our indebtedness (which may impose asset coverage or investment portfolio composition requirements that are more stringent than those imposed by the 1940 Act) limit our flexibility in planning for, or reacting to, changes in our business and industry, as a result of which we could be required to liquidate investments at an inopportune time;

 

   

We are required to dedicate a portion of our cash flow to interest payments, limiting the availability of cash for dividends and other purposes; and

 

   

Our ability to obtain additional financing in the future may be impaired.

We cannot be sure that our leverage will not have a material adverse effect on our business, financial condition, results of operations and cash flows. In addition, we cannot be sure that additional financing will be available when required or, if available, will be on terms satisfactory to it. Further, even if we are able to obtain additional financing, we may be required to use some or all of the proceeds thereof to repay our outstanding indebtedness.

Our Board of Directors has approved its ability to incur additional leverage as permitted by recent legislation.

The 1940 Act generally prohibits BDCs from incurring indebtedness unless immediately after such borrowing they have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). However, the recently enacted SBCA has modified the 1940 Act by allowing a BDC to increase the maximum amount of leverage it may incur from an asset coverage ratio of 200% to an asset coverage ratio of 150%, if certain requirements are met. In other words, prior to the enactment of the SBCA, a BDC could borrow $1 for investment purposes for every $1 of investor equity. Now, for those BDCs that satisfy the SBCA’s approval and disclosure requirements, the BDC can borrow $2 for investment purposes for every $1 of investor equity.

In accordance with the SBCA, on March 29, 2018, our Board of Directors, including a “required majority” 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 March 29, 2019.

 

25


However, despite the SBCA, we will continue to be prohibited by the indentures governing its 2022 Notes from making distributions on our Common Stock if our asset coverage, as defined in the 1940 Act, falls below 200%. In any such event, we would be prohibited from making distributions required in order to maintain our status as a RIC.

Leverage magnifies the potential for loss on investments in our indebtedness and on invested equity capital. As we use leverage to partially finance our investments, you will experience increased risks of investing in our securities. If the value of our assets increase, then leveraging would cause the net asset value attributable to our Common Stock to increase more sharply than it would have had we not leveraged. Conversely, if the value of our assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not leveraged our business. Similarly, any increase in our income in excess of interest payable on the borrowed funds would cause our net investment income to increase more than it would without the leverage, while any decrease in our income would cause net investment income to decline more sharply than it would have had it not borrowed. Such a decline could negatively affect our ability to pay common stock dividends, scheduled debt payments or other payments related to its securities. Leverage is generally considered a speculative investment technique.

We may default under the Revolving Credit Facility or any future borrowing facility we enter into or be unable to amend, repay or refinance any such facility on commercially reasonable terms, or at all, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

In the event we default under the Revolving Credit Facility or any other future borrowing facility, our business could be adversely affected as it may be forced to sell a portion of its investments quickly and prematurely at prices that may be disadvantageous to it in order to meet its outstanding payment obligations and/or support working capital requirements under the Revolving Credit Facility or such future borrowing facility, any of which would have a material adverse effect on its business, financial condition, results of operations and cash flows. In addition, following any such default, the agent for the lenders under the Revolving Credit Facility or such future borrowing facility could assume control of the disposition of any or all of our assets, including the selection of such assets to be disposed and the timing of such disposition, which would have a material adverse effect on our business, financial condition, results of operations and cash flows.

Provisions in the Revolving Credit Facility or any other future borrowing facility may limit our discretion in operating our business.

The Revolving Credit Facility is, and any future borrowing facility may be, backed by all or a portion of our loans and securities on which the lenders will or, in the case of a future facility, may have a security interest. We may pledge up to 100% of its assets and may grant a security interest in all of its assets under the terms of any debt instrument we enter into with lenders. We expect that any security interests it grants will be set forth in a pledge and security agreement and evidenced by the filing of financing statements by the agent for the lenders. In addition, we expect that the custodian for its securities serving as collateral for such loan would include in its electronic systems notices indicating the existence of such security interests and, following notice of occurrence of an event of default, if any, and during its continuance, will only accept transfer instructions with respect to any such securities from the lender or its designee. If we were to default under the terms of any debt instrument, the agent for the applicable lenders would be able to assume control of the timing of disposition of any or all of our assets securing such debt, which would have a material adverse effect on our business, financial condition, results of operations and cash flows.

In addition, any security interests as well as negative covenants under the Revolving Credit Facility or any other borrowing facility may limit our ability to create liens on assets to secure additional debt and may make it difficult for us to restructure or refinance indebtedness at or prior to maturity or obtain additional debt or equity financing. In addition, if our borrowing base under the Revolving Credit Facility or any other borrowing facility were to decrease, we would be required to secure additional assets in an amount equal to any borrowing base

 

26


deficiency. In the event that all of our assets are secured at the time of such a borrowing base deficiency, we could be required to repay advances under the Revolving Credit Facility or any other borrowing facility or make deposits to a collection account, either of which could have a material adverse impact on our ability to fund future investments and to make stockholder distributions.

In addition, under the Revolving Credit Facility or any future borrowing facility, we will be subject to limitations as to how borrowed funds may be used, which may include restrictions on geographic and industry concentrations, loan size, payment frequency and status, average life, collateral interests and investment ratings, as well as regulatory restrictions on leverage, which may affect the amount of funding that may be obtained. There may also be certain requirements relating to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs, a violation of which could limit further advances and, in some cases, result in an event of default. An event of default under the Revolving Credit Facility or any other borrowing facility could result in an accelerated maturity date for all amounts outstanding thereunder, which could have a material adverse effect on our business and financial condition. This could reduce our revenues and, by delaying any cash payment allowed to it under the Revolving Credit Facility or any other borrowing facility until the lenders have been paid in full, reduce our liquidity and cash flow and impair our ability to grow our business and maintain our qualification as a RIC.

Because we intend to continue to distribute substantially all of our income and net realized capital gains to our stockholders, we will need additional capital to finance our growth.

In order to continue to qualify as a RIC, to avoid payment of excise taxes and to minimize or avoid payment of U.S. federal income taxes, we intend to continue to distribute to our stockholders substantially all of our net ordinary income and realized net capital gains (although we may retain certain net long-term capital gains, pay applicable U.S. federal income taxes with respect thereto, and elect to treat as deemed distributions to our stockholders). As a BDC, in order to incur new debt, we are generally required to meet a coverage ratio of total assets to total senior securities, which includes all of our borrowings and any preferred stock we may issue in the future, of at least 200% (or the 150% asset coverage ratio effective as of March 29, 2019), as measured immediately after issuance of such security. This requirement limits the amount that we may borrow. Because we will continue to need capital to grow our loan and investment portfolio, this limitation may prevent us from incurring debt and require us to issue additional equity at a time when it may be disadvantageous to do so. We cannot assure you that debt and equity financing will be available to us on favorable terms, or at all, and debt financings may be restricted by the terms of such borrowings. Also, as a business development company, we generally are not permitted to issue equity securities priced below net asset value without stockholder approval. If additional funds are not available to us, we could be forced to curtail or cease new lending and investment activities.

We may from time to time expand our business through acquisitions, which could disrupt our business and harm our financial condition.

We may pursue potential acquisitions of, and investments in, businesses complementary to our business and from time to time engage in discussions regarding such possible acquisitions. Such acquisition and any other acquisitions we may undertake involve a number of risks, including:

 

   

failure of the acquired businesses to achieve the results we expect;

 

   

substantial cash expenditures;

 

   

diversion of capital and management attention from operational matters;

 

   

our inability to retain key personnel of the acquired businesses;

 

   

incurrence of debt and contingent liabilities and risks associated with unanticipated events or liabilities; and

 

27


   

the potential disruption and strain on our existing business and resources that could result from our planned growth and continuing integration of our acquisitions.

If we fail to properly evaluate acquisitions or investments, we may not achieve the anticipated benefits of such acquisitions, we may incur costs in excess of what it anticipates, and management resources and attention may be diverted from other necessary or valuable activities. Any acquisition may not result in short-term or long-term benefits to us. If we are unable to integrate or successfully manage any business that we acquire, we may not realize anticipated cost savings, improved efficiencies or revenue growth, which may result in reduced profitability or operating losses.

We may invest through joint ventures, partnerships or other special purpose vehicles and its investments through these vehicles may entail greater risks, or risks that it otherwise would not incur, if we otherwise made such investments directly.

We may make indirect investments in portfolio companies through joint ventures, partnerships or other special purpose vehicles (“Investment Vehicles”). In general, the risks associated with indirect investments in portfolio companies through a joint venture, partnership or other special purpose vehicle are similar to those associated with a direct investment in a portfolio company. While we intend to analyze the credit and business of a potential portfolio company in determining whether or not to make an investment in an Investment Vehicle, we will nonetheless be exposed to the creditworthiness of the Investment Vehicle. In the event of a bankruptcy proceeding against the portfolio company, the assets of the portfolio company may be used to satisfy its own obligations prior to the satisfaction of our investment in the Investment Vehicle (i.e., our investment in the Investment Vehicle could be structurally subordinated to the other obligations of the portfolio company). In addition, if we are to invest in an Investment Vehicle, we may be required to rely on our partners in the Investment Vehicle when making decisions regarding the Investment Vehicle’s investments, accordingly, the value of the investment could be adversely affected if our interests diverge from those of our partners in the Investment Vehicle.

Our Board of Directors may change our investment objective, operating policies and strategies without prior notice or stockholder approval.

Our Board of Directors has the authority to modify or waive certain of our operating policies and strategies without prior notice and without stockholder approval. However, absent stockholder approval, our Board of Directors may not change the nature of our business so as to cease to be, or withdraw its election as, a BDC. We cannot predict the effect any changes to our current operating policies and strategies would have on our business and operating results. Nevertheless, the effects may adversely affect our business and they could negatively impact our ability to pay you dividends and could cause you to lose all or part of your investment in our securities.

Our businesses may be adversely affected by litigation and regulatory proceedings.

From time to time, we may be subject to legal actions as well as various regulatory, governmental and law enforcement inquiries, investigations and subpoenas. In any such claims or actions, demands for substantial monetary damages may be asserted against us and may result in financial liability or an adverse effect on our reputation among investors. We may be unable to accurately estimate our exposure to litigation risk when we record balance sheet reserves for probable loss contingencies. As a result, any reserves we establish to cover any settlements or judgments may not be sufficient to cover our actual financial exposure, which may have a material impact on our results of operations or financial condition. In regulatory enforcement matters, claims for disgorgement, the imposition of penalties and the imposition of other remedial sanctions are possible.

 

28


Regulations governing our operation as a BDC affect our ability to, and the way in which we raise, additional capital.

Our business requires a substantial amount of additional capital. We may acquire additional capital from the issuance of senior securities or other indebtedness, the issuance of additional shares of our Common Stock or from securitization transactions. However, we may not be able to raise additional capital in the future on favorable terms or at all. We may issue debt securities or preferred securities, which we refer to collectively as “senior securities,” and we may borrow money from banks or other financial institutions, up to the maximum amount permitted by the 1940 Act. The 1940 Act permits us to issue senior securities or incur indebtedness only in amounts such that its asset coverage, as defined in the 1940 Act, equals at least 200% (or the 150% asset coverage ratio effective as of March 29, 2019) immediately after such issuance or incurrence. With respect to certain types of senior securities, we must make provisions to prohibit any dividend distribution to our stockholders or the repurchase of certain of our securities, unless we meet the applicable asset coverage ratios at the time of the dividend distribution or repurchase. If the value of our assets declines, we may be unable to satisfy the asset coverage test. Furthermore, any amounts that we use to service our indebtedness would not be available for distributions to our common stockholders.

All of the costs of offering and servicing such debt or preferred stock (if issued by us in the future), including interest or preferential dividend payments thereon, will be borne by our common stockholders.

The interests of the holders of any debt or preferred stock we may issue will not necessarily be aligned with the interests of its common stockholders. In particular, the rights of holders of our debt or preferred stock to receive interest, dividends or principal repayment will be senior to those of our common stockholders. Also, in the event we issue preferred stock, the holders of such preferred stock will have the ability to elect two members of our Board of Directors. In addition, we may grant a lender a security interest in a significant portion or all of our assets, even if the total amount we may borrow from such lender is less than the amount of such lender’s security interest in our assets.

We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock at a price below the then-current net asset value of our common stock if our Board of Directors determines that such sale is in the best interests of us and our stockholders, and our stockholders approve, giving us the authority to do so. Although we currently do not have such authorization, we previously sought and received such authorization from our stockholders in the past and may seek such authorization in the future. In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in the determination of our Board of Directors, closely approximates the market value of such securities (less any distributing commission or discount). We are also generally prohibited under the 1940 Act from issuing securities convertible into voting securities without obtaining the approval of our existing stockholders. Sales of common stock at prices below net asset value per share dilute the interests of existing stockholders, have the effect of reducing our net asset value per share and may reduce our market price per share. In addition to issuing securities to raise capital as described above; we may securitize a portion of the loans to generate cash for funding new investments. If we are unable to successfully securitize our loan portfolio, our ability to grow our business and fully execute our business strategy and our earnings (if any) may be adversely affected. Moreover, even successful securitization of our loan portfolio might expose us to losses, as the residual loans in which we do not sell interests tend to be those that are riskier and more apt to generate losses.

The application of the risk retention rules under Section 941 of the Dodd-Frank Act to CLOs may have broader effects on the CLO and loan markets in general, potentially resulting in fewer or less desirable investment opportunities for us.

Section 941 of the Dodd-Frank Act added a provision to the Exchange Act requiring the seller, sponsor or securitizer of a securitization vehicle to retain no less than five percent of the credit risk in assets it sells into a securitization and prohibiting such securitizer from, directly or indirectly, hedging or otherwise transferring the

 

29


retained credit risk. The responsible federal agencies adopted final rules implementing these restrictions on October 22, 2014. The U.S. risk retention rules became effective with respect to CLOs two years after publication in the Federal Register. Under the final rules, the asset manager of a CLO is considered the sponsor of a securitization vehicle and is required to retain five percent of the credit risk in the CLO, which may be retained horizontally in the equity tranche of the CLO or vertically as a five percent interest in each tranche of the securities issued by the CLO.

On February 9, 2018, the D.C. Circuit Court ruled in favor of an appeal brought by the Loan Syndications and Trading Association (the “LSTA”) against the SEC and the Board of Governors of the Federal Reserve System (the “Applicable Governmental Agencies”) that managers of so-called “open market CLOs” are not “securitizers” under Section 941 of the Dodd-Frank Act and, therefore, are not subject to the requirements of the U.S. risk retention rules (the “Appellate Court Ruling”). The LSTA was appealing from a judgment entered by the D.C. District Court, which granted summary judgment in favor of the SEC and Federal Reserve and against the LSTA with respect to its challenges.

On April 5, 2018, the D.C. District Court entered an order implementing the Appellate Court Ruling and thereby vacated the U.S. risk retention rules insofar as they apply to CLO managers of “open market CLOs.” In addition, the Applicable Governmental Agencies did not request that the case be heard by the United States Supreme Court. Since the Applicable Governmental Agencies have not successfully challenged the Appellate Court Ruling and the D.C. District Court has issued the above-described order implementing the Appellate Court Ruling, collateral managers of open market CLOs are no longer required to comply with the U.S. risk retention rules at this time. As such, it is possible that some collateral managers of open market CLOs will decide to dispose of the notes constituting the “eligible vertical interest” or “eligible horizontal interest” they were previously required to retain, or decide to take other action with respect to such notes that is not otherwise permitted by the U.S. risk retention rules. As a result of this decision, certain CLO managers of “open market CLOs” will no longer be required to comply with the U.S. risk retention rules solely because of their roles as managers of “open market CLOs”, and there may be no “sponsor” of such securitization transactions and no party may be required to acquire and retain an economic interest in the credit risk of the securitized assets of such transactions.

There can be no assurance or representation that any of the transactions, structures or arrangements currently under consideration by or currently used by CLO market participants will comply with the U.S. risk retention rules to the extent such rules are reinstated or otherwise become applicable to open market CLOs. The ultimate impact of the U.S. risk retention rules on the loan securitization market and the leveraged loan market generally remains uncertain, and any negative impact on secondary market liquidity for securities comprising a CLO may be experienced due to the effects of the U.S. risk retention rules on market expectations or uncertainty, the relative appeal of other investments not impacted by the U.S. risk retention rules and other factors.

If we do not invest a sufficient portion of our assets in Qualifying Assets, we could be precluded from investing according to our current business strategy.

As a BDC, we may not acquire any assets other than assets of the type listed in Section 55(a) of the 1940 Act (“Qualifying Assets”) unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets are Qualifying Assets. See “Regulation—Qualifying Assets.

We believe that most of the senior loans and mezzanine investments that we acquire constitute Qualifying Assets. However, investments in the securities of CLO Funds generally do not constitute Qualifying Assets, and we may invest in other assets that are not Qualifying Assets. If we do not invest a sufficient portion of our assets in Qualifying Assets, we may be precluded from investing in what we believe are attractive investments, which would have a material adverse effect on our business, financial condition and results of operations. Similarly, these rules could prevent us from making follow-on investments in existing portfolio companies (which could result in the dilution of its position).

 

30


Our ability to enter into transactions with our affiliates is restricted.

We are prohibited under the 1940 Act from participating in certain transactions with certain of our affiliates without the prior approval of the members of our independent directors and, in some cases, the SEC. Any person that owns, directly or indirectly, 5% or more of our outstanding voting securities is our affiliate for purposes of the 1940 Act and we are generally prohibited from buying or selling any securities (other than our securities) from or to such affiliate, absent the prior approval of our independent directors. The 1940 Act also prohibits certain “joint” transactions with certain of our affiliates, which could include investments in the same portfolio company (whether at the same or different times), without prior approval of our independent directors and, in some cases, the SEC. If a person acquires more than 25% of our voting securities, we will be prohibited from buying or selling any security (other than any security of which we are the issuer) from or to such person or certain of that person’s affiliates, or entering into prohibited joint transactions with such person, absent the prior approval of the SEC. Similar restrictions limit our ability to transact business with our officers or directors or their affiliates.

A failure on our part to maintain our status as a BDC would significantly reduce our operating flexibility.

If we fail to maintain our status as a BDC, we might be regulated as a closed-end investment company that is required to register under the 1940 Act, which would subject us to additional regulatory restrictions and significantly decrease our operating flexibility. In addition, any such failure could cause an event of default under our outstanding indebtedness, which could have a material adverse effect on our business, financial condition or results of operations.

Our business and operations could be negatively affected if we become subject to any securities litigation or stockholder activism, which could cause us to incur significant expense, hinder execution of investment strategy and impact our stock price.

In the past, following periods of volatility in the market price of a company’s securities, securities class-action litigation has often been brought against that company. Stockholder activism, which could take many forms or arise in a variety of situations, has been increasing in the BDC space recently. While we are currently not subject to any securities litigation or stockholder activism, we may in the future become the target of securities litigation or stockholder activism. Securities litigation and stockholder activism, including potential proxy contests, could result in substantial costs and divert management’s and our Board of Directors’ attention and resources from our business. Additionally, such securities litigation and stockholder activism could give rise to perceived uncertainties as to our future, adversely affect our relationships with service providers and make it more difficult to attract and retain qualified personnel. Also, we may be required to incur significant legal fees and other expenses related to any securities litigation and activist stockholder matters. Further, our stock price could be subject to significant fluctuation or otherwise be adversely affected by the events, risks and uncertainties of any securities litigation and stockholder activism.

We will be subject to corporate-level U.S. federal income taxes if we are unable to qualify as a RIC under Subchapter M of the Code.

To maintain RIC tax treatment under the Code, we must meet the following annual distribution, income source and asset diversification requirements:

 

   

The annual distribution requirement for a RIC will be satisfied if we distribute to our stockholders on an annual basis at least 90% of the sum of our investment company taxable income (generally, our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any) and net tax-exempt income for each year. Because we use debt financing, we are subject to certain asset coverage ratio requirements under the 1940 Act and are (and may in the future become) subject to certain financial covenants under loan, indenture and credit agreements that could, under certain circumstances, restrict us from making distributions necessary to satisfy the distribution

 

31


 

requirement. If we are unable to obtain cash from other sources, we could fail to qualify for RIC tax treatment and thus become subject to corporate-level U.S. federal income taxes.

 

   

The source income requirement will be satisfied if we obtain at least 90% of our income for each year from dividends, interest, gains from the sale of stock or securities or similar sources.

 

   

The asset diversification requirement will be satisfied if we meet certain asset diversification requirements at the end of each quarter of our taxable year. To satisfy this requirement, at least 50% of the value of our assets must consist of cash, cash equivalents, U.S. Government securities, securities of other RICs, and other acceptable securities; and no more than 25% of the value of our assets can be invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships.” If we do not satisfy the diversification requirements as of the end of any quarter, we will not lose our status as a RIC provided that (i) we satisfied the requirements in a prior quarter and (ii) our failure to satisfy the requirements in the current quarter is not due in whole or in part to an acquisition of any security or other property.

Failure to meet these requirements may result in us having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments will be in private companies, and therefore will be illiquid, any such dispositions could be made at disadvantageous prices and could result in substantial losses. Moreover, if we fail to maintain RIC tax treatment for any reason and are subject to corporate-level U.S. federal income taxes, the resulting taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions. Such a failure would have a material adverse effect on us and on our stockholders.

Risks Associated with Our Information Technology Systems

We rely on various information technology systems to manage our operations. Information technology systems are subject to numerous risks including unanticipated operating problems, system failures, rapid technological change, failure of the systems that operate as anticipated, reliance on third-party computer hardware, software and IT service providers, computer viruses, telecommunication failures, data breaches, denial of service attacks, spamming, phishing attacks, computer hackers and other similar disruptions, any of which could materially adversely impact our consolidated financial condition and results of operations. Additional risks include, but are not limited to, the following:

Disruptions in current systems or difficulties in integrating new systems.

We regularly maintain, upgrade, enhance or replace our information technology systems to support our business strategies and provide business continuity. Replacing legacy systems with successor systems, making changes to existing systems or acquiring new systems with new functionality have inherent risks including disruptions, delays, or difficulties that may impair the effectiveness of our information technology systems.

Internal and external cyber threats, as well as other disasters, could impair our ability to conduct business effectively.

The occurrence of a disaster, such as a cyber-attack against us or against a third-party that has access to our data or networks, a natural catastrophe, an industrial accident, failure of our disaster recovery systems, or consequential employee error, could have an adverse effect on our ability to communicate or conduct business, negatively impacting our operations and financial condition. This adverse effect can become particularly acute if those events affect our electronic data processing, transmission, storage, and retrieval systems, or impact the availability, integrity, or confidentiality of our data.

 

32


We depend heavily upon computer systems to perform necessary business functions. Despite our implementation of a variety of security measures, our computer systems, networks, and data, like those of other companies, could be subject to cyber-attacks and unauthorized access, use, alteration, or destruction, such as from physical and electronic break-ins or unauthorized tampering. Like other companies, we may experience threats to our data and systems, including malware and computer virus attacks, unauthorized access, system failures and disruptions. If one or more of these events occurs, we could potentially jeopardize the confidential, proprietary, and other information processed, stored in, and transmitted through our computer systems and networks. Such an attack could cause interruptions or malfunctions in our operations, which could result in financial losses, litigation, regulatory penalties, client dissatisfaction or loss, reputational damage, and increased costs associated with mitigation of damages and remediation.

Third parties with which we do business may also be sources of cybersecurity or other technological risk. We outsource certain functions and these relationships allow for the storage and processing of our information, as well as client, counterparty, employee, and borrower information. While we engage in actions to reduce our exposure resulting from outsourcing, ongoing threats may result in unauthorized access, loss, exposure, destruction, or other cybersecurity incident that affects our data, resulting in increased costs and other consequences as described above.

Risks Related to Investments

Our investments may be risky, and you could lose all or part of your investment.

We invest primarily in senior secured term loans, mezzanine debt, selected equity investments issued by middle-market companies, CLO Funds and the Joint Venture managed by our Surviving Asset Manager Affiliate. The investments in our debt securities portfolio are all or predominantly below investment grade, may be highly leveraged, and therefore have speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal. Defaults by portfolio companies may harm our operating results.

Secured Loans. When we extend secured term loans, it generally takes a security interest (either as a first lien position or as a second lien position) in the available assets of these portfolio companies, including the equity interests of their subsidiaries, which we expect to assist in mitigating the risk that we will not be repaid. However, there is a risk that the collateral securing our loans may decrease in value over time, may be difficult to sell in a timely manner, may be difficult to appraise and may fluctuate in value based upon the success of the business and market conditions, including as a result of the inability of the portfolio company to raise additional capital, and, in some circumstances, our lien could be subordinated to claims of other creditors. In addition, deterioration in a portfolio company’s financial condition and prospects, including its inability to raise additional capital, may be accompanied by deterioration in the value of the collateral for the loan. Consequently, the fact that a loan is secured does not guarantee that we will receive principal and interest payments according to the loan’s terms, or at all, or that we will be able to collect on the loan should we be forced to exercise its remedies.

Mezzanine Debt. Our mezzanine debt investments generally are subordinated to senior loans and generally are unsecured. This may result in an above average amount of risk and volatility or loss of principal.

These investments may entail additional risks that could adversely affect our investment returns. To the extent interest payments associated with such debt are deferred, such debt is subject to greater fluctuations in value based on changes in interest rates and such debt could subject us to phantom income. Since we generally do not receive any cash prior to maturity of the debt, the investment is of greater risk.

Equity Investments. We have made and expect to make selected equity investments in the middle-market companies. In addition, when we invest in senior secured loans or mezzanine debt, we may acquire warrants in the equity of the portfolio company. Our goal is ultimately to dispose of such equity interests and realize gains upon our disposition of such interests. However, the equity interests we receive may not appreciate in value and,

 

33


in fact, may decline in value. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience.

Risks Associated with Middle-Market Companies. Investments in middle-market companies also involve a number of significant risks, including:

 

   

CLOs typically are comprised of a portfolio of senior secured loans; payments on CLO investments are and will be payable solely from the cash-flows from such senior secured loans;

 

   

CLO investments are exposed to leveraged credit risk;

 

   

CLO Funds are highly leveraged;

 

   

there is the potential for interruption and deferral of cash-flow from CLO investments;

 

   

interest rates paid by corporate borrowers are subject to volatility;

 

   

the inability of a CLO collateral manager to reinvest the proceeds of the prepayment of senior secured loans may adversely affect us;

 

   

our CLO investments are subject to prepayments and calls, increasing re-investment risk;

 

   

We have limited control of the administration and amendment of any CLO in which we invest;

 

   

senior secured loans of CLOs may be sold and replaced resulting in a loss to us;

 

   

Our financial results may be affected adversely if one or more of our significant equity or junior debt investments in a CLO vehicle defaults on its payment obligations or fails to perform as we expect; and

 

   

non-investment grade debt involves a greater risk of default and higher price volatility than investment grade debt.

Our portfolio investments for which there is no readily available market, including our investment in our Asset Manager Affiliates, our Joint Venture and our investments in CLO Funds, are recorded at fair value as determined in good faith by our Board of Directors. As a result, there is uncertainty as to the value of these investments.

Our investments consist primarily of securities issued by privately-held companies, the fair value of which is not readily determinable. In addition, we are not permitted to maintain a general reserve for anticipated loan losses. Instead, we are required by the 1940 Act to specifically value each investment and record an unrealized gain or loss for any asset that it believes has increased or decreased in value. We value these securities at fair value as determined in good faith by its Board of Directors pursuant to a valuation methodology approved by its Board of Directors. These valuations are initially prepared by our management and reviewed by our Valuation Committee of the Board of Directors (the “Valuation Committee”), which uses its best judgment in arriving at the fair value of these securities. However, our Board of Directors retains ultimate authority to determine the appropriate valuation for each investment.

We have engaged an independent valuation firm to provide third-party valuation consulting services to its Board of Directors. Each quarter, the independent valuation firm performs third-party valuations on our material investments in illiquid securities, such that they are reviewed at least once during a trailing 12-month period. These third-party valuation estimates are one of the relevant data points in our Board of Director’s determination of fair value. Our Board of Directors intends to continue to engage an independent valuation firm in the future to provide certain valuation services, including the review of certain portfolio assets, as part of the quarterly and annual year-end valuation process. In addition to such third-party input, the types of factors that may be considered in valuing our investments include the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings, the markets in which the portfolio company does business,

 

34


comparison to publicly-traded companies, discounted cash flow and other relevant factors. Substantially all of our investment in the Asset Manager Affiliates was sold on December 31, 2018. Prior thereto, our investment in our Asset Manager Affiliates was carried at fair value, which was determined after taking into consideration a percentage of assets under management and a discounted cash flow model incorporating different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance. Such valuation included an analysis of comparable asset management companies. In addition, our investment in our Joint Venture is carried at fair value, which is determined based on the fair value of the investments held by the Joint Venture. Because such valuations, and particularly valuations of private investments and private companies, are inherently uncertain and may be based on estimates, our determinations of fair value may differ materially from the values that would be assessed if a ready market for these securities existed. Our net asset value could be adversely affected if our determinations regarding the fair value of our illiquid investments were materially higher than the values that we ultimately realize upon the disposal of such securities.

We are a non-diversified investment company within the meaning of the 1940 Act, and therefore we may invest a significant portion of our assets in a relatively small number of issuers, which subjects us to a risk of significant loss if any of these issuers defaults on its obligations under any of its debt instruments or as a result of a downturn in the particular industry.

We are classified as a non-diversified investment company within the meaning of the 1940 Act, and therefore we may invest a significant portion of our assets in a relatively small number of issuers in a limited number of industries. Beyond the asset diversification requirements associated with its qualification as a RIC, we do not have fixed guidelines for diversification, and while we are not targeting any specific industries, relatively few industries may become significantly represented among our investments. To the extent that we assume large positions in the securities of a small number of issuers, our net asset value may fluctuate to a greater extent than that of a diversified investment company as a result of changes in the financial condition or the market’s assessment of the issuer, changes in fair value over time or a downturn in any particular industry. We may also be more susceptible to any single economic or regulatory occurrence than a diversified investment company.

Defaults by our portfolio companies could harm our operating results.

A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other debt holders could lead to defaults and, potentially, acceleration of the time when the loans are due and foreclosure on our secured assets. Such events could trigger cross-defaults under other agreements and jeopardize a portfolio company’s ability to meet its obligations under the debt that we hold and the value of any equity securities it owns. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company.

When we are a debt or minority equity investor in a portfolio company, which generally is the case, we may not be in a position to control the entity, and the portfolio company’s management may make decisions that could decrease the value of our investment.

Most of our investments are either debt or minority equity investments in our portfolio companies. Therefore, we are subject to the risk that a portfolio company may make business decisions with which we disagree, and the stockholders and management of such company may take risks or otherwise act in ways that do not serve our interests. As a result, a portfolio company may make decisions that could decrease the value of our portfolio holdings. In addition, we generally are not in a position to control any portfolio company by investing in its debt securities.

We may have limited access to information about privately held companies in which we invest.

We invest primarily in privately-held companies. Generally, little public information exists about these companies, and we are required to rely on the ability of our investment professionals to obtain adequate

 

35


information to evaluate the potential returns from investing in these companies. These companies and their financial information are not subject to the Sarbanes-Oxley Act of 2002 and other rules that govern public companies. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and we may lose money on our investment.

Prepayments of our debt investments by our portfolio companies could negatively impact our operating results.

We are subject to the risk that the investments we makes in our portfolio companies may be repaid prior to maturity. When this occurs, we generally reinvest these proceeds in temporary investments, pending their future investment in new portfolio companies. These temporary investments typically have substantially lower yields than the debt being prepaid, and we could experience significant delays in reinvesting these amounts. Any future investment in a new portfolio company may also be at lower yields than the debt that was repaid. Consequently, our results of operations could be materially adversely affected if one or more of our portfolio companies elects to prepay amounts owed to us. Additionally, prepayments could negatively impact our return on equity, which could result in a decline in the market price of our Common Stock.

We may be unable to invest the net proceeds raised from offerings and repayments from investments on acceptable terms, which would harm our financial condition and operating results.

Until we identify new investment opportunities, we intend to either invest the net proceeds of future offerings and repayments from investments in interest-bearing deposits or other short-term instruments or use the net proceeds from such offerings to reduce then-outstanding debt obligations. We cannot assure you that we will be able to find enough appropriate investments that meet our investment criteria or that any investment we complete using the proceeds from an offering will produce a sufficient return.

Our portfolio companies may incur debt that ranks equal with, or senior to, our investments in such companies.

We invest primarily in debt securities issued by our portfolio companies. In some cases portfolio companies are permitted to have other debt that ranks equal with, or senior to, the debt securities in which we invest. By their terms, such debt instruments may provide that the holders thereof are entitled to receive payment of interest or principal on or before the dates on which we are entitled to receive payments in respect of the debt securities in which it invests. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying such senior creditors, such portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equal with debt securities in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company.

Second priority liens on collateral securing loans that we makes to portfolio companies may be subject to control by senior creditors with first priority liens. If there is a default, the value of the collateral may not be sufficient to repay in full both the first priority creditors and us.

Certain loans that we make are secured by a second priority security interest in the same collateral pledged by a portfolio company to secure senior debt owed by the portfolio company to other traditional lenders. Often the senior lender has procured covenants from the portfolio company prohibiting the incurrence of additional secured debt, without the senior lender’s consent. Prior to, and as a condition of, permitting the portfolio company to borrow money from us secured by the same collateral pledged to the senior lender, the senior lender will require assurances that we will control the disposition of any collateral in the event of bankruptcy or other default. In many such cases, the senior lender will require us to enter into an “intercreditor agreement” prior to

 

36


permitting the portfolio company to borrow from us. Typically, the intercreditor agreements we are requested to execute expressly subordinate our debt instruments to those held by the senior lender and further provide that the senior lender shall control: (1) the commencement of foreclosure or other proceedings to liquidate and collect on the collateral; (2) the nature, timing and conduct of foreclosure or other collection proceedings; (3) the amendment of any collateral document; (4) the release of the security interests in respect of any collateral; and (5) the waiver of defaults under any security agreement. Because of the control we may cede to senior lenders under intercreditor agreements we may enter, we may be unable to realize the proceeds of any collateral securing some of our loans.

There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to lender liability claims.

Even though we may have structured certain of our investments as senior loans, if one of our portfolio companies were to go bankrupt, depending on the facts and circumstances, including the size of our investment and the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might recharacterize our debt investment and subordinate all or a portion of our claim to that of other creditors. In addition, lenders can be subject to lender liability claims for actions taken by them where they become too involved in the borrower’s business or exercise control over the borrower. It is possible that we could become subject to a lender’s liability claim, including as a result of actions taken in rendering significant managerial assistance.

Our investments in equity securities involve a substantial degree of risk.

We purchase common stock and other equity securities, including warrants. Although equity securities have historically generated higher average total returns than fixed-income securities over the long term, equity securities have also experienced significantly more volatility in those returns. The equity securities we acquire may fail to appreciate and may decline in value or become worthless, and our ability to recover our investment depends on our portfolio company’s success. Investments in equity securities involve a number of significant risks, including the risk of further dilution as a result of additional issuances, inability to access additional capital and failure to pay current distributions. Investments in preferred securities involve special risks, such as the risk of deferred distributions, credit risk, illiquidity and limited voting rights.

The lack of liquidity in our investments may adversely affect our business.

We may invest in securities issued by private companies. These securities may be subject to legal and other restrictions on resale or otherwise be less liquid than publicly-traded securities. The illiquidity of these investments may make it difficult for us to sell these investments when desired. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we had previously recorded these investments. Our investments are usually subject to contractual or legal restrictions on resale or are otherwise illiquid because there is usually no established trading market for such investments. The illiquidity of most of our investments may make it difficult for us to dispose of them at a favorable price, and, as a result, we may suffer losses.

Our investments in foreign securities may involve significant risks in addition to the risks inherent in U.S. investments.

Our investment strategy contemplates that a portion of our investments may be in securities of foreign companies. Investing in foreign companies may expose us to additional risks not typically associated with investing in U.S. companies. These risks include changes in exchange control regulations, political and social instability, expropriation, imposition of foreign taxes, less liquid markets and less available information than is generally the case in the United States, higher transaction costs, less government supervision of exchanges, brokers and issuers, less developed bankruptcy laws, difficulty in enforcing contractual obligations, lack of uniform accounting and auditing standards and greater price volatility.

 

37


Although it is anticipated that most of our investments will be denominated in U.S. dollars, our investments that are denominated in a foreign currency will be subject to the risk that the value of a particular currency may change in relation to the U.S. dollar. Among the factors that may affect currency values are trade balances, the level of short-term interest rates, differences in relative values of similar assets in different currencies, long-term opportunities for investment and capital appreciation and political developments.

The disposition of our investments may result in contingent liabilities.

We currently expect that a significant portion of our investments will involve lending directly to private companies. In connection with the disposition of an investment in private securities, we may be required to make representations about the business and financial affairs of the portfolio company typical of those made in connection with the sale of a business. We may also be required to indemnify the purchasers of such investment to the extent that any such representations turn out to be inaccurate or with respect to certain potential liabilities. These arrangements may result in contingent liabilities that ultimately yield funding obligations that must be satisfied through our return of certain distributions previously made to us.

We may not receive any return on our investment in the CLO Funds in which we have invested.

As of December 31, 2018, we had $45.0 million at fair value invested in the subordinated securities, preferred shares, or other securities issued by the CLO Funds managed by certain third-party asset managers. Subordinated securities are the most junior class of securities issued by the CLO Funds and are subordinated in priority of payment to every other class of securities issued by these CLO Funds. Therefore, they only receive cash distributions if the CLO Funds have made all cash interest payments to all other debt securities issued by the CLO Fund. The subordinated securities are also unsecured and rank behind all of the secured creditors, known or unknown, of the CLO Fund, including the holders of the senior securities issued by the CLO Fund. Consequently, to the extent that the value of a CLO Fund’s loan investments has been reduced as a result of conditions in the credit markets, or as a result of defaulted loans or individual fund assets, the value of the subordinated securities at their redemption could be reduced.

Risks Related to Our Investment Advisory Relationship with Sierra Crest

Sierra Crest selects our investments and our Stockholders have no input with respect to investment decisions.

Sierra Crest selects our investments and our stockholders have no input with respect to investment decisions. As a result, we will be subject to all of the business risks and uncertainties associated with the origination of new investments, including the risk that we will not achieve our investment objective and that the value of your investment could decline substantially or become worthless.

We are dependent upon Sierra Crest for our future success.

We have no employees and, as a result, depend on the diligence, skill and network of business contacts of Sierra Crest’s investment professionals to source appropriate investments for us. We depend on members of Sierra Crest’s investment team to appropriately analyze our investments and Sierra Crest’s investment committee to approve and monitor our portfolio investments. Sierra Crest’s investment committee, together with the other members of its investment team, evaluate, negotiate, structure, close and monitor our investments. Our future success will depend on the continued availability of the members of Sierra Crest’s investment committee and the other investment professionals available to the Sierra Crest. We do not have employment agreements with these individuals or other key personnel of Sierra Crest, and we cannot provide any assurance that unforeseen business, medical, personal or other circumstances would not lead any such individual to terminate his or her relationship with Sierra Crest. The loss of a material number of senior investment professionals to which Sierra Crest has access, could have a material adverse effect on our ability to achieve our investment objective as well as on our financial condition and results of operations. In addition, we cannot assure you that Sierra Crest will remain our investment adviser or that we will continue to have access to Sierra Crest’s investment professionals or its information and deal flow.

 

38


The structure under our Investment Advisory Agreement may induce Sierra Crest to pursue speculative investments and incur leverage, which may not be in the best interests of our stockholders.

The incentive fees payable by us to Sierra Crest under our Investment Advisory Agreement may create an incentive for Sierra Crest to pursue investments on our behalf that are riskier or more speculative than would be the case in the absence of such compensation arrangement. The incentive fees payable to Sierra Crest are calculated based on a percentage of our return on invested capital. This may encourage Sierra Crest to use leverage to increase the return on our investments. Under certain circumstances, the use of leverage may increase the likelihood of default, which would impair the value of our common stock. In addition, Sierra Crest receives the incentive fees based, in part, upon net capital gains realized on our investments. Unlike that portion of incentive fees based on income, there is no hurdle rate applicable to the portion of the incentive fees based on net capital gains. As a result, Sierra Crest may have a tendency to invest more capital in investments that are likely to result in capital gains as compared to income-producing securities. Such a practice could result in us investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during economic downturns.

Moreover, because the base management fees payable to Sierra Crest under our Investment Advisory Agreement are payable based on our gross assets, excluding cash and cash equivalents but including those assets purchased with borrowed amounts, Sierra Crest has a financial incentive to incur leverage which may not be consistent with our stockholders’ interests.

Sierra Crest’s liability is limited under our Investment Advisory Agreement, and we are required to indemnify Sierra Crest against certain liabilities, which may lead Sierra Crest to act in a riskier manner on our behalf than it would when acting for its own account.

Under our Investment Advisory Agreement, Sierra Crest does not assume any responsibility to us other than to render the services described in our Investment Advisory Agreement, and it is not be responsible for any action of our Board of Directors in declining to follow Sierra Crest’s advice or recommendations. Pursuant to our Investment Advisory Agreement, Sierra Crest and its officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated with Sierra Crest are not liable to us for their acts under our Investment Advisory Agreement, absent criminal conduct, willful misfeasance, bad faith or gross negligence in the performance of their duties or by reason of the reckless disregard of their duties and obligations. We have agreed to indemnify, defend and protect Sierra Crest and its officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated with Sierra Crest with respect to all damages, liabilities, costs and expenses arising out of or otherwise based upon the performance of any of Sierra Crest’s duties or obligations under our Investment Advisory Agreement or otherwise as Sierra Crest for us, and not arising out of criminal conduct, willful misfeasance, bad faith or gross negligence in the performance of their duties or by reason of the reckless disregard of their duties and obligations under our Investment Advisory Agreement. These protections may lead Sierra Crest to act in a riskier manner when acting on our behalf than it would when acting for its own account.

Sierra Crest is able to resign upon 60 days’ written notice, and we may not be able to find a suitable replacement within that time, resulting in a disruption in our operations that could adversely affect our financial condition, business and results of operations.

We are externally managed pursuant to our Investment Advisory Agreement. Pursuant to our Investment Advisory Agreement, Sierra Crest has the right to resign upon 60 days’ written notice, whether a replacement has been found or not. If Sierra Crest resigns, it may be difficult to find a replacement with similar expertise and ability to provide the same or equivalent services on acceptable terms within 60 days, or at all. If a replacement is not found quickly, our business, results of operations and financial condition as well as our ability to pay distributions are likely to be adversely affected and the value of our shares may decline. In addition, the coordination of our internal management and investment activities is likely to suffer if we are unable to identify and reach an agreement with a single institution or group of executives having the expertise possessed by Sierra Crest. Even if a comparable service provider or individuals performing such services are retained, whether

 

39


internal or external, their integration into our business and lack of familiarity with our investment objective may result in additional costs and time delays that may materially adversely affect our business, results of operations and financial condition.

We may not replicate its historical performance, or the historical success of other investment vehicles advised by Sierra Crest.

We cannot provide any assurance that we will replicate our own historical performance, the historical success of Sierra Crest or the historical performance of other investment vehicles that Sierra Crest and its investment team advised in the past. Accordingly, our investment returns could be substantially lower than the returns achieved by us in the past or by other clients of Sierra Crest. We can offer no assurance that Sierra Crest will be able to continue to implement our investment objective with the same degree of success as it has had in the past.

Risks Relating to the Merger

Sales of shares of our Common Stock after the completion of the Merger may cause the market price of our Common Stock to decline.

Former OHAI Stockholders may decide not to hold the shares of PTMN Common Stock that they will receive pursuant to the Merger Agreement. Certain OHAI Stockholders, such as funds with limitations on their permitted holdings of stock in individual issuers, may be required to sell the shares of PTMN Common Stock that they receive pursuant to the Merger Agreement. In addition, PTMN Stockholders may decide not to hold their shares of PTMN Common Stock after completion of the Merger. In each case, such sales of PTMN Common Stock could have the effect of depressing the market price for PTMN Common Stock and may take place promptly following the completion of the Merger.

We may be unable to realize the benefits anticipated by the Merger, including estimated cost savings, or it may take longer than anticipated to achieve such benefits.

The realization of certain benefits anticipated as a result of the Merger will depend in part on the integration of OHAI’s investment portfolio with ours and the integration of OHAI’s business with ours. There can be no assurance that OHAI’s investment portfolio or business can be operated profitably or integrated successfully into our operations in a timely fashion or at all. The dedication of management resources to such integration may detract attention from the day-to-day business of the combined company and there can be no assurance that there will not be substantial costs associated with the transition process or there will not be other material adverse effects as a result of these integration efforts. Such effects, including, but not limited to, incurring unexpected costs or delays in connection with such integration and failure of OHAI’s investment portfolio to perform as expected, could have a material adverse effect on the financial results of the combined company.

We also expect to achieve certain cost savings from the Merger when the two companies have fully integrated their portfolios. It is possible that the estimates of the potential cost savings could ultimately be incorrect. The cost savings estimates also assume we will be able to combine the operations of us and OHAI in a manner that permits those cost savings to be fully realized. If the estimates turn out to be incorrect or if we are not able to successfully combine OHAI’s investment portfolio or business with our operations, the anticipated cost savings may not be fully realized, or realized at all, or may take longer to realize than expected.

If we sell investments acquired as a result of the Merger, it may result in capital gains and increase the incentive fees payable to Sierra Crest.

Investments that we acquire as a result of the Merger will be booked at a discount under ASC 805-50, Business Combinations–Related Issues. To the extent we sell one of these acquired investments at a price that is higher than its then-amortized cost, such sale would result in realized capital gain that would be factored in to the amount of the incentive fee on capital gains, if any, that is paid by us to Sierra Crest. If we sell a significant portion of the investments acquired as a result of the Merger, it may materially increase the incentive fee on capital gains paid to Sierra Crest. The effect on the incentive fee on capital gains would be greater for acquired investments sold closer to the closing date of the Merger.

 

40


FORWARD-LOOKING STATEMENTS

This prospectus includes forward-looking statements. The matters discussed in this prospectus, as well as in future oral and written statements by management of the Company that are forward-looking statements are based on current management expectations that involve substantial risks and uncertainties which could cause actual results to differ materially from the results expressed in, or implied by, these forward-looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar words. Important assumptions include our ability to acquire or originate new investments, achieve certain margins and levels of profitability, the availability of additional capital, and the ability to maintain certain debt to asset ratios. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this prospectus should not be regarded as a representation by us that our plans or objectives will be achieved. The forward-looking statements contained in this prospectus include statements as to:

 

   

our future operating results;

 

   

our business prospects and the prospects of our existing and prospective portfolio companies;

 

   

the return or impact of current and future investments;

 

   

our contractual arrangements and other relationships with third parties;

 

   

the dependence of our future success on the general economy and its impact on the industries in which we invest;

 

   

the financial condition and ability of our existing and prospective portfolio companies to achieve their objectives;

 

   

our expected financings and investments;

 

   

our regulatory structure and tax treatment;

 

   

our ability to operate as a BDC and a RIC, including the impact of changes in laws or regulations governing our operations, the operations of the Asset Manager Affiliates or the operations of our portfolio companies;

 

   

the adequacy of our cash resources and working capital;

 

   

the timing of cash flows, if any, from the operations of our portfolio companies, including our Asset Manager Affiliates;

 

   

the impact of a protracted decline in the liquidity of credit markets on our business;

 

   

the impact of fluctuations in interest rates on our business;

 

   

the valuation of our investments in portfolio companies, particularly those having no liquid trading market;

 

   

our ability to recover unrealized losses;

 

   

market conditions and our ability to access additional capital; and

 

   

the timing, form and amount of any dividend distributions.

There are a number of important risks and uncertainties that could cause our actual results to differ materially from those indicated by such forward-looking statements. For a discussion of factors that could cause our actual results to differ from forward-looking statements contained in this prospectus, please see the discussion under “Risk Factors.” You should not place undue reliance on these forward-looking statements. The forward-looking statements made in this prospectus relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date of this prospectus.

 

41


USE OF PROCEEDS

We intend to use the net proceeds from the sale of our securities for investing in debt and equity securities, repayment of any outstanding indebtedness and other general corporate purposes, which may include investing in portfolio companies and CLO Fund Securities in accordance with our investment objective and strategies described elsewhere in this prospectus. The supplement to this prospectus relating to an offering will more fully identify the use of proceeds from such offering.

We anticipate that substantially all of the net proceeds from any offering of our securities will be used as described above within six to twelve months. However, there can be no assurance that we will be able to achieve this goal. Pending such use, we intend to invest the net proceeds of an offering in cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment. These securities may earn yields substantially lower than the income that we anticipate receiving once we are fully invested in accordance with our investment objective. See “Regulation — Temporary Investments” for additional information about temporary investments we may make while waiting to make longer-term investments in pursuit of our investment objective.

 

42


PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS

Our Common Stock began trading on December 11, 2006 and is currently traded on The Nasdaq Global Select Market under the symbol “PTMN.” The following table sets forth: (i) the net asset value per share of our Common Stock as of the applicable period end, (ii) the range of high and low closing sales prices of our Common Stock as reported on the Nasdaq during the applicable period, (iii) the closing high and low sales prices as a premium (discount) to net asset value during the appropriate period, and (iv) the dividends and distributions per share of our Common Stock declared during the applicable period.

 

Period

   NAV per
share(1)
     Closing Sales Price     Premium/
(Discount) of
High Sales
Price to
NAV(2)
    Premium/
(Discount)
of Low
Sales Price
to NAV(2)
    Dividends
and
Distributions
Declared
 
   High      Low  

Fiscal Year Ended December 31, 2019

              

Fourth quarter (through December 13, 2019)

     N/A      $ 2.26      $ 2.03       N/A       N/A     $ 0.06  

Third quarter

     3.55        2.47        2.15       (30.4 )%      (39.4 )%      0.06  

Second quarter

     3.73        3.75        2.25       0.5     (39.7 )%      0.10  

First quarter

     3.85        3.68        3.32       (4.4 )%      (13.8 )%      0.10  

Fiscal Year Ended December 31, 2018

              

Fourth quarter

   $ 4.23      $ 3.47      $ 2.93       (18.0 )%      (30.7 )%    $ 0.10  

Third quarter

     4.66        3.39        3.13       (27.3 )%      (32.8 )%      0.10  

Second quarter

     4.72        3.28        3.09       (30.5 )%      (34.5 )%      0.10  

First quarter

     4.85        3.57        2.96       (26.4 )%      (39.0 )%      0.10  

Fiscal Year Ended December 31, 2017

              

Fourth quarter

   $ 4.87      $ 3.98      $ 3.34       (18.3 )%      (31.4 )%    $ 0.10  

Third quarter

     4.95        3.67        3.32       (25.9 )%      (32.9 )%      0.12  

Second quarter

     5.10        4.04        3.37       (20.8 )%      (33.9 )%      0.12  

First quarter

     5.14        4.12        3.93       (19.8 )%      (23.5 )%      0.12  

 

(1)

NAV per share is determined as of the last day in the relevant quarter and therefore may not reflect the NAV per share on the date of the high and low closing sales prices. The NAVs shown are based on outstanding shares at the end of each period.

(2)

Calculated as of the respective high or low closing sales price divided by the quarter-end NAV.

Shares of BDCs may trade at a market price that is less than the value of the net assets attributable to those shares. The possibility that our shares of common stock will trade at a discount from net asset value or at premiums that are unsustainable over the long term are separate and distinct from the risk that our net asset value will decrease.

Our stockholder distributions, if any, are determined by our Board of Directors. We have elected to be treated for federal income tax purposes as a RIC under Subchapter M of the Code and intend to operate in a manner to maintain our qualification as a RIC. As long as we maintain our qualification as a RIC, we generally will not pay corporate-level U.S. federal income taxes on our net ordinary income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to stockholders on a timely basis. We intend to distribute to our stockholders substantially all our net taxable income and realized net capital gains (if any).

We intend to continue to make quarterly distributions to our stockholders. To maintain RIC tax treatment, we must, among other things, timely distribute at least 90% of the sum of our investment company taxable income (generally, our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any) and net tax-exempt income for each year.

 

43


To avoid certain excise taxes imposed on RICs, we currently intend to distribute during each calendar year an amount at least equal to the sum of:

 

   

98% of our net ordinary income for the calendar year;

 

   

98.2% of our capital gains, if any, in excess of capital losses for the one-year period ending on October 31 of the calendar year; and

 

   

any net ordinary income and net capital gains for the preceding year that were not distributed during such year.

However, depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay the 4% excise tax on such income. We will not be subject to excise taxes on amounts on which we are required to pay U.S. federal income tax (such as retained realized net long-term capital gains in excess of net short-term capital losses, or “net capital gains”). We may in the future retain for investment net capital gains and elect to treat such net capital gains as a deemed distribution. If this happens, you will be treated as if you received an actual distribution of the capital gains we retain and then reinvested the net after-tax proceeds in our common stock. You would be eligible to claim a tax credit against your U.S. federal income tax liability (or, in certain circumstances, a tax refund) equal to your allocable share of the tax we paid on the capital gains deemed distributed to you. Please refer to “Certain U.S. Federal Income Tax Considerations” for further information regarding the consequences of our possible retention of net capital gains. We can offer no assurance that we will achieve results that will permit the payment of any cash distributions and, if we issue senior securities, we may be prohibited from making distributions if we fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our borrowings. See “Regulation.”

The following table sets forth the quarterly distributions declared by us since 2017:

 

     Distribution      Declaration
Date
    Record Date      Pay Date  

2019:

          

Fourth quarter (through December 13, 2019)

   $ 0.06        11/5/2019       11/15/2019        11/29/2019  

Third quarter

     0.06        8/5/2019       8/12/2019        8/29/2019  

Second quarter

     0.10        3/20/2019       4/5/2019        4/26/2019  

First quarter

   $ 0.10        12/12/2018 (1)      1/7/2019        1/31/2019  
  

 

 

         

Total declared in 2019

   $ 0.32          

2018:

          

Fourth quarter

   $ 0.10        9/18/2018       10/9/2018        10/29/2018  

Third quarter

     0.10        6/19/2018       7/6/2018        7/27/2018  

Second quarter

     0.10        3/20/2018       4/6/2018        4/27/2018  

First quarter

   $ 0.10        12/13/2017 (1)      1/5/2018        1/25/2018  
  

 

 

         

Total declared in 2018

   $ 0.40          

2017:

          

Fourth quarter

   $ 0.12        9/22/2017       10/10/2017        10/26/2017  

Third quarter

     0.12        6/20/2017       7/7/2017        7/27/2017  

Second quarter

     0.12        3/21/2017       4/7/2017        4/28/2017  

First quarter

   $ 0.12        12/14/2016 (1)      1/6/2017        1/27/2017  
  

 

 

         

Total declared in 2017

   $ 0.48          

 

(1)

Since the record date of this distribution is subsequent to year-end, it is a subsequent year tax event.

 

44


Due to our ownership of our Asset Manager Affiliates and certain timing, structural and tax considerations, our stockholder distributions may include a return of capital for tax purposes.

We maintain an “opt out” dividend reinvestment plan for our common stockholders. As a result, when we declare a dividend, cash dividends will be automatically reinvested in additional shares of our common stock unless the stockholder specifically “opts out” of the dividend reinvestment plan and chooses to receive cash dividends. See “Dividend Reinvestment Plan.”

 

45


MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our financial statements and related notes and other financial information appearing elsewhere in this prospectus. In addition to historical information, the following discussion and other parts of this prospectus contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to the factors discussed under “Risk Factors” and “Forward-Looking Statements” appearing elsewhere in this prospectus.

GENERAL

Since April 1, 2019, we have been an externally managed, non-diversified closed-end 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 originate, structure, and invest in secured term loans, bonds or notes and mezzanine debt primarily in privately-held middle market companies but may also invest in other investments such as loans to publicly-traded companies, high-yield bonds, and distressed debt securities (collectively the “Debt Securities Portfolio”). We also invest in joint ventures and debt and subordinated securities issued by collateralized loan obligation funds (“CLO Fund Securities”). In addition, from time to time we may invest in the equity securities of privately held middle market companies and may also receive warrants or options to purchase common stock in connection with its debt investments.

On November 8, 2018, we entered into an agreement with LibreMax Intermediate Holdings, LP (“LibreMax”) under which our wholly-owned subsidiary Commodore Holdings, LLC (“Commodore”) agreed to sell Katonah Debt Advisors, L.L.C. (“Katonah Debt Advisors”), Trimaran Advisors, L.L.C. (“Trimaran Advisors”), and Trimaran Advisors Management, L.L.C. (“Trimaran Advisors Management” and, together with Katonah Debt Advisors and Trimaran Advisors, the “Disposed Manager Affiliates”) to LibreMax for a cash purchase price of approximately $37.9 million (the “LibreMax Transaction”). In connection with the closing of the LibreMax Transaction on December 31, 2018, Commodore sold the Disposed Manager Affiliates, which manage collateralized loan obligation funds (“CLO Funds”), to LibreMax for a cash purchase price of approximately $37.9 million.

As of September 30, 2019, our remaining asset management subsidiaries (the “Asset Manager Affiliates”) were comprised of Commodore, Katonah Management Holdings, LLC, Katonah X Management LLC (“Katonah X Management”), Katonah 2007-1 Management, LLC (“Katonah 2007-I Management”) and KCAP Management, LLC. Commodore, Katonah X Management and Katonah 2007-1 Management have no operations and are expected to be liquidated in the normal course.

On December 14, 2018, we entered into a stock purchase and transaction agreement (the “Externalization Agreement”) with BC Partners Advisors L.P. (“BCP”), an affiliate of BC Partners LLP (“BC Partners”), pursuant to which our management function would be externalized (the “Externalization”) and Sierra Crest Investment Management LLC, an affiliate of BC Partners (the “Adviser”) would be appointed as our investment adviser, subject to our stockholders’ approval of the proposed investment advisory agreement between us and the Adviser (the “Advisory Agreement”). At a special meeting of our stockholders (the “Special Meeting”) held on February 19, 2019, our stockholders approved the Advisory Agreement. Upon closing of the Externalization (the “Closing”) on April 1, 2019, the Company commenced operations as an externally managed BDC managed by the Adviser. On August 1, 2019, we and OHA Investment Corporation (“OHAI”) announced entry into a definitive agreement under which OHAI would merge with and into the Company (the “Merger”). The Merger closed on December 18, 2019.

 

46


In our Debt Securities Portfolio, our investment objective is to generate current income and, to a lesser extent, capital appreciation from the investments in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies. We define the middle market as comprising companies with earnings before interest, taxes, depreciation and amortization (“EBITDA”) of $10 million to $50 million and/or total debt of $25 million to $150 million. We primarily invest in first and second lien term loans which, because of their priority in a company’s capital structure, we expect will have lower default rates and higher rates of recovery of principal if there is a default and which we expect will create a stable stream of interest income. The investments in our Debt Securities Portfolio are all or predominantly below investment grade, and have speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal.

Our investment in CLO Fund Securities are primarily managed by our formerly wholly-owned asset management subsidiaries Trimaran Advisors and Trimaran Advisors Management, L.L.C. From time-to-time we have also made investments in CLO Fund Securities managed by other asset managers. The CLO Funds typically invest in broadly syndicated loans, high-yield bonds and other credit instruments. Our investments in CLO Fund Securities are anticipated to provide us with recurring cash distributions.

Subject to market conditions, we intend to grow our portfolio of assets by raising additional capital, including through the prudent use of leverage available to us. As a BDC, we are limited in the amount of leverage we can incur under the 1940 Act. Effective March 29, 2019, we are only allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 150% after such borrowing. We will continue to be prohibited by the indentures governing our 6.125% Notes due 2022 (the “6.125% Notes due 2022”) from making distributions on our common stock if our asset coverage, as defined in the 1940 Act, falls below 200%. See Note 7 - “Borrowings” to our consolidated financial statements.

We have elected to be treated for U.S. federal income tax purposes as a regulated investment company (“RIC”) under the Code and intend to operate in a manner to maintain our RIC status. As a RIC, we intend to distribute to our stockholders substantially all of our net ordinary taxable income and the excess of realized net short-term capital gains over realized net long-term capital losses, if any, for each year. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any income that we timely distribute to our stockholders.

The Externalization Agreement

Pursuant to the Externalization Agreement with BCP, the Adviser became our investment adviser in exchange for a cash payment from BCP, or its affiliate, of $25 million, or $0.669672 per share of our common stock, directly to our stockholders. In addition, the Adviser (or its affiliate) will use up to $10 million of the incentive fee actually paid to the Adviser prior to the second anniversary of the Closing to buy newly issued shares of our common stock at the most recently determined net asset value per share of our common stock at the time of such purchase. For the period of one year from the first day of the first quarter following the quarter in which the Closing occurred, the Adviser will permanently forego up to the full amount of the incentive fees earned by the Adviser without recourse against or reimbursement by us, to the extent necessary in order to achieve aggregate net investment income per share of our common stock for such one-year period to be at least equal to $0.40 per share, subject to certain adjustments.

On the date of the Closing, we changed our name from KCAP Financial, Inc. to Portman Ridge Finance Corporation and on April 2, 2019, began trading on the NASDAQ Global Select Market under the symbol “PTMN.”

On April 1, 2019, in connection with the Closing, all of our then-current directors resigned from their positions on our Board of Directors (the “Board”), with the exceptions of Dean Kehler and Christopher Lacovara.

 

47


Prior to their resignations, the Board approved an increase in the size of the Board from seven members to eight members and appointed the following new individuals to serve on the Board: Graeme Dell; Alexander Duka; Ted Goldthorpe; George Grunebaum; David Moffitt; and Robert Warshauer. Additionally, in connection with the Closing all of the Company’s then-current officers resigned from their positions with the exceptions of Edward Gilpin and Daniel Gilligan. Effective as of the Closing, Ted Goldthorpe was appointed as President and Chief Executive Officer and Patrick Schafer was appointed as Chief Investment Officer of the Company. In May 2019, Mr. Gilligan resigned as Chief Compliance officer, and Andrew Devine was appointed Chief Compliance Officer.

About the Adviser

The Adviser is an affiliate of BC Partners. LibreMax owns a minority stake in the Adviser. Subject to the overall supervision of the Board, the Adviser is responsible for managing our business and activities, including sourcing investment opportunities, conducting research, performing diligence on potential investments, structuring our investments, and monitoring our portfolio companies on an ongoing basis through a team of investment professionals.

The Adviser seeks to invest on our behalf in performing, well-established middle market businesses that operate across a wide range of industries (i.e., no concentration in any one industry). The Adviser employs fundamental credit analysis, targeting investments in businesses with relatively low levels of cyclicality and operating risk. The holding size of each position will generally be dependent upon a number of factors including total facility size, pricing and structure, and the number of other lenders in the facility. The Adviser has experience managing levered vehicles, both public and private, and seeks to enhance the Company’s returns through the use of leverage with a prudent approach that prioritizes capital preservation. The Adviser believes this strategy and approach offers attractive risk/return with lower volatility given the potential for fewer defaults and greater resilience through market cycles.

Advisory Agreement

The Adviser provides management services to us pursuant to the Advisory Agreement. Under the terms of the Investment Advisory Agreement, the Adviser is responsible for the following:

 

   

managing our assets in accordance with our investment objective, policies and restrictions;

 

   

determining the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes;

 

   

identifying, evaluating and negotiating the structure of our investments;

 

   

monitoring our investments;

 

   

determining the securities and other assets we will purchase, retain or sell;

 

   

assisting the Board with its valuation of our assets;

 

   

directing investment professionals of the Adviser to provide managerial assistance to our portfolio companies;

 

   

performing due diligence on prospective portfolio companies;

 

   

exercising voting rights in respect of portfolio securities and other investments for us;

 

   

serving on, and exercising observer rights for, boards of directors and similar committees of our portfolio companies; and

 

   

providing us with such other investment advisory, research and related services as we may, from time to time, reasonably require for the investment of capital.

 

48


The Adviser’s services under the Advisory Agreement are not exclusive, and it is free to furnish similar services to other entities so long as its services to us are not impaired.

Term

On April 1, 2019, the Company entered into the Advisory Agreement with the Adviser. Unless earlier terminated as described below, the Investment Advisory Agreement will remain in effect until April 1, 2021, a period of two years from the date it first became effective and will remain in effect from year-to-year thereafter if approved annually by a majority of the Board or by the holders of a majority of our outstanding shares, and, in each case, a majority of the independent directors.

The Advisory Agreement will automatically terminate within the meaning of the 1940 Act and related SEC guidance and interpretations in the event of its assignment. In accordance with the 1940 Act, without payment of any penalty, we may terminate the Advisory Agreement with the Adviser upon 60 days’ written notice. The decision to terminate the agreement may be made by a majority our Board or the stockholders holding a majority of the outstanding shares of our common stock. See “Advisory Agreement—Removal of Adviser” below. In addition, without payment of any penalty, the Adviser may generally terminate the Advisory Agreement upon 60 days’ written notice and, in certain circumstances, the Adviser may only be able to terminate the Advisory Agreement upon 120 days’ written notice.

Removal of Adviser

The Adviser may be removed our Board or by the affirmative vote of a Majority of the Outstanding Shares. “Majority of the Outstanding Shares” means the lesser of (1) 67% or more of the outstanding shares of our common stock present at a meeting, if the holders of more than 50% of the outstanding shares of our common stock are present or represented by proxy or (2) a majority of outstanding shares of our common stock.

Compensation of Adviser

Pursuant to the terms of the Advisory Agreement, we pay the Adviser (i) a base management fee (the “Base Management Fee”) and (ii) an incentive fee (the “Incentive Fee”). For the period from the date of the Advisory Agreement (the “Effective Date”) through the end of the first calendar quarter after the Effective Date, the Base Management Fee will be calculated at an annual rate of 1.50% of our gross assets, excluding cash and cash equivalents, but including assets purchased with borrowed amounts, as of the end of such calendar quarter. Subsequently, the Base Management Fee will be 1.50% of our average gross assets, excluding cash and cash equivalents, but including assets purchased with borrowed amounts, at the end of the two most recently completed calendar quarters; provided, however, that the Base Management Fee will be 1.00% of the Company’s average gross assets, excluding cash and cash equivalents, but including assets purchased with borrowed amounts, that exceed the product of (i) 200% and (ii) the value of our net asset value at the end of the most recently completed calendar quarter. The Incentive Fee consists of two parts: (1) a portion based on the Company’s pre-incentive fee net investment income (the “Income-Based Fee”) and (2) a portion based on the net capital gains received on our portfolio of securities on a cumulative basis for each calendar year, net of all realized capital losses and all unrealized capital depreciation on a cumulative basis, in each case calculated from the Effective Date, less the aggregate amount of any previously paid capital gains Incentive Fee (the “Capital Gains Fee”). The Income-Based Fee is 17.50% of pre-incentive fee net investment income with a 7.00% hurdle rate. The Capital Gains Fee is 17.50%.

Pre-incentive fee net investment income means dividends (including reinvested dividends), interest and fee income accrued by us during the calendar quarter, minus operating expenses for the quarter (including the management fee, expenses payable under the administration agreement, and any interest expense and dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest feature (such as original issue

 

49


discount, debt instruments with payment-in-kind(“PIK”) interest and zero coupon securities), accrued income that we may not have received in cash. The Adviser is not obligated to return the incentive fee it receives on PIK interest that is later determined to be uncollectible in cash. See “Item 1A. Risk Factors — Risks Related to the Adviser and its Affiliates.” Pre-incentive fee net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation or depreciation.

To determine the income incentive fee, pre-incentive fee net investment income is expressed as a rate of return on the value of our net assets at the end of the immediately preceding calendar quarter. Because of the structure of the incentive fee, it is possible that we may pay an incentive fee in a calendar quarter in which we incur a loss. For example, if we receive pre-incentive fee net investment income in excess of the quarterly hurdle rate, we will pay the applicable incentive fee even if we have incurred a loss in that calendar quarter due to realized capital losses and unrealized capital depreciation. In addition, because the quarterly hurdle rate is calculated based on our net assets, decreases in our net assets due to realized capital losses or unrealized capital depreciation in any given calendar quarter may increase the likelihood that the hurdle rate is reached and therefore the likelihood of us paying an incentive fee for the subsequent quarter. Our net investment income used to calculate this component of the incentive fee is also included in the amount of our gross assets used to calculate the management fee because gross assets are total assets (including cash received) before deducting liabilities (such as declared dividend payments).

The following is a graphical representation of the calculation of the income-related portion of the incentive fee:

Quarterly Subordinated Incentive Fee on

Pre-Incentive Fee Net Investment Income

(expressed as a percentage of the value of net assets)

 

0%

   1.75%    2.121%
           

f 0% g

   f 100% g    f 17.5% g
           
           
           

The second component of the incentive fee, the capital gains incentive fee, payable at the end of each calendar year in arrears, equals 17.50% of cumulative realized capital gains through the end of such calendar year commencing with the calendar year ending December 31, 2019, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, in each case calculated from the Effective Date, less the aggregate amount of any previously paid capital gains incentive fee for prior periods. We will accrue, but will not pay, a capital gains incentive fee with respect to unrealized appreciation because a capital gains incentive fee would be owed to the Adviser if we were to sell the relevant investment and realize a capital gain. In no event will the capital gains incentive fee payable pursuant to the Investment Advisory Agreement be in excess of the amount permitted by the Investment Advisers Act of 1940, as amended (the “Advisers Act”) including Section 205 thereof.

The fees that are payable under the Investment Advisory Agreement for any partial period will be appropriately prorated.

Limitations of Liability and Indemnification

Under the Advisory Agreement, the Adviser, its officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated with the Adviser, including without limitation its

 

50


managing member, will not be liable to us for acts or omissions performed in accordance with and pursuant to the Advisory Agreement, except those resulting from acts constituting criminal conduct, gross negligence, willful misfeasance, bad faith or reckless disregard of the duties that the Adviser owes to us under the Advisory Agreement. In addition, as part of the Advisory Agreement, we have agreed to indemnify the Adviser and each of its officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated with the Adviser, including without limitation its general partner, and the Administrator from and against any damages, liabilities, costs and expenses, including reasonable legal fees and other expenses reasonably incurred, in or by reason of any pending, threatened or completed action, suit, investigation or other proceeding (including an action or suit by or in the right of the Company or its security holders) arising out of or otherwise based upon the performance of any of the Adviser’s duties or obligations under the Advisory Agreement or otherwise as an investment adviser of the Company, except where attributable to criminal conduct, gross negligence, willful misfeasance, bad faith or reckless disregard of such person’s duties under the Advisory Agreement.

Board Approval of the Advisory Agreement

On December 12, 2018, our then-current Board held an in-person meeting to consider and approve the Advisory Agreement and related matters. The Board of Directors was provided the information required to consider the Advisory Agreement, including: (a) the nature, quality and extent of the advisory and other services to be provided to us by the Adviser; (b) comparative data with respect to advisory fees or similar expenses paid by other BDCs with similar investment objectives; (c) our projected operating expenses and expense ratio compared to BDCs with similar investment objectives; (d) any existing and potential sources of indirect income to the Adviser from its relationship with us and the profitability of that relationship; (e) information about the services to be performed and the personnel performing such services under the Advisory Agreement; (f) the organizational capability and financial condition of the Adviser and its affiliates; (g) the Adviser’s practices regarding the selection and compensation of brokers that may execute our portfolio transactions and the brokers’ provision of brokerage and research services to the Adviser; and (h) the possibility of obtaining similar services from other third-party service providers or continuing to operate as an internally managed BDC.

The Board, including a majority of independent directors, will oversee and monitor our investment performance and, beginning with the second anniversary of the effective date of the Advisory Agreement, will annually review the compensation we pay to the Adviser.

Administration Agreement

Under the terms of the Administration Agreement between the Company and the Administrator, the Administrator will perform, or oversee the performance of, required administrative services, which includes providing office space, equipment and office services, maintaining financial records, preparing reports to stockholders and reports filed with the SEC, and managing the payment of expenses and the performance of administrative and professional services rendered by others. We will reimburse the Administrator for services performed for us pursuant to the terms of the Administration Agreement. In addition, pursuant to the terms of the Administration Agreement, the Administrator may delegate its obligations under the Administration Agreement to an affiliate or to a third party and we will reimburse the Administrator for any services performed for us by such affiliate or third party.

Payments under the Administration Agreement are equal to an amount that reimburses the Administrator for its costs and expenses in performing its obligations and providing personnel and facilities (including rent, office equipment and utilities) for the Company’s use under the Administration Agreement, including an allocable portion of the compensation paid to the Company’s chief compliance officer and chief financial officer and their respective staff who provide services to the Company. The Board, including the independent directors, will review the general nature of the services provided by the Administrator as well as the related cost to the Company for those services and consider whether the cost is reasonable in light of the services provided.

 

51


On April 1, 2019, the Board approved the Administration Agreement with the Administrator. Unless earlier terminated as described below, the Administration Agreement will remain in effect until April 1, 2021, a period of two years from the date it first became effective and will remain in effect from year-to-year thereafter if approved annually by a majority of the Board or by the holders of a Majority of the Outstanding Shares, and, in each case, a majority of the independent directors.

The Company may terminate the Administration Agreement, without payment of any penalty, upon 60 days’ written notice. The decision to terminate the agreement may be made by a majority of the Board or the stockholders holding a Majority of the Outstanding Shares. In addition, the Adviser may terminate the Administration Agreement, without payment of any penalty, upon 60 days’ written notice.

OHAI TRANSACTION

On August 1, 2019, we and OHA Investment Corporation (“OHAI”) announced entry into a definitive agreement under which OHAI would merge with and into the Company (the “Merger”).

Pursuant to the merger agreement, if at any time within one year after the closing date of the transaction our shares are trading at a price below 75% of its net asset value, we will initiate a share buyback program of up to $10 million to support the trading price of the combined entity for up to one year from the date such program is announced.

In accordance with the terms of the merger agreement, each share of common stock, par value $0.001 per share, of OHAI (the “OHAI Common Stock”) issued and outstanding was converted into the right to receive (i) an amount in cash, without interest, equal to approximately $0.42, and (ii) 0.3688 shares of common stock, par value $0.01 per share, of the Company (plus any applicable cash in lieu of fractional shares). Each share of OHAI Common Stock issued and outstanding received, as additional consideration funded by Sierra Crest, an amount in cash, without interest, equal to approximately $0.15.

PORTFOLIO AND INVESTMENT ACTIVITY

Our primary investments are: lending to and investing in middle-market businesses through investments in senior secured loans, junior secured loans, subordinated/mezzanine debt investments, and other equity investments, which may include warrants, investments in joint ventures, and investments in CLO Fund Securities.

 

52


Total portfolio investment activity (excluding activity in U.S. treasury bills and money market investments) for the nine months ended September 30, 2019 (unaudited) and for the year ended December 31, 2018 was as follows:

 

    Debt
Securities
    CLO Fund
Securities
    Equity
Securities
    Asset
Manager
Affiliates
    Joint
Ventures
    Derivatives     Total
Portfolio
 

Fair Value at December 31, 2017 2018 Activity:

  $ 118,197,479     $ 51,678,673     $ 4,414,684     $ 38,849,000     $ 21,516,000     $ —       $ 234,655,836  

Purchases / originations / draws

    92,911,178       12,781,528       —         —         12,466,667       —         118,159,373  

Pay-downs / pay-offs / sales

    (57,125,611     (19,033,322     (1,093,244     (34,800,000     —         —         (112,052,177

Net accretion of interest

    1,289,512       5,878,260       —         —         —         —         7,167,772  

Net realized losses

    9,933       (16,484,872     —         —         —         —         (16,474,939

Increase (decrease) in fair value

    (7,420,747     9,504,733       (1,283,420     (579,000     (3,125,560     —         (2,903,994
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fair Value at December 31, 2018 2019 Activity:

    147,861,744       44,325,000       2,038,020       3,470,000       30,857,107       —         228,551,871  

Purchases / originations / draws

    102,582,196       —         11,773,915       —         14,141,340       30,609       128,528,061  

Pay-downs / pay-offs / sales

    (67,500,973     (10,874,805     (80,640     —         (2,470,090     —         (80,926,508

Net accretion of interest

    185,412       4,815,733       —         —         —         —         5,001,145  

Net realized gains (losses)

    (11,088,612     (595,571     (1,642,282     (3,470,000     —         —         (16,796,465

Increase (decrease) in fair value

    3,584,578       (799,062     (5,809,402     —         2,897,649       (20,959     (147,196
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fair Value at September 30, 2019

  $ 175,624,345     $ 36,871,295     $ 6,279,611     $ —       $ 45,426,006     $ 9,650     $ 264,210,907  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The level of investment activity for investments funded and principal repayments for our investments can vary substantially from period to period depending on the number and size of investments that we invest in or divest of, and many other factors, including the amount and competition for the debt and equity securities available to middle market companies, the level of merger and acquisition activity for such companies and the general economic environment.

The following table shows the Company’s portfolio by security type at September 30, 2019 and December 31, 2018:

 

     September 30, 2019 (unaudited)     December 31, 2018  
Security Type    Cost/Amortized
Cost
     Fair Value      %(1)     Cost/Amortized
Cost
     Fair Value      %(1)  

Short-term investments(2)

   $ 23,180,863      $ 23,180,863        8     $ 44,756,478      $ 44,756,478        17  

Senior Secured Loan

     106,682,014        104,599,092        36       86,040,921        77,616,209        28  

Junior Secured Loan

     79,140,346        70,492,986        25       76,223,561        70,245,535        26  

Senior Unsecured Bond

     620,145        532,267        0       —          —          —    

CLO Fund Securities

     48,825,983        36,871,295        13       55,480,626        44,325,000        16  

Equity Securities

     19,528,755        6,279,611        2       9,477,763        2,038,020        1  

Asset Manager Affiliates(3)

     17,791,230        —          —         17,791,230        3,470,000        1  

Joint Ventures

     49,052,776        45,426,006        16       37,381,525        30,857,107        11  

Derivatives

     30,609        9,650        0       —          —          —    
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 344,852,721      $ 287,391,771        100   $ 327,152,104      $ 273,308,349        100
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

(1)

Represents percentage of total portfolio at fair value.

(2)

Includes money market accounts and U.S. treasury bills.

(3)

Represents the equity investment in the Asset Manager Affiliates.

 

53


The industry concentrations, based on the fair value of the Company’s investment portfolio as of September 30, 2019 and December 31, 2018, were as follows:

 

     September 30, 2019 (unaudited)     December 31, 2018  
Industry Classification    Cost/Amortized
Cost
     Fair Value      %(1)     Cost/Amortized
Cost
     Fair Value      %  

Aerospace and Defense

   $ 9,657,656      $ 9,696,240        3     $ 5,434,927      $ 4,049,940        1  

Asset Management Company(2)

     17,791,230        —          —         17,791,230        3,470,000        1  

Automotive

     4,903,922        4,887,750        2       —          —          —    

Banking, Finance, Insurance & Real Estate

     6,409,973        6,312,997        2       8,831,841        8,733,933        3  

Beverage, Food and Tobacco

     7,927,106        7,708,868        3       5,963,334        5,796,506        2  

Capital Equipment

     10,868,848        9,621,366        3       10,888,432        9,831,391        4  

Chemicals, Plastics and Rubber

     —          —          —         4,862,063        4,801,645        2  

CLO Fund Securities

     48,825,983        36,871,295        13       55,480,626        44,325,000        16  

Construction & Building

     1,528,417        1,491,999        1       1,400,223        1,394,163        1  

Consumer goods: Durable

     1,251,118        4,474        0       1,140,500        364,240        0  

Containers, Packaging and Glass

     2,839,628        2,623,104        1       1,434,568        1,440,525        1  

Electronics

     2,972,114        2,973,750        1       3,007,500        3,007,500        1  

Energy: Oil & Gas

     9,527,648        1,620,635        1       16,827,204        8,946,568        3  

Environmental Industries

     4,011,769        3,996,789        1       8,371,180        6,939,794        3  

Forest Products & Paper

     1,569,078        1,525,481        1       1,564,583        1,553,920        1  

Healthcare, Education and Childcare

     9,366,290        9,119,290        3       —          —          —    

Healthcare & Pharmaceuticals

     41,732,075        32,182,240        11       38,638,822        32,287,288        12  

High Tech Industries

     24,229,777        22,864,112        8       23,971,435        23,662,459        9  

Hotel, Gaming & Leisure

     —          —          —         400,000        1,000        0  

Joint Ventures

     49,052,776        45,426,006        16       37,381,525        30,857,107        11  

Media: Advertising, Printing & Publishing

     359,765        98,827        0       6,113,852        5,590,863        2  

Media: Broadcasting & Subscription

     4,858,333        4,892,093        2       —          —          —    

Services: Business

     29,630,110        28,244,892        9       10,398,710        9,213,416        3  

Services: Consumer

     4,580,275        4,594,427        2       —          —          —    

Telecommunications

     6,892,524        6,694,100        2       8,351,775        8,343,919        3  

Textiles and Leather

     12,383,112        12,257,840        4       10,140,662        9,940,294        4  

Money Market Accounts

     13,181,680        13,181,680        5       34,757,129        34,757,129        13  

Transportation: Cargo

     8,502,331        8,502,333        3       4,000,634        4,000,400        1  

U.S. Government Obligations

     9,999,183        9,999,183        3       9,999,349        9,999,349        4  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 344,852,721      $ 287,391,771        100   $ 327,152,104      $ 273,308,349        100
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

(1)

Calculated as a percentage of total portfolio at fair value.

(2)

Represents the equity investment in the Asset Manager Affiliates.

Debt Securities Portfolio

At September 30, 2019 and December 31, 2018, the weighted average contractual interest rate on our loans and debt securities was approximately 9.4% and 10.0%, respectively. At September 30, 2019 and December 31, 2018, the weighted average contractual interest rate on our loans and debt securities, excluding non-accrual and partial non-accrual investments, was approximately 9.0% and 9.1%, respectively.

 

54


The investment portfolio (excluding the Company’s investment in Asset Manager Affiliates, CLO Fund Securities, and Joint Ventures) at September 30, 2019 was spread across 21 different industries and 51 different entities with an average balance per entity of approximately $3.3 million. As of September 30, 2019, six of our investments were on non-accrual status. As of December 31, 2018 five of our investments were on non-accrual status.

We may invest up to 30% of our investment portfolio in “non-qualifying” opportunistic investments such as high-yield bonds, debt and equity securities of CLO Funds, foreign investments, and distressed debt or equity securities of large cap public companies. At September 30, 2019 and December 31, 2018, the total amount of non-qualifying assets was approximately 28.3% and 28.0%, respectively. The majority of non-qualifying assets were foreign investments which were approximately 12.8% and 16.5%, respectively, of our total assets (including our investments in CLO Funds, which are typically domiciled outside the U.S. and represented approximately 12.6% and 15.5% of its total assets, respectively). The investments in our Debt Securities Portfolio are all or predominantly below investment grade, and therefore have speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal.

Asset Manager Affiliates

The Disposed Manager Affiliates manage CLO Funds that invest in broadly syndicated loans, high yield bonds and other credit instruments. The CLO Funds managed by the Disposed Asset Manager Affiliates consist primarily of credit instruments issued by corporations. In connection with the LibreMax Transaction, on December 31, 2018, our wholly-owned subsidiary Commodore Holdings, LLC sold the Disposed Manager Affiliates, which represented substantially all of our investment in the Asset Manager Affiliates, to LibreMax for a cash purchase price of approximately $37.9 million. Accordingly, certain CLO Fund investments were reclassified from CLO Funds managed by affiliates to CLO funds managed by non-affiliates on December 31, 2018. Effective April 1, 2019, as a result of the Externalization and related transactions, CLO Fund investments managed by LibreMax were assigned to CLO Funds managed by affiliates. As of September 30, 2019, our Asset Manager Affiliates had approximately $300 million of par value of assets under management, for which management fees were waived and thus were deemed to have no value. As of December 31, 2018, our Asset Manager Affiliates had approximately $300 million of par value of assets under management on which they earned management fees, and were valued at approximately $3.5 million.

CLO Fund Securities

We have made minority investments in the subordinated securities or preferred shares of CLO Funds managed by the Disposed Manager Affiliates and may selectively invest in securities issued by CLO Funds managed by other asset management companies. As of September 30, 2019 and December 31, 2018, we had approximately $36.9 million and $44.3 million, respectively, invested in CLO Fund Securities, issued primarily by CLO Funds managed by the Disposed Manager Affiliates.

The CLO Funds invest primarily in broadly syndicated non-investment grade loans, high-yield bonds and other credit instruments of corporate issuers. The underlying assets in each of the CLO Fund Securities in which we have an investment are generally diversified secured or unsecured corporate debt.

The structure of CLO Funds, which are highly levered, is extremely complicated. Since we primarily invest in securities representing the residual interests of CLO Funds, our investments are much riskier than the risk profile of the loans by which such CLO Funds are collateralized. Our investments in CLO Funds may be riskier and less transparent to us and our stockholders than direct investments in the underlying loans. The CLO Funds in which we invest have debt that ranks senior to our investment. For a more detailed discussion of the risks related to our investments in CLO Funds, please see “Risk Factors — Risks Related to Our Investments — Our investments may be risky, and you could lose all or part of your investment.” in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018.

 

55


Our CLO Fund Securities as of September 30, 2019 and December 31, 2018 are as follows:

 

                September 30, 2019(3)     December 31, 2018(2)  

CLO Fund Securities

  Investment     %(1)     Amortized
Cost
    Fair Value     Amortized
Cost
    Fair Value  

Katonah III, Ltd.

    Income Notes       23.1     $ 1,287,155     $ 487,508     $ 1,287,155     $ 369,280  

Catamaran CLO 2013- 1 Ltd.

   
Subordinated
Notes
 
 
    23.3       6,294,986       6,268,534       6,378,611       7,016,733  

Catamaran CLO 2014-1 Ltd.

   
Subordinated
Notes
 
 
    22.2       10,192,718       8,302,955       11,740,622       9,777,251  

Great Lakes KCAP F3C Senior LLC

    Class E Notes       27.4       —         —         4,407,106       4,473,840  

Dryden 30 Senior Loan Fund

   
Subordinated
Notes
 
 
    6.8       1,516,717       1,932,505       1,438,701       1,913,925  

Catamaran CLO 2014-2 Ltd.

   
Subordinated
Notes
 
 
    24.9       6,132,465       1,221,236       6,314,484       2,158,200  

Catamaran CLO 2015-1 Ltd.

   
Subordinated
Notes
 
 
    9.9       4,190,443       2,856,878       4,353,347       3,048,698  

Catamaran CLO 2016-1 Ltd.

   
Subordinated
Notes
 
 
    24.9       9,440,106       6,854,783       9,717,150       7,067,073  

Catamaran CLO 2018-1 Ltd.

   
Subordinated
Notes
 
 
    24.8       9,771,393       8,946,896       9,843,450       8,500,000  
     

 

 

   

 

 

   

 

 

   

 

 

 

Total

      $ 48,825,983     $ 36,871,295     $ 55,480,626     $ 44,325,000  
     

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Represents percentage of class held at September 30, 2019.

(2)

Other than Great Lakes KCAP F3C Senior LLC, none of our CLO Fund securities investments were managed by affiliates as of December 31, 2018

(3)

Other than Katonah III, Ltd and Dryden 30, all of our CLO Fund securities investments were managed by affiliates as of September 30, 2019.

Investment in Joint Ventures:

KCAP Freedom 3 LLC

During the third quarter of 2017, we and Freedom 3 Opportunities LLC (“Freedom 3 Opportunities”), an affiliate of Freedom 3 Capital LLC, entered into an agreement to create KCAP Freedom 3 LLC (the “Joint Venture”). We contributed approximately $37 million and Freedom 3 Opportunities contributed approximately $25 million, in assets to the Joint Venture, which in turn used the assets to capitalize a new fund, Great Lakes KCAP F3C Senior Funding, L.L.C. (formerly known as KCAP F3C Senior Funding, L.L.C.) (the “Fund”) managed by KCAP Management, LLC, one of the Asset Manager Affiliates. In addition, the Fund used cash on hand and borrowings under a credit facility to purchase approximately $184 million of primarily middle-market loans from us and we used the proceeds from such sale to redeem approximately $147 million in debt issued by KCAP Senior Funding I, LLC (“KCAP Senior Funding”). The Fund invests primarily in middle-market loans and the Joint Venture partners may source middle-market loans from time-to-time for the Fund.

During the fourth quarter of 2017, the Fund was refinanced through the issuance of senior and subordinated notes. The Joint Venture purchased 100% of the subordinated notes issued by the Fund. In connection with the refinancing, the Joint Venture made a cash distribution to us of approximately $12.6 million. $11.8 million of this distribution was a return of capital, reducing the cost basis of our investment in the Joint Venture by that amount. The final determination of the tax attributes of distributions from the Joint Venture is made on an annual (full calendar year) basis at the end of the year, therefore, any estimate of tax attributes of distributions made on an interim basis may not be representative of the actual tax attributes of distributions for the full year.

 

56


We own a 60% equity investment in the Joint Venture. The Joint Venture is structured as an unconsolidated Delaware limited liability company. All portfolio and other material decisions regarding the Joint Venture must be submitted to its board of managers, which is comprised of four members, two of whom were selected by us and two of whom were selected by Freedom 3 Opportunities, and must be approved by at least one member appointed by us and one appointed by Freedom 3 Opportunities. In addition, certain matters may be approved by the Joint Venture’s investment committee, which is comprised of one member appointed by us and one member appointed by Freedom 3 Opportunities.

In connection with the Externalization, during the first quarter of 2019, KCAP Management agreed to waive management fees it is otherwise entitled to receive for managing the Fund. In addition, the Joint Venture was restructured such that we are now entitled to receive a preferred distribution in an amount equal to the fees waived by KCAP Management. The impact of these transactions was a reduction in the fair value of the Asset Manager Affiliates (realized loss) and increase the fair value of our investment in the Joint Venture (unrealized gain) during the first quarter of 2019.

We have determined that the Joint Venture is an investment company under Accounting Standards Codification (“ASC”), Financial Services — Investment Companies (“ASC 946”), however, in accordance with such guidance, we will generally not consolidate our investment in a company other than a wholly owned investment company subsidiary or a controlled operating company whose business consists of providing services to us. We do not consolidate its interest in the Joint Venture because we do not control the Joint Venture due to allocation of the voting rights among the Joint Venture partners.

KCAP Freedom 3 LLC

Summarized Statement of Financial Condition

 

     As of
September 30,
2019
     As of
December 31,
2018
 

Investment at fair value

   $ 33,548,354      $ 32,621,188  
  

 

 

    

 

 

 

Total Assets

   $ 33,548,354      $ 32,621,188  
  

 

 

    

 

 

 

Total Liabilities

   $ 968,642      $ 1,970,455  
  

 

 

    

 

 

 

Total Equity

     32,579,712        30,650,733  
  

 

 

    

 

 

 

Total Liabilities and Equity

   $ 33,548,354      $ 32,621,188  
  

 

 

    

 

 

 

KCAP Freedom 3 LLC

Summarized Statement of Operations

 

    Nine Months Ended
September 30,
    Three Months Ended
September 30,
 
    2019     2018     2019     2018  

Investment income

  $ 1,341,881     $ 1,148,571     $ 3,957,429     $ 3,566,385  

Operating expenses

    35,191       56,512       54,183       110,273  
 

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

    1,306,690       1,092,059       3,903,246       3,456,112  

Unrealized appreciation on investments

    (1,663,956     529,662       1,928,979       (35,274
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ (357,266   $ 1,621,721     $ 5,832,225     $ 3,420,838  
 

 

 

   

 

 

   

 

 

   

 

 

 

 

57


KCAP Freedom 3 LLC

Schedule of Investments

September 30, 2019

 

Portfolio Company

  

Investment

   Percentage
Ownership
by Joint
Venture
    Amortized
Cost
     Fair Value  

Great Lakes KCAP F3C Senior, LLC(1)(2)(3)

   Subordinated Securities, effective interest 14.9%, 12/29 maturity      100.0   $ 41,634,567      $ 33,548,354  
       

 

 

    

 

 

 

Total Investments

        $ 41,634,567      $ 33,548,354  
       

 

 

    

 

 

 

 

(1)

CLO Subordinated Investments are entitled to periodic distributions which are generally equal to the remaining cash flow of the payments made by the underlying fund’s investments less contractual payments to debt holders and fund expenses. The estimated annualized effective yield indicated is based upon a current projection of the amount and timing of these distributions. Such projections are updated on a quarterly basis and the estimated effective yield is adjusted prospectively.

(2)

Fair value of this investment was determined using significant unobservable inputs, including default rates, prepayment rates, spreads, and the discount rate by which to value the resulting cash flows.

(3)

Formerly known as KCAP F3C Senior Funding, LLC

KCAP Freedom 3 LLC

Schedule of Investments

December 31, 2018

 

Portfolio Company

  

Investment

   Percentage
Ownership
by Joint
Venture
    Amortized
Cost
     Fair Value  

KCAP F3C Senior Funding, LLC (1)(2)

   Subordinated Securities, effective interest 11.5%, 12/29 maturity      100.0   $ 42,636,380      $ 32,621,188  
       

 

 

    

 

 

 

Total Investments

        $ 42,636,380      $ 32,621,188  
       

 

 

    

 

 

 

 

(1)

CLO Subordinated Investments are entitled to periodic distributions which are generally equal to the remaining cash flow of the payments made by the underlying fund’s investments less contractual payments to debt holders and fund expenses. The estimated annualized effective yield indicated is based upon a current projection of the amount and timing of these distributions. Such projections are updated on a quarterly basis and the estimated effective yield is adjusted prospectively.

(2)

Fair value of this investment was determined using significant unobservable inputs, including default rates, prepayment rates, spreads, and the discount rate by which to value the resulting cash flows.

BCP Great Lakes Partnership LP

BCP Great Lakes Partnership LP (the “BCP Great Lakes Partnership”) has invested in BCP Great Lakes Holdings LP, a vehicle formed as a co-investment vehicle to facilitate the participation of certain co-investors to invest, directly or indirectly, in BCP Great Lakes Funding, LLC. The investment strategy of BCP Great Lakes Funding, LLC is to underwrite and hold senior, secured unitranche loans made to middle-market companies. The Company does not pay any advisory fees in connection with its investment in the BCP Great Lakes Partnership.

The fair value of the Company’s investment in the BCP Great Lakes Partnership at September 30, 2019 and December 31, 2018 was $24.2 million and $12.5 million. Fair value has been determined utilizing the practical

 

58


expedient pursuant to ASC 820-10. Pursuant to the terms of the BCP Great Lakes Fund LP Amended and Restated Exempted Limited Partnership Agreement (the “BCP Great Lakes Partnership Agreement”), the Company generally may not sell, exchange, assign, pledge or otherwise transfer its interest, in whole or in part, without the prior written consent of the General Partner which consent may be given or withheld in its sole and absolute discretion, and may be conditioned upon repayment of its share of indebtedness incurred by the partnership.

In March 2019, the Company increased its aggregate commitment to the BCP Great Lakes Partnership to $50 million, subject to certain limitations (including that the Company is not obligated to fund capital calls if such funding would cause the Company to be out of compliance with certain provisions of the Investment Company Act of 1940). As of September 30, 2019 and December 31, 2018, the Company has a $25.9 million and $12.5 million, respectively unfunded commitment to the BCP Great Lakes Partnership.

RESULTS OF OPERATIONS

The principal measure of our financial performance is the net increase (decrease) in stockholders’ equity resulting from operations, which includes net investment income (loss) and net realized and unrealized appreciation (depreciation). Net investment income (loss) is the difference between our income from interest, distributions, fees, and other investment income and our operating expenses. Net realized gain (loss) on investments is the difference between the proceeds received from dispositions of portfolio investments and their amortized cost. Net change in unrealized appreciation (depreciation) on investments is the net change in the fair value of our investment portfolio.

Set forth below is a discussion of our results of operations for the three and nine months ended September 30, 2019 and 2018.

Revenue

Revenues consist primarily of investment income from interest and dividends on our investment portfolio and various ancillary fees related to our investment holdings.

Interest from Investments in Debt Securities. We generate interest income from our investments in debt securities that consist primarily of senior and junior secured loans. Our Debt Securities Portfolio is spread across multiple industries and geographic locations, and as such, we are broadly exposed to market conditions and business environments. As a result, although our investments are exposed to market risks, we continuously seek to limit concentration of exposure in any particular sector or issuer.

Investment Income on Investments in CLO Fund Securities. We generate investment income from our investments in the securities (typically preferred shares or subordinated securities) of CLO Funds. We distinguish CLO Funds managed by its Asset Manager Affiliates as “CLO Fund Securities Managed by Affiliates”, in our consolidated financial statements. Since the Asset Manager Affiliates were owned throughout 2018 and sold on December 31, 2018, investment income on these CLO Fund securities is reflected on the statement of operations for the year of 2018 as “managed by affiliates”, while on the consolidated balance sheet at December 31, 2018 these investments are reflected as “managed by non-affiliates”. Effective April 1, 2019, as a result of the Externalization and related transactions, CLO Fund investments managed by LibreMax were assigned to CLO Funds managed by affiliates. CLO Funds invest primarily in broadly syndicated non-investment grade loans, high-yield bonds and other credit instruments of corporate issuers. The underlying assets in each of the CLO Funds in which we have an investment are generally diversified secured or unsecured corporate debt. Our CLO Fund Securities that are subordinated securities or preferred shares (“junior securities”) are subordinated to senior note holders who typically receive a return on their investment at a fixed spread relative to the LIBOR index. The CLO Funds are leveraged funds and any excess cash flow or “excess spread” (interest earned by the underlying securities in the fund less payments made to senior bond holders and less fund expenses and management fees) is

 

59


paid to the holders of the CLO Fund’s subordinated securities or preferred shares. The level of excess spread from CLO Fund Securities can be impacted by the timing and level of the resetting of the benchmark interest rate for the underlying assets (which reset at various times throughout the quarter) in the CLO Fund and the related CLO Fund note liabilities (which reset at each quarterly distribution date); in periods of short-term and volatile changes in the benchmark interest rate, the levels of excess spread and resulting cash distributions to us can vary significantly.

Interest income on investments in CLO equity investments is recorded using the effective interest method in accordance with the provisions of ASC 325-40, Beneficial Interests in Securitized Financial Assets (“ASC 325-40”), based on the anticipated yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual or estimated projected future cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes in estimated yield are recognized as an adjustment to the estimated yield prospectively over the remaining life of the investment from the date the estimated yield was changed. Accordingly, investment income recognized on CLO equity securities in the U.S. generally accepted accounting principles (“GAAP”) statement of operations differs from both the tax–basis investment income and from the cash distributions actually received by the Company during the period. As a RIC, we anticipate a timely distribution of our tax-basis taxable income.

For non-junior class CLO Fund securities, interest is earned at a fixed spread relative to the LIBOR index.

Distributions from Asset Manager Affiliates. Substantially all of the investment in the Asset Manager Affiliates was sold on December 31, 2018. Prior thereto, we have received cash distributions from the Asset Manager Affiliates, which manage CLO Funds that invest primarily in broadly syndicated non-investment grade loans, high yield bonds and other credit instruments issued by corporations. As managers of CLO Funds, the Asset Manager Affiliates receive contractual and recurring management fees from the CLO Funds for their management and advisory services. In addition, the Asset Manager Affiliates may also earn income related to net interest on assets accumulated for future CLO issuances on which they have taken a first loss position in connection with loan warehouse arrangements for their future CLO Funds.

As a result of tax-basis goodwill amortization and certain other tax-related adjustments, portions of distributions received may be deemed return of capital. The fair value of our investment in our Asset Manager Affiliates was de minimis at September 30, 2019. There were no distributions from the Asset Manager Affiliates during the first three quarters of 2019. For the nine months ended September 30, 2018, we recognized dividend income of $920,000 from the Asset Manager Affiliates, while cash distributions received were approximately $1.9 million. The difference between cash distributions received and the tax-basis earnings and profits is recorded as an adjustment to the cost basis of the Asset Manager Affiliates investments. For interim periods, we estimate the tax attributes of any distributions as being either from tax-basis earnings and profits (i.e. dividend income) or return of capital (i.e. adjustment to our cost basis in the Asset Manager Affiliates). The final determination of the tax attributes of distributions from our Asset Manager Affiliates is made on an annual (full calendar year) basis at the end of the year based upon taxable income and distributions for the full-year. Therefore, any estimate of tax attributes of distributions made on a quarterly basis may not be representative of the actual tax attributes of distributions for a full year. The aggregate of par value of assets under management by our Asset Manager Affiliates was $300 million as of September 30, 2019 and December 31, 2018.

Investment in Joint Ventures. For the three months ended September 30, 2019 and 2018, the Company recognized $1.3 million and $0.8 million, respectively, in investment income from its investment in Joint Ventures. For the nine months ended September 30, 2019 and 2018, the Company recognized $3.5 million and $2.2 million, respectively, in investment income from its investments in Joint Ventures. As of September 30, 2019 and December 31, 2018, the fair value of our investments in Joint Ventures was approximately $45.4 million and $30.9 million, respectively. For interim periods, we recognize investment income on its investment in the Joint Ventures based upon our share of estimated earnings and profits of the Joint Venture. The final determination of the tax attributes of distributions from Joint Ventures is made on an annual (full calendar

 

60


year) basis at year-end of the year based upon taxable income and distributions for the full year. Therefore, any estimate of tax attributes of distributions made on an interim basis may not be representative of the actual tax attributes of distributions for the full year.

Capital Structuring Service Fees. We may earn ancillary structuring and other fees related to the origination, investment, disposition or liquidation of debt and investment securities.

Investment Income

Investment income for the three months ended September 30, 2019 and 2018 was approximately $7.1 million and $7.2 million, respectively. Of these amounts, approximately $4.2 million and $4.8 million, respectively was attributable to interest income on our Debt Securities Portfolio. The decrease in interest income on our Debt Securities Portfolio was primarily the result of additional investments placed on non-accrual status since the prior period and the decrease in LIBOR rates.

Investment income for the nine months ended September 30, 2019 and 2018 was approximately $19.8 million and $20.8 million, respectively. Of these amounts, approximately $11.0 million and $12.9 million, respectively was attributable to interest income on our Debt Securities Portfolio.

At September 30, 2019 and December 31, 2018, the weighted average contractual interest rate on our loans and debt securities was approximately 9.4% and 10.0%, respectively. At September 30, 2019 and December 31, 2018, the weighted average contractual interest rate on our loans and debt securities, excluding non-accrual and partial non-accrual investments, was approximately 9.0% and 9.1%, respectively.

Investment income is primarily dependent on the composition and credit quality of our investment portfolio. Generally, our Debt Securities Portfolio is expected to generate predictable, recurring interest income in accordance with the contractual terms of each loan. Corporate equity securities may pay a dividend and may increase in value for which a gain may be recognized; generally, such dividend payments and gains are less predictable than interest income on our loan portfolio.

For the three months ended September 30, 2019 and 2018, approximately $1.6 million and $1.3 million, respectively, of investment income was attributable to investments in CLO Fund Securities. For the nine months ended September 30, 2019 and 2018, approximately $5.1 million and $4.7 million, respectively, of investment income was attributable to investments in CLO Fund Securities. On a tax basis, the Company recognized $5.9 million and $4.7 million of taxable distributable income on distributions from our CLO Fund Securities during the nine months ended September 30, 2019 and 2018, respectively. Distributions from CLO Fund Securities are dependent on the performance of the underlying assets in each CLO Fund; interest payments, principal amortization and prepayments of the underlying loans in each CLO Fund are primary factors which determine the level of distributions on our CLO Fund Securities. The level of excess spread from CLO Fund Securities can be impacted by the timing and level of the resetting of the benchmark interest rate for the underlying assets (which reset at various times throughout the quarter) in the CLO Fund and the related CLO Fund bond liabilities (which reset at each quarterly distribution date); in periods of short-term and volatile changes in the benchmark interest rate, the levels of excess spread and distributions to us can vary significantly.

Expenses

Through March 31, 2019 we were internally managed, and directly incurred the cost of management and operations. As a result, we paid no investment management fees or other fees to an external advisor. Our expenses consisted primarily of interest expense on outstanding borrowings, compensation expense and general and administrative expenses, including professional fees. Interest and compensation expense are typically our largest expenses each period. Since the Closing, we have been externally managed and no longer have any employees. However, in connection with the Advisory Agreement, we pay the Adviser certain investment

 

61


advisory fees and reimburse the Adviser and Administrator for certain expenses incurred in connection with the services they provide. We bear our allocable portion of the compensation paid by the Adviser (or its affiliates) to our chief compliance officer and chief financial officer and their respective staffs (based on a percentage of time such individuals devote, on an estimated basis, to our business affairs). We also bear all other costs and expenses of our operations, administration and transactions, including, but not limited to (i) investment advisory fees, including management fees and incentive fees, to the Adviser, pursuant to the Advisory Agreement; (ii) our allocable portion of overhead and other expenses incurred by the Adviser (or its affiliates) in performing its administrative obligations under the Advisory Agreement, and (iii) all other expenses of our operations and transactions including, without limitation, those relating to:

 

   

the cost of calculating our net asset value, including the cost of any third-party valuation services;

 

   

the cost of effecting any sales and repurchases of our common stock and other securities;

 

   

fees and expenses payable under any dealer manager or placement agent agreements, if any;

 

   

administration fees payable under the Administration Agreement and any sub-administration agreements, including related expenses;

 

   

debt service and other costs of borrowings or other financing arrangements;

 

   

costs of hedging;

 

   

expenses, including travel expense, incurred by the Adviser, or members of the investment team, or payable to third parties, performing due diligence on prospective portfolio companies and, if necessary, enforcing our rights;

 

   

transfer agent and custodial fees;

 

   

fees and expenses associated with marketing efforts;

 

   

federal and state registration fees, any stock exchange listing fees and fees payable to rating agencies;

 

   

federal, state and local taxes;

 

   

independent directors’ fees and expenses including certain travel expenses;

 

   

costs of preparing financial statements and maintaining books and records and filing reports or other documents with the SEC (or other regulatory bodies) and other reporting and compliance costs, including registration and listing fees, and the compensation of professionals responsible for the preparation of the foregoing;

 

   

the costs of any reports, proxy statements or other notices to stockholders (including printing and mailing costs), the costs of any stockholder or director meetings and the compensation of personnel responsible for the preparation of the foregoing and related matters;

 

   

commissions and other compensation payable to brokers or dealers;

 

   

research and market data;

 

   

fidelity bond, directors and officers errors and omissions liability insurance and other insurance premiums;

 

   

direct costs and expenses of administration, including printing, mailing, long distance telephone and staff;

 

   

fees and expenses associated with independent audits, outside legal and consulting costs;

 

   

costs of winding up our affairs;

 

   

costs incurred by either the Administrator or us in connection with administering our business, including payments under the Administration Agreement;

 

62


   

extraordinary expenses (such as litigation or indemnification); and

 

   

costs associated with reporting and compliance obligations under the 1940 Act and applicable federal and state securities laws.

Management Fees. Management fees for the three and nine months ended September 30, 2019 were approximately $1.0 million and $2.1 million, respectively. There were no incentive fees earned during the third quarter of 2019.

Interest and Amortization of Debt Issuance Costs. Interest expense is dependent on the average outstanding balance on our borrowings and, the base index rate for the period. Debt issuance costs represent fees, and other direct costs incurred in connection with the Company’s borrowings. These amounts are capitalized and amortized ratably over the expected term of the borrowing.

Compensation Expense. Prior to the Closing of the Externalization on April 1, 2019, compensation expense included base salaries, bonuses, stock compensation, employee benefits and employer-related payroll costs. The largest components of total compensation costs are base salaries and bonuses; generally, base salaries are expensed as incurred and annual bonus expenses are estimated and accrued. Our compensation arrangements with our employees contained a profit sharing and/or performance-based bonus component. Following the Closing, we no longer have any employees and therefore do not have any related expenses.

Professional Fees, Administrative services expense and General Administrative Expenses. The balance of our expenses includes professional fees (primarily legal, accounting, director fees, valuation and other professional services), insurance costs, Administrative services expense under the Administration Agreement and general administrative and other costs.

Total expenses for the three months ended September 30, 2019 and 2018 were approximately $4.8 million and $4.2 million, respectively.

For the three months ended September 30, 2019 and 2018, interest expense and amortization on debt issuance costs for the period was approximately $2.3 million and $1.9 million, respectively, on average debt outstanding of $131 million and $103 million, respectively.

Total expenses for the nine months ended September 30, 2019 and 2018 were approximately $18.9 million and $12.9 million, respectively. For the nine months ended September 30, 2019, we incurred approximately $3.4 million in total expenses in connection with the Externalization and approximately $1.4 million related to a non-cash impairment charge to write down the value of the right-of-use asset for the lease of office space formerly occupied by the Company prior to the Externalization. The impairment charge related to our write down of our lease right-of-use asset is recorded as a separate line item within the expense section of the consolidated statement of operations. For the nine months ended September 30, 2019 and 2018, interest expense and amortization on debt issuance costs for the period was approximately $6.1 million and $5.6 million, respectively, on average debt outstanding of $117 million and $106 million, respectively.

For the three months ended September 30, 2019 and 2018, approximately $0 and $1.0 million of expenses were attributable to employee compensation, including salaries, bonuses, employee benefits, payroll taxes and stock-based compensation expense, respectively. Since April 1, 2019, as a result of the Externalization, the Company has no longer has employees and does not incur employee compensation costs. For the three months ended September 30, 2019 and 2018, respectively, professional fees and insurance expenses totaled approximately $0.8 million and $0.9 million. For the three months ended September 30, 2019, Administrative services expense was approximately $0.4 million. Other general and administrative costs, which include rent expense on the Company’s lease obligation, and other administrative expenses, totaled approximately $0.3 million and $0.4 million for the three months ended September 30, 2019 and 2018, respectively.

 

63


The impairment charge related to our write down of our lease right-of-use asset is recorded as a separate line item within the expense section of the consolidated statement of operations.

For the nine months ended September 30, 2019 and 2018, approximately $3.7 million and $3.2 million of expenses were attributable to compensation of former employees, including salaries, bonuses, employee benefits, payroll taxes and stock-based compensation expense, respectively. For the nine months ended September 30, 2019, we incurred approximately $2.2 million in compensation expense (primarily severance) in connection with the Externalization.

For the nine months ended September 30, 2019 and 2018, professional fees and insurance expenses totaled approximately $3.4 million and $2.7 million respectively. For nine months ended September 30, 2019, the Company incurred approximately $1.0 million of professional fees in connection with the Externalization. For the nine months ended September 30, 2019, Administrative services expense was approximately $0.8 million. Other general and administrative expenses, which includes rent expense on the Company’s lease obligation, technology and other office and administrative expenses, totaled approximately $1.4 million and $1.4 million for the nine months ended September 30, 2019 and 2018, respectively. For the nine months ended September 30, 2019, we incurred approximately $187,000 in administrative costs in connection with the Externalization.

Net Investment Income and Net Realized Gains (Losses)

Net investment income and net realized gains (losses) represents the change in stockholder’s equity before net unrealized appreciation or depreciation on investments. For the three months ended September 30, 2019, net investment income and net realized losses were approximately $1.1 million, or $0.03 per share. For the three months ended September 30, 2018, net investment income and net realized gains were approximately $2.8 million, or $0.08 per share. Net investment income represents the income earned on our investments less operating and interest expense before net realized gains or losses and unrealized appreciation or depreciation on investments.

For the nine months ended September 30, 2019, net investment loss and net realized losses were approximately ($15.9) million, or ($0.42) per share. For the nine months ended September 30, 2018, net investment income and net realized gains were approximately $7.8 million, or $0.21 per share.

Investments are carried at fair value, with changes in fair value recorded as unrealized appreciation (depreciation) in the statement of operations. When an investment is sold or liquidated, any previously recognized unrealized appreciation/depreciation is reversed and a corresponding amount is recognized as realized gain (loss). For the nine months ended September 30, 2019, GAAP-basis net investment income was approximately $0.9 million or $0.02 per share, while tax-basis distributable income was approximately $5.1 million or $0.14 per share. For the nine months ended September 30, 2018, GAAP-basis net investment income was approximately $7.9 million or $0.21 per basic share, while tax-basis distributable income was approximately $8.8 million or $0.24 per share.

Net Unrealized (Depreciation) Appreciation on Investments

During the three months ended September 30, 2019, our total investments had net unrealized depreciation of approximately $5.3 million. Included in the net unrealized depreciation are unrealized depreciation on CLO Fund Securities of approximately $2.7 million unrealized depreciation and on equity securities of approximately $(910) thousand, an unrealized depreciation of $1.1 million on our Joint Ventures investment, unrealized depreciation on our debt securities of $0.6 million, and unrealized depreciation of $21 thousand on our derivatives. During the three months ended September 30, 2018, our total investments had net unrealized depreciation of approximately $1.5 million. Included in the net unrealized depreciation are unrealized appreciation on CLO Fund Securities of approximately $688 thousand unrealized depreciation and on equity securities of approximately $172 thousand, as well as unrealized depreciation of the Asset Manager Affiliates of

 

64


$1.0 million thousand, an unrealized appreciation of $282 thousand on our Joint Ventures investment and unrealized depreciation on our debt securities of $1.2 million.

During the nine months ended September 30, 2019, our total investments had net unrealized depreciation of approximately $0.1 million. Included in the net unrealized depreciation for the nine months ended September 30, 2019, are unrealized depreciation on CLO Fund Securities of approximately $0.8 million, net unrealized depreciation on equity securities of approximately $5.8 million, no unrealized on the Asset Manager Affiliates, as well as an unrealized appreciation of $2.9 million on our Joint Ventures investment and unrealized appreciation on our debt securities of approximately $3.6 million. During the nine months ended September 30, 2018, our total investments had net unrealized depreciation of approximately $5.0 million. Included in the net unrealized depreciation are unrealized depreciation on CLO Fund Securities of approximately $125 thousand unrealized depreciation and on equity securities of approximately $335 thousand, as well as unrealized depreciation of the Asset Manager Affiliates of $2.0 million, an unrealized depreciation of $142 thousand on our Joint Ventures investment and unrealized depreciation on our debt securities of $2.4 million.

Net Change in Stockholder’s Equity Resulting From Operations

The net decrease in stockholders’ equity resulting from operations for the three months ended September 30, 2019 was ($4.3) million, or $(0.11) per basic share. Net increase in stockholders’ equity resulting from operations for the three months ended September 30, 2018 was $1.3 million, or $0.04 per share.

The net decrease in stockholders’ equity resulting from operations for the nine months ended September 30, 2019 was ($16.0) million, or $(0.43) per basic share. Net increase in stockholders’ equity resulting from operations for the nine months ended September 30, 2018 was $2.6 million, or $0.07 per share.

FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES

Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain investments, pay distributions to our stockholders and other general business needs. We recognize the need to have funds available for operating our business and to make investments. We seek to have adequate liquidity at all times to cover normal cyclical swings in funding availability and to allow us to meet irregular and unexpected funding requirements. We plan to satisfy our liquidity needs through normal operations with the goal of avoiding unplanned sales of assets or emergency borrowing of funds.

As of September 30, 2019 and December 31, 2018 the fair value of investments and cash were as follows:

 

     Investments at Fair Value  
Security Type    September 30,
2019
     December 31,
2018
 

Cash

   $ 341,166      $ 5,417,125  

Restricted Cash

     1,010,578        3,907,341  

Short-term investments(2)

     23,180,863        44,756,478  

Senior Secured Loan

     104,599,092        77,616,209  

Junior Secured Loan

     70,492,986        70,245,535  

Senior Unsecured Bond

     532,267        —    

CLO Fund Securities

     36,871,295        44,325,000  

Equity Securities

     6,279,611        2,038,020  

Joint Ventures

     45,426,006        30,857,107  

Derivatives

     9,650        —    

Asset Manager Affiliates

     —          3,470,000  
  

 

 

    

 

 

 

Total

   $ 288,743,515      $ 282,632,815  
  

 

 

    

 

 

 

 

65


We use borrowed funds, known as “leverage,” to make investments and to attempt to increase returns to our shareholders by reducing our overall cost of capital. As a BDC, we are limited in the amount of leverage we can incur under the 1940 Act. We are only allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 150% after such borrowing. As of September 30, 2019, we had approximately $125 million of par value of outstanding borrowings and our asset coverage ratio of total assets to total borrowings was 204%, compliant with the minimum asset coverage level of 150% generally required for a BDC by the 1940 Act. We may also borrow amounts of up to 5% of the value of our total assets for temporary purposes.

The recently enacted Small Business Credit Availability Act (the “SBCA”) has modified the 1940 Act by allowing a BDC to increase the maximum amount of leverage it may incur from an asset coverage ratio of 200% to an asset coverage ratio of 150%, if certain requirements are met. On March 29, 2018, the Board , including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of its Board, approved the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act, as amended by the SBCA. As a result, the Company’s asset coverage requirements for senior securities changed from 200% to 150%, effective as of March 29, 2019. We will continue to be prohibited by the indentures governing our 6.125% Notes (each, as defined and discussed in Note 6- “Borrowings”) from making distributions on our common stock if our asset coverage, as defined in the 1940 Act, falls below 200%.

During the third quarter of 2017, the company issued $77.4 million aggregate principal amount of 6.125% Notes due 2022 (the “6.125% Notes Due 2022”). The net proceeds for the 6.125% Notes Due 2022, after the payment of underwriting expenses, were approximately $74.6 million. Interest on the 6.125% Notes Due 2022 is paid quarterly in arrears on March 30, June 30, September 30 and December 30, at a rate of 6.125% commencing September 30, 2017. The 6.125% Notes Due 2022 mature on September 30, 2022 and are senior unsecured obligations. In addition, due to the asset coverage requirement currently applicable to us as a BDC and a covenant that we agreed to in connection with the issuance of the 6.125% Notes Due 2022, the Company is limited in its ability to make distributions if its asset coverage, as defined in the 1940 Act, is below 200% at the time of the declaration of the distribution. As a result, despite the SBCA, we will continue to be prohibited by the indenture governing the 6.125% Notes Due 2022 from making distributions on its common stock if its asset coverage, as defined in the 1940 Act, falls below 200%. At September 30, 2019, we were in compliance with all of our debt covenants. The indenture governing the 6.125% Notes Due 2022 contains certain restrictive covenants, including compliance with certain provisions of the 1940 Act relating to borrowing and dividends.

The Company expects to maintain adequate liquidity and compliance with regulatory and contractual asset coverage requirements.

On March 1, 2018, Great Lakes KCAP Funding I, LLC (“Funding”), our wholly owned subsidiary, entered into a senior secured revolving credit facility (the “Revolving Credit Facility”) with certain institutional lenders, State Bank and Trust Company, as the administrative agent, lead arranger and bookrunner, CIBC Bank USA, as documentation agent and us, as the servicer. The maximum commitment amount of the Revolving Credit Facility was increased on March 27, 2019 to $57.5 million, and on April 1, 2019 to $67.5 million, subject to availability under the borrowing base. Borrowings under the Revolving Credit Facility bear interest at a rate per annum equal to (i) in the case of LIBOR rate loans, an adjusted LIBOR rate for the applicable interest period plus 3.25% or (ii) in the case of base rate loans, the prime rate plus 3.25%. Funding will pay a fee on any undrawn amounts of 0.375% per annum; provided that if 50% or less of the Revolving Credit Facility is drawn, the fee will be 0.50% per annum. We intend to use the proceeds from borrowings under the Revolving Credit Facility for general corporate purposes, including to acquire certain qualifying loans, and such other uses as permitted under the Loan and Security Agreement.

The maturity date is the earliest of: (a) March 1, 2022 and (b) the date upon which all loans shall become due and payable in full, whether by acceleration or otherwise. The Revolving Credit Facility is secured by all of the assets held by Funding, and we have pledged our interests in Funding as collateral to State Bank and Trust

 

66


Company, as the administrative agent, to secure the obligations of Funding under the Revolving Credit Facility. The Revolving Credit Agreement includes customary affirmative and negative covenants, including certain limitations on the incurrence of additional indebtedness and liens, as well as usual and customary events of default for revolving credit facilities of this nature. At September 30, 2019, Funding was in compliance with all of its debt covenants. As of September 30, 2019, $48.0 million principal amount of borrowings was outstanding under the Revolving Credit Facility. Interest on borrowings under the Revolving Credit Facility is paid monthly. Borrowings under the Revolving Credit Facility are subject to redemption in whole or in part at any time or from time to time, at the option of the Funding.

Investment in Joint Ventures

During the third quarter of 2017, we entered into an agreement with Freedom 3 Opportunities, an affiliate of Freedom 3 Capital LLC, entered into an agreement to create the Joint Venture See “Investment in Joint Venture,” above for further information.

In connection with the Externalization, during the first quarter of 2019, KCAP Management agreed to waive management fees it is otherwise entitled to receive for managing Great Lakes KCAP FC3 Senior, LLC (formerly known as KCAP F3C Senior Funding, LLC). In addition, the Joint Venture was restructured such that the Company is now entitled to receive a preferred distribution in an amount equal to the fees waived by KCAP Management. The impact of these transactions is a reduction in the fair value of the Asset Manager Affiliates and increase the fair value of the Company’s investment in the Joint Venture. The reduction in the fair value of the Asset Manager Affiliates was recognized as a realized loss on the Statement of Operations during the first quarter of 2019. The increase in the fair value our investment in the Joint Venture was recognized as an unrealized gain in the Statement of Operations during the first quarter of 2019.

Investment in Great Lakes and Asset Purchase Letter Agreement

We have invested in BCP Great Lakes Fund LP (the “BCP Great Lakes Partnership”), which in turn has invested in BCP Great Lakes Holdings LP, a vehicle formed as a co-investment vehicle to facilitate the participation of certain co-investors to invest, directly or indirectly, in Great Lakes Funding LLC. The investment strategy of BCP Great Lakes Funding, LLC is to underwrite and hold senior, secured unitranche loans made to middle-market companies. We do not pay any advisory fees in connection with our investment in the BCP Great Lakes Partnership.

The fair value of our investment in the BCP Great Lakes Partnership at September 30, 2019 was $24.2 million. Fair value has been determined utilizing the practical expedient pursuant to ASC 820-10. Pursuant to the terms of the BGP Great Lakes Fund LP Amended and Restated Exempted Limited Partnership Agreement (the “BCP Great Lakes Partnership Agreement”), we generally may not sell, exchange, assign, pledge or otherwise transfer its interest, in whole or in part, without the prior written consent of the General Partner which consent may be given or withheld in its sole and absolute discretion, and may be conditioned upon repayment of its share of indebtedness incurred by the BCP Great Lakes Partnership.

In March 2019, we increased its aggregate commitment to the BCP Great Lakes Partnership to $50 million, subject to certain limitations (including that we are not obligated to fund capital calls if such funding would cause us to be out of compliance with certain provisions of the Investment Company Act of 1940). As of September 30, 2019, we had a $25.9 million unfunded commitment to the BCP Great Lakes Partnership, subject to the limitations noted above.

On December 12, 2018, we and BCP entered into a letter agreement (the “Asset Purchase Letter Agreement”) pursuant to which we and BCP each agreed to use commercially reasonable efforts to effect the sale by BCP (or its affiliates or advisory clients of its affiliates), in one or more transactions, of certain assets held by BCP (or its affiliates or advisory clients thereof) that, taken together, have an aggregate principal amount of

 

67


approximately $75 million, less $25 million of aggregate amount of capital contributions made by us to the BCP Great Lakes Partnership. In the second quarter of 2019 BCP’s obligations under the Asset Purchase Letter Agreement were satisfied.

Subject to prevailing market conditions, we intend to grow our portfolio of assets by raising additional capital, including through the prudent use of leverage available to us. However, we may face difficulty in obtaining a new debt and equity financing as a result of current market conditions. In this regard, because our common stock has traded at a price below our current net asset value per share and we are limited in our ability to sell our common stock at a price below net asset value per share without stockholder approval (which we currently do not have), we have been and may continue to be limited in our ability to raise equity capital. See “Part I. Item 1. Business — Regulation — Common Stock”.” of our Annual Report on Form 10-K for the year ended December 31, 2018. From time to time, we may seek to retire, repurchase, or exchange debt securities in open market purchases or by other means dependent on market conditions, liquidity, contractual obligations, and other matters. In addition, we evaluate strategic opportunities available to us, including mergers, divestures, spin-offs, joint ventures and other similar transactions from time to time.

Stockholder Distributions

We intend to continue to make quarterly distributions to our stockholders. To avoid certain excise taxes imposed on RICs, we generally endeavor to distribute during each calendar year an amount at least equal to the sum of:

 

   

98% of our ordinary net taxable income for the calendar year;

 

   

98.2% of our capital gains, if any, in excess of capital losses for the one-year period ending on October 31 of the calendar year; and

 

   

any net ordinary income and net capital gains for the preceding year that were not distributed during such year and on which we do not pay corporate tax.

We may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income, to the extent required.

The amount of our declared distributions, as evaluated by management and approved by our Board, is based primarily on our evaluation of our net investment income and distributable taxable income.

On March 29, 2018, our Board, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act) of the Board, approved the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act, as amended by the SBCA. As a result, our asset coverage requirement for senior securities changed from 200% to 150%, effective as of March 29, 2019. However, despite the SBCA, we will continue to be prohibited by the indentures governing our 6.125% Notes Due 2022 from making distributions on our common stock if our asset coverage, as defined in the 1940 Act, falls below 200%. In any such event, we would be prohibited from making distributions required in order to maintain our status as a RIC.

The following table sets forth the quarterly distributions paid by us since 2017.

 

     Distribution      Declaration
Date
    Record
Date
     Pay Date  

2019:

          

Third quarter

   $ 0.06        8/5/2019       8/12/2019        8/29/2019  

Second quarter

     0.10        3/20/2019       4/5/2019        4/26/2019  

First quarter

     0.10        12/12/2018 (1)      1/7/2019        1/31/2019  
  

 

 

         

Total declared in 2019

   $ 0.26          
  

 

 

         

 

68


     Distribution      Declaration
Date
    Record Date      Pay Date  

2018:

          

Fourth quarter

   $ 0.10        9/18/2018       10/9/2018        10/29/2018  

Third quarter

     0.10        6/19/2018       7/6/2018        7/27/2018  

Second quarter

     0.10        3/20/2018       4/6/2018        4/27/2018  

First quarter

     0.10        12/13/2017 (1)      1/5/2018        1/25/2018  
  

 

 

         

Total declared in 2018

   $ 0.40          
  

 

 

         

2017:

          

Fourth quarter

     0.12        9/22/2017       10/10/2017        10/26/2017  

Third quarter

     0.12        6/20/2017       7/7/2017        7/27/2017  

Second quarter

     0.12        3/21/2017       4/7/2017        4/28/2017  

First quarter

     0.12        12/14/2016 (1)      1/6/2017        1/27/2017  
  

 

 

         

Total declared in 2017

   $ 0.48          
  

 

 

         

 

(1)

Since the record date of this distribution is subsequent to year-end, it is a subsequent year tax event.

OFF-BALANCE SHEET ARRANGEMENTS

From time-to-time the Company is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the needs of the Company’s investment in portfolio companies. Such instruments include commitments to extend credit and may involve, in varying degrees, elements of credit risk in excess of amounts recognized on the Company’s balance sheet. Prior to extending such credit, the Company attempts to limit its credit risk by conducting extensive due diligence, obtaining collateral where necessary and negotiating appropriate financial covenants. As of September 30, 2019 and December 31, 2018, the Company had approximately $28.3 million and $12.9 million commitments to fund investments, respectively. The Company may also enter into derivative contracts with off-balance sheet risk in connection with its investing activities.

CONTRACTUAL OBLIGATIONS

The following table summarizes our contractual cash obligations and other commercial commitments as of September 30, 2019:

 

     Payments Due by Period  

Contractual Obligations

   Total      Less than
one year
     1 - 3 years      3 - 5 years      More than
5 years
 

Long-term debt obligations

   $ 125,427,686      $ —        $ 125,427,686      $ —        $ —    

Obligations under long-term lease

   $ 3,735,368      $ 800,436      $ 2,401,308        533,624        —    

CRITICAL ACCOUNTING POLICIES

The consolidated financial statements are based on the selection and application of critical accounting policies, which require management to make significant estimates and assumptions. Critical accounting policies are those that are both important to the presentation of our financial condition and results of operations and require management’s most difficult, complex, or subjective judgments. Our critical accounting policies are those applicable to the basis of presentation, valuation of investments, and certain revenue recognition matters as discussed below. See Note 2 to our consolidated financial statements, contained elsewhere herein: Significant Accounting Policies — Investments.

 

69


Valuation of Portfolio Investments

The most significant estimate inherent in the preparation of our consolidated financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded.

Value, as defined in Section 2(a)(41) of 1940 Act, is (1) the market price for those securities for which a market quotation is readily available and (2) for all other securities and assets, fair value as determined in good faith by our Board pursuant to procedures approved by our Board. Our valuation policy is intended to provide a consistent basis for determining the fair value of the portfolio based on the nature of the security, the market for the security and other considerations including the financial performance and enterprise value of the portfolio company. Because of the inherent uncertainty of valuation, the Board determined values may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.

Pursuant to ASC 946: Financial Services — Investment Companies (“ASC 946”), we reflect our investments on our balance sheet at their determined fair value with unrealized gains and losses resulting from changes in fair value reflected as a component of unrealized gains or losses on our statements of operations. Fair value is the amount that would be received to sell the investments in an orderly transaction between market participants at the measurement date (i.e., the exit price).

See the Portfolio and Investment Activity Section within this Section for the table showing additional information about the level of market observability associated with investments carried at fair value.

We follow the provisions of ASC 820: Fair Value Measurements and Disclosures (“ASC 820: Fair Value”), which among other matters, requires enhanced disclosures about investments that are measured and reported at fair value. This standard defines fair value and establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability used in measuring investments at fair value and expands disclosures about assets and liabilities measured at fair value. ASC 820: Fair Value defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This fair value definition focuses on an exit price in the principle, or most advantageous market, and prioritizes, within a measurement of fair value, the use of market-based inputs (which may be weighted or adjusted for relevance, reliability and specific attributes relative to the subject investment) over entity-specific inputs. Market price observability is affected by a number of factors, including the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. Subsequent to the adoption of ASC 820: Fair Value, the FASB has issued various staff positions clarifying the initial standard (see Note 2 to the consolidated financial statements: “Significant Accounting Policies — Investments”).

ASC 820: Fair Value establishes the following three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement date:

 

   

Level I – Unadjusted quoted prices are available in active markets for identical investments as of the reporting date. The type of investments included in Level I include listed equities and listed securities. As required by ASC 820: Fair Value, the Company does not adjust the quoted price for these investments, even in situations where the Company holds a large position and a sale could reasonably affect the quoted price.

 

   

Level II – Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date. Such inputs may be quoted prices for similar assets or liabilities, quoted markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full character of the financial instrument, or inputs that

 

70


 

are derived principally from, or corroborated by, observable market information. Investments which are generally included in this category include illiquid debt securities and less liquid, privately held or restricted equity securities, for which some level of recent trading activity has been observed.

 

   

Level III – Pricing inputs are unobservable for the investment and includes situations where there is little, if any, market activity for the investment. The inputs may be based on the Company’s own assumptions about how market participants would price the asset or liability or may use Level II inputs, as adjusted, to reflect specific investment attributes relative to a broader market assumption. These inputs into the determination of fair value may require significant management judgment or estimation. Even if observable market data for comparable performance or valuation measures (earnings multiples, discount rates, other financial/valuation ratios, etc.) are available, such investments are grouped as Level III if any significant data point that is not also market observable (private company earnings, cash flows, etc.) is used in the valuation methodology.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. We assess of the significance of a particular input to the fair value measurement in its entirety requires judgment, and the Company considers factors specific to the investment. The majority of our investments are classified as Level III. We evaluate the source of inputs, including any markets in which its investments are trading, in determining fair value. Inputs that are backed by actual transactions, those that are highly correlated to the specific investment being valued and those derived from reliable or knowledgeable sources will tend to have a higher weighting in determining fair value. Our fair value determinations may include factors such as an assessment of each underlying investment, its current and prospective operating and financial performance, consideration of financing and sale transactions with third parties, expected cash flows and market-based information, including comparable transactions, performance factors, and other investment or industry specific market data, among other factors.

We have valued our investments, in the absence of observable market prices, using the valuation methodologies described below applied on a consistent basis. For some investments little market activity may exist; management’s determination of fair value is then based on the best information available in the circumstances, and may incorporate management’s own assumptions and involves a significant degree of management’s judgment.

Our investments in CLO Fund Securities are carried at fair value, which is based either on (i) the present value of the net expected cash inflows for interest income and principal repayments from underlying assets and the cash outflows for interest expense, debt paydown and other fund costs for the CLO Funds which are approaching or past the end of their reinvestment period and therefore are selling assets and/or using principal repayments to pay-down CLO Fund debt, and for which there continue to be net cash distributions to the class of securities we own, or (ii) a discounted cash flow model that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable yields for similar securities or preferred shares to those in which the Company has invested, or (iii) indicative prices provided by the underwriters or brokers who arrange CLO Funds. We recognize unrealized appreciation or depreciation on our investments in CLO Fund Securities as comparable yields in the market change and/or based on changes in net asset values or estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. As each investment in CLO Fund Securities ages, the expected amount of losses and the expected timing of recognition of such losses in the underlying collateral pool are updated and the revised cash flows are used in determining the fair value of the CLO Fund Securities. We determine the fair value of our investments in CLO Fund Securities on a security-by-security basis.

Our investments in its wholly-owned Asset Manager Affiliates are carried at fair value, which is primarily determined utilizing a discounted cash flow model which incorporates different levels of discount rates

 

71


depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance (“Discounted Cash Flow”). Such valuation takes into consideration an analysis of comparable asset management companies and a percentage of assets under management. The Asset Manager Affiliates are classified as a Level III investment (as described above). Any change in value from period to period is recognized as net change in unrealized appreciation or depreciation.

We carry investments in joint ventures at fair value based upon the fair value of the investments held by the joint venture.

Fair values of other investments for which market prices are not observable are determined by reference to public market or private transactions or valuations for comparable companies or assets in the relevant asset class and/or industry when such amounts are available. Generally, these valuations are derived by multiplying a key performance metric of the investee company or asset (e.g., EBITDA) by the relevant valuation multiple observed for comparable companies or transactions, adjusted by management for differences between the investment and the referenced comparable. Such investments may also be valued at cost for a period of time after an acquisition as the best indicator of fair value. If the fair value of such investments cannot be valued by reference to observable valuation measures for comparable companies, then the primary analytical method used to estimate the fair value is a discounted cash flow method and/or cap rate analysis. A sensitivity analysis is applied to the estimated future cash flows using various factors depending on the investment, including assumed growth rates (in cash flows), capitalization rates (for determining terminal values) and appropriate discount rates to determine a range of reasonable values or to compute projected return on investment.

For bond rated note tranches of CLO Fund securities (those above the junior class) without transactions to support a fair value for the specific CLO Fund and tranche, fair value is based on discounting estimated bond payments at current market yields, which may reflect the adjusted yield on the leveraged loan index for similarly rated tranches, as well as prices for similar tranches for other CLO Funds and also other factors such as indicative prices provided by underwriters or brokers who arrange CLO Funds, and the default and recovery rates of underlying assets in the CLO Fund, as may be applicable. Such model assumptions may vary and incorporate adjustments for risk premiums and CLO Fund specific attributes.

We derive fair value for our illiquid loan investments that do not have indicative fair values based upon active trades primarily by using the Income Approach, and also consider recent loan amendments or other activity specific to the subject asset as described above. Other significant assumptions, such as coupon and maturity, are asset-specific and are noted for each investment in the Schedules of Investments.

The determination of fair value using this methodology takes into consideration a range of factors, including but not limited to the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance and financing transactions subsequent to the acquisition of the investment. This valuation methodology involves a significant degree of Management’s judgment.

Our Board may consider other methods of valuation to determine the fair value of investments as appropriate in conformity with GAAP.

Interest Income

Interest income, including amortization of premium and accretion of discount and accrual of payment-in-kind (“PIK”) interest, is recorded on the accrual basis to the extent that such amounts are expected to be collected. We generally place a loan on non-accrual status and cease recognizing interest income on such loan or security when a loan or security becomes 90 days or more past due or if we otherwise do not expect the debtor to be able to service its debt obligations. For investments with PIK interest, which represents contractual interest accrued and added to the principal balance that generally becomes due at maturity, we will not accrue PIK

 

72


interest if the portfolio company valuation indicates that the PIK interest is not collectible (i.e. via a partial or full non-accrual). Loans which are on partial or full non-accrual remain in such status until the borrower has demonstrated the ability and intent to pay contractual amounts due or such loans become current. As of September 30, 2019, six of our investments were on non-accrual status.

Investment Income on CLO Fund Securities

We receive distributions from our investments in the most junior class of securities of CLO Funds (typically preferred shares or subordinated securities). Our CLO Fund junior class securities are subordinated to senior note holders who typically receive a return on their investment at a fixed spread relative to the LIBOR index. The CLO Funds are leveraged funds and any excess cash flow or “excess spread” (interest earned by the underlying securities in the fund less payments made to senior note holders and less fund expenses and management fees) is paid to the holders of the CLO Fund’s subordinated securities or preferred shares. The level of excess spread from CLO Fund Securities can be impacted from the timing and level of the resetting of the benchmark interest rate for the underlying assets (which reset at various times throughout the quarter) in the CLO Fund and the related CLO Fund note liabilities (which reset at each quarterly distribution date); in periods of short-term and volatile changes in the benchmark interest rate, the levels of excess spread and distributions to us can vary significantly. In addition, the failure of CLO Funds in which we invest to comply with certain financial covenants may lead to the temporary suspension or deferral of cash distributions to us.

GAAP-basis investment income on CLO equity investments is recorded using the effective interest method in accordance with the provisions of ASC 325-40, based on the anticipated yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual or estimated projected future cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes in estimated yield are recognized as an adjustment to the estimated yield prospectively over the remaining life of the investment from the date the estimated yield was changed. Accordingly, investment income recognized on CLO equity securities in the GAAP statement of operations differs from both the tax-basis investment income and from the cash distributions actually received by the Company during the period.

For non-junior class CLO Fund Securities interest is earned at a fixed spread relative to the LIBOR index.

Distributions from Asset Manager Affiliates

We record distributions from our Asset Manager Affiliates on the declaration date, which represents the ex-dividend date. Distributions in excess of tax-basis earnings and profits are recorded as tax-basis return of capital. For interim periods, the Company estimates the tax attributes of any distributions as being either from tax-basis earnings and profits (i.e. dividend income) or return of capital (i.e. adjustment to the Company’s cost basis in the Asset Manager Affiliates). The final determination of the tax attributes of distributions from our Asset Manager Affiliates is made on an annual (full calendar year) basis at the end of the year based upon taxable income and distributions for the full-year. Therefore, any estimate of tax attributes of distributions made on a quarterly basis may not be representative of the actual tax attributes of distributions for a full year.

Payment in Kind Interest

We may have loans in our portfolio that contain a payment-in-kind (“PIK”) provision. PIK interest, computed at the contractual rate specified in each loan agreement, is added to the principal balance of the loan and recorded as interest income. To maintain our RIC status, this non-cash source of income must be distributed to stockholders in the form of cash dividends, even though the Company has not yet collected any cash.

 

73


Fee Income

Fee income includes fees, if any, for due diligence, structuring, commitment and facility fees, and fees, if any, for transaction services and management services rendered by us to portfolio companies and other third parties. Commitment and facility fees are generally recognized as income over the life of the underlying loan, whereas due diligence, structuring, transaction service and management service fees are generally recognized as income when the services are rendered.

Management Compensation

As a result of the Closing we will no longer issue stock options or restricted stock under the Equity Incentive Plan or the 2008 Non-Employee Director Plan. The 1940 Act does not permit externally managed investment companies and BDCs to issue or have outstanding options or restricted stock granted to directors and employees. Immediately prior to the Closing, by virtue of the Externalization and subject to the execution of an option cancellation agreement, each option to purchase shares of the Company’s common stock granted under the Company’s 2008 Non-Employee Director Plan that was outstanding immediately prior to the Externalization (each, a “Company Stock Option”) was cancelled in exchange for the payment in cash to the holder thereof.

Immediately prior to the Closing, each restricted share of the Company (the “Company Restricted Share”) outstanding and not previously forfeited under the Company’s Equity Incentive Plan and the Company’s Non-Employee Director Plan became fully vested, all restrictions with respect to such Company Restricted Shares lapsed, and the holders of such Company Restricted Shares became entitled to receive a pro rata share of the Stockholder Payment.

United States Federal Income Taxes

The Company has elected and intends to continue to qualify for the tax treatment applicable to RICs under Subchapter M of the Code and, among other things, intends to make the required distributions to its stockholders as specified therein. In order to qualify as a RIC, the Company is required to timely distribute to its stockholders at least 90% of the sum of its investment company taxable income, as defined by the Code, and its net tax-exempt income for each taxable year. Depending on the level of taxable income earned in a tax year, the Company may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income, to the extent required.

Distributions to Shareholders

The amount of our declared distributions, as evaluated by management and approved by our Board, is based primarily on our evaluation of net investment income and distributable taxable income. The following table sets forth the quarterly distributions paid by us for the 2019, 2018 and 2017 calendar years.

 

     Distribution      Declaration
Date
    Record
Date
     Pay Date  

2019:

          

Third quarter

   $ 0.06        8/5/2019       8/12/2019        8/29/2019  

Second quarter

     0.10        3/20/2019       4/5/2019        4/26/2019  

First quarter

     0.10        12/12/2018 (1)      1/7/2019        1/31/2019  
  

 

 

         

Total declared in 2019

   $ 0.26          
  

 

 

         

2018:

          

Fourth quarter

   $ 0.10        9/18/2018       10/9/2018        10/29/2018  

Third quarter

     0.10        6/19/2018       7/6/2018        7/27/2018  

Second quarter

     0.10        3/20/2018       4/6/2018        4/27/2018  

First quarter

     0.10        12/13/2017 (1)      1/5/2018        1/25/2018  
  

 

 

         

Total declared in 2018

   $ 0.40          
  

 

 

         

 

74


     Distribution      Declaration
Date
    Record
Date
     Pay Date  

2017:

          

Fourth quarter

     0.12        9/22/2017       10/10/2017        10/26/2017  

Third quarter

     0.12        6/20/2017       7/7/2017        7/27/2017  

Second quarter

     0.12        3/21/2017       4/7/2017        4/28/2017  

First quarter

     0.12        12/14/2016 (1)      1/6/2017        1/27/2017  
  

 

 

         

Total declared in 2017

   $ 0.48          
  

 

 

         

 

(1)

Since the record date of this distribution is subsequent to year-end, it is a subsequent year tax event.

 

75


UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The unaudited pro forma condensed consolidated financial information has been derived from and should be read in conjunction with the historical consolidated financial statements and the related notes of both PTMN and OHAI, which are included elsewhere in this proxy statement/prospectus. See “Index to Financial Statements.”

The following unaudited pro forma condensed consolidated financial information and explanatory notes illustrate the effect of the Merger on PTMN’s financial position and results of operations based upon the companies’ respective historical financial positions and results of operations under the asset acquisition method of accounting with PTMN treated as the acquirer.

Generally, under asset acquisition accounting, acquiring assets in groups not only requires ascertaining the cost of the asset (or net assets), but also allocating that cost to the individual assets (or individual assets and liabilities) that make up the group. The cost of the group of assets acquired in an asset acquisition is allocated to the individual assets acquired or liabilities assumed based on their relative fair values of net identifiable assets acquired other than certain “non-qualifying” assets (for example cash) and does not give rise to goodwill. PTMN believes that the acquisition of OHAI should be accounted for as an asset acquisition based on the nature of its pre-acquisition operations, asset or capital allocation and other factors outlined in ASC 805-50—Business Combinations–Related Issues.

The unaudited pro forma condensed consolidated financial information includes the unaudited pro forma condensed consolidated balance sheet as of September 30, 2019 assuming the Merger had been completed on September 30, 2019. The unaudited pro forma condensed consolidated income statements for nine months ended September 30, 2019 and for the year ended December 31, 2018 were prepared assuming the Merger had been completed on December 31, 2017.

The unaudited pro forma condensed consolidated financial information is presented for illustrative purposes only and does not necessarily indicate the results of operations or the combined financial position that would have resulted had the Merger been completed at the beginning of the applicable period presented, nor the impact of expense efficiencies, asset dispositions, share repurchases and other factors. In addition, as explained in more detail in the accompanying notes to the unaudited pro forma condensed consolidated financial information, the allocation of the pro forma purchase price reflected in the unaudited pro forma condensed consolidated financial information involves estimates, is subject to adjustment and may vary significantly from the actual purchase price allocation that will be recorded upon completion of the Merger.

 

76


Portman Ridge Finance Corporation

Pro Forma Condensed Consolidated Statement of Financial Condition

As of September 30, 2019

(Unaudited)

(in thousands except share and per share amounts)

 

     Actual      Actual           Pro forma  
     Portman Ridge
Finance
Corporation
     OHA
Investment
Corporation
    Pro forma
Adjustments
    Portman Ridge
Finance
Corporation
 

Assets and Liabilities Data:

         

Investments, at fair value

   $ 264,211      $ 62,404     $ —       $ 326,615  

Cash, cash equivalents and restricted cash

     24,533        14,496       (9,416 )(A)      29,612  

Other assets

     4,422        1,109       —         5,531  
  

 

 

    

 

 

   

 

 

   

 

 

 

Total assets

   $ 293,166      $ 78,009     $ (9,416   $ 361,759  
  

 

 

    

 

 

   

 

 

   

 

 

 
         

Debt, net of unamortized debt issuance costs

   $ 122,479      $ 29,894     $ —       $ 152,373  

Other liabilities

     37,963        12,611         50,574  
  

 

 

    

 

 

   

 

 

   

 

 

 

Total liabilities

     160,443        42,505       —         202,948  

Net Assets

     132,723        35,504       (9,416 )(A)      158,811  
  

 

 

    

 

 

   

 

 

   

 

 

 

Total liabilities and net assets

   $ 293,166      $ 78,009     $ (9,416   $ 361,759  
  

 

 

    

 

 

   

 

 

   

 

 

 

Number of common shares outstanding

     37,371,912        20,172,392       (12,735,382     44,808,922  

Net asset value per common share

   $ 3.55      $ 1.76       $ 3.54  

See notes to pro forma condensed consolidated financial statements.

 

77


Portman Ridge Finance Corporation

Pro Forma Condensed Consolidated Statement of Operations

For the Nine Months Ended September 30, 2019

(Unaudited)

(in thousands except share and per share amounts)

 

     Actual     Actual           Pro forma  
     Portman Ridge
Finance
Corporation
    OHA
Investment
Corporation
    Pro forma
Adjustments
    Portman Ridge
Finance
Corporation
 

Performance Data:

        

Interest and dividend income

   $ 19,673     $ 4,549     $ 599 (B)    $ 24,821  

Fee and other income

     117       18       —         135  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     19,790       4,567       599       24,955  

Interest expense and other debt financing expenses

     6,064       1,860       —         7,924  

Base management fee

     2,052       925       (132 )(C)      2,845  

Incentive fee

     —         46       267       313  

Compensation expenses

     3,689       —         —         3,689  

Other expenses

     7,058       2,927       (1,528 )(D)      8,457  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     18,863       5,758       (1,393     23,228  

Management fee waiver

     —         —         —         —    

Incentive fee waiver

     —         —         (313     (313
  

 

 

   

 

 

   

 

 

   

 

 

 

Net expenses

     18,863       5,758       (1,706     22,915  

Income tax provision, net

     —         15       —         15  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income (loss)

     927       (1,206     2,305       2,026  

Net realized gain (loss) on investments

     (16,796     629       —         (16,167

Realized (loss) on early extinguishment of debt

     —         —         —         —    

Net unrealized gain (loss) on investments

     (147     1,382       (599 )(B)      636  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in net assets resulting from operations

   $ (16,017   $ 805     $ 1,706     $ (13,506
  

 

 

   

 

 

   

 

 

   

 

 

 

Per Common Share Data:

        

Net increase (decrease) in net assets resulting from operations - basic

   $ (0.43   $ 0.04       $ (0.30

Net increase (decrease) in net assets resulting from operations - diluted

   $ (0.43   $ 0.04       $ (0.30

Net investment income (loss) per common share - basic

   $ 0.02     $ (0.06     $ 0.05  

Net investment income (loss) per common share - diluted

   $ 0.02     $ (0.06     $ 0.05  

Weighted average shares outstanding - basic

     37,348,835       20,172,392       (12,735,382     44,785,845  

Weighted average shares outstanding - diluted

     37,348,835       20,172,392       (12,735,382     44,785,845  

 

(1)

Basic and diluted weighted average common shares outstanding for the Pro Forma Portman Ridge Finance Corporation is determined by adding estimated issuance of 7,437,010 PTMN shares, (or 19.9% of PTMN shares outstanding as of September 30, 2019 of 37,371,912) to the average common shares outstanding for PTMN for the nine-months ended September 30, 2019 (after accounting for anticipated expenses of both parties related to the transaction).

See notes to pro forma condensed consolidated financial statements.

 

78


Portman Ridge Finance Corporation

Pro Forma Condensed Consolidated Statement of Operations

For the Year Ended December 31, 2018

(Unaudited)

(in thousands except share and per share amounts)

 

     Actual     Actual           Pro forma  
     Portman Ridge
Finance
Corporation
    OHA
Investment
Corporation
    Pro forma
Adjustments
    Portman Ridge
Finance
Corporation
 

Performance Data:

        

Interest and dividend income

   $ 26,841     $ 8,425     $ 798 (B)    $ 36,064  

Fee and other income

     245       43         288  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     27,087       8,468       798       36,353  

Interest expense and other debt financing expenses

     7,403       2,984       —         10,387  

Base management fee

     —         1,547       (221 )(C)      1,326  

Incentive fee

     —         —         —         —    

Compensation expenses

     4,013       —         —         4,013  

Other expenses

     5,666       3,229       (2,846 )(D)      6,049  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     17,082       7,760       (3,067     21,775  

Management fee waiver

     —         —         —         —    

Incentive fee waiver

     —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Net expenses

     17,082       7,760       (3,067     21,775  

Income tax provision, net

       37         37  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

     10,004       671       3,865       14,540  

Net realized gain (loss) on investments

     (16,475     (55,952     —         (72,427

Realized (loss) on early extinguishment of debt

     (197     —         —         (197

Net unrealized gain (loss) on investments

     (2,904     45,033       5,205 (E)      47,334  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase in net assets resulting from operations

   $ (9,572   $ (10,248   $ 9,070     $ (10,750
  

 

 

   

 

 

   

 

 

   

 

 

 
Per Common Share Data:         

Net increase (decrease) in net assets resulting from operations - basic

   $ (0.26   $ (0.51     $ (0.24

Net increase (decrease) in net assets resulting from operations - diluted

   $ (0.26   $ (0.51     $ (0.24

Net investment income (loss) per common share - basic

   $ 0.27     $ 0.03       $ 0.32  

Net investment income (loss) per common share - diluted

   $ 0.27     $ 0.03       $ 0.32  

Weighted average shares outstanding - basic

     37,356,241       20,172,392       (12,735,382     44,793,251  

Weighted average shares outstanding - diluted

     37,356,241       20,172,392       (12,735,382     44,793,251  

 

(1)

Basic and diluted weighted average common shares outstanding for the Pro Forma Portman Ridge Finance Corporation is determined by adding estimated issuance of 7,437,010 PTMN shares, (or 19.9% of PTMN shares outstanding as of September 30, 2019 of 37,371,912) to the average common shares outstanding for PTMN for the year ended December 31, 2018.

See notes to pro forma condensed consolidated financial statements.

 

79


Portman Ridge Finance Corporation

Notes to Pro Forma Condensed Consolidated Financial Statements

Unaudited

(In thousands, except share and per share data)

1. BASIS OF PRO FORMA PRESENTATION

The unaudited pro forma condensed consolidated financial information related to the Merger is included as of September 30, 2019, for the nine months ended September 30, 2019 and for the year ended December 31, 2018. On July 31, 2019, PTMN and OHAI Corporation entered into the Merger Agreement. The unaudited pro forma condensed consolidated financial information includes the unaudited pro forma condensed consolidated statement of financial condition assuming the First Merger and Second Merger had been completed on September 30, 2019. The unaudited pro forma condensed consolidated income statements for the nine months ended September 30, 2019 and for the year ended December 31, 2018 were prepared assuming the First Merger and Second Merger had been completed on December 31, 2017.

For the purposes of the pro forma condensed consolidated financial statements, the net asset value of both companies as of September 30, 2019 was used to determine the number of shares of PTMN to be issued and the amount of cash consideration to be paid to stockholders of OHAI. The pro forma adjustments included herein reflect the issuance of 7,437,010 shares or approximately 19.9% of PTMN outstanding shares as of September 30, 2019, the payment of approximately $8.5 million in cash consideration to OHAI Stockholders for the difference between its net asset value and the value of the shares issued by PTMN (at net asset value), and transaction expenses borne by each company.

The Merger will be accounted for as an asset acquisition of OHAI by PTMN in accordance with the asset acquisition method of accounting as detailed in ASC 805-50, Business Combinations Related Issues. In applying the asset acquisition method of accounting, PTMN uses a cost approach to allocate the cost of the assets purchased against the assets being acquired. The cost of the acquisition is determined to be the fair value of the consideration given or the fair value of the assets acquired, whichever is more clearly evident. PTMN has determined that the price of its common stock is most evident of fair value. On a pro forma basis, PTMN’s closing stock price as of September 30, 2019 was used as a preliminary estimate of purchase price. The fair value of the Merger Consideration paid by PTMN is allocated to assets acquired and liabilities assumed based on their relative fair values as of the date of acquisition other than certain “non-qualifying” assets (for example cash) and will not give rise to goodwill.

The Merger will be accounted for using the asset acquisition method of accounting. Accordingly, the purchase price paid by PTMN in connection with the Merger will be allocated to the acquired assets and assumed liabilities of OHAI at their relative fair values estimated by PTMN as of the effective date. The fair value of the Merger Consideration paid by PTMN is assumed to be equal to the fair value of OHAI’s net assets acquired. Accordingly, PTMN intends to assign all acquired assets and assumed liabilities the same carrying value as OHAI before the Merger. Investments owned by OHAI are carried at fair value as of September 30, 2019 as determined by the OHAI Board. With regard to the OHAI debt assumed by PTMN, the estimated fair value of OHAI’s debt is assumed to be approximately equal to its carrying value as of September 30, 2019. It is expected that other assets and other liabilities are short term in nature and therefore it can be assumed that fair value approximates carrying value at September 30, 2019.

Pursuant to the application of ASC 805-50, Business Combinations — Related Issues, since the cost of the net assets acquired is less than their fair value, there is a day-one unrealized gain as a result of the Merger. The consideration paid is allocated to individual investments acquired based upon their fair values as of September 30, 2019. The resulting discount will be accreted into investment income over the period from the date of acquisition to the final maturity of each investment. To the extent that any of those investments is sold in the future at price in excess of its then amortized cost (such amortized cost reflecting accumulated accretion from

 

80


the date of acquisition), then such sale will result in a realized gain, which realized gain would be a considered in the determination of any incentive fees pursuant to the Advisory Agreement.

PTMN’s financial statements include its accounts and the accounts of all its consolidated subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates: The preparation of the unaudited pro forma condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Many of the amounts have been rounded, and all amounts are in thousands, except share and per share amounts.

Valuation of Portfolio Investments: Each quarter, PTMN and OHAI determine the net asset value of their respective investment portfolios. Securities are valued at fair value as determined in good faith by both companies’ boards of directors pursuant to each company’s valuation policies. In connection with that determination, each company’s adviser (OHA and Sierra Crest, each an “Adviser”) provides its board with portfolio company valuations which are based on relevant inputs, including, but not limited to, indicative dealer quotes, values of like securities, recent portfolio company financial statements and forecasts, and valuations prepared by independent third-party valuation services. The boards of both companies have delegated day-to-day responsibility for implementing its valuation policies to each Adviser’s management team and has authorized the Advisers’ management teams to utilize third-party valuation services, to the extent deemed appropriate. The boards remain responsible for overseeing each Adviser’s implementation of the valuation process.

ASC Topic 820 issued by the Financial Accounting Standards Board, or the FASB, clarifies the definition of fair value and requires companies to expand their disclosure about the use of fair value to measure assets and liabilities in interim and annual periods subsequent to initial recognition. ASC Topic 820 defines fair value as the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 also establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, which includes inputs such as quoted prices for similar securities in active markets and quoted prices for identical securities where there is little or no activity in the market; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.

Income Taxes: PTMN has elected to be treated for U.S. federal income tax purposes, and intends to qualify annually, as a RIC under Subchapter M of the Code. To qualify for and maintain qualification as a RIC, PTMN must, among other things, meet certain source-of-income and asset diversification requirements, as well as distribute to its stockholders, for each tax year, at least 90% of its “investment company taxable income,” which is generally PTMNs net ordinary income plus the excess, if any, of realized net short-term capital gains over realized net long-term capital losses, determined without regard to any deduction for distributions paid. As a RIC, PTMN will not have to pay corporate-level U.S. federal income taxes on any income that it distributes to its stockholders. PTMN intends to make distributions in an amount sufficient to qualify for and maintain its RIC tax status each tax year and to not pay any U.S. federal income taxes on income so distributed. PTMN is also subject to nondeductible federal excise taxes if it does not distribute in respect of each calendar year an amount at least equal to the sum of 98% of net ordinary income, 98.2% of any capital gain net income, if any, and any recognized and undistributed income from prior years for which it paid no U.S. federal income taxes.

Transaction Costs: Both PTMN and OHAI are expected to incur direct transaction costs resulting from the Merger. The Merger Agreement stipulates that each company shall bear its own transaction costs which will be expensed as incurred prior to the merger closing. PTMN expects to incur $1.0 million in estimated transaction costs, while OHAI expects to incur $1.7 million in estimated transaction costs. Those costs are incorporated into the pro forma condensed consolidated financial statements and reflected as an adjustment to the pro forma combined net asset value.

 

81


2. PRELIMINARY PRO FORMA ADJUSTMENTS

(A) The pro forma adjustment to cash and cash equivalents and restricted cash, and to stockholders’ equity, is composed of the following:

 

     Amounts in
Thousands
 

Cash paid to OHAI shareholders

   $ 8,484  

Estimated transaction expenses:

  

Estimated PTMN transaction expenses

     324  

Estimated OHAI transaction expenses

     608  
  

 

 

 

Total pro-forma adjustment to cash and stockholders’ equity

   $ 9,416  
  

 

 

 

(B) The pro forma adjustment to interest income represents the accretion of discount on OHAI investments acquired by PTMN, reflecting the discounted cost relative to the fair value of the investments acquired.

(C) The pro forma adjustment to base management fees reflects the lower base management fee rate in PTMN’s Investment Advisory Agreement when compared with OHAI’s investment advisory agreement.

(D) This pro forma adjustment reflects impact of the Merger on professional fees and general and administrative expenses representing cost savings and synergies attributable to the Merger.

(E) This pro forma adjustment represents a day-one unrealized gain resulting from the Merger pursuant to ASC 805-50, Business Combinations — Related Issues, reduced by the pro forma accretion of discount on the OHAI investments acquired.

 

82


PORTMAN RIDGE FINANCE CORPORATION

PRO FORMA CONDENSED CONSOLIDATED SCHEDULE OF INVESTMENTS

As of September 30, 2019

(unaudited)

Debt Securities Portfolio

 

   

Investment

Interest Rate¹ /
Maturity15,21

  Actual     Actual     Pro Forma
Adjustments

Amortized
Cost
    Pro Forma unaudited  
    Portman Ridge Finance
Corporation
    OHAI
Investment Corporation
 

Portfolio Company /

Principal Business

  Amortized
Cost
    Fair Value2     Amortized
Cost
    Fair Value2     Amortized
Cost
    Fair Value2  

Acrisure, LLC(8)(14)

Banking, Finance, Insurance & Real Estate

  Senior Secured Loan –
2017-2 Refinancing Term Loan (First Lien) 6.4% Cash, 3 month LIBOR(2.10%) + 4.25%; LIBOR Floor 1.00%,
Due 11/23
  $ 1,992,417     $ 1,992,417     $ —       $ —       $ —       $ 1,992,417     $ 1,992,417  

Advanced Lighting Technologies, Inc.(5)(8)(13)
Consumer goods: Durable

  Junior Secured Loan –
Second Lien Notes 9.1%
Cash, 10.0% PIK, 1 month LIBOR(2.10%) + 7.00%; LIBOR Floor 1.00%, Due 10/23
    1,069,118       2,474       —         —         —         1,069,118       2,474  

Akumin Corp.(8)(14)
Healthcare & Pharmaceuticals

  Senior Secured Loan –
Initial Term B Loan 8.0% Cash, 3 month LIBOR(2.04%) +
6.00%; LIBOR Floor 1.00%, Due 5/24
    2,202,509       2,199,488       —         —         —         2,202,509       2,199,488  

Anthem Sports & Entertainment Inc.(8)
Media: Broadcasting & Subscription

  Senior Secured Loan –
Revolving Loan 11.6%
Cash, 3 month LIBOR(2.10%) +
9.50%; LIBOR Floor 1.00%, Due 9/24
    374,954       400,708       —         —         —         374,954       400,708  

Anthem Sports & Entertainment Inc.(8)
Media: Broadcasting & Subscription

  Senior Secured Loan –
Term Loan 8.9% Cash, 2.8% PIK, 3 month LIBOR(2.10%) +
6.75%; LIBOR Floor 1.00%, Due 9/24
    4,406,856       4,414,862       —         —         —         4,406,856       4,414,862  

Aptean(22)
Software

  Second Lien Term Loan (LIBOR+8.50%), 10.60%, due 4/27     —         —         1,359,000       1,372,000       (118,981     1,240,019       1,372,000  

Ardonagh(23)

Banking, Finance, Insurance & Real Estate

  Senior Secured Notes 8.63%, due 7/23     —         —         549,000       573,000       (31,120     517,880       573,000  

ATP Oil & Gas Corporation/Bennu Oil & Gas, LLC(22)(27)(31)
Energy: Oil & Gas

  Limited Term Royalty Interest (notional rate of 13.2%)     —         —         24,561,000       3,672,000       (21,242,231     3,318,769       3,672,000  

Blackboard Transact(22)
Software

  Second Lien Term Loan (LIBOR+8.50%), 10.76%, due 4/27     —         —         1,405,000       1,425,000       (117,079     1,287,921       1,425,000  

 

83


   

Investment

Interest Rate¹ /
Maturity15,21

  Actual     Actual     Pro Forma
Adjustments

Amortized
Cost
    Pro Forma unaudited  
    Portman Ridge Finance
Corporation
    OHAI
Investment Corporation
 

Portfolio Company /

Principal Business

  Amortized
Cost
    Fair Value2     Amortized
Cost
    Fair Value2     Amortized
Cost
    Fair Value2  

BMC Acquisition, Inc. (aka BenefitMall)(8)(13)(14)
Banking, Finance, Insurance & Real Estate

  Senior Secured Loan –
Initial Term Loan 7.4%
Cash, 1 month LIBOR(2.26%) + 5.17%; LIBOR Floor 1.00%,
Due 12/24
    2,946,198       2,883,539       —         —         —         2,946,198       2,883,539  

BW NHHC Holdco Inc.(8)(13)(14)
Healthcare & Pharmaceuticals

  Senior Secured Loan –
Initial Term Loan (First
Lien) 7.1% Cash, 1 month LIBOR(2.05%) + 5.00%, Due 5/25
    1,951,130       1,793,893       —         —         —         1,951,130       1,793,893  

Caliber Collision(23)
Automotive

  Second Lien Term Loan (LIBOR+7.25%), 9.29%,
due 2/27
    —         —         1,082,000       1,100,000       (87,815     994,185       1,100,000  

Carestream Health, Inc.(8)(13)
Healthcare & Pharmaceuticals

  Junior Secured Loan –
Extended Term Loan (Second Lien) 11.5% Cash, 3 month LIBOR(2.04%) + 9.50%;
LIBOR Floor 1.00%,
Due 6/21
    1,500,652       1,480,736       —         —         —         1,500,652       1,480,736  

CentralSquare Technologies(23)
Software

  Second Lien Term Loan (LIBOR+7.50%), 9.54%,
due 8/26
    —         —         1,953,000       1,903,000       (233,061     1,719,939       1,903,000  

Child Development Schools, Inc.(8)(14)
Services: Consumer

  Senior Secured Loan –
Term Loan 6.5% Cash, 1 month LIBOR(2.26%) +
4.25%, Due 5/23
    4,580,275       4,594,427       —         —         —         4,580,275       4,594,427  

ClearChoice (CC Dental Implants Intermediate)(22)(30)
Healthcare

  First Lien Term Loan
(Last Out) (LIBOR+6.50%
with a 1.0% floor), 8.90%, due 1/23
    —         —         496,000       500,000       (44,098     451,902       500,000  

ClearChoice (CC Dental Implants Intermediate)(22)(29)(30)
Healthcare

  First Lien Revolver (Last
Out) (Funded: LIBOR+
6.50% with a 1.0% floor, Unfunded: 0.75%), 8.55%, due 1/23
    —         —         (11,000     —         11,000       —         —    

Community Care Health Network, Inc. (aka Matrix Medical Network)(8)(14)
Healthcare & Pharmaceuticals

 

Senior Secured Loan –
Closing Date Term Loan
6.8% Cash, 1 month LIBOR(2.04%) + 4.75%;

LIBOR Floor 1.00%,
Due 2/25

    1,971,196       1,848,108       —         —         —         1,971,196       1,848,108  

Coinamatic Canada, Inc.(23)
Industrials - Laundry Equipment

  Second Lien Term Loan (LIBOR+7.00% with a
1.0% floor), 9.04%,
due 5/23
    —         —         520,000       509,000       (59,964     460,036       509,000  

Corsair Gaming, Inc.(8)
High Tech Industries

  Junior Secured Loan –
Term Loan (Second
Lien) 10.6% Cash, 1
month LIBOR(2.10%) +
8.50%; LIBOR Floor 1.00%, Due 8/25
    2,966,199       2,947,500       —         —         —         2,966,199       2,947,500  

 

84


   

Investment

Interest Rate¹ /
Maturity15,21

  Actual     Actual     Pro Forma
Adjustments

Amortized
Cost
    Pro Forma unaudited  
    Portman Ridge Finance
Corporation
    OHAI
Investment Corporation
 

Portfolio Company /

Principal Business

  Amortized
Cost
    Fair Value2     Amortized
Cost
    Fair Value2     Amortized
Cost
    Fair Value2  

CSM Bakery Solutions Limited (fka CSM Bakery Supplies Limited)(8)
Beverage, Food and Tobacco

  Junior Secured Loan –
Term Loan (Second Lien) 10.0% Cash, 1 month LIBOR(2.29%) + 7.75%; LIBOR Floor 1.00%, Due 7/21
    3,004,425       2,790,000       —         —         —         3,004,425       2,790,000  

DexKo Global, Inc.(23)
Automotive

  Second Lien Term Loan (LIBOR+8.25% with a
1.0% floor), 10.35%,
due 7/25
    —         —         2,917,000       2,935,000       (264,335     2,652,665       2,935,000  

Digitran Innovations B.V. (Pomeroy Solutions Holding Company, Inc.)(8)(13)(14)
High Tech Industries

  Senior Secured Loan –
Term Loan 9.8% Cash,
3 month LIBOR(2.33%) + 7.50%; LIBOR Floor 1.50%, Due 7/24
    4,919,934       3,706,297