Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-K

 


 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to            

Commission File No. 814-00735

 


Kohlberg Capital Corporation

(Exact name of Registrant as specified in its charter)

 


 

Delaware   20-5951150

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

295 Madison Avenue, 6th Floor

New York, New York 10017

(Address of principal executive offices)

(212) 455-8300

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange

    on which registered    

Common Shares, par value $0.01 per share   The NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act: None

 


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:    YES  x    NO  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨                    Accelerated filer  ¨                    Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of March 28, 2007 was approximately $293 million based upon a closing price of $16.34 reported for such date by The Nasdaq Global Market. Common shares held by each executive officer and director and by each person who owns 5% or more of the outstanding common shares have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of outstanding common shares of the registrant as of March 16, 2007 was 17,946,333.

 



Table of Contents

DOCUMENTS INCORPORATED BY REFERENCE

Documents incorporated by reference: Portions of Kohlberg Capital Corporation’s Proxy Statement for its 2007 Annual Meeting of Shareholders to be held on June 8, 2007 (the “Proxy Statement”) are incorporated by reference in this Annual Report on Form 10-K in response to Part III, Items 10, 11, 12, 13 and 14.

NOTE ABOUT REFERENCES TO KOHLBERG CAPITAL CORPORATION

In this Annual Report on Form 10-K (the “Annual Report”), the “Company”, “we”, “us” and “our” refer to Kohlberg Capital Corporation, its subsidiaries and its wholly-owned portfolio company, Katonah Debt Advisors, L.L.C. and related companies, unless the context otherwise requires.

NOTE ABOUT TRADEMARKS

Kohlberg Capital Corporation, our logo and other trademarks of Kohlberg Capital Corporation are the property of Kohlberg Capital Corporation. All other trademarks or trade names referred to in this Annual Report are the property of their respective owners.

NOTE ABOUT FORWARD-LOOKING STATEMENTS

This Annual Report includes forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. The matters discussed in this Annual Report, as well as in future oral and written statements by management of Kohlberg Capital Corporation, 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 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 Annual Report should not be regarded as a representation by us that our plans or objectives will be achieved. The forward-looking statements contained in this Annual Report include statements as to:

 

   

our future operating results;

 

   

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

 

   

the impact of investments that we expect to make;

 

   

our informal 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 ability of our 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;

 

   

the adequacy of our cash resources and working capital; and

 

   

the timing of cash flows, if any, from the operations of our portfolio companies, including Katonah Debt Advisors.

For a discussion of factors that could cause our actual results to differ from forward-looking statements contained in this Annual Report, please see the discussion under “Risk Factors” in Item 1A. You should not place undue reliance on these forward-looking statements. The forward-looking statements made in this Annual Report 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 Annual Report.

 

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TABLE OF CONTENTS

 

          Page
Part I   
Item 1.    Business    4
Item 1A.    Risk Factors    33
Item 1B.    Unresolved Staff Comments    41
Item 2.    Properties    41
Item 3.    Legal Proceedings    41
Item 4.    Submission of Matters to a Vote of Security Holders    41
Part II   
Item 5.    Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    42
Item 6.    Selected Financial Data    45
Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    46
Item 7A.    Quantitative and Qualitative Disclosures About Market Risk    53
Item 8.    Financial Statements and Supplementary Data    54
Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    54
Item 9A.    Controls and Procedures    54
Item 9B.    Other Information    54
Part III   
Item 10.    Directors, Executive Officers and Corporate Governance    55
Item 11.    Executive Compensation    55
Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    55
Item 13.    Certain Relationships and Related Transactions, and Director Independence    55
Item 14.    Principle Accountant Fees and Services    55
Part IV   
Item 15.    Exhibits and Financial Statement Schedules    56
Signatures    58
Financial Statements    F -1

 

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PART I

 

Item 1. Business

GENERAL

We are an internally 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 were organized to continue and expand the middle market investment business and asset management business of Katonah Debt Advisors, L.L.C. (together with any additional direct or indirect wholly-owned subsidiaries that we organize in connection with the business of Katonah Debt Advisors, L.L.C., “Katonah Debt Advisors”). Prior to our election to be regulated as a BDC, we acquired Katonah Debt Advisors from affiliates of Kohlberg & Co., L.L.C. (“Kohlberg & Co.”), a leading private equity firm focusing on middle market investing. Our middle market investment business originates, structures and manages a portfolio of senior secured term loans and also invests in mezzanine debt and selected equity securities in privately-held middle market companies. We define the middle market as comprising companies with earnings before interest, taxes, depreciation and amortization, which we refer to as “EBITDA,” of $10 million to $50 million and/or total debt of $25 million to $150 million. We used the net proceeds of our initial public offering (the “IPO”) in December 2006 to acquire a portfolio of approximately $185 million in aggregate principal amount of senior secured loans that were originated during 2006 by Katonah Debt Advisors’ middle market lending group.

Our wholly-owned portfolio company, Katonah Debt Advisors, manages collateralized debt obligation funds (“CDO Funds”) that invest in broadly syndicated loans, high-yield bonds and other credit instruments. As of December 31, 2006, Katonah Debt Advisors had approximately $1.4 billion of assets under management. We maintain a strategic relationship with Kohlberg & Co., whose affiliates received, prior to our election to be regulated as a BDC, an aggregate of 3,484,333 shares of our common stock, $0.01 par value, in exchange for contributing to us their ownership interests in Katonah Debt Advisors and in securities issued by CDO Funds managed by Katonah Debt Advisors and two other asset managers.

Our investment objective is to generate current income and capital appreciation from the investments made by our middle market business in senior secured first and second lien term loans, mezzanine debt and selected equity investments in privately-held middle market companies. While our primary investment focus is on making loans to, and selected equity investments in, privately-held middle market companies, we may invest up to 30% of our capital in other investments such as loans to larger, publicly-traded companies, high-yield bonds, distressed debt securities and debt and equity securities issued by CDO Funds managed by Katonah Debt Advisors or by other asset managers. We also expect to receive distributions of recurring fee income and to generate capital appreciation from our investment in the asset management business of Katonah Debt Advisors. Our investment portfolio, as well as the CDO Funds managed by Katonah Debt Advisors, consist almost exclusively of credit instruments issued by corporations and do not include investments in asset-backed securities such as those secured by residential mortgages or other consumer borrowings.

As a Regulated Investment Company (“RIC”), we intend to distribute to our stockholders substantially all of our net taxable income and the excess of realized net short-term capital gains over realized net long-term capital losses. In addition, we may retain certain net long-term capital gains and elect to treat such net capital gains as deemed distributed to our stockholders. Provided we qualify for tax treatment as a RIC, we generally will be required to pay income taxes only on the portion of our net taxable income and gains that we do not distribute (actually or constructively).

Our common stock is traded on The Nasdaq Global Market under the symbol “KCAP.” The net asset value per share of our common stock at December 31, 2006 was $14.29. On December 31, 2006, the last reported sale price of a share of our common stock on The Nasdaq Global Market was $17.30.

 

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CORPORATE HISTORY AND OFFICES

In 1999, affiliates of Kohlberg & Co. formed a lending platform called Katonah Capital, L.L.C. (“Katonah Capital”) to capitalize on the experience of Kohlberg & Co. in arranging and structuring debt financing for its own portfolio companies. From its inception through 2005, Katonah Capital organized six CDO Funds that raised in excess of $2 billion in capital to invest in below-investment-grade broadly syndicated loans, bonds and other credit instruments. In 2005, affiliates of Kohlberg & Co. organized Katonah Debt Advisors as a new platform to continue to manage CDO Funds investing in broadly syndicated loans and high-yield bonds and to diversify into lending to middle market companies and investing in other types of credit instruments, and the operations of Katonah Capital were discontinued. In 2005 and 2006, Katonah Debt Advisors raised three CDO Funds with approximately $1.1 billion in assets under management to invest in broadly syndicated loans and high-yield bonds. Beginning in the first quarter of 2006, Katonah Debt Advisors assembled the portfolio of approximately $185 million in middle market senior secured loans that we acquired with the net proceeds of our IPO.

We were formed in August 2006 as a Delaware limited liability company. Prior to the issuance of shares of our common stock in our initial public offering we converted into a Delaware corporation. We are an internally managed, non-diversified, closed-end investment company that has elected to be regulated as a BDC under the 1940 Act.

Our principal executive offices are located at 295 Madison Avenue, 6th Floor, New York, New York 10017 and our telephone number is (212) 455-8300. Information about us may also be obtained from the Securities and Exchange Commission’s website (http://www.sec.gov). We maintain a website on the Internet at http://www.kohlbergcap.com. Information contained in our website is not incorporated by reference into this Annual Report, and that information should not be considered as part of this Annual Report. We make available free of charge on our website our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (the “SEC”).

BUSINESS STRATEGY

Our investment objective is to generate current income and capital appreciation from the investments made by our middle market business in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies, and from our investment in Katonah Debt Advisors. We intend to grow our portfolio of assets by raising additional capital, including through the prudent use of leverage available to us. We will 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. While our primary investment focus is on making loans to, and selected equity investments in, privately-held middle market companies, we may also invest in other investments such as loans to larger, publicly-traded companies, high-yield bonds and distressed debt securities. We may also receive warrants or options to purchase common stock in connection with our debt investments. In addition, we may also invest in debt and equity securities issued by CDO Funds managed by Katonah Debt Advisors or by other asset managers. However, our investment strategy is to limit the value of our investments in the debt or equity securities issued by CDO Funds to not more than 15% of the value of our total investment portfolio. We invest almost exclusively in credit instruments issued by corporations and do not invest in asset-backed securities such as those secured by residential mortgages or other consumer borrowings.

Our middle market business will target companies that have strong historical cash flows, experienced management teams and identifiable and defendable market positions in industries with positive dynamics. Our senior management team has strong relationships with numerous middle market private equity sponsors and regional banks which will provide substantial opportunities for our purchase of participations in loans. We also have extensive relationships with the traditional middle market “club” lenders which will provide a source of direct lending opportunities. We will seek to manage risk through a rigorous credit and investment underwriting

 

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process and an active portfolio monitoring program. Our underwriting and monitoring program is credit driven by a team of experienced professionals and a modeling process we call “Maximum Reasonable Adversity.” Our investment portfolio, as well as the CDO Funds managed by Katonah Debt Advisors, consist almost exclusively of credit instruments issued by corporations and do not include investments in asset-backed securities such as those secured by residential mortgages or other consumer borrowings.

We expect to benefit from our ownership of Katonah Debt Advisors in four ways. First, by working with the investment professionals at Katonah Debt Advisors, we will have multiple sources of investment opportunities. We can maximize our investment scale and flexibility by selectively choosing to make an investment through the Company or through a CDO Fund managed by Katonah Debt Advisors, depending on the type of security, the type of transaction and other relevant factors. We expect that Katonah Debt Advisors will be our primary source of broadly syndicated non-investment grade loans, high-yield bonds, CDO equity and mezzanine investments and distressed debt. Second, the experienced team of credit analysts at Katonah Debt Advisors, the members of which also serve as officers of the Company, have specializations covering more than 20 industry groups and they will assist us in reviewing potential investments and monitoring our portfolio. Third, we expect to continue to make investments in CDO Funds managed by Katonah Debt Advisors, which we believe will provide us with a current cash investment return. We believe that these investments will provide Katonah Debt Advisors with greater opportunities to access new sources of capital which will ultimately increase Katonah Debt Advisors’ assets under management and resulting management fee income. Fourth, we expect to receive distributions of recurring fee income and to generate capital appreciation from our investment in Katonah Debt Advisors.

Our strategic relationship with Kohlberg & Co. is also an important part of our overall strategy. We believe that the participation of its Chairman and co-managing partners on our Board of Directors and of its co-managing partners on our Investment Committee will enhance our asset selection and portfolio performance and that Kohlberg & Co. will serve as an important source of private equity opportunities. We also believe that the participation of the Kohlberg & Co. co-managing partners on our Investment Committee will enhance the due diligence and credit analysis of our lending operations. Christopher Lacovara, one of the co-managing partners of Kohlberg & Co., serves as Chairman of the Board of Directors and of our Investment Committee.

Middle Market Business

Our management team maintains longstanding relationships with middle market private equity sponsors, lenders who work in small groups, or “club” lenders, and sources of non-sponsored middle market transactions. Members of our senior management team have a proven track record of originating, structuring and managing middle market investments.

Our middle market investment team has experience assembling portfolios of middle market loans and investments and managing these portfolios through several credit cycles, including both attractive and stressed credit environments. Our middle market investment team reviewed over 250 middle market investment opportunities while building the portfolio of senior secured loans that we acquired with the net proceeds of our initial public offering.

As a BDC, we will offer, and will provide upon request, managerial assistance to our portfolio companies. This assistance could involve, among other things, monitoring the operations of our portfolio companies, participating in board and management meetings, consulting with and advising officers of portfolio companies and providing other organizational and financial guidance. We may receive fees for these services.

Katonah Debt Advisors

Katonah Debt Advisors is our wholly-owned asset manager that manages CDO Funds which invest in broadly syndicated senior loans, second lien loans, high-yield bonds and other credit instruments. The securities issued by these CDO Funds are primarily held by third parties. Katonah Debt Advisors structures and sponsors CDO Funds for which it serves as the asset manager and invests in syndicated term loans and high-yield bonds (rated lower than Baa3 by Moody’s or lower than BBB- by Standard & Poor’s). The CDO Funds managed by

 

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Katonah Debt Advisors invest almost exclusively in credit instruments issued by corporations and do not invest in asset-backed securities such as those secured by residential mortgages or other consumer borrowings. As of December 31, 2006, Katonah Debt Advisors managed three CDO Funds and one special purpose vehicle formed to raise a fourth CDO Fund with aggregate assets of approximately $1.4 billion. Katonah Debt Advisors is currently in the process of organizing and raising a total of five additional CDO Funds for which it has acquired over $450 million in assets.

The CDO Funds managed by Katonah Debt Advisors allow it to securitize portfolios of loan and bond investments and enhance the funds’ return on capital by issuing debt for which the portfolios of investments serve as collateral. A typical CDO Fund portfolio managed by Katonah Debt Advisors consists primarily of broadly syndicated non-investment grade loans and high-yield bonds typically issued by large capitalization companies. Leveraged loans typically experience less market volatility than high-yield bonds, and also are generally secured by assets, thereby improving the likelihood of principal preservation. The CDO Funds managed by Katonah Debt Advisors currently pay it, as the asset manager, an annual management fee of 0.50% of assets under management and an annual incentive fee of 20% of the profits of the fund, provided that the investment return of the CDO Fund has exceeded a specified minimum rate of return.

Katonah Debt Advisors generally participates in the markets for senior secured syndicated term loans greater than $100 million, high-yield bonds (rated BBB or below) and mezzanine securities of other CDO Funds. The investment portfolios managed by Katonah Debt Advisors typically carry an average overall credit quality of B1/Ba3 Moody’s rating equivalent or B+/BB- Standard & Poor’s rating equivalent. Katonah Debt Advisors believes that this ratings category generally provides the best risk/reward combination as well as more stable returns as compared with other lower rated assets. The markets in which Katonah Debt Advisors invests are large and generally offer considerable trading liquidity. The strategy of the Katonah Debt Advisors is to select and maintain portfolios of syndicated loans and high-yield bonds, which offer a balance of interest rate spreads and credit risks appropriate for CDO securitizations in order to maintain a stable, attractive level of current cash return to investors. The CDO Funds typically invest only in credit instruments issued by corporations and do not invest in asset-backed securities such as those secured by residential mortgages or other consumer borrowings.

As of December 31, 2006, Katonah Debt Advisors employed an experienced team of ten investment professionals. The investment professionals of Katonah Debt Advisors source and evaluate selected CDO equity and mezzanine investment opportunities for us and assist us in identifying ways to optimize the use of our capital through securitizations of assets and other potential refinancing structures. Each analyst at Katonah Debt Advisors follows a specific set of industries, allowing them to develop deep insight and broad industry contacts. This credit team reviews, when appropriate, loans sourced by us as well as investment opportunities for CDO Funds managed by Katonah Debt Advisors.

Our Strategic Relationship with Kohlberg & Co.

We believe that we derive substantial benefits from our strategic relationship with Kohlberg & Co. as evidenced by the participation of its Chairman and co-managing partners on our Board of Directors and of its co-managing partners on our Investment Committee. Through such participation, we will have access to the expertise of these individuals in the middle market and leveraged investing, which we believe will enhance our capital raising, due diligence, investment selection and credit analysis. In addition, affiliates of Kohlberg & Co., including those who serve on our Board of Directors and on our Investment Committee, own, in the aggregate, approximately 19% of our outstanding common stock. We have entered into a License and Referral Agreement with Kohlberg & Co. pursuant to which Kohlberg & Co. has agreed to notify us of equity investment opportunities that are presented to Kohlberg & Co. but that it has determined in its sole discretion are not appropriate for any investment funds managed by Kohlberg & Co. or any of its affiliates, typically due to the small size or non-control nature of the investment, prior to making such investment opportunity available to any third party. Kohlberg & Co. has also granted us a royalty-free license to use the “Kohlberg” name, which we believe is one of the most widely recognized names in middle market investing, and is providing certain administrative services to us on a transitional basis.

 

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Kohlberg & Co. is a leading U.S. private equity firm which manages investment funds that acquire middle market companies. Kohlberg & Co. was formed in 1987 by Jerome Kohlberg Jr., the senior founding partner of Kohlberg Kravis Roberts & Co. (“KKR”) and his son, James A. Kohlberg, at the time an executive with KKR. Since its inception, Kohlberg & Co. has organized five private equity funds, through which it has raised approximately $2 billion of committed capital and completed more than 80 platform and add-on acquisitions with an aggregate value of approximately $6 billion. The Chairman and co-managing partners of Kohlberg & Co., who are members of our Board of Directors, and, in the case of the co-managing partners, also members of our Investment Committee, average more than 20 years of investment banking and middle market investing experience, and have worked together across all of the firm’s private equity funds. Christopher Lacovara, the co-managing partner who had the primary responsibility for the formation and oversight of both Katonah Debt Advisors and Katonah Capital, serves as the Chairman of our Board of Directors.

Because we are an internally managed BDC, we do not pay any fees to Kohlberg & Co. or any of its affiliates. Under the 1940 Act we are not permitted to invest in any portfolio company in which Kohlberg & Co. or any fund that it manages has a pre-existing investment unless we obtain SEC exemptive relief.

INVESTMENTS AND OPERATIONS

Overview

Our investment objective is to generate current income and capital appreciation from the investments made by our middle market business in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies. While our primary investment focus is on making loans to, and selected equity investments in, privately-held middle market companies, we may invest up to 30% of our capital in other investments such as loans to larger, publicly-traded companies, high-yield bonds, distressed debt securities and debt and equity securities issued by CDO Funds managed by Katonah Debt Advisors or by other asset managers.

Following completion of our IPO, we used approximately $185 million of the net proceeds of that offering to acquire a portfolio of approximately $185 million in aggregate principal amount of senior secured term loans that were originated during 2006 through a special purpose vehicle organized by Katonah Debt Advisors (“IPO Initial Assets”). These loans were acquired by us for cash at their fair market value, as determined by our Board of Directors. The purchase of these loans was originally financed with a credit facility and the proceeds that we paid to the special purpose vehicle in order to acquire these loans was used by that entity to repay the credit facility. Our Board of Directors approved the portfolio acquisition and determined that (i) the terms thereof, including the consideration paid, was reasonable and fair to our shareholders and did not involve overreaching by any party and (ii) the acquisition was consistent with the interests of our shareholders and our investment policies.

Prior to our IPO, we also acquired 100% ownership of Katonah Debt Advisors and a portfolio of investments in CDO Funds managed by Katonah Debt Advisors and two other managers in exchange for a total of 3,484,333 shares of our common stock issued to affiliates of Kohlberg & Co.

As of December 31, 2006, we had total middle-market investments of approximately $191 million, total equity investments in CDO Funds managed by our wholly-owned portfolio company Katonah Debt Advisors and two other asset managers of approximately $21 million, and total investment in 100% of Katonah Debt Advisors’ asset management company of approximately $38 million. We acquired the equity investments in CDO Funds and the 100% ownership of Katonah Debt Advisors in exchange for shares of our common stock that we issued to affiliates of Kohlberg & Co.

As of December 31, 2006, we had a diversified portfolio that included first and second lien senior loans. Our investments generally averaged between $1 million to $10 million, although particular investments may be larger or smaller. We expect that the size of investment will grow as our available capital grows. After our acquisition of the IPO Initial Assets and consistent with our investment strategy, we have begun to reposition the investment portfolio to focus increasingly on second lien senior loans and mezzanine loans.

 

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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. We expect that the size of our investments and maturity dates will vary as follows:

 

   

senior secured term loans from $10 to $20 million maturing in five to seven years;

 

   

second lien term loans from $5 to $20 million maturing in six to eight years;

 

   

senior unsecured loans $5 to $10 million maturing in six to eight years;

 

   

mezzanine loans from $5 to $10 million maturing in seven to ten years; and

 

   

equity investments from $1 to $5 million.

When we extend senior secured term loans, we will generally take a security interest in the available assets of the portfolio company, including the equity interests of their subsidiaries, which we expect to help mitigate the risk that we 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 repaid 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 their 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.

At December 31, 2006, we did not have any mezzanine debt investments. Consistent with our investment strategy, we have begun investing in mezzanine debt and have invested $16 million in mezzanine debt investments as of March 16, 2007.

Credit and Investment Process

We employ the same due diligence intensive investment strategy that our senior management team, Katonah Debt Advisors and Kohlberg & Co. have used over the past 20 years. Due to our ability to source transactions through multiple channels, we expect to maintain a substantial pipeline of opportunities to allow comparative risk return analysis and selectivity. By focusing on the drivers of revenue and cash flow, we develop our own underwriting cases, and multiple stress and event specific case scenarios for each company analyzed.

We focus on lending and investing opportunities in:

 

   

companies with EBITDA of $10 to $50 million;

 

   

companies with financing needs of $25 to $150 million;

 

   

companies purchased by top tier equity sponsors;

 

   

non-sponsored companies with successful management and systems;

 

   

high-yield bonds and broadly syndicated loans to larger companies on a selective basis; and

 

   

equity co-investment in companies where we see substantial opportunity for capital appreciation.

We expect to source investment opportunities from:

 

   

private equity sponsors;

 

   

regional investment banks for non-sponsored companies;

 

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other middle market lenders with whom we can “club” loans;

 

   

Katonah Debt Advisors with regard to high-yield bonds and syndicated loans; and

 

   

Kohlberg & Co. with regard to selected private equity investment opportunities.

In our experience, good credit judgment is based on a thorough understanding of both the qualitative and quantitative factors which determine a company’s performance. Our analysis begins with an understanding of the fundamentals of the industry in which a company operates, including the current economic environment and the outlook for the industry. We also focus on the company’s relative position within the industry and its historical ability to weather economic cycles. Other key qualitative factors include the experience and depth of the management team and the financial sponsor, if any.

Only after we have a comprehensive understanding of the qualitative factors do we focus on quantitative metrics. We believe that with the context provided by the qualitative analysis, we can gain a better understanding of a company’s financial performance. We analyze a potential portfolio company’s sales growth and margins in the context of its competition as well as its ability to manage its working capital requirements and its ability to generate consistent cash flow. Based upon this historical analysis, we develop a set of projections which represents a reasonable underwriting case of most likely outcomes for the company over the period of our investment. Using our Maximum Reasonable Adversity model, we also look at a variety of potential downside cases to determine a company’s ability to service its debt in a stressed credit environment.

Elements of the qualitative analysis we use in evaluating investment opportunities include the following:

 

   

Industry fundamentals;

 

   

Competitive position and market share;

 

   

Past ability to work through historical down-cycles;

 

   

Quality of financial and technology infrastructure;

 

   

Asian sourcing risks and opportunities;

 

   

Labor and union strategy;

 

   

Technology risk;

 

   

Diversity of customer base and product lines;

 

   

Quality and experience of management;

 

   

Quality of financial sponsor (if applicable); and

 

   

Acquisition and integration history.

Elements of the quantitative analysis we use in evaluating investment opportunities include the following:

 

   

Income statement analysis of growth and margin trends;

 

   

Balance sheet analysis of working capital efficiency;

 

   

Cash flow analysis of capital expenditures and free cash flow;

 

   

Financial ratio and market share standing among comparable companies;

 

   

Financial projections: underwriting versus stress case;

 

   

Event specific Maximum Reasonable Adversity credit modeling;

 

   

Future capital expenditure needs and asset sale plans;

 

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Downside protection to limit losses in an event of default;

 

   

Risk adjusted returns and relative value analysis; and

 

   

Enterprise and asset valuations.

The origination, structuring and credit approval processes are fully integrated. Our credit team is directly involved in all due diligence and analysis prior to the formal credit approval process.

Credit Monitoring

Our management team has significant experience monitoring portfolios of middle market investments and this is enhanced by the credit monitoring procedures of Katonah Debt Advisors. Along with origination and credit analysis, portfolio management is one of the key elements of our business. Most of our investments will not be liquid and, therefore, we must prepare to act quickly if potential issues arise so that we can work closely with the management and private equity sponsor, if applicable, of the portfolio company to take any necessary remedial action quickly. In addition, most of our senior management team, including the credit team at Katonah Debt Advisors, have substantial workout and restructuring experience.

In order to assist us in detecting issues with portfolio companies as early as possible, we perform a monthly financial analysis of each portfolio company. This analysis typically includes:

 

   

reviewing financial statements with comparisons to prior year financial statements, as well as the current budget including key financial ratios such as debt/EBITDA, margins and fixed charge coverage;

 

   

independently computing and verifying compliance with financial covenants;

 

   

reviewing and analyzing monthly borrowing base, if any;

 

   

a monthly discussion of MD&A with company management and the private equity sponsor, if applicable;

 

   

determining if current performance could cause future financial covenant default;

 

   

discussing prospects with the private equity sponsor, if applicable;

 

   

determining if a portfolio company should be added to our “watch list” (companies to be reviewed in more depth);

 

   

if a company is not meeting expectations, reviewing original underwriting assumptions and determining if either enterprise value or asset value has deteriorated enough to warrant further action; and

 

   

a monthly update to be reviewed by both the Chief Executive Officer (“CEO”) and Chief Investment Officer (“CIO”).

Investment Securities

We invest in senior secured loans and mezzanine debt and, in the future and to a lesser extent, equity capital, of middle market companies in a variety of industries. We generally target companies that generate positive cash flows because we look to cash flows as the primary source for servicing debt. As of December 31, 2006, together with our wholly-owned portfolio company Katonah Debt Advisors, we had a staff of 14 investment professionals who specialize in specific industries and generally seek to invest in companies about which we have direct expertise. However, we may invest in other industries if we are presented with attractive opportunities. The tables below show our investments by security type and industry as a percentage of total investments.

 

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The following table shows our portfolio by security type at December 31, 2006:

 

Security Type

   December 31,
2006
 

Senior secured loan

   65.5 %

Junior secured loan

   11.0  

CDO equity

   8.4  

Wholly-owned portfolio company (Katonah Debt Advisors)

   15.1  
      

Total

   100.0 %
      

The industry concentrations, based on the fair value of our investment portfolio as of December 31, 2006, was as follows:

 

Industry

   December 31,
2006
 

Aerospace and defense

   4.0 %

Automobile

   3.7  

Beverage, food and tobacco

   1.0  

Buildings and real estate(1)

   7.7  

Cargo transport

   2.6  

CDO equity

   8.4  

Containers, packaging and glass

   2.0  

Diversified/conglomerate manufacturing

   2.4  

Diversified/conglomerate Service

   2.2  

Ecological

   1.6  

Electronics

   3.0  

Farming and agriculture

   2.0  

Finance

   4.1  

Healthcare, education and childcare

   11.5  

Home and office furnishings, housewares, and durable consumer

   1.2  

Insurance

   4.9  

Leisure, amusement, motion pictures, entertainment

   2.8  

Machinery (non-agriculture, non-construction, non-electronic)

   2.8  

Mining, steel, iron and non-precious metals

   1.6  

Personal and non-durable consumer products (mfg. only)

   2.2  

Personal transportation

   1.6  

Portfolio company (Katonah Debt Advisors)

   15.1  

Printing and publishing

   3.5  

Retail stores

   0.8  

Utilities

   7.3  
      

Total

   100.0 %
      

(1)

Buildings and real estate relate to real estate ownership, builders, managers and developers and excludes mortgage debt investments and mortgage lenders or originators. As of December 31, 2006, we had no exposure to mortgage securities (residential mortgage bonds, commercial mortgage backed securities, or related asset backed securities) or companies providing mortgage lending.

We may invest up to 30% of our investment portfolio in opportunistic investments in high-yield bonds, debt and equity securities in CDO Funds, distressed debt or equity securities of public companies. We expect that these public companies generally will have debt that is non-investment grade. We also may invest in debt of middle market companies located outside of the United States, which investments are not anticipated to be in

 

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excess of 10% of our investment portfolio at the time such investments are made. At December 31, 2006, approximately 13% of our investments were foreign assets (including our investments in CDO Funds, which are typically domiciled outside the U.S. and represent approximately 8% of our portfolio). As a result of regulatory restrictions, we are not permitted to invest in any portfolio company in which Kohlberg & Co. or any fund that it manages has a pre-existing investment.

At December 31, 2006, our ten largest portfolio companies represented approximately 35% of the total fair value of our investments. Our largest investment, Katonah Debt Advisors which is our wholly-owned portfolio company, represented 15% of the total fair value of our investments.

Investment in CDO Fund Securities

Prior to our IPO, we issued an aggregate of 1,258,000 common shares, having a value of approximately $19 million, to affiliates of Kohlberg & Co. to acquire subordinated debt and preferred stock securities issued by CDO Funds (Katonah III, Ltd., Katonah IV, Ltd., Katonah V, Ltd., Katonah VII CLO, Ltd., and Katonah VIII CLO, Ltd.) managed by Katonah Debt Advisors and two other asset managers. Subsequent to our IPO we purchased $2 million of CDO Fund securities issued by Katonah IX CLO, Ltd. bringing our total investment in CDO Fund securities (collectively, our “CDO Investments”) to approximately $21 million as of December 31, 2006.

Our CDO Funds invest primarily in non-investment grade broadly syndicated loans, high-yield bonds and other credit instruments of corporate issuers. The underlying assets in each of the CDO Funds in which we have any investment are generally diversified secured or unsecured corporate debt and exclude mortgage pools or mortgage securities (residential mortgage bonds, commercial mortgage backed securities, or related asset backed securities), debt to companies providing mortgage lending and emerging markets investments. The CDO 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 appropriate fund expenses (including management fees)) is paid to the holders of the CDO Fund’s subordinated securities or preferred stock. As an investor in the subordinated securities or preferred stock of CDO Funds we expect to receive our pro-rata portion (relative to our percentage ownership of the subordinated securities or preferred stock) of the fund’s excess spread. As a manager of the CDO Funds, Katonah Debt Advisors expects to receive its contractual and recurring management fee and any subsequent incentive management fees from the CDO Funds for its management and advisory services.

The securities issued by CDO Funds managed by Katonah Debt Advisors are primarily held by third parties. Our CDO Investments are carried at fair value, which is based on 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 bonds and preferred shares/income notes, when available. We recognize unrealized appreciation or depreciation on our CDO Investments as comparable yields in the market change and/ or based on changes in estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. As each CDO Investment ages, the expected amount of losses and the expected timing of recognition of such losses in the underlying collateral pool is updated and the revised cash flows are used in determining the fair value of the CDO Investment. We determine the fair value of our CDO Investments on an individual security-by-security basis.

 

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The following table sets forth information regarding our CDO Investments as of December 31, 2006:

 

CDO Fund Security

  

Principal
Business

  

Type of
Security

   Percentage
of Class Held
    Cost of
Investment
   Fair Value of
Investment

Katonah III, Ltd.

   CDO Fund    Preferred Shares    23.08 %   $ 4,500,000    $ 4,500,000

Katonah IV, Ltd.

   CDO Fund    Preferred Shares    17.14 %     3,150,000      3,150,000

Katonah V, Ltd.

   CDO Fund    Preferred Shares    26.67 %     3,320,000      3,320,000

Katonah VII CLO Ltd.

   CDO Fund    Subordinated Securities    16.36 %     4,500,000      4,500,000

Katonah VIII CLO Ltd.

   CDO Fund    Subordinated Securities    10.30 %     3,400,000      3,400,000

Katonah IX CLO Ltd.

   CDO Fund    Preferred Shares    6.86 %     2,000,000      2,000,000
                     

Subtotal

           $ 20,870,000    $ 20,870,000
                     

Investment in Katonah Debt Advisors

Prior to our IPO, we issued an aggregate of 2,226,333 common shares, having a value of approximately $33 million, to affiliates of Kohlberg & Co. to acquire Katonah Debt Advisors. As a result, Katonah Debt Advisors is a wholly-owned portfolio company. Katonah Debt Advisors is an asset management company that manages CDO Funds that invest in broadly syndicated loans, high yield bonds and other credit instruments. The CDO Funds managed by Katonah Debt Advisors invest almost exclusively in credit instruments issued by corporations and do not invest in asset-backed securities such as those secured by residential mortgages or other consumer borrowings. Katonah Debt Advisors receives management fees, which are generally based on a fixed percentage of assets under management, and generates annual operating income equal to the amount by which its fee income exceeds it operating expenses. Katonah Debt Advisors may also receive incentive fees paid by the CDO Funds if it achieves a specified rate of return to the subordinated debt or preferred stock securities. As of December 31, 2006, Katonah Debt Advisors had approximately $1.4 billion of assets under management.

We expect to receive distributions of recurring fee income and to generate capital appreciation from our investment in the asset management business of Katonah Debt Advisors. By making investments in CDO Funds raised by Katonah Debt Advisors in the future, for which we expect to receive a current cash return, we can help Katonah Debt Advisors to raise these funds which in turn will increase its assets under management which will result in additional management fee income.

Katonah Debt Advisors, as a wholly-owned portfolio company, is accounted for using the equity method of accounting consistent with our status as a BDC. Under the equity method of accounting, Katonah Debt Advisors is initially recorded at cost on our balance sheet. Subsequent net income or losses of Katonah Debt Advisors under accounting principles generally accepted in the United States (“GAAP”) is recognized as affiliate income or loss on our income statement with a corresponding increase (in the case of net income) or decrease (in the case of net loss) in our investment in Katonah Debt Advisors on the balance sheet. The revenue that Katonah Debt Advisors generates through the fees it receives for managing CDO Funds and after paying the expenses associated with its operations, including compensation of its employees, may be distributed to us. Cash distributions of Katonah Debt Advisors’ accumulated GAAP net income would reduce the basis of Katonah Debt Advisors on our balance sheet. As with all other investments, Katonah Debt Advisors’ market value is periodically determined. The valuation is primarily based on a percentage of its assets under management and/or based on Katonah Debt Advisors’ estimated net cash flows. Any change in value from period to period is recognized as unrealized gain or loss.

 

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As a separately regarded entity for tax purposes, Katonah Debt Advisors, L.L.C. is taxed at normal corporate rates. For tax purposes, any distributions of taxable net income earned by Katonah Debt Advisors to us would generally need to be distributed to our shareholders. Katonah Debt Advisors’ taxable net income will differ from GAAP net income for both deferred tax timing adjustments and permanent tax adjustments. Deferred tax timing adjustments may include differences between lease cash payments to GAAP straight line expense and adjustments for the recognition and timing of depreciation, bonuses to employees, stock option expense, and interest rate caps. Permanent differences may include adjustments, limitations or disallowances for meals and entertainment expenses, penalties and tax goodwill amortization.

Tax goodwill amortization was created upon the purchase of 100% of the equity interests in Katonah Debt Advisors prior to our IPO in exchange for shares of our stock valued at $33 million. Although this transaction was a stock transaction rather than an asset purchase and thus no goodwill was recognized for GAAP purposes, for tax purposes such exchange was considered an asset purchase under Section 351(a) of the Internal Revenue Code of 1986, as amended (the “Code”). At the time of the transfer, Katonah Debt Advisors had equity of approximately $1 million resulting in tax goodwill of approximately $32 million which will be amortized for tax purposes on a straight-line basis over 15 years, resulting in an annual difference between GAAP income and distributable income by which GAAP income will exceed distributable income by approximately $2 million per year over such period. As a result, if Katonah Debt Advisors were to distribute its GAAP net income to us, only Katonah Debt Advisors’ taxable net income after such goodwill amortization will be required to be distributed to our shareholders.

Revenues

We will generate revenue in the form of interest income on debt securities and capital gains, if any, on warrants or other equity-related securities that we acquire in our portfolio companies. In addition, we expect to generate revenue in the form of commitment and facility fees and, to a lesser extent, due diligence fees. Any such fees will be generated in connection with our investments and recognized as earned or, in some cases, recognized over the life of the loan. We expect our investments generally to have a term of between five and eight years and bear interest at various rates ranging from 2% to 10% over the prevailing market rates for Treasury securities. Where applicable, we will seek to collateralize our investments by obtaining security interests in our portfolio companies’ assets. Interest on debt securities will generally be payable monthly or quarterly, with amortization of principal typically occurring over the term of the security. In those limited instances where we choose to defer amortization of the loan for a period of time from the date of the initial investment, the principal amount of the debt securities and any accrued but unpaid interest will generally become due at the maturity date.

We also generate dividend income from our investment in CDO equities. These subordinated securities are the most junior class of securities issued by the CDO Funds and are subordinated in priority of payment to each other class of securities issued by these CDO Funds. Dividends on CDO equities are generally paid quarterly.

Expenses

Because we are an internally managed BDC, we will pay the costs associated with employing investment management professionals and other employees as well as running our operations. Our primary non-interest expenses will include employee salaries and benefits, the costs of identifying, evaluating, negotiating, closing, monitoring and servicing our investments and our related overhead charges and expenses, including rental expense and any interest expense incurred in connection with borrowings. Because we are internally managed, we do not pay any management fees to any third party.

Employees

Including employees of our wholly-owned portfolio company Katonah Debt Advisors, some of whom also serve as officers of the Company, we employed an experienced team of 14 investment professionals and 18 total

 

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staff members as of December 31, 2006. We currently employ a CEO, CIO, Chief Financial Officer (“CFO”) and Chief Compliance Officer (“CCO”), three credit analysts, a director and a manager of portfolio administration, a manager of Information Technology and a manager of Investor Relations. Including its managing director, Katonah Debt Advisors employed, as of December 31, 2006, a highly experienced team of 10 investment professionals, all of whom are officers of the Company. All of our employees are located in our New York office.

LEVERAGE

In addition to funds available from the issuance of our common stock, 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 200% after such borrowing. The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing. As of December 31, 2006, we had no outstanding borrowings.

On February 14, 2007, we entered into a securitization revolving credit facility (the “Facility”) under which we may obtain up to $200 million (with an ability to increase to $250 million subject to certain conditions) in financing. Advances under the Facility will be used by us primarily to make additional investments. We expect that the Facility will be secured by loans that we currently own and the loans acquired by us with the advances under the Facility. We will borrow under the Facility through our wholly-owned, special-purpose bankruptcy remote subsidiary, Kohlberg Capital Funding LLC I. Under the Facility, funds are loaned by or through certain lenders at prevailing commercial paper rates or, if the commercial paper market is at any time unavailable, at prevailing LIBOR rates, plus an applicable margin. The interest charged on borrowed funds is based on the commercial paper rate plus 0.70% and is payable monthly. The Facility has a commitment termination date of February 14, 2012. Under the terms of the Facility, we were required to pay a one-time 0.50% structuring fee. Additionally, we are also required to pay an ongoing commitment fee equal to 0.225% for any unused portion of the Facility. The portfolio of loans securing the Facility will be required to generate an annual rate of return of approximately 3% to cover annual interest payments on obligations incurred under the Facility.

Under the Facility, we are subject to limitations as to how borrowed funds may be used, including restrictions on geographic and industry concentrations, loan size, payment frequency and status, average life, collateral interests and investment ratings. We are also subject to regulatory restrictions on leverage which may affect the amount of funding that we can obtain under the Facility. The Facility also includes certain requirements relating to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs, a violation of which could result in the early amortization of the Facility, limit further advances and, in some cases, result in an event of default. As a result of these eligibility criteria, there can be no assurance that we will be able to borrow the amounts anticipated under the Facility.

COMPETITION

Our primary competitors provide financing to prospective portfolio companies and include commercial banks, specialty finance companies as well as hedge funds, structured investment funds and investment banks. Many of these entities have greater financial and managerial resources than we will have, and the 1940 Act imposes certain regulatory restrictions on us as a BDC to which many of our competitors are not subject. A large number of entities will compete with us to make the types of investments that we plan to make in prospective portfolio companies. We will compete with a large number of private equity firms as well as other BDCs, 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, technical, marketing and other resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. This may

 

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enable some of our competitors to make commercial loans with interest rates that are comparable to or lower than the rates we typically offer. We may lose prospective portfolio companies if we do not match our competitors’ pricing, terms and structure. If we do match our competitors’ pricing, terms or structure, we may experience decreased net interest income and increased risk of credit losses. 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 have greater experience operating under, or 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, our business and financial condition and results of operations will be adversely affected.

We believe that we provide a unique combination of an experienced middle market origination and credit team, an existing credit platform at Katonah Debt Advisors that includes experienced lenders with broad industry expertise and an Investment Committee that includes co-managing partners of Kohlberg & Co., a leading experienced and successful middle market private equity firm. We believe that this combination of resources provides us with a thorough credit process and multiple sources of investment opportunities to enhance our asset selection process.

COMPETITIVE ADVANTAGES

We believe that we can successfully compete with other providers of capital in the markets in which we compete for the following reasons:

Internally managed structure and significant management resources

We are internally managed by our executive officers under the supervision of our Board of Directors and do not depend on a third party investment advisor. As a result, we do not pay investment advisory fees and all of our income is available to pay our operating costs, including the costs associated with employing investment management professionals, and to make distributions to our shareholders. Including employees of Katonah Debt Advisors, some of whom also serve as officers of the Company, we employed, as of December 31, 2006, a team of 14 experienced investment professionals with substantial experience in middle market lending, credit analysis, loan securitization and portfolio administration.

We believe that we derive substantial benefits from our internally managed structure. First, because they are employed by us, the individuals responsible for managing our investments are dedicated solely to the success of our business. Our investment professionals do not serve as advisors to any other investment funds other than the CDO Funds managed by our wholly-owned portfolio company Katonah Debt Advisors and therefore we do not compete with other investment funds for investment opportunities, although some investment opportunities may be allocated to funds managed by Katonah Debt Advisors. Second, through their participation in our 2006 Kohlberg Capital Equity Incentive Plan (the “Equity Incentive Plan”), a significant portion of the compensation of our senior managers is tied to the performance of our investments, resulting in an alignment of interests between our management and shareholders. Third, we leverage our management resources and those of Katonah Debt Advisors across our portfolio of investments and the investments of the CDO Funds managed by Katonah Debt Advisors.

Multiple sourcing capabilities for assets

We have multiple sources of loans, mezzanine investments and equity investments. Through industry relationships, we believe that we will have the ability to participate in loans originated by other capital providers to middle market companies as well as to source assets directly from private equity sponsors and regional banks. We recently hired a new senior analyst, who joined us in March, and we expect to add additional professional

 

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staff with a track record of originating senior loans and mezzanine and equity investments. Through Katonah Debt Advisors we have the ability to acquire participations in selected syndicated secured and second lien term loans whose borrowers and investment returns meet our investment criteria. Through Katonah Debt Advisors we also have the opportunity to invest in selected equity and mezzanine securities issued by CDO Funds, including those managed by Katonah Debt Advisors. Through our strategic relationship with Kohlberg & Co., we expect to have access to a variety of equity investments and mezzanine and other lending opportunities which are presented to Kohlberg & Co. but do not meet Kohlberg & Co.’s applicable investment criteria for reasons such as the small size or non-control nature of the investment.

Disciplined investment process

We employ the rigorous credit review process and due diligence intensive investment strategy which our senior management has developed over more than 20 years of lending. Due to our ability to source transactions through multiple channels, we expect to maintain a substantial pipeline of opportunities to allow comparative risk return analysis and selectivity. By focusing on the drivers of revenue and cash flow, we develop our own underwriting cases and multiple stress case scenarios for each company analyzed. An event specific financial model reflecting company, industry and market variables support each investment decision. We also expect to benefit from the credit and industry expertise of Katonah Debt Advisors’ credit team, the members of which also serve as officers of the Company, and the Chairman and co-managing partners of Kohlberg & Co. serving on our Board of Directors and, in the case of the co-managing partners, Investment Committee.

Katonah Debt Advisors’ credit platform

We expect that Katonah Debt Advisors will serve as a source of direct investment opportunities and cash flow. In addition, certain credit analysts employed by Katonah Debt Advisors who also serve as officers of the Company serve as sources of credit analysis. Katonah Debt Advisor’s credit team employs a highly rigorous process in selecting and reviewing investment opportunities for CDO Funds managed by Katonah Debt Advisors. We will have the opportunity to make investments in CDO Funds managed by Katonah Debt Advisors, which we would expect to generate regular cash dividends or interest income. Katonah Debt Advisors also generates revenue through the fees it receives for managing CDO Funds and may distribute its income, after paying the expenses associated with its operations, including compensation of its employees, to us. Further we may co-invest with CDO Funds managed by Katonah Debt Advisors when we believe it will be advantageous for us to do so.

Strategic relationship with Kohlberg & Co.

We believe that Kohlberg & Co. is one of the oldest and most well-known private equity firms focused on the middle market, and we expect to derive substantial benefits from our strategic relationship with Kohlberg & Co. Through the participation of the Chairman and co-managing partners of Kohlberg & Co. on our Board of Directors and, in the case of the co-managing partners, our Investment Committee, we will have access to the expertise of these individuals in middle market leveraged investing, which we believe will enhance our capital raising, due diligence, investment selection and credit analysis. The Chairman of our Board of Directors and Investment Committee, Christopher Lacovara, has been the Kohlberg & Co. co-managing partner primarily responsible for establishing and providing oversight for the operations of both Katonah Debt Advisors and Katonah Capital. In addition, we have entered into a License and Referral Agreement with Kohlberg & Co. pursuant to which Kohlberg & Co. has agreed to notify us of equity investment opportunities that are presented to Kohlberg & Co. but that it determines in its sole discretion are not appropriate for any investment fund managed by Kohlberg & Co. or any of its affiliates, typically due to the small size or non-control nature of the investment, prior to making such investment opportunity available to any third party. Under this agreement, Kohlberg & Co. has also granted us a royalty-free license to use the “Kohlberg” name, which we believe is one of the most widely recognized names in middle market investing.

 

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Significant equity ownership and alignment of incentives

Our senior management team, the senior management team of Katonah Debt Advisors and affiliates of Kohlberg & Co. together have a significant equity interest in the Company, ensuring that their incentives are strongly aligned with those of our shareholders. Affiliates of Kohlberg & Co., including the Chairman and co-managing partners of Kohlberg & Co. who serve on our Board of Directors and, in the case of the co-managing partners, our Investment Committee, own, in the aggregate, approximately 19% of our outstanding common stock which they received, in lieu of cash, as consideration for the contribution to the Company of 100% of the equity of Katonah Debt Advisors and certain subordinated debt investments in CDO Funds managed by Katonah Debt Advisors and two other asset managers. We have also issued to our senior management team options to purchase shares of our common stock under our Equity Incentive Plan.

ELECTION TO BE REGULATED AS A BUSINESS DEVELOPMENT COMPANY AND A REGULATED INVESTMENT COMPANY

In December 2006, we completed a public offering of 14,462,000 shares of our common stock, par value $0.01 per share, at a price of $15.00 per share, which we refer to as our initial public offering.

Our elections to be regulated as a BDC and to be treated as a RIC will have a significant impact on our future operations:

We report our investments at market value or fair value with changes in value reported through our statement of operations.

We report all of our investments, including debt investments, at market value or, for investments that do not have a readily available market value, at their “fair value” as determined in good faith pursuant to procedures approved by our Board of Directors. Changes in these values are reported through our statement of operations under the caption of “net unrealized appreciation (depreciation) on investments.”

Our ability to use leverage as a means of financing our portfolio of investments is limited.

As a BDC, we are required to meet a coverage ratio of total assets to total senior securities of at least 200%. For this purpose, senior securities generally include all borrowings, guarantees of borrowings and any preferred stock we may issue in the future. Our ability to utilize leverage as a means of financing our portfolio of investments is limited by this asset coverage test.

We intend to distribute substantially all of our net taxable income to our stockholders. We generally will be required to pay U.S. federal income taxes only on the portion of our taxable income and gains we do not distribute to stockholders (actually or constructively).

As a RIC, we intend to distribute to our stockholders substantially all of our net taxable income and the excess of realized net short-term capital gains over realized net long-term capital losses. In addition, we may retain certain net long-term capital gains and elect to treat such net capital gains as deemed distributed to our stockholders. If this happens, stockholders will be treated as if they received an actual distribution of the capital gains and reinvested the net after-tax proceeds in us. Stockholders also may be eligible to claim a tax credit against their federal income tax liability (or, in certain circumstances, a tax refund) equal to their allocable share of the tax we pay on the deemed distribution.

Provided we qualify for tax treatment as a RIC, we generally are required to pay U.S. federal income taxes only on the portion of our net taxable income and gains that we do not distribute (actually or constructively). Katonah Debt Advisors, which is a wholly-owned taxable subsidiary for federal income tax purposes, will receive fee income earned with respect to its management services. We plan to form additional direct or indirect wholly-owned subsidiaries which will receive similar fee income. Some of the wholly-owned subsidiaries may

 

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be treated as corporations for U.S. federal income tax purposes, and as a result, such subsidiaries will be subject to tax at regular corporate rates. Although, as a RIC, dividends and distributions of capital received by us from our taxable subsidiaries and distributed to our stockholders will not be subject to federal income taxes, our taxable subsidiaries will generally be subject to federal and state income taxes on their income. As a result, the net return to us on such investments held by such subsidiaries will be reduced to the extent that the subsidiaries are subject to income taxes.

We are required to comply with the provisions of the 1940 Act applicable to BDCs.

As a BDC, we are required to have a majority of directors who are not “interested” persons under the 1940 Act. In addition, we are required to comply with other applicable provisions of the 1940 Act, including those requiring the adoption of a code of ethics, fidelity bond and custody arrangements.

REGULATION

The following discussion is a general summary of some of the material regulations governing BDCs generally. It does not purport to be a complete description of all the laws and regulations affecting BDCs.

A BDC is a unique kind of investment company that primarily focuses on investing in or lending to private companies and making managerial assistance available to them. A BDC provides stockholders with the ability to retain the liquidity of a publicly traded stock, while sharing in the possible benefits of investing in emerging-growth or expansion-stage privately-owned companies. The 1940 Act contains prohibitions and restrictions relating to transactions between BDCs and their directors and officers and principal underwriters and certain other related persons and requires that a majority of the directors be persons other than “interested persons,” as that term is defined in the 1940 Act. In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC unless approved by a majority of our outstanding voting securities. A majority of the outstanding voting securities of a company is defined under the 1940 Act as the lesser of (i) 67% or more of such company’s shares present at a meeting or represented by proxy if more than 50% of the outstanding shares of such company are present or represented by proxy or (ii) more than 50% of the outstanding shares of such company.

Qualifying Assets

Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in Section 55(a) of the 1940 Act, or “qualifying assets,” unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. The principal categories of qualifying assets relevant to our business are the following:

 

   

Securities of an “eligible portfolio company” purchased in transactions not involving any public offering. An “eligible portfolio company” is defined in the 1940 Act as any issuer which:

 

  (a) is organized under the laws of, and has its principal place of business in, the United States;

 

  (b) is not an investment company (other than a small business investment company wholly-owned by the BDC) or a company that would be an investment company but for certain exclusions under the 1940 Act; and

 

  (c) satisfies any of the following:

 

  (i) does not have outstanding any class of securities with respect to which a broker or dealer may extend margin credit;

 

  (ii) is controlled by a BDC or a group of companies including a BDC and the BDC has an affiliated person who is a director of the eligible portfolio company;

 

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  (iii) is a small and solvent company having total assets of not more than $4 million and capital and surplus of not less than $2 million; or

 

  (iv) does not have any class of securities listed on a national securities exchange.

 

   

Securities of any eligible portfolio company that we control;

 

   

Securities purchased in a private transaction from a U.S. issuer that is not an investment company and is in bankruptcy and subject to reorganization;

 

   

Securities received in exchange for or distributed on or with respect to securities described above, or pursuant to the conversion of warrants or rights relating to such securities;

 

   

Cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment; and

 

   

Under certain circumstances, securities of companies that were eligible portfolio companies at the time of the initial investment but that are not eligible portfolio companies at the time of the follow-on investment.

On October 25, 2006, the SEC reproposed a rule under the 1940 Act that would further expand the definition of an “eligible portfolio company” to include certain domestic operating companies that list their securities on a national securities exchange.

Significant Managerial Assistance

A BDC must have been organized and have its principal place of business in the United States and must be operated for the purpose of making investments in the types of securities described above. However, to count portfolio securities as qualifying assets for the purpose of the 70% test, the BDC must either control the issuer of the securities or must offer to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial assistance; except that, where the BDC purchases such securities in conjunction with one or more other persons acting together, one of the other persons in the group may make available such managerial assistance. Making available significant managerial assistance means, among other things, any arrangement whereby the BDC, through its directors, officers or employees, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company through monitoring of portfolio company operations, selective participation in board and management meetings, consulting with and advising a portfolio company’s officers or other organizational or financial guidance.

Temporary Investments

Pending investment in other types of qualifying assets, as described above, our investments may consist of cash, cash equivalents, U.S. government securities or high quality debt securities maturing in one year or less from the time of investment, which we refer to, collectively, as temporary investments, so that at least 70% of our assets are qualifying assets. Typically, we will invest in U.S. treasury bills or in repurchase agreements, provided that such agreements are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed upon future date and at a price which is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, if more than 25% of our total assets constitute repurchase agreements from a single counterparty, we would not meet the diversification tests imposed on us by the Code to qualify for tax treatment as a RIC for federal income tax purposes. Thus, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. We will monitor the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.

 

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Senior Securities; Coverage Ratio

We are permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, 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. We may also borrow amounts up to 5% of the value of our total assets for temporary purposes. For a discussion of the risks associated with the resulting leverage, see “Risk Factors—Risks Related to Our Business—If we incur additional debt, it could increase the risk of investing in our Company.”

Code of Ethics

We adopted and maintain a code of ethics pursuant to Rule 17j-1 under the 1940 Act that establishes procedures for personal investments and restricts certain personal securities transactions. Personnel subject to the code may invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with the code’s requirements. We may be prohibited under the 1940 Act from conducting certain transactions with our affiliates without the prior approval of our directors who are not interested persons and, in some cases, the prior approval of the SEC. A copy of the code of ethics is available on our website at http://www.kohlbergcap.com.

Privacy Principles

We are committed to maintaining the privacy of our stockholders and safeguarding their non-public personal information. The following information is provided to help explain what personal information we collect, how we protect that information and why, in certain cases, we may share information with select other parties.

Generally, we do not receive any non-public personal information relating to our stockholders, although some non-public personal information of our stockholders may become available to us. We do not disclose any non-public personal information about our stockholders or former stockholders to anyone, except as permitted by law or as is necessary to service stockholder accounts, such as to a transfer agent.

We restrict access to non-public personal information about our stockholders to our employees with a legitimate business need for the information. We maintain physical, electronic and procedural safeguards designed to protect the non-public personal information of our stockholders.

Proxy Voting Policies and Procedures

Although most of the securities we hold are not voting securities, we expect that some of our investments will entitle us to vote proxies. We vote proxies relating to our portfolio securities in the best interest of our stockholders. We review on a case-by-case basis each proposal submitted to a stockholder vote to determine its impact on the portfolio securities held by us. Although we generally vote against proposals that we believe may have a negative impact on our portfolio securities, we may vote for such a proposal if we believe there exists a compelling long-term reason to do so.

Our proxy voting decisions are made by our Investment Committee, which is responsible for monitoring each of our investments. To ensure that our vote is not the product of a conflict of interest, we require that (1) anyone involved in the decision making process disclose to our CCO any potential conflict that he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote; and (2) employees involved in the decision making process or vote administration are prohibited from revealing how we intend to vote on a proposal to reduce any attempted influence from interested parties.

 

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Other

We will be periodically examined by the SEC for compliance with the 1940 Act.

We will not “concentrate” our investments, that is, invest 25% or more of our assets in any particular industry (determined at the time of investment).

We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a BDC, we are prohibited from indemnifying any director or officer against any liability to our stockholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.

We are required to adopt and implement written policies and procedures reasonably designed to prevent violation of the federal securities laws and to review these policies and procedures annually for their adequacy and the effectiveness of their implementation. We have a designated Chief Compliance Officer (“CCO”) who is responsible for administering these policies and procedures.

CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS

The following discussion is a general summary of certain material U.S. federal income tax considerations applicable to us and to an investment in our shares. This summary does not purport to be a complete description of the income tax considerations applicable to such an investment. For example, we have not described tax consequences that we assume to be generally known by investors or certain considerations that may be relevant to certain types of holders subject to special treatment under federal income tax laws, including stockholders subject to the alternative minimum tax, tax-exempt organizations, insurance companies, regulated investment companies, dealers in securities, pension plans and trusts, and financial institutions. This summary assumes that investors hold our common stock as capital assets (within the meaning of the Code). The discussion is based upon the Code, Treasury regulations, and administrative and judicial interpretations, each as in effect as of the date of this Annual Report and all of which are subject to change, possibly retroactively, which could affect the continuing validity of this discussion. We have not sought and will not seek any ruling from the Internal Revenue Service (the “IRS”) in connection with this discussion. This summary does not discuss any aspects of U.S. estate or gift tax or foreign, state or local tax. It does not discuss the special treatment under federal income tax laws that could result if we invested in tax-exempt securities or certain other investment assets in which we do not currently intend to invest.

A “U.S. stockholder” generally is a beneficial owner of shares of our common stock who is for federal income tax purposes:

 

   

a citizen or individual resident of the United States including an alien individual who is a lawful permanent resident of the United States or meets the “substantial presence” test in Section 7701(b) of the Code;

 

   

a corporation or other entity taxable as a corporation, for federal income tax purposes, created or organized in or under the laws of the United States or any political subdivision thereof;

 

   

a trust over the administration of which a court in the U.S. has primary supervision or over which U.S. persons have control; or

 

   

an estate, the income of which is subject to U.S. federal income taxation regardless of its source.

A “Non-U.S. stockholder” is a beneficial owner of shares of our common stock that is neither a U.S. stockholder nor a partnership for federal income tax purposes. If a partnership (including an entity treated as a partnership for federal income tax purposes) holds shares of our common stock, the tax treatment of a partner in the partnership will generally depend upon the status of the partner and the activities of the partnership. A

 

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prospective stockholder who is a partner of a partnership holding shares of our common stock should consult his, her or its tax advisors with respect to the purchase, ownership and disposition of shares of our common stock.

Tax matters are very complicated and the tax consequences to an investor of an investment in our shares will depend on the facts of his, her or its particular situation. We encourage investors to consult their own tax advisors regarding the specific consequences of such an investment, including tax reporting requirements, the applicability of federal, state, local and foreign tax laws, eligibility for the benefits of any applicable tax treaty and the effect of any possible changes in the tax laws.

Election to be Taxed as a Regulated Investment Company

As a BDC, we intend to elect to be treated as a RIC under Subchapter M of the Code commencing with our first taxable year as a corporation. As a RIC, we generally will not have to pay corporate-level taxes on any income or gains that we distribute to our stockholders as dividends. To qualify for tax treatment as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below). In addition, to obtain the federal income tax benefits allowable to RICs, we must distribute to our stockholders, for each taxable year, at least 90% of our “investment company taxable income,” which is generally the sum of our net ordinary income plus the excess, if any, of realized net short-term capital gains over realized net long-term capital losses (the “Annual Distribution Requirement”) and our net tax-exempt interest income, if any.

Taxation as a Regulated Investment Company

For any taxable year in which we qualify as a RIC and satisfy the Annual Distribution Requirement, we generally will not be subject to federal income tax on the portion of our investment company taxable income and net capital gain (i.e., net realized long-term capital gains in excess of net realized short-term capital losses) we distribute to stockholders with respect to that year. We will be subject to federal income tax at the regular corporate rates on any net ordinary income or capital gain not distributed (or deemed distributed) to our stockholders. As a RIC, we will be subject to a 4% nondeductible federal excise tax on certain net taxable undistributed income unless we distribute in a timely manner an amount at least equal to the sum of (1) 98% of our net ordinary income for each calendar year, (2) 98% of our capital gain net income for the 1-year period ending October 31 in that calendar year and (3) any net income realized, but not distributed, in the preceding year. We will not be subject to excise taxes on amounts on which we are required to pay corporate income tax (such as retained net capital gains). We currently intend to make sufficient distributions each taxable year and/or pay sufficient corporate income tax to avoid any excise tax liability, although we reserve the right to pay an excise tax rather than make an additional distribution when circumstances warrant (e.g., the payment of an excise tax amount that we deem to be de minimis).

To qualify for tax treatment as a RIC for federal income tax purposes, in addition to satisfying the Annual Distribution Requirement, we must, among other things:

 

   

have in effect at all times during each taxable year an election to be regulated as a BDC under the 1940 Act;

 

   

derive in each taxable year at least 90% of our gross income from (a) dividends, interest, payments with respect to certain securities loans, gains from the sale of stock or other securities, or other income derived with respect to our business of investing in such stock or securities and (b) net income derived from an interest in a “qualified publicly traded partnership” (as defined by the Code) (all such income “Qualifying Income”); and

 

   

diversify our holdings so that at the end of each quarter of the taxable year: (i) at least 50% of the value of our assets consists of cash, cash equivalents, U.S. government securities, securities of other RICs, and other securities if such other securities of any one issuer do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of such issuer; and (ii) no more than 25% of the value of our assets is invested in the securities, other than U.S. government

 

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securities or securities of other RICs, of (a) one issuer, (b) two or more issuers that are controlled, as determined under applicable tax rules, by us and that are engaged in the same or similar or related trades or businesses or (c) one or more “qualified publicly traded partnerships” (the “Diversification Tests”).

We may organize and conduct the business of Katonah Debt Advisors through additional direct or indirect wholly-owned subsidiaries of the Company. Some of the wholly-owned subsidiaries may be treated as corporations for federal income tax purposes. As a result, such subsidiaries will be subject to tax at regular corporate rates. We will recognize income from these subsidiaries to the extent that we receive dividends and distributions of capital from these subsidiaries. Some of the wholly-owned subsidiaries may be treated as disregarded entities for federal income tax purposes. As a result, we will directly recognize fee income earned by these subsidiaries. Fee income that we recognize directly through entities that are treated as disregarded entities for federal tax purposes will generally not constitute Qualifying Income. We intend to monitor our recognition of fee income to ensure that at least 90% of our gross income in each taxable year is Qualifying Income.

We may be required to recognize taxable income in circumstances in which we do not receive cash. For example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount (such as debt instruments with payment-in-kind interest or, in certain cases, with increasing interest rates or that are issued with warrants), we must include in income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. Because any original issue discount accrued will be included in our investment company taxable income for the year of accrual, we may be required to make a distribution to our stockholders to satisfy the Annual Distribution Requirement, even though we will not have received any corresponding cash amount. We could also be subject to a federal income tax (including interest charges) on distributions received from investments in passive foreign investment companies “PFICs” (defined below) or on proceeds received from the disposition of shares in PFICs, which tax cannot be eliminated by making distributions to our shareholders. A PFIC is any foreign corporation in which (i) 75% or more of the gross income for the taxable year is passive income, or (ii) the average percentage of the assets (generally by value, but by adjusted tax basis in certain cases) that produce or are held for the production of passive income is at least 50%. Generally, passive income for this purpose means dividends, interest (including income equivalent to interest), royalties, rents, annuities, the excess of gains over losses from certain property transactions and commodities transactions, and foreign currency gains. Passive income for this purpose does not include rents and royalties received by the foreign corporation from active business and certain income received from related persons. If we are in a position to treat and so treat such a PFIC as a “qualified electing fund” (“QEF”) we will be required to include our share of the company’s income and net capital gain annually, regardless of whether we receive any distribution from the company. Alternately, we may make an election to mark the gains (and to a limited extent losses) in such holdings “to the market” as though we had sold and repurchased our holdings in those PFICs on the last day of our taxable year. Such gains and losses are treated as ordinary income and loss. The QEF and mark-to-market elections may have the effect of accelerating the recognition of income (without the receipt of cash) and increasing the amount required to be distributed for us to avoid taxation.

We may also invest in “controlled foreign corporations” (“CFCs”). A non-U.S. corporation will be a CFC if “U.S. Shareholders” (i.e., each U.S. investor that owns (directly or by attribution) 10% or more of the interests in the non-U.S. corporation (by vote)) own (directly or by attribution) more than 50% (by vote or value) of the outstanding interests of the non-U.S. corporation. If we are a U.S. Shareholder with respect to a non-U.S. corporation, we will be required each year to include in income our pro rata share of the corporation’s “Subpart F income” (as defined in the Code). Therefore, investments in CFCs may have the effect of accelerating the recognition of income (without the receipt of cash) and increasing the amount required to be distributed for us to avoid taxation.

We are authorized to borrow funds and to sell assets to satisfy the Annual Distribution Requirement and to avoid any excise tax liability. However, under the 1940 Act, we are not permitted to make distributions to our

 

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stockholders while our debt obligations and other senior securities are outstanding unless certain “asset coverage” tests are met. Moreover, our ability to dispose of assets to meet the Annual Distribution Requirement and to avoid any excise tax liability may be limited by (1) the illiquid nature of our portfolio, or (2) other requirements relating to our tax treatment as a RIC, including the Diversification Tests. If we dispose of assets to meet the Annual Distribution Requirements and to avoid any excise tax liability, we may make such dispositions at times that, from an investment standpoint, are not advantageous.

Gain or loss realized by us from the sale or exchange of warrants acquired by us as well as any loss attributable to the lapse of such warrants generally will be treated as capital gain or loss. Such gain or loss generally will be long-term or short-term, depending on how long we held a particular warrant. Our transactions in options, futures contracts, hedging transactions and forward contracts will be subject to special tax rules, the effect of which may be to accelerate income to us, defer losses, cause adjustments to the holding periods of our investments, convert long-term capital gains into short-term capital gains, convert short-term capital losses into long-term capital losses or have other tax consequences. These rules could affect the amount, timing and character of distributions to stockholders. We do not currently intend to engage in these types of transactions.

A RIC is not permitted to deduct expenses in excess of its “investment company taxable income” (which is, generally, ordinary income plus net short-term capital gains in excess of net long-term capital losses). If our expenses in a given year exceed investment company taxable income (e.g., as the result of large amounts of equity-based compensation), we would experience a net operating loss for that year. However, a RIC is not permitted to carry forward net operating losses to subsequent years. In addition, expenses can be used only to offset investment company taxable income, not net capital gain (that is, the excess of net long-term capital gains over the net short-term capital losses). Due to these limits on the deductibility of expenses, we may for tax purposes have aggregate taxable income over a period of several years that we are required to distribute and that is taxable to our stockholders even if such income is greater than the net income we actually earned during those years in the aggregate. Such required distributions may be made from our cash assets or by liquidation of investments, if necessary. We may realize gains or losses from such liquidations. In the event we realize net capital gains from such transactions, stockholders may receive larger capital gain distributions than they would have received in the absence of such transactions. Assuming we qualify for tax treatment as a RIC, our corporate-level U.S. federal income tax should be substantially reduced or eliminated, and, as explained above, a portion of our distributions or deemed distributions may be characterized as long-term capital gain in the hands of stockholders. Except as otherwise provided, the remainder of this discussion assumes that we qualify for tax treatment as a RIC and have satisfied the Annual Distribution Requirement.

Failure to Qualify as a Regulated Investment Company

If we were to fail to qualify for treatment as a RIC (including if our Board of Directors elected to temporarily or permanently revoke our RIC election), we would be subject to tax on all of our taxable income at regular corporate rates. We would not be able to deduct distributions to stockholders, nor would distributions be required to be made. Such distributions would be taxable to our stockholders as dividend income to the extent of our current and accumulated earnings and profits and (if made during a taxable year beginning before January 1, 2011) provided certain holding period and other requirements were met, could potentially qualify for treatment as “qualified dividend income” in the hands of stockholders taxed as individuals eligible for the 15% maximum rate. Subject to certain limitations under the Code, corporate distributees may be eligible for the dividends received deduction with respect to our dividend distributions. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the stockholder’s tax basis, and any remaining distributions would be treated as a capital gain. To requalify as a RIC in a subsequent taxable year, we would be required to satisfy the RIC qualification requirements for that year and dispose of any earnings and profits from any year in which we failed to qualify for tax treatment as a RIC. Subject to a limited exception applicable to RICs that qualified as such under Subchapter M of the Code for at least one year prior to disqualification and that requalify as a RIC no later than the second year following the nonqualifying year, we could be subject to tax on any unrealized net built-in gains in the assets held by us during the period in which we

 

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failed to qualify for tax treatment as a RIC that are recognized within the subsequent 10 years, unless we made a special election to pay corporate-level tax on such built-in gain at the time of our requalification as a RIC.

Taxation of U.S. Stockholders

For federal income tax purposes, distributions by us generally are taxable to U.S. stockholders as ordinary income or capital gains. Distributions of our “investment company taxable income” (which is, generally, our ordinary income plus net realized short-term capital gains in excess of net realized long-term capital losses) will be taxable as ordinary income to U.S. stockholders to the extent of our current or accumulated earnings and profits, whether paid in cash or reinvested in additional common stock through our dividend reinvestment plan. For taxable years beginning before January 1, 2011, to the extent such distributions paid by us are attributable to dividends from U.S. corporations and certain qualified foreign corporations, such distributions may be designated by us as “qualified dividend income” eligible to be taxed in the hands of non-corporate stockholders at the rates applicable to long-term capital gains, provided holding period and other requirements are met at both the stockholder and company levels. In this regard, it is anticipated that distributions paid by us generally will not be attributable to dividends and, therefore, generally will not be qualified dividend income. Distributions of our net capital gains (which is generally our realized net long-term capital gains in excess of realized net short-term capital losses) properly designated by us as “capital gain dividends” will be taxable to a U.S. stockholder as long- term capital gains (currently at a maximum rate of 15% in the case of individuals, trusts or estates), regardless of the U.S. stockholder’s holding period for his, her or its common stock and regardless of whether paid in cash or reinvested in additional common stock. Distributions in excess of our current and accumulated earnings and profits first will reduce a U.S. stockholder’s adjusted tax basis in such stockholder’s common stock and, after the adjusted basis is reduced to zero, will constitute capital gains to such U.S. stockholder.

We may retain some or all of our realized net long-term capital gains in excess of realized net short-term capital losses and designate the retained net capital gains as a “deemed distribution.” In that case, among other consequences, we will pay tax on the retained amount, each U.S. stockholder will be required to include his, her or its share of the deemed distribution in income as if it had been actually distributed to the U.S. stockholder, and the U.S. stockholder will be entitled to claim a credit equal to his, her or its allocable share of the tax paid thereon by us. The amount of the deemed distribution net of such tax will be added to the U.S. stockholder’s cost basis for his, her or its common stock. Since we expect to pay tax on any retained net capital gains at our regular corporate tax rate, and since that rate is in excess of the maximum rate currently payable by individuals on long-term capital gains, the amount of tax that individual stockholders will be treated as having paid and for which they will receive a credit will exceed the tax they owe on the retained net capital gain. Such excess generally may be claimed as a credit against the U.S. stockholder’s other federal income tax obligations or may be refunded to the extent it exceeds a stockholder’s liability for federal income tax. A stockholder that is not subject to federal income tax or otherwise required to file a federal income tax return would be required to file a federal income tax return on the appropriate form to claim a refund for the taxes we paid. For federal income tax purposes, the tax basis of shares owned by a stockholder will be increased by an amount equal to the difference between the amount of undistributed capital gains included in the stockholder’s gross income and the tax deemed paid by the stockholder as described in this paragraph. To utilize the deemed distribution approach, we must provide written notice to our stockholders prior to the expiration of 60 days after the close of the relevant taxable year. We cannot treat any of our investment company taxable income as a “deemed distribution.” We may also make actual distributions to our stockholders of some or all of realized net long-term capital gains in excess of realized net short-term capital losses.

For purposes of determining (1) whether the Annual Distribution Requirement is satisfied for any year and (2) the amount of capital gain dividends paid for that year, we may, under certain circumstances, elect to treat a dividend that is paid during the following taxable year as if it had been paid during the taxable year in question. If we make such an election, the U.S. stockholder will still be treated as receiving the dividend in the taxable year in which the distribution is made. However, any dividend declared by us in October, November or December of any calendar year, payable to stockholders of record on a specified date in such a month and actually paid during

 

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January of the following year, will be treated as if it had been received by our U.S. stockholders on December 31 of the year in which the dividend was declared. A U.S. stockholder generally will recognize taxable gain or loss if the U.S. stockholder sells or otherwise disposes of his, her or its shares of our common stock. Any gain arising from such sale or disposition generally will be treated as long-term capital gain or loss if the U.S. stockholder has held his, her or its shares for more than one year. Otherwise, it will be classified as short-term capital gain or loss. However, any capital loss arising from the sale or disposition of shares of our common stock held for six months or less will be treated as long-term capital loss to the extent of the amount of capital gain dividends received, or undistributed capital gain deemed received, with respect to such shares. In addition, all or a portion of any loss recognized upon a disposition of shares of our common stock may be disallowed if other shares of our common stock are purchased (whether through reinvestment of distributions or otherwise) within 30 days before or after the disposition. In such a case, the basis of the newly purchased shares will be adjusted to reflect the disallowed loss. For taxable years beginning before January 1, 2011, individual U.S. stockholders are subject to a maximum federal income tax rate of 15% on their net capital gain (i.e., the excess of realized net long-term capital gain over realized net short-term capital loss for a taxable year) including any long-term capital gain derived from an investment in our shares. Such rate is lower than the maximum rate on ordinary income currently payable by individuals. Corporate U.S. stockholders currently are subject to federal income tax on net capital gain at the maximum 35% rate also applied to ordinary income. Non-corporate stockholders with net capital losses for a year (i.e., capital losses in excess of capital gains) generally may deduct up to $3,000 of such losses against their ordinary income each year ($1,500 for married individuals filing separately); any net capital losses of a non-corporate stockholder in excess of $3,000 ($1,500 for married individuals filing separately) generally may be carried forward and used in subsequent years as provided in the Code. Corporate stockholders generally may not deduct any net capital losses for a year, but may carry back such losses for three years or carry forward such losses for five years.

Distributions are taxable to stockholders even if they are paid from income or gains earned by us before a stockholder’s investment (and thus were included in the price the stockholder paid). If an investor purchases shares of our common stock shortly before the record date of a distribution, the price of the shares will include the value of the distribution and the investor will be subject to tax on the distribution even though economically, it may represent a return of his, her or its investment. Distributions are taxable whether stockholders receive them in cash or reinvest them in additional shares through the Dividend Reinvestment Plan. A stockholder whose distributions are reinvested in shares will be treated as having received a dividend equal to either (i) the fair market value of the shares issued to the stockholder (if we issue new shares), or (ii) the amount of cash allocated to the stockholder for the purchase of shares on its behalf (if we purchase shares on the open market). We will send to each of our U.S. stockholders, as promptly as possible after the end of each calendar year, a notice detailing, on a per share and per distribution basis, the amounts includible in such U.S. stockholder’s taxable income for such year as ordinary income and as long-term capital gain. In addition, the federal tax status of each year’s distributions generally will be reported to the IRS (including the amount of dividends, if any, eligible for the 15% “qualified dividend income” rate). Distributions may also be subject to additional state, local and foreign taxes depending on a U.S. stockholder’s particular situation. Dividends distributed by us generally will not be eligible for the corporate dividends-received deduction or the preferential rate applicable to “qualified dividend income.”

We may be required to withhold U.S. federal income tax (“backup withholding”), currently at a rate of 28%, from all distributions to any non-corporate U.S. stockholder (1) who fails to furnish us with a correct taxpayer identification number or a certificate that such stockholder is exempt from backup withholding, or (2) with respect to whom the IRS notifies us that such stockholder has failed to properly report certain interest and dividend income to the IRS and to respond to notices to that effect. An individual’s taxpayer identification number is his or her social security number. Any amount withheld under backup withholding is allowed as a credit against the U.S. stockholder’s federal income tax liability, provided that proper information is provided to the IRS.

 

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Under Treasury regulations, if a stockholder recognizes a loss with respect to our shares of $2 million or more for an individual stockholder or $10 million for a corporate stockholder, the stockholder must file with the IRS a disclosure statement on Form 8886. Direct stockholders of portfolio securities are in many cases excepted from this reporting requirement, but under current guidance, stockholders of a RIC are not excepted. Future guidance may extend the current exception from this reporting requirement to stockholders of most or all RICs. The fact that a loss is reportable under these regulations does not affect the legal determination of whether a taxpayer’s treatment of the loss is proper. Stockholders should consult their tax advisors to determine the applicability of these regulations in light of their individual circumstances.

Taxation of Non-U.S. Stockholders

Whether an investment in the shares is appropriate for a non-U.S. stockholder will depend upon that person’s particular circumstances. Non-U.S. stockholders should consult their tax advisors before investing in our common stock. In general, dividend distributions (other than certain distributions derived from net long-term capital gains, certain interest income and short term capital gains, as described below) paid by us to a non-U.S. stockholder are subject to withholding of federal income tax at a rate of 30% (or lower applicable treaty rate) even if they are funded by income or gains that, if paid to a non-U.S. stockholder directly, would not be subject to withholding. If the distributions are effectively connected with a U.S. trade or business of the non-U.S. stockholder, (and, if an income tax treaty applies, attributable to a permanent establishment in the United States), we will not be required to withhold federal tax if the non-U.S. stockholder complies with applicable certification and disclosure requirements, although the distributions will be subject to federal income tax at the rates applicable to U.S. stockholders. (Special certification requirements apply to a non-U.S. stockholder that is a foreign partnership or a foreign trust and such entities are urged to consult their tax advisors.) For taxable years beginning prior to January 1, 2008, except as provided below, we generally will not be required to withhold any amounts with respect to certain distributions of (1) U.S.-source interest income that meets certain requirements, and (2) net short-term capital gains in excess of net long-term capital losses, in each case to the extent we properly designate such distributions. We intend to make such designations. In respect of distributions described in clause (1) above, however, we will be required to withhold amounts with respect to distributions to a non-U.S. stockholder:

 

   

that has not provided a satisfactory statement that the beneficial owner is not a U.S. person;

 

   

to the extent that the dividend is attributable to certain interest on an obligation if the non-U.S. stockholder is the issuer or is a 10% stockholder of the issuer;

 

   

that is within certain foreign countries that have inadequate information exchange with the United States; or

 

   

to the extent the dividend is attributable to interest paid by a person that is a related person of the non-U.S. stockholder and the non-U.S. stockholder is a “controlled foreign corporation” for federal income tax purposes.

Actual or deemed distributions of our net capital gain to a non-U.S. stockholder, and gains realized by a non-U.S. stockholder upon the sale of our common stock, will not be subject to federal withholding tax and generally will not be subject to federal income tax unless the distributions or gain, as the case may be, are effectively connected with a U.S. trade or business of the non-U.S. stockholder (and, if an income tax treaty applies, are attributable to a permanent establishment maintained by the non-U.S. stockholder in the U.S.), or in the case of an individual stockholder, the stockholder is present in the U.S. for a period or periods aggregating 183 days or more during the year of the sale or capital gain dividend and certain other conditions are met. If we distribute our net capital gain in the form of deemed rather than actual distributions, a non-U.S. stockholder will be entitled to a federal income tax credit or tax refund equal to the stockholder’s allocable share of the tax we pay on the capital gains deemed to have been distributed. To obtain the refund, the non-U.S. stockholder must obtain a U.S. taxpayer identification number and file a federal income tax return even if the non-U.S. stockholder would not otherwise be required to obtain a U.S. taxpayer identification number or file a federal income tax return. For

 

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a corporate non-U.S. stockholder, distributions (both actual and deemed), and gains realized upon the sale of our common stock that are effectively connected to a U.S. trade or business may, under certain circumstances, be subject to an additional “branch profits tax” at a 30% rate (or at a lower rate if provided for by an applicable treaty).

A non-U.S. stockholder who is a non-resident alien individual, and who is otherwise subject to withholding of federal tax, may be subject to information reporting and backup withholding of federal income tax on dividends unless the non-U.S. stockholder provides us or the dividend paying agent with an IRS Form W-8BEN (or an acceptable substitute or successor form) or otherwise meets documentary evidence requirements for establishing that it is a non-U.S. stockholder or otherwise establishes an exemption from backup withholding. Investment in the shares may not be appropriate for a non-U.S. stockholder. non-U.S. persons should consult their tax advisors with respect to the federal income tax and withholding tax, and state, local and foreign tax consequences of an investment in the shares.

DIVIDEND REINVESTMENT PLAN

We have adopted a dividend reinvestment plan that provides for reinvestment of our distributions on behalf of our stockholders, unless a stockholder elects to receive cash as provided below. As a result, if our Board of Directors authorizes, and we declare, a cash dividend, then our stockholders who have not “opted out” of our dividend reinvestment plan will have their cash dividends automatically reinvested in additional shares of our common stock, rather than receiving the cash.

No action will be required on the part of a registered stockholder to have their cash dividend reinvested in shares of our common stock. A registered stockholder may elect to receive an entire dividend in cash by notifying American Stock Transfer & Trust Company, the plan administrator and our transfer agent and registrar, in writing so that such notice is received by the plan administrator no later than the record date for dividends to stockholders. The plan administrator will set up an account for shares acquired through the plan for each stockholder who has not elected to receive dividends in cash and hold such shares in non-certificated form. Upon request by a stockholder participating in the plan, received in writing not less than ten days prior to the record date, the plan administrator will, instead of crediting shares to the participant’s account, issue a certificate registered in the participant’s name for the number of whole shares of our common stock and a check for any fractional share.

Those stockholders whose shares are held by a broker or other financial intermediary may receive dividends in cash by notifying their broker or other financial intermediary of their election.

We intend to use primarily newly issued shares to implement the plan, whether our shares are trading at a premium or at a discount to net asset value. However, we reserve the right to purchase shares in the open market in connection with our implementation of the plan. The number of shares to be issued to a stockholder is determined by dividing the total dollar amount of the dividend payable to such stockholder by the market price per share of our common stock at the close of regular trading on The Nasdaq Global Market on the dividend payment date. Market price per share on that date will be the closing price for such shares on The Nasdaq Global Market or, if no sale is reported for such day, at the average of their reported bid and asked prices. The number of shares of our common stock to be outstanding after giving effect to payment of the dividend cannot be established until the value per share at which additional shares will be issued has been determined and elections of our stockholders have been tabulated.

There will be no brokerage charges or other charges to stockholders who participate in the plan. The plan administrator’s fees under the plan will be paid by us. If a participant elects by written notice to the plan administrator to have the plan administrator sell part or all of the shares held by the plan administrator in the participant’s account and remit the proceeds to the participant, the plan administrator is authorized to deduct a $15.00 transaction fee plus a $0.10 per share brokerage commission from the proceeds.

 

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Participants may terminate their accounts under the plan by notifying the plan administrator via its website at www.amstock.com, by filling out the transaction request form located at bottom of their statement and sending it to the plan administrator at the address set forth below or by calling the plan administrator at 1-866-668-8564.

The plan may be terminated by us upon notice in writing mailed to each participant at least 30 days prior to any record date for the payment of any dividend by us. All correspondence concerning the plan should be directed to the plan administrator by mail at American Stock Transfer & Trust Company, Attn. Dividend Reinvestment Department, P.O. Box 922, Wall Street Station, New York, NY 10269-0560 or by telephone at 1-866-668-8564.

DETERMINATION OF NET ASSET VALUE

We determine the net asset value per share of our common stock quarterly. The net asset value per share is equal to the value of our total assets minus liabilities and any preferred stock outstanding divided by the total number of shares of common stock outstanding. As of December 31, 2006, we did not have any preferred stock outstanding.

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 of Directors, based on the recommendations of the Valuation Committee of the Board of Directors. Our quarterly valuation process begins with each portfolio company or investment being initially valued by the investment professionals responsible for the portfolio investment. Preliminary valuation conclusions will then be documented and discussed with our senior management. The Valuation Committee of our Board of Directors will review these preliminary valuations and make recommendations to our Board of Directors. Where appropriate, the Valuation Committee will utilize an independent valuation firm selected by the Board of Directors. The Valuation Committee is currently in the process of selecting an independent valuation firm to assist with the periodic valuation of our illiquid securities. The Board of Directors will discuss valuations and will determine the fair value of each investment in our portfolio in good faith based on the recommendations of the Valuation Committee.

Since there is typically no readily available market value for the investments in our portfolio, we value substantially all of our investments at fair value. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments determined under our procedures 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.

There is no single standard for determining fair value. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses. Instead, we must determine the fair value of each individual investment on a quarterly basis. We record unrealized depreciation on investments when we believe that an investment has decreased in value, including where collection of a loan or realization of an equity security is doubtful. Conversely, we record unrealized appreciation if we believe that as a result our investment has appreciated in value, for example, because the underlying portfolio company has appreciated in value.

As a BDC, we invest primarily in illiquid securities, including loans to and warrants of private companies and interests in other illiquid securities, such as interests in the underlying CDO Funds. Our investments are generally subject to restrictions on resale and generally have no established trading market. Because of the type of investments that we make and the nature of our business, our valuation process requires an analysis of various factors. Our valuation methodology includes the examination of, among other things, the underlying investment performance, financial condition and market changing events that impact valuation.

 

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With respect to private debt and equity investments, each investment is valued using industry valuation benchmarks, and, where appropriate, such as valuing private warrants, the input value in our valuation model may be assigned a discount reflecting the illiquid nature of the investment and our minority, non-control position. When a qualifying external event such as a significant purchase transaction, public offering or subsequent loan or warrant sale occurs, the pricing indicated by the external event is considered in determining our private debt or equity valuation. Securities that are traded in the over-the-counter market or on a stock exchange generally are valued at the prevailing bid price on the valuation date. However, restricted or thinly traded public securities may be valued at discounts from the public market value due to limitations on our ability to sell the securities.

Our CDO Investments are carried at fair value, which is based on 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 bonds and preferred shares/income notes, when available. We recognize unrealized appreciation or depreciation on our CDO Investments as comparable yields in the market change and/or based on changes in estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. As each CDO Investment ages, the expected amount of losses and the expected timing of recognition of such losses in the underlying collateral pool is updated and the revised cash flows are used in determining the fair value of the CDO Investment. We determine the fair value of our CDO Investments on an individual security-by-security basis. If we were to sell a group of CDO Investments in a pool in one or more transactions, the total value received for that pool may be different than the sum of the fair values of the individual CDO Investments.

 

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Item 1A. Risk Factors

Investing in our common stock involves a high degree of risk. 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, our net asset value and the trading price of our common stock could decline.

RISKS RELATED TO OUR BUSINESS

We are dependent upon senior management personnel for our future success, and if we are unable to hire and retain qualified personnel or if we lose any member of our senior management team, our ability to achieve our investment objective could be significantly harmed.

We depend on the members of our senior management as well as other key personnel for the identification, final selection, structuring, closing and monitoring of our investments. These employees have critical industry experience and relationships that we rely on to implement our business plan. Our future success will depend on the continued service of our senior management team and our Board of Directors. The departure of any of the members of our senior management, or a significant number of our senior personnel, could have a material adverse effect on our ability to achieve our investment objective. As a result, we may not be able to operate our business as we expect, and our ability to compete could be harmed, which could cause our operating results to suffer.

We operate in a highly competitive market for investment opportunities.

A large number of entities will compete with us to make the types of investments that we plan to make in prospective portfolio companies. We will compete with a large number of private equity firms as well as other BDCs, 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, technical, marketing and other resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. This may enable some of our competitors to make commercial loans with interest rates that are comparable to or lower than the rates we typically offer. We may lose prospective portfolio companies if we do not match our competitors’ pricing, terms and structure. If we do match our competitors’ pricing, terms or structure, we may experience decreased net interest income and increased risk of credit losses. 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 have greater experience operating under, or 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, our business and financial condition and results of operations will be adversely affected.

There is a risk that we may not make distributions.

We intend to make distributions on a quarterly basis to our stockholders. We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, due to the asset coverage test applicable to us as a BDC, we may be limited in our ability to make distributions. Also, restrictions and provisions under the Facility may limit our ability to make distributions. If we do not distribute a certain percentage of our income annually, we could fail to qualify for tax treatment as a RIC and we would be subject to corporate level federal income tax. We cannot ensure that we will make distributions at a particular level or at all.

 

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Any unrealized losses we experience on our loan portfolio may be an indication of future realized losses, which could reduce our income available for distribution.

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. Decreases in the market values or fair values of our investments will be recorded as unrealized depreciation. Any unrealized losses in our loan portfolio could be an indication of a portfolio company’s inability to meet its repayment obligations to us with respect to the affected loans. This could result in realized losses in the future and ultimately in reductions of our income available for distribution in future periods.

We will be exposed to risks associated with changes in interest rates.

General interest rate fluctuations may have a substantial negative impact on our investments, the value of our common stock and our 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 our interest expense, thereby decreasing our net income. Also, an increase in interest rates available to investors could make investment in our common stock less attractive if we are not able to increase our dividend rate, which could reduce the value of our common stock.

If we incur additional debt, it could increase the risk of investing in our Company.

As of December 31, 2006, we had no outstanding indebtedness. However, we expect, in the future, to borrow from, and issue senior debt securities to, banks, insurance companies and other lenders, including pursuant to the Facility that we entered into on February 14, 2007. Lenders will have fixed dollar claims on our assets that are superior to the claims of our stockholders, and we may grant a security interest in our assets in connection with our borrowings. In the case of a liquidation event, those lenders would receive proceeds before our stockholders. In addition, borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increase the risks associated with investing in our securities. Leverage is generally considered a speculative investment technique. If the value of our assets increases, then leveraging would cause the net asset value attributable to our common stock to increase more than it otherwise would have had we not leveraged. Conversely, if the value of our assets decreases, leveraging would cause the net asset value attributable to our common stock to decline more than it otherwise would have had we not leveraged. Similarly, any increase in our revenue in excess of interest expense on our borrowed funds would cause our net income to increase more than it would without the leverage. Any decrease in our revenue would cause our net income to decline more than it would have had we not borrowed funds and could negatively affect our ability to make distributions on our common stock. Our ability to service any debt that we incur will depend largely on our financial performance and will be subject to prevailing economic conditions and competitive pressures.

As a BDC, we generally are required to meet a coverage ratio of total assets to total borrowings and other senior securities, which include all of our borrowings and any preferred stock we may issue in the future, of at least 200%. If this ratio declines below 200%, we may not be able to incur additional debt and may need to sell a portion of our investments to repay some debt when it is disadvantageous to do so, and we may not be able to make distributions.

Risks Related to Our Investments

Our investments may be risky, and investors could lose all or part of their investments in the Company.

We invest primarily in senior secured term loans, mezzanine debt and selected equity investments issued by middle market companies.

Senior Secured Loans. When we extend senior secured term loans, we will generally take a security interest in the available assets of these portfolio companies, including the equity interests of their subsidiaries, which we

 

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expect to help mitigate 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 our remedies.

Mezzanine Debt. Our mezzanine debt investments will generally be subordinated to senior loans and will generally be 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 will be subject to greater fluctuations in value based on changes in interest rates and such debt could subject us to phantom income. Since we will generally not receive any cash prior to maturity of the debt, the investment will be of greater risk.

Equity Investments. We expect to make selected equity investments. In addition, when we invest in senior secured loans or mezzanine debt, we may acquire warrants. 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, 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:

 

   

limited financial resources and being unable to meet their obligations, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of us realizing on any guarantees we may have obtained in connection with our investment;

 

   

shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors’ actions and market conditions, as well as general economic downturns;

 

   

dependence on management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn, on us;

 

   

less predictable operating results, being parties to litigation from time to time, engaging in rapidly changing businesses with products subject to a substantial risk of obsolescence, and requiring substantial additional capital to support their operations, finance expansion or maintain their competitive position;

 

   

difficulty accessing the capital markets to meet future capital needs; and

 

   

generally less publicly available information about their businesses, operations and financial condition.

Many of our portfolio investments will be recorded at fair value as determined in good faith by our Board of Directors. As a result, there will be uncertainty as to the value of our investments.

Our investments are expected to 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

 

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an unrealized gain or loss for any asset that we believe has increased or decreased in value. We value these securities at fair value as determined in good faith by our Board of Directors, based on the recommendations of the Valuation Committee of the Board of Directors. These valuations are initially prepared by our management and reviewed by our Valuation Committee which utilizes its best judgment in arriving at the fair value of these securities. However, the Board of Directors retains ultimate authority as to the appropriate valuation of each investment. Where appropriate, our Board of Directors may utilize the services of an independent valuation firm to aid it in determining fair value. 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, comparison to publicly-traded companies, discounted cash flow and other relevant factors. 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 investments were materially higher than the values that we ultimately realize upon the disposal of such securities.

Our portfolio is and may continue to be concentrated in a limited number of portfolio companies and industries, which will subject us to a risk of significant loss if any of these companies defaults on its obligations under any of its debt instruments or by a downturn in the particular industry.

Our portfolio is and may continue to be concentrated in a limited number of portfolio companies and industries. At December 31, 2006, our largest investment, our 100% equity interests in Katonah Debt Advisors, represented approximately 15% of our investments at fair value. Beyond the asset diversification requirements associated with our qualification as a RIC, we do not have fixed guidelines for diversification, and while we are not targeting any specific industries, our investments could be concentrated in relatively few industries. Additionally, a downturn in any particular industry in which we are invested could also significantly impact the aggregate returns we realize.

Economic recessions or downturns could impair our portfolio companies and harm our operating results.

Many of our portfolio companies may be susceptible to economic slowdowns or recessions and may be unable to repay our loans during these periods. Therefore, our non-performing assets are likely to increase and the value of our portfolio is likely to decrease during these periods. Adverse economic conditions may also decrease the value of collateral securing some of our loans and the value of our equity investments. Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing investments and harm our operating results.

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 its 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 we own. 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 we expect will generally be 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 anticipate that most of our investments will be either debt or minority equity investments in our portfolio companies. Therefore, we will be subject to the risk that a portfolio company may make business

 

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decisions with which we disagree, and the shareholders 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 will generally not be in a position to control any portfolio company by investing in its debt securities.

Prepayments of our debt investments by our portfolio companies could adversely impact our results of operations and reduce our return on equity.

We are subject to the risk that the investments we make in our portfolio companies may be repaid prior to maturity. When this occurs, we will generally reinvest these proceeds in temporary investments, pending their future investment in new portfolio companies. These temporary investments will 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. As a result, 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.

Our portfolio companies may incur debt that ranks equally 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 will be permitted to have other debt that ranks equally with, or senior to, the debt securities in which we invest. By their terms, such debt 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 we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. 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 equally with debt securities in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company.

Investments in equity securities involve a substantial degree of risk.

We may 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 and in recent years have significantly underperformed relative to fixed-income securities. The equity securities we acquire may fail to appreciate and may decline in value or become worthless, and our ability to recover our investment will depend 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 expect to 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. As a result, we do not expect to achieve liquidity in our investments in the near-term. Our investments are usually subject to contractual or legal restrictions on resale or are otherwise

 

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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.

If we incur indebtedness or issue senior securities, we will be exposed to additional risks, including the typical risks associated with leverage.

We may borrow funds or issue senior securities, pursuant to the Facility or other agreements, to make additional investments. 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% after such borrowing or issuance. The amount of leverage that we employ 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. Leverage involves risks and special considerations of stockholders, including:

 

   

a likelihood of greater volatility of net asset value and market price of our common stock than a comparable portfolio without leverage;

 

   

exposure to increased risk of loss if we incur debt or issue senior securities to finance investments because a decrease in the value of our investments would have a greater negative impact on our returns and therefore the value of our common stock than if we did not use leverage;

 

   

that the covenants contained in the documents governing the Facility or other debt instruments could restrict our operating flexibility. Such covenants may impose asset coverage or investment portfolio composition requirements that are more stringent than those imposed by the 1940 Act and could require us to liquidate investments at an inopportune time; and

 

   

that we, and indirectly our stockholders, will bear the cost of leverage, including issuance and servicing costs (i.e., interest).

Any requirement that we sell assets at a loss to redeem or pay interest or dividends on any leverage, or for other reasons, would reduce our net asset value and also make it difficult for the net asset value to recover. Our Board of Directors, in their judgment, nevertheless may determine to use leverage if they expect that the benefits to our stockholders of maintaining the leveraged position will outweigh the risks.

The agreements governing the Facility contain various covenants that, among other things, limit our discretion in operating our business and provide for certain minimum financial covenants.

We have entered into the Facility, which is backed by a revolving pool of loans. Under the Facility, we are subject to limitations as to how borrowed funds may be used, including restrictions on geographic and industry concentrations, loan size, payment frequency and status, average life, collateral interests and investment ratings. We are also subject to regulatory restrictions on leverage which may affect the amount of funding that we can obtain under the Facility. The Facility also includes certain requirements relating to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs, a violation of which could result in the early amortization of the Facility, limit further advances and, in some cases, result in an event of default. An event of default under the Facility would result, among other things, in termination of the availability of further funds under the Facility and an accelerated maturity date for all amounts outstanding under the Facility, which would likely disrupt our business and, potentially, the portfolio companies whose loans we financed through the Facility. This could reduce our revenues and, by delaying any cash payment allowed to us under the Facility until the lender has been paid in full, reduce our liquidity and cash flow and impair our ability to grow our business and maintain our status as a RIC. If we default under certain provisions of the Facility, the remedies available to the lender may limit our ability to declare dividends. Moreover, we cannot assure you that we will be able to borrow funds under the Facility at any particular time or at all.

 

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Risks Related to Our Operation as a BDC

Our ability to enter into transactions with our affiliates will be restricted.

We will be prohibited under the 1940 Act from participating in certain transactions with certain of our affiliates without the prior approval 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 will be our affiliate for purposes of the 1940 Act and we will generally be prohibited from buying or selling any security 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 from or to such person or certain of that person’s affiliates, or entering into prohibited joint transactions with such persons, absent the prior approval of the SEC. Similar restrictions limit our ability to transact business with our officers or directors or their affiliates. As a result of these restrictions, we will be prohibited from buying or selling any security from or to any portfolio company of a private equity fund managed by Kohlberg & Co. without the prior approval of the SEC.

Changes in the laws or regulations governing our business, or changes in the interpretations thereof, and any failure by us to comply with these laws or regulations, could negatively affect the profitability of our operations.

Changes in the laws or regulations or the interpretations of the laws and regulations that govern BDCs, RICs or non-depository commercial lenders, could significantly affect our operations and our cost of doing business. We are subject to federal, state and local laws and regulations and are subject to judicial and administrative decisions that affect our operations, including our loan originations, maximum interest rates, fees and other charges, disclosures to portfolio companies, the terms of secured transactions, collection and foreclosure procedures and other trade practices. If these laws, regulations or decisions change, or if we expand our business into jurisdictions that have adopted more stringent requirements than those in which we currently conduct business, we may have to incur significant expenses in order to comply or we might have to restrict our operations. In addition, if we do not comply with applicable laws, regulations and decisions, we may lose licenses needed for the conduct of our business and be subject to civil fines and criminal penalties, any of which could have a material adverse effect upon our business, results of operations or financial condition.

If we are unable to qualify for tax treatment as a RIC, we will be subject to corporate-level income tax, which will adversely affect our results of operations and financial condition.

Provided we qualify for tax treatment as a RIC, we can generally avoid corporate-level federal income taxes on income distributed to our stockholders as dividends. We will not qualify for this pass-through tax treatment, and thus will be subject to corporate-level federal income taxes, if we are unable to comply with the source of income, diversification and distribution requirements contained in the Code, or if we fail to maintain our election to be regulated as a BDC under the 1940 Act. If we fail to qualify for tax treatment as a RIC, the resulting taxes could substantially reduce our net assets, the amount of income available for distribution to our stockholders and the actual amount of our distributions. As such, our failure to qualify for tax treatment as a RIC would have a material adverse effect on us, the net asset value of our common stock and the total return obtainable from an investment in our common stock. We may, from time to time, organize and conduct the business of our wholly-owned portfolio company, Katonah Debt Advisors, through additional direct or indirect wholly-owned subsidiaries which may, in some cases, be taxable as corporations.

Risks Related to an Investment in Our Shares

Shares of closed-end investment companies, including BDCs, frequently trade at a discount to their net asset value.

Shares of closed-end investment companies frequently trade at discounts to their net asset values and our stock may also be discounted in the market. This characteristic of closed-end investment companies is separate

 

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and distinct from the risk that our net asset value per share may decline. We cannot predict whether shares of our common stock will trade above, at or below our net asset value. The risk of loss associated with this characteristic of closed-end investment companies may be greater for investors expecting to sell shares of common stock purchased in the IPO soon after the IPO. In addition, if our common stock trades below its net asset value, we will generally not be able to issue additional shares of our common stock at its market price without first obtaining the approval of our stockholders and our independent directors.

Our common stock price may be volatile and may fluctuate substantially.

The trading price of our common stock may fluctuate substantially. The liquidity of our common stock may be limited, depending on many factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include:

 

   

price and volume fluctuations in the overall stock market from time to time;

 

   

significant volatility in the market price and trading volume of securities of BDCs or other companies in our sector, which are not necessarily related to the operating performance of these companies;

 

   

our inability to deploy or invest our capital;

 

   

fluctuations in interest rates;

 

   

any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts;

 

   

operating performance of companies comparable to us;

 

   

changes in regulatory policies or tax rules, particularly with respect to RICs or BDCs;

 

   

loss of RIC tax treatment;

 

   

changes in earnings or variations in operating results;

 

   

changes in the value of our portfolio;

 

   

general economic conditions and trends; and

 

   

departure of key personnel.

Our principal stockholders may continue to have substantial ownership in us and this could limit other investors’ ability to influence the outcome of key transactions, including a change of control. In addition, some of our stockholders may have interests in Kohlberg Capital that differ from those of other stockholders.

Individuals and entities affiliated with Kohlberg & Co. beneficially own, in the aggregate, approximately 19% of the outstanding shares of our common stock. James A. Kohlberg, the Vice-Chairman of our Board of Directors, is a founder and the Chairman of Kohlberg & Co. Christopher Lacovara, who serves as the Chairman of our Board of Directors and Investment Committee, and Samuel P. Frieder, who serves as a member of our Board of Directors and our Investment Committee, are co-managing partners of Kohlberg & Co. Our Board of Directors and our Investment Committee must approve of the acquisition and disposition of our investments. As a result, these individuals may be able to exert influence over our management and policies. Affiliates of Kohlberg & Co. may also acquire additional shares of our equity securities in the future. This concentration of ownership may have the effect of delaying, preventing or deterring a change of control of our Company, deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our Company or may ultimately affect the market price of our common stock. In addition, Mr. Kratzman, who serves on our Investment Committee, is also employed by Katonah Debt Advisors and is compensated, in part, based upon the performance of Katonah Debt Advisors. As a result, Mr. Kratzman may have interests in Katonah Debt Advisors that differ from those of other stockholders of Kohlberg Capital.

 

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Item 1B. Unresolved Staff Comments

None.

 

Item 2. Properties

We do not own any real estate or other real property. Our wholly-owned portfolio company, Katonah Debt Advisors, is the lessee for our principal headquarters at 295 Madison Avenue, 6th Floor, New York, New York 10017. We have entered into an Overhead Allocation Agreement with Katonah Debt Advisors which provides for the sharing of the expenses under the lease agreement.

 

Item 3. Legal Proceedings

We are not a party to any pending legal proceedings.

 

Item 4. Submission of Matters to a Vote of Security Holders

On December 11, 2006, prior to our conversion to a corporation, the members of Kohlberg Capital, LLC, by written consent without a special meeting, adopted resolutions:

1. Electing, effective immediately following the conversion of Kohlberg Capital, LLC into the Company, (i) Gary Cademartori and C. Turney Stevens, Jr. as Class I Directors, to serve until the annual meeting of stockholders in 2007; (ii) Samuel P. Frieder, C. Michael Jacobi and Albert Pastino as Class II Directors, to serve until the annual meeting of stockholders in 2008; and (iii) Christopher Lacovara and James A. Kohlberg as Class III Directors, to serve until the annual meeting of stockholders in 2009.

2. Approving the issuance in an underwritten public offering of shares of the Company’s authorized but unissued common stock.

3. Approving the Certificate of Incorporation of Kohlberg Capital Corporation.

4. Approving the Bylaws of Kohlberg Capital Corporation.

5. Approving the 2006 Equity Incentive Plan.

6. Approving the form of indemnification agreement.

7. Approving the selection of Deloitte & Touche LLP as Kohlberg Capital Corporation’s independent public accounting firm.

Votes cast for the above matters: all outstanding membership interests in Kohlberg Capital, LLC.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

PRICE RANGE OF COMMON STOCK

Our common stock is quoted on The Nasdaq Global Market under the symbol “KCAP.” We completed our initial public offering on December 11, 2006 at an initial public offering price of $15.00 per share. Prior to such date there was no public market for our common stock. Our common stock has traded in excess of net asset value. However, there can be no assurance that our shares will continue to trade at a premium to our net asset value.

The following table sets forth the range of high and low closing sales prices per share of our common stock as reported on The Nasdaq Global Market and the dividends declared by us for each fiscal quarter following completion of our initial public offering. The stock quotations are interdealer quotations and do not include markups, markdowns or commissions and may not necessarily represent actual transactions.

 

     NAV(1)    Price Range    Cash Dividend
Per Share(2)
        High    Low   

Fiscal 2006

           

Fourth quarter (December 11, 2006—December 31, 2006)

   $ 14.29    $ 17.70    $ 14.54    $  —  

(1)

Net asset value per share is determined as of the last day in the relevant quarter and therefore may not reflect the net asset value per share on the date of the high and low closing sales prices. The net asset value shown is based on outstanding shares at December 31, 2006.

(2)

No dividend was declared for the period from December 11, 2006 to December 31, 2006. We plan to distribute the distributable income earned during this period during 2007.

 

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Performance Graph

The following graph compares the return on our common stock with that of the Standard & Poor’s 500 Stock Index and the Russell 2000 Financial Index, for the period December 11, 2006 (the date of our initial public offering) to December 31, 2006. The graph assumes that, on December 11, 2006, a person invested $100 in each of our common stock, the S&P 500 Stock Index and the Russell 2000 Financial Index. The graph measures total shareholder return, which takes into account both changes in stock price and dividends. It assumes that dividends are reinvested in like securities.

Shareholder Return Performance Graph

Cumulative Total Return Since Initial Public Offering(1)

(Through December 31, 2006)

LOGO


(1)

Total return includes reinvestment of dividends through December 31, 2006.

HOLDERS

As of February 21, 2007, there were 5,078 holders of record of our common stock.

SALES OF UNREGISTERED SECURITIES

We issued an aggregate of 2,226,333 common units to James A. Kohlberg and an entity affiliated with Kohlberg & Co. to acquire 100% of the outstanding limited liability company interests of Katonah Debt Advisors on October 30, 2006 and November 17, 2006. These common units converted into shares of our common stock upon our conversion to a Delaware corporation. On the date of our initial public offering, these common shares had a value of approximately $33 million, based on our initial public offering price of $15.00 per share. Prior to the completion of our initial public offering, James A. Kohlberg and the entity affiliated with Kohlberg & Co. transferred certain of these common units to certain employees and officers of Kohlberg & Co. and Katonah Debt Advisors.

We issued an aggregate of 1,258,000 common units to affiliates of Kohlberg & Co. to acquire certain subordinated debt and preferred stock securities issued by CDO Funds managed by Katonah Debt Advisors and two other asset managers on November 1, 2006, November 15, 2006 and November 19, 2006. These common units converted into shares of our common stock upon our conversion to a Delaware corporation. On the date of our initial public offering, these common shares had a value of approximately $19 million based on our initial public offering price of $15.00 per share.

 

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No underwriters were involved in the foregoing issuances of securities. The securities described above were issued to United States investors in reliance upon the exemption from the registration requirements of the Securities Act, as set forth in Section 4(2) under the Securities Act and Rule 506 of Regulation D promulgated thereunder relative to sales by an issuer not involving any public offering. All recipients of common units described above represented to us in connection with their receipt of common units that they were acquiring the shares for investment and not with a view to distribution in violation of applicable securities laws, that they could bear the risks of the investment and could hold the securities for an indefinite period of time. The recipients received written disclosures that the securities had not been registered under the Securities Act and that any resale must be made pursuant to a registration statement or an available exemption from such registration requirement.

ISSUER PURCHASES OF EQUITY SECURITIES

We did not repurchase any shares of our common stock during the three months ended December 31, 2006.

DIVIDEND POLICY

We currently intend to distribute quarterly dividends to our stockholders. Our quarterly dividends, if any, will be determined by our Board of Directors. To maintain our RIC status, we must timely distribute an amount equal to at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, reduced by deductible expenses, out of the assets legally available for distribution, for each year. To avoid certain excise taxes imposed on RICs, we are generally required to distribute during each calendar year an amount at least equal to the sum of (1) 98% of our ordinary income for the calendar year, (2) 98% of our capital gains in excess of capital losses for the one-year period ending on October 31 of the calendar year and (3) any ordinary income and net capital gains for preceding years that were not distributed during such years. If this requirement is not met, we will be required to pay a nondeductible excise tax equal to 4% of the amount by which 98% of the current year’s taxable income exceeds the distribution for the year. The taxable income on which an excise tax is paid is generally carried forward and distributed to stockholders in the next tax year. 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 a 4% excise tax on such income, to the extent required. We did not declare or pay any dividends in 2006. As of December 31, 2006, our excise tax liability related to our 2006 distributable income was approximately $21,000. We plan to distribute our 2006 distributable income in 2007.

We cannot assure you that we will achieve results that will permit the payment of any cash distributions and, if we incur indebtedness or issue senior securities, we will be prohibited from making distributions if doing so causes us to 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.

We maintain an “opt out” dividend reinvestment plan for our common stockholders. As a result, if we declare a dividend, then stockholders’ cash dividends will be automatically reinvested in additional shares of our common stock, unless they specifically “opt out” of the dividend reinvestment plan so as to receive cash dividends.

 

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Item 6. Selected Financial Data

The following selected financial and other data for the period from December 11, 2006, the date of our initial public offering and conversion to a corporation, through December 31, 2006 is derived from our financial statements which have been audited by Deloitte & Touche LLP, an independent registered public accounting firm whose report thereon is included within this Annual Report. 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 Annual Report.

KOHLBERG CAPITAL CORPORATION

SELECTED FINANCIAL DATA

Period December 11, 2006 (inception) through December 31, 2006

 

     For the Period
December 11,
2006
(inception)
Through
December 31,
2006
 

Income Statement Data

  

Total investment income

   $ 1,151,903  

Net realized and unrealized gain on investments

     4,253,787  

Total expenses

     (641,278 )

Equity in loss of affiliate

     (72,710 )

Excise taxes

     (21,162 )
        

Net increase in stockholders’ equity resulting from operations

   $ 4,670,540  
        

Per Common Share Data:

  

Net investment income:

  

Basic and diluted:

   $ 0.02  

Cash dividend declared:

   $ —    

Net increase in stockholder’s equity resulting from operations:

  

Basic and diluted:

   $ 0.26  

Net asset value per common share

   $ 14.29  

Select Period-End Balances

  

Total assets

   $ 282,375,847  

Total debt

   $ —    

Total stockholders’ equity

   $ 256,400,423  

Other Data:

  

Number of portfolio companies / investments at period end

     86  

Principal amount of loans and mezzanine debt purchased

   $ 191,706,724  

Principal amount of loans and mezzanine debt sold and repayments

   $ 533,315  

Weighted average yield of income producing debt investments(1):

     9.03 %

Fair value of CDO equity investments

   $ 20,870,000  

Fair value of investment in wholly-owned portfolio management company

   $ 37,574,995  

Total return based on market value

     15.33 %

(1)

Weighted average yield of income producing debt investments is calculated as the average yield to par outstanding balances for investments in loans and mezzanine debt. The yield on CDO equities and investment in our wholly-owned portfolio manager, Katonah Debt Advisors, are excluded.

 

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Item 7. 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 Annual Report. In addition to historical information, the following discussion and other parts of this Annual Report 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 “Note about Forward-Looking Statements” appearing elsewhere herein.

OVERVIEW

We were formed as a Delaware limited liability company on August 8, 2006 and, in connection with our IPO, converted on December 11, 2006 to a corporation incorporated in Delaware. Prior to our IPO, we did not have material operations. Our IPO of 14,462,000 shares of common stock raised net proceeds of approximately $200 million. We are an internally managed BDC, whose activities include a middle market investment business, which we conduct under the Kohlberg Capital name, and asset management business of Katonah Debt Advisors, our wholly-owned portfolio company.

Our investment objective is to generate current income and capital appreciation from the investments made by our middle market business in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies. Our primary investment focus is on making loans to, and selected equity investments in, privately-held middle market companies, and we may invest up to 30% of our capital in other investments such as loans to larger, publicly-traded companies, high-yield bonds, distressed debt securities and debt and equity securities issued by CDO Funds managed by Katonah Debt Advisors or by other asset managers. We also expect to receive distributions of recurring fee income and to generate capital appreciation from our investment in the asset management business of Katonah Debt Advisors.

We intend to elect to be treated as a RIC, under Subchapter M of the Code. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. Pursuant to this election, we generally will not have to pay corporate-level taxes on any income that we distribute to our stockholders.

CRITICAL ACCOUNTING POLICIES

Basis of Presentation

The accompanying financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States. The financial statements reflect all adjustments and reclassifications which, in the opinion of management, are necessary for the fair presentation of the Company’s results of operations and financial condition for the periods presented. Furthermore, the financial statements are based on the selection and application of critical accounting policies which may require management to make significant estimates and assumptions. Actual results could differ from those estimates. Critical accounting policies are those that are important to the presentation of our financial condition and results of operations that require management’s most difficult, complex or subjective judgments.

Valuation of Portfolio Investments

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

As a BDC, we invest a substantial portion of our assets in illiquid securities including debt and equity securities of primarily privately-held companies. These securities will be valued and carried at fair value, as determined in good faith by our Board of Directors each quarter. We will determine fair value to be the amount

 

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for which an investment could be exchanged in an orderly disposition over a reasonable period of time between willing parties other than in a forced or liquidation sale. 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 of Directors’ 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.

Our Board of Directors may consider other methods of valuation to determine the fair value of investments as appropriate in conformity with accounting principles generally accepted in the United States.

Interest Income

Interest income, adjusted for amortization of premium and accretion of discount, 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. Non-accrual loans remain in such status until the borrower has demonstrated the ability and intent to pay contractual amounts due or such loans become current. At December 31, 2006, no loans or debt securities were greater than 90 days past due or on non-accrual status.

Payment in Kind Interest

The Company may have loans in its 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 paid out to stockholders in the form of dividends, even though the Company has not yet collected the cash.

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

We may, from time to time, issue stock options under our Equity Incentive Plan to officers and employees for services rendered to us. We will follow Statement of Financial Accounting Standards No. 123R (revised 2004), Accounting for Stock-Based Compensation, a method by which the fair value of options are determined and expensed. We are internally managed and therefore do not incur management fees payable to third parties.

U.S. Federal Income Taxes

The Company intends to qualify and elect 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 investment company taxable income, as defined by the Code, for each year. 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 a 4% excise tax on such income, to the extent required.

 

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In accordance with Statement of Position 93-2, “Determination, Disclosure, and Financial Statement Presentation of Income, Capital Gain, and Return of Capital Distributions by Investment Companies,” book and tax basis differences relating to stockholder distributions and other permanent book and tax differences are reclassified to capital in excess of par value. In addition, the character of income and gains to be distributed is determined in accordance with income tax regulations that may differ from accounting principles generally accepted in the United States of America. See “Certain United States Federal Income Tax Considerations” in Item 1.

Dividends

Dividends and distributions to common stockholders are recorded on the record date. The amount to be paid out as a dividend is determined by the Board of Directors each quarter and is generally based upon the earnings estimated by management for the period and fiscal year.

We have adopted a dividend reinvestment plan that provides for reinvestment of our distributions on behalf of our stockholders, unless a stockholder “opts out” of the plan to receive cash in lieu of having their cash dividends automatically reinvested in additional shares of our common stock.

PORTFOLIO AND INVESTMENT ACTIVITY

Our primary business is lending to and investing in middle-market businesses through investments in senior secured loans, junior secured loans, subordinated/mezzanine debt investments, CDO equity investments and other equity-based investments, which may include warrants.

Total portfolio investment activity (excluding unearned income) as of December 31, 2006 was as follows:

 

     December 31,
2006
 

Middle Market Investments

  

Purchases / originations / draws

   $ 191,706,724  

Pay-downs / pay-offs / sales

     (533,315 )

Net amortized discount

     (406,025 )
        

Increase in fair value

     —    
        

Total debt securities at fair value

   $ 190,767,384  
        

CDO Equity Investments

  

Cost basis

   $ 20,870,000  

Increase (decrease) in fair value

     —    
        

Total CDO equity investments at fair value

   $ 20,870,000  
        

Asset Management Company Investment

  

Cost basis

   $ 33,394,995  

Accumulated loss net of distributions

     (72,710 )

Increase in fair value

     4,252,710  
        

Total asset management company investment at fair value

   $ 37,574,995  
        

Total Portfolio

   $ 249,212,379  
        

Following completion of our IPO, we used approximately $185 million of the net proceeds of that offering to acquire a portfolio of approximately $185 million in aggregate principal amount of senior secured loans that were originated during 2006 through a special purpose vehicle organized by Katonah Debt Advisors. These loans were acquired by us for cash at their fair market value. Subsequent to our acquisition of the IPO Initial Assets and consistent with our investment strategy, we began to reposition our investment portfolio toward a heavier weighting in second lien senior loans and mezzanine loans.

 

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Prior to our IPO, we issued an aggregate of 1,258,000 common shares, having a value of approximately $19 million, to affiliates of Kohlberg & Co. to acquire certain subordinated debt and preferred stock securities issued by CDO Funds (Katonah III, Ltd., Katonah IV, Ltd., Katonah V, Ltd., Katonah VII CLO, Ltd., and Katonah VIII CLO, Ltd.) managed by Katonah Debt Advisors and two other asset managers. Subsequent to our IPO we purchased $2 million of CDO Fund securities issued by Katonah IX CLO, Ltd. bringing our total investment in CDO Fund securities to approximately $21 million as of December 31, 2006.

Prior to our IPO, we issued an aggregate of 2,226,333 common shares, having a value of approximately $33 million, to affiliates of Kohlberg & Co. to acquire Katonah Debt Advisors. As a result, Katonah Debt Advisors is a wholly-owned portfolio company that manages CDO Funds which invest in broadly syndicated loans, high-yield bonds and other credit instruments. As of December 31, 2006, Katonah Debt Advisors had approximately $1.4 billion of assets under management.

The level of investment activity for investments funded and principal repayments for our investments can substantially vary 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 capital available to middle market companies, the level of merger and acquisition activity for such companies and the general economic environment.

RESULTS OF OPERATIONS

Set forth below is a discussion of our results of operations for the period December 11, 2006 (completion of our IPO) through December 31, 2006. Prior to the completion of our IPO, we had no material operations. Therefore, there are no comparable prior periods presented.

Investment Income

Investment income for the period December 11, 2006 (completion of our IPO) through December 31, 2006 was approximately $1 million. Of this amount, approximately $705,000 was related to interest income on our middle market investments and $405,000 related to CDO equity investments.

Expenses

Total expenses for the period December 11, 2006 (completion of our IPO) through December 31, 2006 were approximately $662,000. Approximately $175,000 related to employment compensation, including salaries, bonuses and stock option expense for the period. Other expenses included approximately $412,000 in organizational expenses for costs related to the formation of the Company and professional fees. Approximately $21,000 was attributable to the 4% excise tax imposed on net distributable income that was not distributed as dividends in 2006. We plan to distribute such distributable income in 2007.

Net Change in Unrealized Appreciation on Investments

During the period December 11, 2006 (completion of our IPO) through December 31, 2006, the Company’s investments had an increase in net unrealized appreciation of $4 million. The increase in net unrealized appreciation was primarily a result of the appreciation of our wholly-owned portfolio company, Katonah Debt Advisors. Katonah Debt Advisors, as a portfolio manager, receives fee income from managing CDO Funds which invest in broadly syndicated loans, high-yield bonds and other credit instruments The increase in value is primarily as a result of an increase in Katonah Debt Advisors’ assets under management from $1.2 billion prior to our IPO to $1.4 billion as of December 31, 2006.

 

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Net Increase in Stockholders’ Equity Resulting From Operations

The net increase in stockholders’ equity resulting from operations from December 11, 2006 (completion of our IPO) as compared to December 31, 2006 was approximately $5 million, or $0.26 per outstanding 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 dividends 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 abnormal 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.

We believe our existing cash balances, funds available under the Facility and cash flows from operations will be sufficient for our liquidity requirements over the next 12 months. Unused borrowing capacity will vary as the market values of our securities vary. Our investments and assets will also generate liquidity on an ongoing basis through principal and interest payments, pre-payments and net earnings held prior to payment of dividends. Should our liquidity needs ever exceed these ongoing or immediate sources of liquidity discussed above, we believe that our securities could be sold to raise additional cash in most circumstances.

As a BDC, we are limited in the amount of leverage we can incur to finance our investment portfolio. We are required to meet a coverage ratio of total assets to total senior securities of at least 200%. For this purpose, senior securities include all borrowings and any preferred stock. As a result, our ability to utilize leverage as a means of financing our portfolio of investments is limited by this asset coverage test.

On December 11, 2006, we completed our IPO of 14,462,000 shares of common stock at $15.00 per share, less an underwriting discount and IPO expenses paid by us totaling $1.22 per share. Prior to our IPO, we issued to affiliates of Kohlberg & Co. a total of 3,484,333 shares of our common stock for the acquisition of certain subordinated securities issued by CDO Funds and for the acquisition of Katonah Debt Advisors. Total shares outstanding as of December 31, 2006 was 17,946,333.

As of December 31, 2006 the fair value of investments and cash and cash equivalents were as follows:

 

     December 31,
2006

Cash and cash equivalents

   $ 32,404,493

Senior Secured Loan

     163,313,492

Junior Secured Loan

     27,453,892

Equity in CDOs

     20,870,000

Katonah Debt Advisors (wholly-owned portfolio company)

     37,574,995
      

Total

   $ 281,616,872
      

In an effort to increase our returns and the number of loans that we can originate, we have entered into the Facility through which we plan to aggregate pools of funded loans that can then be securitized. On February 14, 2007, our wholly-owned special-purpose bankruptcy remote subsidiary, Kohlberg Capital Funding LLC I, was established. We will borrow under the Facility through Kohlberg Capital Funding LLC I. Under the Facility, we may obtain up to $200 million (with an ability to increase to $250 million subject to certain conditions) in financing. Under the Facility, funds are loaned by or through certain lenders at prevailing commercial paper rates or, if the commercial paper market is at any time unavailable, at prevailing LIBOR rates, plus an applicable margin.

 

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COMMITMENTS

We are a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the needs of our 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 our balance sheet. Prior to extending such credit, we attempt to limit our credit risk by conducting extensive due diligence, obtaining collateral where necessary and negotiating appropriate financial covenants. As of December 31, 2006, the Company had committed to make a total of approximately $2 million of investments in various revolving senior secured loans, all of which was unfunded. As of December 31, 2006, the Company had committed to make a total of approximately $667,000 of investments in a delayed draw senior secured loan.

We may make first loss guarantees in connection with loan warehouse arrangements for Katonah Debt Advisors CDO Funds. Loan warehouse arrangements are used to accumulate assets that will ultimately be collateralized with a CDO Fund. The amount of such guarantees generally approximate 1% of the planned CDO Fund value and generally correlate to our planned equity investment in the CDO Fund. In return for such guarantee, we receive net spread income from the underlying assets in the loan warehouse.

At December 31, 2006 there were no such first loss commitments or guarantees.

CONTRACTUAL OBLIGATIONS

The following table summarizes our contractual cash obligations and other commercial commitments as of December 31, 2006:

 

Contractual Obligations

   Payments Due by Period
   Total    2007    2008    2009    2010    2011   

More than

5 Years

Operating lease obligations

   $ 2,092,099    $ 298,871    $ 298,871    $ 298,871    $ 298,871    $ 298,871    $ 597,744

Long-term debt obligations

     —        —        —        —        —        —        —  

Unused lending commitments1

     2,291,666      2,291,666      —        —        —        —        —  
                                                

Total

   $ 4,383,765    $ 2,590,537    $ 298,871    $ 298,871    $ 298,871    $ 298,871    $ 597,744
                                                

1

Represents the unfunded lending commitment in connection with revolving lines of credit or delayed funding draws on loans made to portfolio companies.

RECENT DEVELOPMENTS

On January 19, 2007, our Board of Directors approved grants of options to purchase 345,000 shares of our common stock under our Equity Incentive Plan to employees with an exercise price per share equal to the closing price on that day of $16.36. These options vest ratably over a four year period and expire in ten years.

On February 5, 2007, our Board of Directors approved a grant of options to purchase 25,000 shares of our common stock options under our Equity Incentive Plan to an employee with an exercise price per share equal to the closing price on that day of $17.37. These options vest ratably over a four year period and expire in ten years.

On February 7, 2007, we entered into an agreement with Bear, Stearns & Co. Inc. (“Bear Stearns”) pursuant to which Bear Stearns will provide services relating to the formation of a CDO Fund managed by Katonah Debt Advisors, to be named Briarcliff CLO I Ltd. (“Briarcliff”), which will invest in broadly syndicated corporate loans and mezzanine securities of CDO funds (other than the CDO Funds managed by Katonah Debt Advisors) rated “BBB” or “BB”, with a total fund size expected to be $300 million. As part of this engagement, we entered

 

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into a warehouse credit agreement under which Bear Stearns will provide funding which will allow us to accumulate assets for Briarcliff. Pursuant to this warehouse credit agreement, we agreed to reimburse Bear Stearns for losses incurred on loans acquired for Briarcliff prior to the completion of the fund (a “First Loss Guarantee”) with such reimbursement limited based on a percentage of warehoused assets. We believe the risk of such loss is low because of the limited duration of the warehouse period. In return for providing this First Loss Guarantee, we will receive all interest and other non-principal distributions made with respect to the CDO’s investments serving as collateral upon the closing of the securitization, less the financing costs of LIBOR plus 0.75%, reset daily.

On February 14, 2007, we entered into the Facility through which we may obtain up to $200 million (with an ability to increase to $250 million subject to certain conditions) in financing. Advances under the Facility will be used by us primarily to make additional investments. We expect that the Facility will be secured by loans that we currently own and the loans acquired by us with the advances under the Facility. We will borrow under the Facility through our wholly-owned, special-purpose bankruptcy remote subsidiary, Kohlberg Capital Funding LLC I. Under the Facility, funds are loaned by or through certain lenders at prevailing commercial paper rates or, if the commercial paper market is at any time unavailable, at prevailing LIBOR rates, plus an applicable margin. The interest charged on borrowed funds is based on the commercial paper rate plus 0.70% and is payable monthly. See “Leverage.”

On March 3, 2007, we entered into an agreement with Bear Stearns pursuant to which Bear Stearns will provide services relating to the formation of a CDO Fund managed by Katonah Debt Advisors, to be named Katonah CLO XI Ltd. (“Katonah CLO XI”), which will invest in broadly syndicated senior loans, second lien loans, and other credit instruments (excluding asset backed securities such as those secured by residential mortgages or other consumer borrowings) with a total fund size expected to be $400 million. As part of this engagement, we entered into a warehouse credit agreement under which Bear Stearns will provide funding which will allow us to accumulate assets for Katonah CLO XI. Pursuant to this warehouse credit agreement, we agreed to reimburse Bear Stearns for losses incurred on loans acquired for Katonah CLO XI prior to the completion of the fund with such reimbursement limited based on a percentage of warehoused assets. We believe the risk of such loss is low because of the limited duration of the warehouse period. In return for providing this First Loss Guarantee, we will receive all interest and other non-principal distributions made with respect to the CDO’s investments serving as collateral upon closing of the securitization, less the financing costs of 0.75% plus LIBOR, reset daily.

On March 12, 2007, we entered into an agreement with Lehman Commercial Paper Inc. (“Lehman”) pursuant to which Lehman will provide services relating to the formation of a CDO Fund managed by Katonah Debt Advisors, to be named Ardsley CLO 2007-1 Ltd. (“Ardsley CLO 2007-1”), which will invest in senior loans to middle market companies, broadly syndicated senior loans and other credit instruments (excluding asset backed securities such as those secured by residential mortgages or other consumer borrowings) of corporate issuers with a total fund size expected to be $300 million. As part of this engagement, we entered into a warehouse credit agreement under which Lehman will provide funding which will allow us to accumulate assets for Ardsley CLO 2007-1. Pursuant to this warehouse credit agreement, we agreed to reimburse Lehman for losses incurred on loans acquired for Ardsley CLO 2007-1 prior to the completion of the fund with such reimbursement limited based on a percentage of warehoused assets. We believe the risk of such loss is low because of the limited duration of the warehouse period. In return for providing this First Loss Guarantee, we will receive all interest and other non-principal distributions made with respect to the CDO’s investments serving as collateral upon closing of the securitization, less the financing costs of 0.75% plus LIBOR, reset daily.

During the first quarter of 2007, we hired two credit analysts and a controller. In addition, Katonah Debt Advisors hired an additional analyst. We expect to make additional hires throughout the year as we seek to implement our business plan.

 

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Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Our business activities contain elements of market risks. We consider our principal market risks to be fluctuations in interest rates and the valuations of our investment portfolio. Essential to our business is managing these risks. Accordingly, we have systems and procedures designed to identify and analyze our risks, to establish appropriate policies and thresholds and to continually monitor these risks and thresholds by means of administrative and information technology systems and other policies and processes.

Interest Rate Risk

Interest rate risk is defined as the sensitivity of our current and future earnings to interest rate volatility, variability of spread relationships, the difference in re-pricing intervals between our assets and liabilities and the effect that interest rates may have on our cash flows. Changes in the general level of interest rates can affect our net interest income, which is the difference between the interest income earned on interest earning assets and our interest expense incurred in connection with our interest bearing debt and liabilities. Changes in interest rates can also affect, among other things, our ability to acquire and originate loans and securities and the value of our investment portfolio.

Our investment income is affected by fluctuations in various interest rates, including LIBOR and prime rates. As of December 31, 2006, all of our loans at fair value in our portfolio were at floating rates with a spread to an interest rate index such as LIBOR or the prime rate. However, we expect that future portfolio investments may include assets that carry a fixed interest rate. As of December 31, 2006, we had no borrowings outstanding. However, on February 14, 2007, we established the Facility allowing us to obtain up to $200 million (with an ability to increase to $250 million subject to certain conditions) in financing at a floating rate tied to prevailing commercial paper rates plus a margin of 0.70%.

Because we plan on borrowing money to make investments, our net investment income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest the funds borrowed. Accordingly, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income. In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment income if there is not a corresponding increase in interest income generated by floating rate assets in our investment portfolio.

We have analyzed the potential impact of changes in interest rates on interest income net of interest expense. Assuming that our balance sheet at December 31, 2006 were to remain constant and no actions were taken to alter the existing interest rate sensitivity, a hypothetical increase or decrease of a 1% change in interest rates would correspondingly affect net interest income proportionately by approximately 1% over a one-year period. Because we had no debt outstanding as of December 31, 2006, there would be no impact on our interest expense in 2006.

Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size and composition of the assets on the balance sheet and other business developments that could affect a net change in assets resulting from operations or net income. Accordingly, no assurances can be given that actual results would not materially differ from the potential outcome simulated by this estimate.

We did not hold any derivative financial instruments for hedging purposes as of December 31, 2006. In connection with the Facility established on February 14, 2007, our consolidated special purpose subsidiary may be required under certain circumstances to enter into interest rate swap agreements or other interest rate hedging transactions.

 

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Portfolio Valuation

We carry our investments at fair value, as determined in good faith by our Board of Directors. Investments for which market quotations are readily available are valued at such market quotations. Because there is not a readily available market value for some of the investments in our portfolio, we value substantially all of our portfolio investments at fair value as determined in good faith by our board under a valuation policy and a consistently applied valuation process. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may differ significantly from the values that would have been used had a ready market existed for such investments, and the differences could be material. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the valuations that are assigned. The types of factors that we may take into account in fair value pricing of our investments include, as relevant, the nature and realizable value of any collateral, third party valuations, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, comparison to publicly-traded securities, recent sales of or offers to buy comparable companies, and other relevant factors.

 

Item 8. Financial Statements and Supplementary Data

Our financial statements are annexed to this Annual Report beginning on page F-1.

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable.

 

Item 9A. Controls and Procedures

Evaluation of Controls and Procedures. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act. The Company’s management, under the supervision and with the participation of various members of management, including our CEO and our CFO, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, our CEO and CFO have concluded that our current disclosure controls and procedures are effective as of the end of the period covered by this report. This annual report does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of the company’s registered public accounting firm due to a transition period established by rules of the Securities and Exchange Commission for newly public companies.

Changes in Internal Controls. There have been no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934) that occurred during the quarter ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

Item 9B. Other Information

None.

 

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PART III

 

Item 10. Directors, Executive Officers and Corporate Governance

The information required by this item will be contained in the Proxy Statement under the headings “Item 1: Election of Directors,” “Control Persons and Principal Stockholders” and “Corporate Governance Principles and Director Information”, to be filed with the Securities and Exchange Commission on or prior to April 30, 2007, and is incorporated herein by reference.

We have adopted a Code of Ethics that applies to directors and officers of the Company and a Sarbanes-Oxley Code of Ethics that applies to directors, officers and employees of the Company. Both of these codes of conduct are published on our website at www.kohlbergcap.com. We intend to disclose any future amendments to, or waivers from, these codes of conduct within four business days of the waiver or amendment through a website posting.

 

Item 11. Executive Compensation

The information required by this item will be contained in the Proxy Statement under the headings “Item 1: Election of Directors,” “Executive Compensation,” “Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report”, to be filed with the Securities and Exchange Commission on or prior to April 30, 2007, and is incorporated herein by reference.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by this item will be contained in the Proxy Statement under the headings “Executive Compensation” and “Control Persons and Principal Stockholders”, to be filed with the Securities and Exchange Commission on or prior to April 30, 2007, and is incorporated herein by reference.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information required by this item will be contained in the Proxy Statement under the headings “Transactions with Related Persons” and “Item 1: Election of Directors”, to be filed with the Securities and Exchange Commission on or prior to April 30, 2007, and is incorporated herein by reference.

 

Item 14. Principal Accountant Fees and Services

The information required by this item will be contained in the Proxy Statement under the heading “Item 2: Ratification of Independent Registered Public Accounting Firm”, to be filed with the Securities and Exchange Commission on or prior to April 30, 2007, and is incorporated herein by reference.

 

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PART IV

 

Item 15. Exhibits and Financial Statement Schedules

1. Financial Statements

The following financial statements of Kohlberg Capital Corporation (the “Company” or the “Registrant”) are filed herewith:

 

Balance Sheet as of December 31, 2006

   F-3

Statement of Operations for the period from December 11, 2006 (inception) through December 31, 2006

  

F-4

Schedule of Investments as of December 31, 2006

   F-5

Statement of Changes in Net Assets for the period from December 11, 2006 (inception) through December 31, 2006

  

F-10

Statement of Cash Flows for the period from December 11, 2006 (inception) through December 31, 2006

  

F-11

Financial Highlights for the period from December 11, 2006 (inception) through December 31, 2006

   F-12

Notes to Financial Statements

   F-13

2. Exhibits

EXHIBIT INDEX

 

Exhibit
Number
  

Description

  3.1    Form of Certificate of Incorporation of Kohlberg Capital Corporation (the “Company”).*
  3.2    Form of Bylaws of the Company.***
  4.1    Specimen certificate of the Company’s common stock, par value $0.01 per share.*
  4.2    Form of Registration Rights Agreement.*
  4.3    Form of Dividend Reinvestment Plan.*
10.1    Form of the 2006 Equity Incentive Plan.*1
10.2    Form of Kohlberg Capital Non-Qualified Stock Option Certificate.*1
10.3    Form of Custodian Agreement by and among Kohlberg Capital Corporation and U.S. Bank National Association.*
10.4    Form of Amended and Restated Irrevocable Exchange and Subscription Agreement—Katonah Debt Advisors, effective as of August 17, 2006 between Katonah Capital, LLC, James A. Kohlberg and KAT Associates LLC.*
10.5    Form of Irrevocable Exchange and Subscription Agreement—CDO Securities, dated August 17, 2006 between Kohlberg Capital, LLC, KKAT Acquisition Company III, LLC, KKAT Acquisition Company IV, LLC, KKAT Acquisition Company V, LLC, KKAT Acquisition Company VII, LLC and KKAT Acquisition Company VIII, LLC.*
10.6    Form of Transition Services Agreement between the Company and Kohlberg & Company, LLC.*
10.7    Form of License and Referral Agreement between the Company and Kohlberg & Company, LLC.*
10.8    Form of Overhead Allocation Agreement between the Company and Katonah Debt Advisors, LLC.*
10.9    Form of Employment Agreement between Kohlberg Capital Corporation and Dayl W. Pearson.*1
10.10    Form of Employment Agreement between Kohlberg Capital Corporation and Michael I. Wirth.*1

 

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Exhibit
Number
  

Description

10.11    Form of Employment Agreement between Kohlberg Capital Corporation and R. Jon Corless.*1
10.12    Form of Employment Agreement between Kohlberg Capital Corporation and E.A. Kratzman.*1
10.13    Form of Employment Agreement between Katonah Debt Advisors and E.A. Kratzman.*1
10.14    Form of Indemnification Agreement for Officers and Directors of the Company.*1
10.15    Execution Copy of Loan Funding and Servicing Agreement dated as of February 14, 2007, by and among Kohlberg Capital Funding LLC I, Kohlberg Capital Corporation, each of the conduit lenders and institutional lenders from time to time party thereto, each of the lender agents from time to time party thereto, BMO Capital Markets Corp., as the Agent, Lyon Financial Services, Inc. (d/b/a U.S. Bank Portfolio Services), as the Backup Services, and U.S. Bank National Association, as Trustee.
10.16    Execution Copy of Purchase and Sale Agreement dated as of February 14, 2007, by and among Kohlberg Capital Funding LLC I and Kohlberg Capital Corporation.**
14.1    Form of Code of Ethics.*
21.1    List of Subsidiaries.
23.1    Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm.
31.1    Chief Executive Officer Certification Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2    Chief Financial Officer Certification Pursuant to Rule 13a-14 of the Securities Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1    Chief Executive Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Chief Financial Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

  * Incorporated by reference to the exhibit filed as part the Company’s Registration Statement on Form N-2 filed with the SEC on August 18, 2006, as amended (Registration No. 333-136714).
 ** Incorporated by reference to the exhibit filed as part of the Company’s Current Report on Form 8-K filed with the SEC on February 16, 2007.
*** Incorporated by reference to the exhibit filed as part of the Company’s Registration Statement on Form N-2 filed with the SEC on March 16, 2007, as amended (Registration No. 333-141382)

1

Management contract or compensatory plan or arrangement.

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  KOHLBERG CAPITAL CORPORATION
Date: March 29, 2007   By  

/s/     DAYL W. PEARSON        

   

Dayl W. Pearson

President and Chief Executive Officer

*  *  *  *  *

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature

  

Title

   Date

/S/    DAYL W. PEARSON

DAYL W. PEARSON

  

President and Chief Executive Officer (principal executive officer)

   March 29, 2007

/S/    MICHAEL I. WIRTH

MICHAEL I. WIRTH

  

Chief Financial Officer, Chief Compliance Officer, Secretary and Treasurer (principal financial and accounting officer)

   March 29, 2007

/S/    CHRISTOPHER LACOVARA

CHRISTOPHER LACOVARA

   Member of the Board of Directors    March 29, 2007

/S/    JAMES A. KOHLBERG

JAMES A. KOHLBERG

   Member of the Board of Directors    March 29, 2007

/S/    SAMUEL P. FRIEDER

SAMUEL P. FRIEDER

   Member of the Board of Directors    March 29, 2007

/S/    GARY CADEMARTORI

GARY CADEMARTORI

   Member of the Board of Directors    March 29, 2007

/S/    C. MICHAEL JACOBI

C. MICHAEL JACOBI

   Member of the Board of Directors    March 29, 2007

/S/    ALBERT G. PASTINO

ALBERT G. PASTINO

   Member of the Board of Directors    March 29, 2007

/S/    C. TURNEY STEVENS, JR.

C. TURNEY STEVENS, Jr.

   Member of the Board of Directors    March 29, 2007

 

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INDEX TO FINANCIAL STATEMENTS

 

Report of Independent Registered Public Accounting Firm

   F-2

Balance Sheet as of December 31, 2006

   F-3

Statement of Operations for the period from December 11, 2006 (inception) through December 31, 2006

  

F-4

Schedule of Investments as of December 31, 2006

   F-5

Statement of Changes in Net Assets for the period from December 11, 2006 (inception) through December 31, 2006

  

F-10

Statement of Cash Flows for the period from December 11, 2006 (inception) through December 31, 2006

  

F-11

Financial Highlights for the period from December 11, 2006 (inception) through December 31, 2006

   F-12

Notes to Financial Statements

   F-13

 

F-1


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of

Kohlberg Capital Corporation

New York, NY:

We have audited the accompanying balance sheet of Kohlberg Capital Corporation (the “Company”) as of December 31, 2006 and the related statements of operations, changes in net assets, cash flows and the financial highlights for the period December 11, 2006 (commencement of operations) through December 31, 2006. These financial statements and financial highlights are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial highlights based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as December 31, 2006, by correspondence with the custodian and brokers; where replies were not received from brokers, we performed other auditing procedures. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Kohlberg Capital Corporation as of December 31, 2006, and the results of its operations, the changes in its net assets, its cash flows and the financial highlights for the period December 11, 2006 (commencement of operations) through December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.

DELOITTE & TOUCHE LLP

New York, NY

March 23, 2007

 

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K OHLBERG CAPITAL CORPORATION

BALANCE SHEET

As of December 31, 2006

 

     As of
December 31, 2006

ASSETS

  

Investments at fair value:

  

Investments in debt securities (cost of $190,767,384)

   $ 190,767,384

Investments in CDO fund securities (cost of $20,870,000)

     20,870,000

Affiliate investment (cost of $33,394,995)

     37,574,995
      

Total investments at fair value

     249,212,379

Cash and cash equivalents

     32,404,493

Interest receivable

     602,085

Other assets

     156,890
      

Total assets

   $ 282,375,847
      

LIABILITIES

  

Payable for open trades

     24,183,044

Accounts payable and accrued expenses

     1,704,548

Due to affiliate

     87,832
      

Total liabilities

   $ 25,975,424
      

Commitments and contingencies (Note 7)

  

STOCKHOLDERS’ EQUITY

  

Common stock, par value $.001 per share, 100,000,000 common shares authorized, 17,946,333 common shares issued and outstanding

     179,463

Capital in excess of par value

     251,550,420

Undistributed net investment income

     416,753

Undistributed net realized gains

     1,077

Net unrealized appreciation on investments

     4,252,710
      

Total stockholders’ equity

     256,400,423
      

Total liabilities and stockholders’ equity

   $ 282,375,847
      

NET ASSETS PER SHARE

   $ 14.29
      

 

See accompanying notes to financial statements.

 

F-3


Table of Contents

K OHLBERG CAPITAL CORPORATION

STATEMENT OF OPERATIONS

 

     For the Period
December 11, 2006
(inception)
through
December 31, 2006
 

INVESTMENT INCOME:

  

Interest from investments in debt securities

   $ 572,065  

Interest from cash & cash equivalents

     132,841  

Dividends from investments in CDO fund securities

     405,203  

Capital structuring service fees

     41,794  
        

Total investment income

     1,151,903  
        

EXPENSES:

  

Compensation expenses

     175,186  

Professional fees

     371,624  

Insurance

     12,821  

Organizational Expenses

     40,000  

Administrative and other

     41,647  
        

Total expenses

     641,278  

Equity in loss of affiliate

     (72,710 )
        

NET INVESTMENT INCOME BEFORE INCOME TAX EXPENSE

     437,915  

Excise taxes

     (21,162 )
        

NET INVESTMENT INCOME

     416,753  

REALIZED AND UNREALIZED GAIN ON INVESTMENTS:

  

Net realized gains from investment transactions

     1,077  

Net unrealized gains on affiliate investment

     4,252,710  
        

Net realized and unrealized gain on investments

     4,253,787  
        

NET INCREASE IN STOCKHOLDERS’ EQUITY RESULTING FROM OPERATIONS

   $ 4,670,540  
        

BASIC AND DILUTED EARNINGS PER COMMON SHARE (see Note 3)

   $ 0.26  

WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING—BASIC AND DILUTED

     17,946,333  

 

See accompanying notes to financial statements.

 

F-4


Table of Contents

K OHLBERG CAPITAL CORPORATION

SCHEDULE OF INVESTMENTS

As of December 31, 2006

 

Portfolio Company / Principal Business

 

Investment / Interest Rate(1) / Maturity

  Principal   Cost   Value(2)

AGA Medical Corporation

Healthcare, Education and Childcare

  Senior Secured Loan; Tranche B (7.4%, Due 4/13)   $ 3,826,751   $ 3,823,346   $ 3,823,346

Astoria Generating Company

Acquisitions, LLC Utilities

  Junior Secured Loan; Second Lien Term C (9.1%, Due 8/13)     2,000,000     2,000,000     2,000,000

Atlantic Marine Holding Company

Cargo Transport

  Senior Secured Loan; Term Loan (7.9%, Due 8/13)     1,990,000     2,004,839     2,004,839

Bankruptcy Management Solutions, Inc.

Diversified/Conglomerate Service

  Senior Secured Loan; First Lien Term Loan (8.1%, Due 7/12)     1,995,000     2,009,860     2,009,860

Bay Point Re Limited(3)

Insurance

  Senior Secured Loan; Term Loan (9.9%, Due 12/10)     3,000,000     3,026,001     3,026,001

Byram Healthcare Centers, Inc.

Healthcare, Education and Childcare

  Senior Secured Loan; Revolver (11.4%, Due 11/11)     375,000     375,000     375,000

Byram Healthcare Centers, Inc.

Healthcare, Education and Childcare

  Senior Secured Loan; Term Loan A (11.4%, Due 11/11)     4,000,000     4,000,000     4,000,000

Capital Automotive REIT

Automobile

  Senior Secured Loan; Term Loan (7.1%, Due 12/10)     3,721,052     3,730,265     3,730,265

Caribe Information Investments

Incorporated Printing and Publishing

  Senior Secured Loan; Term Loan (7.6%, Due 3/13)     6,315,895     6,310,527     6,310,527

Cast & Crew Payroll, LLC

(Payroll Acquisition) Leisure, Amusement, Motion Pictures, Entertainment

  Senior Secured Loan; Initial Term Loan (8.6%, Due 9/12)     7,000,000     7,034,764     7,034,764

Clarke American Corp.

Printing and Publishing

  Senior Secured Loan; Term Loan B (8.6%, Due 12/11)     2,478,134     2,508,872     2,508,872

Clayton Holdings, Inc

Finance

  Senior Secured Loan; Term Loan (8.4%, Due 12/11)     811,555     815,586     815,586

Concord Re Limited(3)

Insurance

  Senior Secured Loan; Term Loan (9.6%, Due 2/12)     3,000,000     3,029,779     3,029,779

CST Industries, Inc.

Diversified/Conglomerate Manufacturing

  Senior Secured Loan; Term Loan (8.5%, Due 8/13)     997,500     1,001,219     1,001,219

Dayco Products LLC—(Mark IV Industries, Inc.)

Automobile

  Junior Secured Loan; Second Lien Term Loan (11.1%, Due 12/11)     500,000     501,861     501,861

Dealer Computer Services, Inc.

(Reynolds & Reynolds) Electronics

  Junior Secured Loan; Second Lien Term Loan (10.9%, Due 10/13)     1,000,000     1,011,187     1,011,187

Dealer Computer Services, Inc.

(Reynolds & Reynolds) Electronics

  Junior Secured Loan; Third Lien Term Loan (12.9%, Due 4/14)     1,500,000     1,518,652     1,518,652

Delta Educational Systems, Inc.

Healthcare, Education and Childcare

  Senior Secured Loan; Term Loan (8.9%, Due 6/12)     2,985,987     2,985,987     2,985,987

 

F-5


Table of Contents

Portfolio Company / Principal Business

  

Investment / Interest Rate(1) / Maturity

   Principal    Cost    Value(2)

Fasteners For Retail, Inc.

Diversified/Conglomerate Manufacturing

   Senior Secured Loan; Term Loan (8.1%, Due 12/12)    5,000,000    5,000,000    5,000,000

First American Payment Systems, L.P.

Finance

   Senior Secured Loan; Term Loan (8.6%, Due 10/13)    3,990,000    3,990,000    3,990,000

Flatiron Re Ltd.(3)

Insurance

   Senior Secured Loan; Closing Date Term Loan (9.6%, Due 12/10)    4,042,105    4,082,142    4,082,142

Flatiron Re Ltd.(3)

Insurance

   Senior Secured Loan; Delayed Draw Term Loan (9.6%, Due 12/10)    1,957,895    1,977,287    1,977,287

Gentiva Health Services, Inc.

Healthcare, Education and Childcare

   Senior Secured Loan; Term Loan (7.7%, Due 3/13)    1,848,649    1,848,649    1,848,649

Ginn LA Conduit Lender, Inc.

Buildings and Real Estate(4)

   Senior Secured Loan; First Lien Tranche A Credit-Linked Deposit (8.3%, Due 6/11)    1,257,143    1,207,290    1,207,290

Ginn LA Conduit Lender, Inc.

Buildings and Real Estate(4)

   Senior Secured Loan; First Lien Tranche B Term Loan (8.4%, Due 6/11)    2,729,143    2,620,917    2,620,917

Ginn LA Conduit Lender, Inc.

Buildings and Real Estate(4)

   Junior Secured Loan; Second Lien Term Loan (12.4%, Due 6/12)    1,000,000    851,051    851,051

Gleason Works

Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

   Senior Secured Loan; First Lien Term Loan (7.9%, Due 6/13)    1,878,788    1,888,127    1,888,127

Hawkeye Renewables, LLC

Farming and Agriculture

   Senior Secured Loan; First Lien Term Loan (9.4%, Due 6/12)    2,992,481    2,908,240    2,908,240

HCA Inc.

Healthcare, Education and Childcare

   Senior Secured Loan; Tranche B Term Loan (8.1%, Due 11/13)    4,000,000    4,037,307    4,037,307

HealthSouth Corporation

Healthcare, Education and Childcare

   Senior Secured Loan; Term Loan B (8.6%, Due 3/13)    2,985,000    2,996,125    2,996,125

Infiltrator Systems, Inc.

Ecological

   Senior Secured Loan; Term Loan (8.9%, Due 9/12)    4,000,000    3,985,099    3,985,099

Intrapac Corporation/Corona Holdco

Containers, Packaging and Glass

   Senior Secured Loan; 1st Lien Term Loan (8.4%, Due 5/12)    3,854,545    3,864,114    3,864,114

Intrapac Corporation/Corona Holdco

Containers, Packaging and Glass

   Junior Secured Loan; 2nd Lien Term Loan (12.4%, Due 5/13)    1,000,000    1,004,970    1,004,970

IPC Systems, Inc.

Diversified/Conglomerate Service

   Junior Secured Loan; Second Lien Term Loan (11.9%, Due 9/14)    2,500,000    2,500,000    2,500,000

Jones Stephens Corp.

Buildings and Real Estate(4)

   Senior Secured Loan; Term Loan (9.2%, Due 9/12)    7,000,000    6,965,235    6,965,235

JW Aluminum Company

Mining, Steel, Iron and Non-Precious Metals

   Junior Secured Loan; Term Loan (2nd Lien) (11.6%, Due 12/13)    2,000,000    2,000,000    2,000,000

La Paloma Generating Company, LLC

Utilities

   Junior Secured Loan; Second Lien Term Loan (8.9%, Due 8/13)    2,000,000    2,000,000    2,000,000

LBREP/L-Suncal Master I LLC

Buildings and Real Estate(4)

   Senior Secured Loan; 1st Lien (8.6%, Due 1/10)    3,960,000    3,842,676    3,842,676

LBREP/L-Suncal Master I LLC

Buildings and Real Estate(4)

   Junior Secured Loan; 2nd Lien (12.6%, Due 1/11)    2,000,000    1,891,032    1,891,032

Legacy Cabinets, Inc.

Home and Office Furnishings, Housewares, and Durable Consumer

   Senior Secured Loan; First Lien Term Loan (9.2%, Due 8/12)    2,985,000    2,985,000    2,985,000

 

F-6


Table of Contents

Portfolio Company/Principal Business

 

Investment /Interest Rate(1) /Maturity

  Principal   Cost   Value(2)

Levlad LLC & Arbonne International LLC

Personal and Non Durable Consumer Products (Mfg. Only)

  Senior Secured Loan; First Lien Term Loan (8.4%, Due 6/13)   1,946,667   1,956,351   1,956,351

Longyear Canada, ULC (Boart Longyear)(3)

Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

  Senior Secured Loan; 1st Lien Term Loan (8.6%, Due 10/12)   245,603   245,603   245,603

Longyear Global Holdings, Inc.

(Boart Longyear) Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

  Senior Secured Loan; First (8.6%, Due 10/12)   264,495   264,495   264,495

Longyear Global Holdings, Inc.

(Boart Longyear) Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

  Senior Secured Loan; First Lien Term Loan (8.6%, Due 10/12)   2,450,264   2,450,264   2,450,264

LPL Holdings, Inc.

Finance

  Senior Secured Loan; Tranche C Term Loan (8.1%, Due 6/13)   5,392,462   5,414,881   5,414,881

LSP Kendall Energy, LLC

Utilities

  Senior Secured Loan; Term Loan (7.4%, Due 10/13)   1,922,988   1,913,428   1,913,428

MCCI Group Holdings, LLC

Healthcare, Education and Childcare

  Junior Secured Loan; Second Lien Term Loan (14.3%, Due 6/13)   1,000,000   1,000,000   1,000,000

MCCI Group Holdings, LLC

Healthcare, Education and Childcare

  Senior Secured Loan; Term Loan (10.8%, Due 12/12)   4,000,000   4,000,000   4,000,000

Metaldyne Corporation

Automobile

  Senior Secured Loan; Term D (10.1%, Due 12/09)   1,997,475   1,997,475   1,997,475

Michaels Stores, Inc.

Retail Stores

  Senior Secured Loan; Term Loan (8.4%, Due 10/13)   1,958,333   1,958,333   1,958,333

Mirant North America, LLC

Utilities

  Senior Secured Loan; Term Loan (7.1%, Due 1/13)   3,960,000   3,950,163   3,950,163

Murray Energy Corporation

Mining, Steel, Iron and Non-Precious Metals

  Senior Secured Loan; Tranche B Term Loan (8.4%, Due 1/10)   1,989,873   2,004,614   2,004,614

Northeast Biofuels, LLC

Farming and Agriculture

  Senior Secured Loan; Construction Term Loan (8.6%, Due 6/13)   1,365,854   1,369,248   1,369,248

Northeast Biofuels, LLC

Farming and Agriculture

  Senior Secured Loan; Synthetic LC (8.6%, Due 6/13)   634,146   635,722   635,722

PAS Technologies Inc.

Aerospace and Defense

  Senior Secured Loan; Term Loan (8.6%, Due 6/11)   4,756,944   4,721,569   4,721,569

Primus International Inc.

Aerospace and Defense

  Senior Secured Loan; Term Loan (7.9%, Due 6/12)   3,292,188   3,300,360   3,300,360

Rhodes Companies, LLC

(The) Buildings and Real Estate(4)

  Junior Secured Loan; Second Lien Term Loan (12.9%, Due 11/11)   2,000,000   1,910,700   1,910,700

Sorenson Communications, Inc.

Electronics

  Senior Secured Loan; Tranche B Term Loan (8.4%, Due 8/13)   2,978,525   2,997,041   2,997,041

Standard Steel, LLC

Cargo Transport

  Senior Secured Loan; Delayed Draw Term Loan (1.%, Due 6/12)   —     4,965   4,965

Standard Steel, LLC

Cargo Transport

  Senior Secured Loan; Initial Term Loan (7.9%, Due 6/12)   3,316,667   3,341,369   3,341,369

Standard Steel, LLC

Cargo Transport

  Junior Secured Loan; Second Lien Term Loan (11.4%, Due 6/13)   1,000,000   1,009,941   1,009,941

 

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Table of Contents

Portfolio Company /Principal Business

 

Investment /Interest Rate(1) /Maturity

  Principal   Cost   Value(2)

Stolle Machinery Company

Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

  Senior Secured Loan; First Lien Term Loan (7.9%, Due 9/12)     1,995,000     2,007,386     2,007,386

Stratus Technologies, Inc.

Electronics

  Senior Secured Loan; First Lien Term Loan (8.4%, Due 3/11)     1,990,000     1,985,070     1,985,070

Thermal North America, Inc.

Utilities

  Senior Secured Loan; Credit Linked Deposit (8.1%, Due 10/08)     400,000     401,469     401,469

Thermal North America, Inc.

Utilities

  Senior Secured Loan; Term Loan (8.1%, Due 10/08)     3,600,000     3,617,627     3,617,627

TLC Funding Corp.

Healthcare, Education and Childcare

  Senior Secured Loan; First Lien Term Loan (12.3%, Due 5/12)     3,970,000     3,871,451     3,871,451

TransAxle LLC

Automobile

  Senior Secured Loan; Revolver (8.9%, Due 9/12)     —       —       —  

TransAxle LLC

Automobile

  Senior Secured Loan; Term Loan (8.9%, Due 9/12)     2,962,500     2,962,500     2,962,500

United Air Lines, Inc.

Personal Transportation

  Senior Secured Loan; Delayed Draw Tranche B Loan (9.1%, Due 2/12)     750,000     750,000     750,000

United Air Lines, Inc.

Personal Transportation

  Senior Secured Loan; Tranche B Term Loan (9.1%, Due 2/12)     3,250,000     3,250,000     3,250,000

Valleycrest Holding Co.

(VCC Holdco) Diversified/Conglomerate Service

  Junior Secured Loan; Second Lien Term Loan (10.9%, Due 4/14)     1,000,000     1,007,461     1,007,461

Water Pik Technologies, Inc.

Personal and Non Durable Consumer Products (Mfg. Only)

  Senior Secured Loan; First Lien Term Loan (7.6%, Due 6/13)     902,313     902,313     902,313

Water Pik Technologies, Inc.

Personal and Non Durable Consumer Products (Mfg. Only)

  Junior Secured Loan; Second Lien Term Loan (11.9%, Due 12/13)     2,500,000     2,512,432     2,512,432

Wesco Aircraft Hardware Corp.

Aerospace and Defense

  Junior Secured Loan; Second Lien Term Loan (11.1%, Due 3/14)     2,000,000     2,044,763     2,044,763

WM. Bolthouse Farms, Inc.

Beverage, Food and Tobacco

  Senior Secured Loan; Term Loan (First Lien) (7.6%, Due 12/12)     2,592,462     2,586,023     2,586,023

Wolf Hollow I, LP

Utilities

  Senior Secured Loan; Acquisition Term Loan (7.6%, Due 6/12)     792,335     778,545     778,545

Wolf Hollow I, LP

Utilities

  Senior Secured Loan; Synthetic Letter of Credit (7.6%, Due 6/12)     668,412     656,779     656,779

Wolf Hollow I, LP

Utilities

  Senior Secured Loan; Synthetic Revolver Deposits (7.6%, Due 6/12)     167,103     164,195     164,195

Wolf Hollow I, LP

Utilities

  Junior Secured Loan; Term Loan (Second Lien) (9.9%, Due 12/12)     2,683,177     2,689,842     2,689,842

Total Investments in Debt Securities (77% of total investment assets at fair value)

    $ 191,173,409   $ 190,767,384   $ 190,767,384

 

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Table of Contents

CDO Fund Investments

  

Investment

   Percent of
Class Held
    Cost    Value(2)

Katonah III, Ltd.

   Preferred Shares    23.08 %   $ 4,500,000    $ 4,500,000

Katonah IV, Ltd.

   Preferred Shares    17.14 %     3,150,000      3,150,000

Katonah V, Ltd.

   Preferred Shares    26.67 %     3,320,000      3,320,000

Katonah VII CLO Ltd.

   Subordinated Securities    16.36 %     4,500,000      4,500,000

Katonah VIII CLO Ltd.

   Subordinated Securities    10.30 %     3,400,000      3,400,000

Katonah IX CLO Ltd.

   Preferred Shares    6.86 %     2,000,000      2,000,000
                  

Total Investments in CDO Funds (8% of total investment assets at fair value)

        $ 20,870,000    $ 20,870,000
                  

 

Portfolio Company / Principal Business

  

Investment

   Percent of
Interests
Held
    Cost    Value(2)

Katonah Debt Advisors, L.L.C. / Asset Management (15% of total investment assets at fair value)

   Membership Interests    100.00 %   $ 33,394,995    $ 37,574,995
                  

Total Investments(5)

        $ 245,032,379    $ 249,212,379
                  

(1)

A majority of the variable rate loans to our portfolio companies bear interest at a rate that may be determined by reference to either LIBOR or an alternate Base Rate (commonly based on the Federal Funds Rate or the Prime Rate), which reset semi-annually , quarterly , or monthly. For each such loan, we have provided the weighted average annual stated interest rate in effect at December 31, 2006.

(2)

Reflects the fair market value of all existing investments as of December 31, 2006, as determined by our Board of Directors.

(3)

Non-U.S. company or principal place of business outside the U.S.

(4)

Buildings and real estate relate to real estate ownership, builders, managers and developers and excludes mortgage debt investments and mortgage lenders or originators. As of December 31, 2006, we had no exposure to mortgage securities (residential mortgage bonds, commercial mortgage backed securities, or related asset backed securities), companies providing mortgage lending or emerging markets investments either directly or through our investments in CDO funds.

(5)

The aggregate cost of investments for federal income tax purposes is approximately $245 million. The aggregate gross unrealized appreciation is approximately $4 million and there is no gross unrealized depreciation.

 

See accompanying notes to financial statements.

 

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Table of Contents

K OHLBERG CAPITAL CORPORATION

STATEMENT OF CHANGES IN NET ASSETS

For the Period December 11, 2006 (inception) through December 31, 2006

 

     For the Period
December 11, 2006
(inception)
through
December 31, 2006

Operations:

  

Net investment income

   $ 416,753

Net realized gains from investment transactions

     1,077

Net unrealized gains on affiliate investment

     4,252,710
      

Net increase in net assets resulting from operations

     4,670,540
      

Capital share transactions:

  

Issuance of common stock—initial public offering

     199,451,388

Issuance of common stock—for interests in affiliate company

     33,394,995

Issuance of common stock—for interests in CDO securities

     18,870,000

Stock based compensation

     13,500
      

Net increase in net assets resulting from capital share transactions

     251,729,883
      

Net assets at beginning of period

     —  
      

Net assets at end of period (including accumulated undistributed net investment income of $416,753)

   $ 256,400,423
      

Net asset value per common share

   $ 14.29

Common shares outstanding at end of period

     17,946,333

 

See accompanying notes to financial statements.

 

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Table of Contents

K OHLBERG CAPITAL CORPORATION

STATEMENT OF CASH FLOWS

 

     For the Period
December 11, 2006
(inception)
through
December 31, 2006
 

OPERATING ACTIVITIES:

  

Net increase in stockholders’ equity resulting from operations

   $ 4,670,540  

Adjustments to reconcile net increase in stockholders’ equity resulting from operations:

  

Realized gain on investment transactions

     (1,077 )

Unrealized gain on investment transactions

     (4,252,710 )

Net accretion of discount on securities

     (3,819 )

Purchases of investments

     (169,112,759 )

Proceeds from sale and redemption of investments

     533,315  

Stock based compensation expense

     13,500  

Loss from affiliate—undistributed

     72,710  

Changes in operating assets and liabilities:

  

Interest receivable

     (602,085 )

Other assets

     (156,890 )

Accounts payable and accrued expenses

     1,704,548  

Due to affiliate

     87,832  
        

Net cash used in operating activities

     (167,046,895 )

FINANCING ACTIVITIES:

  

Net proceeds from issuance of common stock

     199,451,388  

Dividends paid in cash

     —    
        

Net cash provided by financing activities

     199,451,388  
        

CHANGE IN CASH AND CASH EQUIVALENTS

     32,404,493  

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     —    
        

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 32,404,493  
        

Supplemental Information:

  

Interest paid during the period

   $ —    

Issuance of common stock for affiliate investment

   $ 33,394,995  

Issuance of common stock for CDO equity investments

   $ 18,870,000  

Dividends declared during the period

   $ —    

 

See accompanying notes to financial statements.

 

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Table of Contents

K OHLBERG CAPITAL CORPORATION

FINANCIAL HIGHLIGHTS

Period December 11, 2006 (inception) Through December 31, 2006

($ per share)

 

     For the Period
December 11,
2006 (inception)
Through
December 31,
2006
 

Per Share Data:

  

Net asset value, at beginning of period

   $ 15.00  

Underwriting costs

     (0.97 )
        

Post-IPO net asset value

     14.03  
        

Net investment income (1)

     0.02  

Net realized gains (1)(2)

     —    

Net change in unrealized appreciation on investments(1)(2)

     0.24  
        

Net increase in net assets resulting from operations(1)

     0.26  
        

Net asset value, end of year

   $ 14.29  
        

Ratio/Supplemental Data:

  

Per share market value at end of period

   $ 17.30  

Total return(3)

     15.3 %

Shares outstanding at end of period

     17,946,333  

Net assets at end of period

   $ 256,400,423  

Portfolio turnover rate

     0.3 %

Average debt outstanding

   $ —    

Ratio of net investment income to average net assets

     4.4 %

Ratio of non-interest expenses to average net assets(4)

     6.3 %

Interest expense to average net assets

     0.0 %

(1)

Based on weighted average number of common shares outstanding for the period.

(2)

Net realized gains and net change in unrealized appreciation or depreciation can fluctuate significantly from period to period.

(3)

Total return equals the change in the ending market value over the beginning of period price per share plus dividends paid, if any, during the period, divided by the beginning price.

(4)

The ratio of non-interest expenses to average net assets for the 20 day period December 11, 2006 through December 31, 2006 has been annualized and includes various organizational and professional fees related to the Company’s IPO and may not be indicative of future results.

 

See accompanying notes to financial statements.

 

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Table of Contents

K OHLBERG CAPITAL CORPORATION

NOTES TO FINANCIAL STATEMENTS

As of December 31, 2006

1. ORGANIZATION

Kohlberg Capital Corporation is an internally managed, non-diversified closed-end investment company that is regulated as a business development company (“BDC”) under the 1940 Act. The Company was formed as a Delaware LLC on August 8, 2006 and, prior to the issuance of shares of the Company’s common stock in its initial public offering, converted to a corporation incorporated in Delaware on December 11, 2006. Prior to its initial public offering (“IPO”), the Company did not have material operations. The Company’s IPO of 14,462,000 shares of our common stock raised net proceeds of approximately $200 million.

The Company’s investment objective is to generate current income and capital appreciation from investments made in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies. The Company also plans to expand the middle market investment business and asset management business of Katonah Debt Advisors, which the Company acquired prior to the IPO. As of December 31, 2006, Katonah Debt Advisors had approximately $1.4 billion of assets under management and continues to manage CDO Funds which invest in broadly syndicated loans, high-yield bonds and other credit instruments.

The Company intends to elect to be treated as a Regulated Investment Company (“RIC”) under Subchapter M of the Code. To qualify as a RIC, the Company must, among other things, meet certain source-of-income and asset diversification requirements. Pursuant to this election, the Company generally will not have to pay corporate-level taxes on any income that it distributes to its stockholders.

2. SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States. The financial statements reflect all adjustments and reclassifications which, in the opinion of management, are necessary for the fair presentation of the Company’s results of operations and financial condition for the periods presented. Furthermore, the preparation of the financial statements requires management to make significant estimates and assumptions. Actual results could differ from those estimates.

Cash and Cash Equivalents

Cash and cash equivalents include short-term, liquid investments in a money market fund. Cash and cash equivalents are carried at cost which approximates fair value.

Investments

Investment transactions are recorded on the applicable trade date. Realized gains or losses are computed using the specific identification method. The Company carries its investments at fair value, as determined by the Board of Directors.

Loans and Debt Securities.    For loans and debt securities, fair value generally approximates amortized cost unless the borrower’s enterprise value or overall financial condition or other factors lead to a determination of fair value at a different amount. As a general rule, the Company does not value its loans or debt securities above cost, but loans and debt securities will be subject to fair value write-downs when the asset is considered impaired.

 

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Equity and Equity-Related Securities.    The Company’s equity and equity-related securities in portfolio companies for which there is no liquid public market are valued at fair value based on the enterprise value of the portfolio company, which will be determined using various factors, including cash flow from operations of the portfolio company and other pertinent factors, such as recent offers to purchase a portfolio company’s securities or other liquidation events. The determined fair values are generally discounted to account for restrictions on resale and minority ownership positions.

The value of the Company’s equity and equity-related securities in public companies for which market quotations are readily available are based upon the closing public market price on the balance sheet date. Securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security.

CDO Fund Securities.    The securities issued by CDO funds managed by Katonah Debt Advisors (“CDO Funds”) are primarily held by third parties. The Company’s investments in CDO Funds (“CDO Investments”) are carried at fair value, which is based on 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 bonds and preferred shares/income notes, when available. The Company recognizes unrealized appreciation or depreciation on its CDO Investments as comparable yields in the market change and/ or based on changes in estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. As each CDO Investment ages, the expected amount of losses and the expected timing of recognition of such losses in the underlying collateral pool is updated and the revised cash flows are used in determining the fair value of the CDO Investment. The Company determines the fair value of its CDO Investments on an individual security-by-security basis. If the Company were to sell a group of CDO Investments in a pool in one or more transactions, the total value recorded for that pool may be different than the sum of the fair values of the individual CDO Investments.

The Board of Directors may consider other methods of valuation to determine the fair value of investments as appropriate in conformity with accounting principles generally accepted in the United States.

Earnings per Common Share.    Basic earnings per common share (“EPS”) is computed by dividing the net increase in stockholders’ equity resulting from operations by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the assumed conversion of all dilutive securities, including stock options.

Interest Income.    Interest income, adjusted for amortization of premium and accretion of discount, is recorded on the accrual basis to the extent that such amounts are expected to be collected. The Company generally places a loan on non-accrual status and ceases recognizing interest income on such loan or security when a loan or security becomes 90 days or more past due or if the Company otherwise does not expect the debtor to be able to service its debt obligations. Non-accrual loans remain in such status until the borrower has demonstrated the ability and intent to pay contractual amounts due or such loans become current. At December 31, 2006, no loans or debt securities were greater than 90 days past due or on non-accrual status.

Payment in Kind Interest.    The Company may have loans in its 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. In order for the Company to maintain its RIC status, this non-cash source of income must be paid out to stockholders in the form of dividends, even though the Company has not yet collected the cash.

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 the Company 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.

 

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Management Compensation.    The Company may, from time to time, issue stock options under the 2006 Kohlberg Capital Equity Incentive Plan (“Equity Incentive Plan”) to officers and employees for services rendered to us. The Company will follow Statement of Financial Accounting Standards No. 123R (revised 2004), Accounting for Stock-Based Compensation, a method by which the fair value of options are determined and expensed. The Company is internally managed and therefore does not incur management fees payable to third parties.

Stock-Based Compensation.    The Company follows the provisions of SFAS No. 123R “Share-Based Payment,” (“SFAS No. 123R”) which requires all companies to measure compensation costs for all share-based payments, including employee stock options, at fair value. Under SFAS 123R, compensation expense associated with stock based compensation is measured at the grant date based on the fair value of the award and is recognized over the vesting period. Determining the appropriate fair value model and calculating the fair value of stock-based awards at the grant date requires judgment, including estimating stock price volatility, forfeiture rate and expected option life.

Federal Income Taxes.    The Company intends to qualify and elect and intends to continue to qualify for the tax treatment applicable to regulated investment companies (“RIC”) 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 investment company taxable income, as defined by the Code, each 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.

In accordance with Statement of Position 93-2, “Determination, Disclosure, and Financial Statement Presentation of Income, Capital Gain, and Return of Capital Distributions by Investment Companies,” book and tax basis differences relating to stockholder distributions and other permanent book and tax differences are reclassified to capital in excess of par value. In addition, the character of income and gains to be distributed is determined in accordance with income tax regulations that may differ from accounting principles generally accepted in the United States of America.

Dividends.    Dividends and distributions to common stockholders are recorded on the record date. The amount to be paid out as a dividend is determined by the Board of Directors each quarter and is generally based upon the earnings estimated by management for the period and fiscal year.

The Company has adopted a dividend reinvestment plan that provides for reinvestment of our distributions on behalf of its stockholders, unless a stockholder “opts out” of the plan to receive cash in lieu of having their cash dividends automatically reinvested in additional shares of the Company’s common stock.

Offering Expenses

The Company’s offering costs were charged against the net proceeds from the IPO.

 

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3. EARNINGS PER SHARE

The following information sets forth the computation of basic and diluted net increase in stockholders’ equity per share resulting for the period of December 11, 2006 (the date of our initial public offering) through December 31, 2006:

 

Numerator for basic and diluted net increase in stockholders’ equity resulting from operations per share:

   $ 4,670,540

Denominator for basic net increase in stockholders’ equity resulting from operations per share:

     17,946,333

Basic net increase in stockholders’ equity resulting from operations per share:

   $ 0.26

Denominator for diluted net increase in stockholders’ equity resulting from operations per share:

     17,946,333

Diluted net increase in stockholders’ equity resulting from operations per share:

   $ 0.26

4. INVESTMENTS

For the period of December 11, 2006 (the date of our initial public offering) through December 31, 2006, the Company purchased approximately $191 million of investments in debt securities and $2 million of investments in collateralized debt obligation securities. As of December 31, 2006, no debt securities were on non-accrual status.

Investment Securities

The Company invests in senior secured loans and mezzanine debt and, in the future and to a lesser extent, equity capital, of middle market companies in a variety of industries. The Company generally targets companies that generate positive cash flows because the Company looks to cash flows as the primary source for servicing debt. As of December 31, 2006, together with its wholly-owned portfolio company Katonah Debt Advisors, the Company had a staff of 14 investment professionals who specialize in specific industries and generally seek to invest in companies about which the Company has direct expertise. However, the Company may invest in other industries if it is presented with attractive opportunities.

The following table shows the Company’s portfolio by security type at December 31, 2006:

 

     December 31, 2006  

Security Type

   Investments at
Fair Value
   Percentage
of
Portfolio
 

Senior Secured Loan

   $ 163,313,492    65.5 %

Junior Secured Loan

     27,453,892    11.0  

CDO Equity

     20,870,000    8.4  

Portfolio Management Company

     37,574,995    15.1  

Total

   $ 249,212,379    100 %

 

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The industry concentrations, based on the fair value of the Company’s investment portfolio as of December 31, 2006, was as follows:

 

     December 31, 2006 (unaudited)  

Industry

  

Investments

at Fair Value

   Percentage
of
Portfolio
 

Aerospace and Defense

   $ 10,066,692    4.0 %

Automobile

     9,192,101    3.7  

Beverage, Food and Tobacco

     2,586,023    1.0  

Buildings and Real Estate

     19,288,901    7.7  

Cargo Transport

     6,361,114    2.6  

CDO Equity

     20,870,000    8.4  

Containers, Packaging and Glass

     4,869,084    2.0  

Diversified/Conglomerate Manufacturing

     6,001,219    2.4  

Diversified/Conglomerate Service

     5,517,321    2.2  

Ecological

     3,985,099    1.6  

Electronics

     7,511,950    3.0  

Farming and Agriculture

     4,913,210    2.0  

Finance

     10,220,467    4.1  

Healthcare, Education and Childcare

     28,937,865    11.5  

Home and Office Furnishings, Housewares, and Durable Consumer

     2,985,000    1.2  

Insurance

     12,115,209    4.9  

Leisure, Amusement, Motion Pictures, Entertainment

     7,034,764    2.8  

Machinery (Non-Agriculture, Non-Construction, Non-Electronic)

     6,855,875    2.8  

Mining, Steel, Iron and Non-Precious Metals

     4,004,614    1.6  

Personal and Non Durable Consumer Products (Mfg. Only)

     5,371,096    2.2  

Personal Transportation

     4,000,000    1.6  

Portfolio Management Company

     37,574,995    15.1  

Printing and Publishing

     8,819,399    3.5  

Retail Stores

     1,958,333    0.8  

Utilities

     18,172,048    7.3  
             

Total

   $ 249,212,379    100.0 %
             

The Company may invest up to 30% of the investment portfolio in opportunistic investments in high-yield bonds, debt and equity securities in CDO Funds, distressed debt or equity securities of public companies. The Company expects that these public companies generally will have debt that is non-investment grade. The Company also may invest in debt of middle market companies located outside of the United States, which investments are not anticipated to be in excess of 10% of the investment portfolio at the time such investments are made. At December 31, 2006, approximately 13% of the Company’s investments were foreign assets (including the Company’s investments in CDO Funds, which are typically domiciled outside the U.S. and represent approximately 8% of its portfolio). As a result of regulatory restrictions, the Company is not permitted to invest in any portfolio company in which Kohlberg & Co. or any fund that it manages has a pre-existing investment.

At December 31, 2006, the Company’s ten largest portfolio companies represented approximately 35% of the total fair value of its investments. The Company’s largest investment, Katonah Debt Advisors which is its wholly-owned portfolio company, represented 15% of the total fair value of the Company’s investments.

Investment in CDO Fund Securities

Prior to its IPO, the Company issued an aggregate of 1,258,000 common shares, having a value of approximately $19 million, to affiliates of Kohlberg & Co. to acquire certain subordinated debt and preferred stock securities issued by CDO Funds (Katonah III, Ltd., Katonah IV, Ltd., Katonah V, Ltd., Katonah VII CLO, Ltd., and Katonah VIII CLO, Ltd.) managed by Katonah Debt Advisors and two other asset managers.

 

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Subsequent to its IPO, the Company purchased $2 million of CDO Fund securities issued by Katonah IX CLO, Ltd. bringing the Company’s CDO Investments to approximately $21 million as of December 31, 2006. The CDO Funds managed by Katonah Debt Advisors invest almost exclusively in credit instruments issued by corporations and do not invest in asset-backed securities such as those secured by residential mortgages or other consumer borrowings.

The following table sets forth information regarding CDO Funds securities investments as of December 31, 2006:

 

CDO Fund Equity Security

  

Principal
Business

   Type of Security    Percentage of
Class Held
   

Cost of

Investment

   Fair Value of
Investment

Katonah III, Ltd.

   CDO Fund    Preferred Shares    23.08 %   $ 4,500,000    $ 4,500,000

Katonah IV, Ltd.

   CDO Fund    Preferred Shares    17.14 %     3,150,000      3,150,000

Katonah V, Ltd.

   CDO Fund    Preferred Shares    26.67 %     3,320,000      3,320,000

Katonah VII CLO Ltd.

   CDO Fund    Subordinated Securities    16.36 %     4,500,000      4,500,000

Katonah VIII CLO Ltd.

   CDO Fund    Subordinated Securities    10.30 %     3,400,000      3,400,000

Katonah IX CLO Ltd.

   CDO Fund    Preferred Shares    6.86 %     2,000,000      2,000,000
                     

Total CDO Equity

           $ 20,870,000    $ 20,870,000
                     

5. WHOLLY-OWNED ASSET MANAGER

Prior to its IPO, the Company issued an aggregate of 2,226,333 common shares, having a value of approximately $33 million, to affiliates of Kohlberg & Co. to acquire Katonah Debt Advisors. As a result, Katonah Debt Advisors is a wholly-owned portfolio company. As of December 31, 2006, Katonah Debt Advisors had approximately $1.4 billion of assets under management.

The Company expects to receive distributions of recurring fee income and to generate capital appreciation from its investment in the asset management business of Katonah Debt Advisors. By making investments in CDO Funds raised by Katonah Debt Advisors in the future, for which the Company expects to receive a current cash return, the Company can help Katonah Debt Advisors to raise these funds which in turn will increase its assets under management which will result in additional management fee income.

Katonah Debt Advisors, as a wholly-owned portfolio company, is accounted for using the equity method of accounting consistent with the Company’s status as a BDC. Under the equity method of accounting, Katonah Debt Advisors is initially recorded at cost on the Company’s balance sheet. Subsequent net income or losses of Katonah Debt Advisors under accounting principles generally accepted in the United States (“GAAP”) is recognized as affiliate income or loss on the Company’s income statement with a corresponding increase (in the case of net income) or decrease (in the case of net loss) in the cost basis of the investment in Katonah Debt Advisors on the Company’s balance sheet. The revenue that Katonah Debt Advisors generates through the fees it receives for managing CDO Funds and after paying the expenses associated with its operations, including compensation of its employees, may be distributed to the Company. Cash distributions of Katonah Debt Advisors’ accumulated GAAP net income would increase cash and reduce the basis of Katonah Debt Advisors on the Company’s balance sheet. As with all other investments, Katonah Debt Advisors’ market value is periodically determined. The valuation is primarily based on a percentage of its assets under management and/or based on Katonah Debt Advisors’ estimated net cash flows. Any change in value from period to period is recognized as unrealized gain or loss.

As a separately regarded entity for tax purposes, Katonah Debt Advisors, L.L.C. is taxed at normal corporate rates. For tax purposes, any distributions of taxable net income earned by Katonah Debt Advisors to the Company would generally need to be distributed to the Company’s shareholders. Katonah Debt Advisors’ taxable net income will differ from GAAP net income for both deferred tax timing adjustments and permanent tax adjustments. Deferred tax timing adjustments may include differences between lease cash payments to GAAP

 

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straight line expense and adjustments for the recognition and timing of depreciation, bonuses to employees, stock option expense, and interest rate caps. Permanent differences may include adjustments, limitations or disallowances for meals and entertainment expenses, penalties and tax goodwill amortization.

Tax goodwill amortization was created upon the purchase of 100% of the equity interests in Katonah Debt Advisors prior to the Company ‘s IPO in exchange for shares of the Company’s stock valued at $33 million. Although this transaction was a stock transaction rather than an asset purchase and thus no goodwill was recognized for GAAP purposes, for tax purposes such exchange was considered an asset purchase under Section 351(a) of the Code. At the time of the transfer, Katonah Debt Advisors had equity of approximately $1 million resulting in tax goodwill of approximately $32 million which will be amortized for tax purposes on a straight-line basis over 15 years, resulting in an annual difference between GAAP income and distributable income by which GAAP income will exceed distributable income by approximately $2 million per year over such period. As a result, if Katonah Debt Advisors were to distribute its GAAP net income to the Company, only Katonah Debt Advisors’ taxable net income after such goodwill amortization will be required to be distributed to the Company’s shareholders.

At December 31, 2006, amounts due to affiliates totaled approximately $88,000.

Summarized financial information for Katonah Debt Advisors follows:

 

     As of
December 31, 2006
 

ASSETS

  

Current assets

   $ 2,860,329  

Noncurrent assets

     661,637  
        

Total assets

   $ 3,521,966  
        

LIABILITIES

  

Current liabilities

   $ 2,602,755  
        

Total liabilities

   $ 2,602,755  
        
     For the Period
December 11, 2006
through
December 31, 2006
 

Gross revenue

   $ 200,610  

Total expenses

     (273,320 )
        

Net income

     (72,710 )
        

6. DISTRIBUTABLE TAX INCOME

The Company currently intends to distribute quarterly dividends to its stockholders. The Company’s quarterly dividends, if any, will be determined by the Board of Directors. To maintain its RIC status, the Company must timely distribute an amount equal to at least 90% of its ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any, reduced by deductible expenses, out of the assets legally available for distribution, for each year. To avoid certain excise taxes imposed on RICs, the Company is generally required to distribute during each calendar year an amount at least equal to the sum of (1) 98% of its ordinary income for the calendar year, (2) 98% of its capital gains in excess of capital losses for the one-year period ending on October 31 of the calendar year, and (3) any ordinary income and net capital gains for preceding years that were not distributed during such years. If this requirement is not met, the Company will be required to pay a nondeductible excise tax equal to 4% of the amount by which 98% of the current year’s taxable income exceeds the distribution for the year. The taxable income on which an excise tax is paid is

 

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generally carried forward and distributed to stockholders in the next tax 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. As of December 31, 2006, the Company’s undistributed taxable income was approximately $529,000 and its excise tax liability was approximately $21,000. The Company plans to distribute 2006 distributable income in 2007.

The following reconciles net increase in stockholders’ equity resulting from operations to taxable income for the period of December 11, 2006 (inception) through December 31, 2006:

 

Pre-tax net increase in stockholders’ equity resulting from operations

   $ 4,691,702  

Net unrealized gain on investments transactions not taxable

     (4,252,710 )

Other losses not currently taxable

     72,710  

Expenses not currently deductible

     17,345  
        

Taxable income before deductions for distributions

   $ 529,047  
        

Taxable income before deductions for distributions per outstanding share

   $ 0.03  

7. COMMITMENTS AND CONTINGENCIES

As of December 31, 2006, the Company had committed to make a total of approximately $2 million of investments in various revolving senior secured loans, all of which was unfunded. As of December 31, 2006, the Company had committed to make a total of approximately $667,000 of investments in a delayed draw senior secured loan.

The following table summarizes our operating lease obligations as of December 31, 2006:

 

     Payments Due by Period

Contractual Obligations

   Total    2007    2008    2009    2010    2011   

More than

5 Years

Operating lease obligations

   $ 2,092,099    $ 298,871    $ 298,871    $ 298,871    $ 298,871    $ 298,871    $ 597,744

8. STOCKHOLDERS’ EQUITY

On December 11, 2006, the Company completed its IPO of 14,462,000 shares of common stock at $15.00 per share, less an underwriting discount and IPO expenses paid by the Company totaling $1.22 per share for net proceeds of approximately $199 million. Prior to its IPO, the Company issued to affiliates of Kohlberg & Co. a total of 3,484,333 shares of its common stock for the acquisition of certain subordinated securities issued by CDO Funds and for the acquisition of Katonah Debt Advisors. Total shares outstanding as of December 31, 2006 was 17,946,333.

9. STOCK OPTIONS

During 2006, the Company established a stock option plan (the “Plan”) and reserved 1,500,000 shares of common stock for issuance under the Plan. The purpose of the Plan is to provide officers and prospective employees of the Company with additional incentives and align the interests of its employees with those of its shareholders. Options are exercisable at a price equal to the fair market value (market closing price) of the shares on the day the option is granted.

On December 11, 2006, concurrent with the completion of the Company’s IPO, options to purchase a total of 910,000 shares of common stock were granted to the Company’s executive officers and directors with an exercise price per share of $15.00 (the public offering price of the common stock). Such options vest equally

 

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over two, three or four years from the date of grant and have a ten-year exercise period. As of December 31, 2006, 910,000 options were outstanding, none of which where exercisable. The options have an estimated remaining contractual life of 9 years and 11 months.

A summary of the status of our stock option plan as of and for the year ended December 31, 2006 is as follows:

 

    Options Outstanding   Options Exercisable
Range of
Exercise
Prices
  Number
Outstanding at
December 31, 2005
  Weighted Average
Remaining
Contractual Life
  Weighted Average
Exercise Price
 

Number

Exercisable at
December 31, 2005

  Weighted
Average
Exercise Price
$15.00   910,000   10.0   $ 15.00   —     $ 15.00

The following table reflects the weighted average fair value per option granted during 2006, as well as the weighted average assumptions used in determining those fair values using the American Binary Option pricing model.

 

     Year Ended
December 31, 2006
 

Options granted

     910,000  

Fair value on date of grant

   $ 1.43  

Dividend yield

     10.0 %

Expected volatility

     21 %

Risk-free interest rate

     4.6 %

Expected life (years)

     10.0  

The expected stock price volatility has been determined based upon the historical volatilities for similar publicly traded BDC’s over a similar time period of the expected option life.

For the period December 11, 2006 (inception) through December 31, 2006, stock option expense of $13,500 was recognized. At December 31, 2006, the Company had approximately $1.3 million of compensation cost related to unvested stock-based awards the cost for which is expected to be recognized over a weighted average period of 3.2 years.

10. OTHER EMPLOYEE COMPENSATION

The Company adopted a 401(k) plan (“401K Plan”) effective January 1, 2007. The 401K Plan is open to all full time employees. The Plan permits an employee to defer a portion of their total annual compensation up to the Internal Revenue Service annual maximum based on age and eligibility. The Company makes contributions to the 401K Plan of up to 2.67% of the employee’s first 74.9% of contributions, which fully vest at the time of contribution. For the year ended December 31, 2006, no employer contributions to the 401K Plan were made.

The Company has also adopted a deferred compensation plan (“Pension Plan”) effective January 1, 2007. Employees are eligible for the Pension Plan provided that they are employed and working with the Company for at least 100 days during the year and remain employed as of the last day of the year. Employees do not make contributions to the Pension Plan. On behalf of the employee, the Company contributes to the Pension Plan 1) 8.0% of all compensation up to the Internal Revenue Service annual maximum and 2) 5.7% excess contributions on any incremental amounts above the social security wage base limitation and up to the Internal Revenue Service annual maximum. Employees vest 100% in the Pension Plan after five years of service. For the year ended December 31, 2006, no employer contributions to the Pension Plan were made.

 

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11. IMPACT OF NEW ACCOUNTING STANDARDS

In July 2006, the Financial Accounting Standards Board issued Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 provides guidance on the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We do not expect the adoption of FIN 48 to materially impact our financial position or results of operations.

In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157 (“SFAS 157”), Fair Value Measurements. SFAS 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years, with early adoption permitted. We do not expect the adoption of SFAS 157 to materially impact our financial position or results of operations.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), which provides companies with an option to report selected financial assets and liabilities at fair value. The objective of SFAS 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS 159 establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities and to more easily understand the effect of the company’s choice to use fair value on its earnings. SFAS 159 also requires entities to display the fair value of the selected assets and liabilities on the face of the balance sheet. SFAS 159 does not eliminate disclosure requirements of other accounting standards, including fair value measurement disclosures in SFAS 157. This Statement is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of Statement 157. At this time, the Company is evaluating the implications of SFAS No. 159, and its impact in the financial statements has not yet been determined.

 

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12. SELECTED QUARTERLY DATA

 

     For the Period
December 11, 2006
(inception)
Through
December 31, 20061
 

Total Investment Income

   $ 1,151,903  

Net Realized and Unrealized Gain on Investments

     4,253,787  

Equity in loss of affiliate

     (72,710 )

Total Expenses

     (662,400 )
        

Net Increase in Stockholders’ Equity Resulting from Operations

   $ 4,670,580  
        

Per Share Data:

  

Net Investment Income:

  

Basic:

   $ 0.02  

Diluted:

   $ 0.02  

Cash Dividend Declared:

   $ —    

Net Increase in Stockholder’s Equity Resulting from Operations:

  

Basic:

   $ 0.26  

Diluted:

   $ 0.26  

Total Assets

   $ 282,375,847  

Total Debt

   $ —    

Total Stockholders’ Equity

   $ 256,400,423  

Net Asset Value per Common Share

   $ 14.29  

1

Prior to December 11, 2006 the Company had no material operations.

13. SUBSEQUENT EVENTS

On January 19, 2007, our Board of Directors approved grants of options to purchase 345,000 shares of our common stock under our Equity Incentive Plan to employees with an exercise price per share equal to the closing price on that day of $16.36. These options vest ratably over a four year period and expire in ten years.

On February 5, 2007, the Board of Directors approved a grant of options to purchase 25,000 shares of the Company’s common stock options under the Company’s Equity Incentive Plan to an employee with an exercise price per share equal to the closing price on that day of $17.37. These options vest ratably over a four year period and expire in ten years.

On February 7, 2007, the Company entered into an agreement with Bear, Stearns & Co. Inc. (“Bear Stearns”) pursuant to which Bear Stearns will provide services relating to the formation of a CDO Fund, managed by Katonah Debt Advisors, to be named Briarcliff CLO I Ltd. (“Briarcliff”), which will invest in broadly syndicated corporate loans and mezzanine securities of CDO funds (other than the CDO Funds managed by Katonah Debt Advisors) rated “BBB” or “BB”, with a total fund size expected to be $300 million. As part of this engagement, the Company entered into a warehouse credit agreement, under which Bear Stearns will provide funding which will allow the Company to accumulate assets for Briarcliff. Pursuant to this warehouse credit agreement, the Company agreed to reimburse Bear Stearns for losses incurred on loans acquired for Briarcliff prior to the completion of the fund (a “First Loss Guarantee”) with such reimbursement limited based on a percentage of warehoused assets. In return for providing this First Loss Guarantee, the Company will receive all interest and other non-principal distributions made with respect to the CDO’s investments serving as collateral upon the closing of the securitization, less the financing costs of LIBOR plus 0.75%, reset daily.

On February 14, 2007, the Company entered into an arrangement under which the Company may obtain up to $200 million (with an ability to increase to $250 million subject to certain conditions) in financing (the “Facility”). Advances under the Facility will be used by the Company primarily to make additional investments.

 

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The Company expects that the Facility will be secured by loans that it currently owns and the loans acquired by the Company with the advances under the Facility. The Company will borrow under the Facility through its wholly-owned, special-purpose bankruptcy remote subsidiary, Kohlberg Capital Funding LLC I. Under the Facility, funds are loaned by or through certain lenders at prevailing commercial paper rates or, if the commercial paper market is at any time unavailable, at prevailing LIBOR rates, plus an applicable margin. The interest charged on borrowed funds is based on the commercial paper rate plus 0.70% and is payable monthly.

On March 3, 2007, the Company entered into an agreement with Bear Stearns pursuant to which Bear Stearns will provide services relating to the formation of a CDO Fund, managed by Katonah Debt Advisors, to be named Katonah CLO XI Ltd. (“Katonah CLO XI”) which will invest in broadly syndicated senior loans, second lien loans, and other credit instruments (excluding asset backed securities such as those secured by residential mortgages or other consumer borrowings) with a total fund size expected to be $400 million. As part of this engagement, the Company entered into a warehouse credit agreement, under which Bear Stearns will provide funding which will allow the Company to accumulate assets for Katonah CLO XI. Pursuant to this warehouse credit agreement, the Company agreed to reimburse Bear Stearns for losses incurred on loans acquired for Katonah CLO XI prior to the completion of the fund with such reimbursement limited based on a percentage of warehoused assets. In return for providing this First Loss Guarantee, the Company will receive all interest and other non-principal distributions made with respect to the CDO’s investments serving as collateral upon closing of the securitization, less the financing costs of 0.75% plus LIBOR, reset daily.

On March 12, 2007, the Company entered into an agreement with Lehman Commercial Paper Inc. (“Lehman”) pursuant to which Lehman will provide services relating to the formation of a CDO Fund, managed by Katonah Debt Advisors, to be named Ardsley CLO 2007-1 Ltd. (“Ardsley CLO 2007-1”) which will invest in senior loans to middle market companies, broadly syndicated senior loans and other credit instruments (excluding asset backed securities such as those secured by residential mortgages or other consumer borrowings) of corporate issuers with a total fund size expected to be $300 million. As part of this engagement, the Company entered into a warehouse credit agreement, under which Lehman will provide funding which will allow the Company to accumulate assets for Ardsley CLO 2007-1. Pursuant to this warehouse credit agreement, the Company agreed to reimburse Lehman for losses incurred on loans acquired for Ardsley CLO 2007-1 prior to the completion of the fund with such reimbursement limited based on a percentage of warehoused assets. In return for providing this First Loss Guarantee, the Company will receive all interest and other non-principal distributions made with respect to the CDO’s investments serving as collateral upon closing of the securitization, less the financing costs of 0.75% plus LIBOR, reset daily.

 

F-24


Table of Contents

EXHIBIT INDEX

 

Exhibit
Number
  

Description

  3.1    Form of Certificate of Incorporation of Kohlberg Capital Corporation (the “Company”).*
  3.2    Form of Bylaws of the Company.***
  4.1    Specimen certificate of the Company’s common stock, par value $0.01 per share.*
  4.2    Form of Registration Rights Agreement.*
  4.3    Form of Dividend Reinvestment Plan.*
10.1    Form of the 2006 Equity Incentive Plan.*1
10.2    Form of Kohlberg Capital Non-Qualified Stock Option Certificate.*1
10.3    Form of Custodian Agreement by and among Kohlberg Capital Corporation and U.S. Bank National Association.*
10.4    Form of Amended and Restated Irrevocable Exchange and Subscription Agreement—Katonah Debt Advisors, effective as of August 17, 2006 between Katonah Capital, LLC, James A. Kohlberg and KAT Associates LLC.*
10.5    Form of Irrevocable Exchange and Subscription Agreement—CDO Securities, dated August 17, 2006 between Kohlberg Capital, LLC, KKAT Acquisition Company III, LLC, KKAT Acquisition Company IV, LLC, KKAT Acquisition Company V, LLC, KKAT Acquisition Company VII, LLC and KKAT Acquisition Company VIII, LLC.*
10.6    Form of Transition Services Agreement between the Company and Kohlberg & Company, LLC.*
10.7    Form of License and Referral Agreement between the Company and Kohlberg & Company, LLC.*
10.8    Form of Overhead Allocation Agreement between the Company and Katonah Debt Advisors, LLC.*
10.9    Form of Employment Agreement between Kohlberg Capital Corporation and Dayl W. Pearson.*1
10.10    Form of Employment Agreement between Kohlberg Capital Corporation and Michael I. Wirth.*1
10.11    Form of Employment Agreement between Kohlberg Capital Corporation and R. Jon Corless.*1
10.12    Form of Employment Agreement between Kohlberg Capital Corporation and E.A. Kratzman.*1
10.13    Form of Employment Agreement between Katonah Debt Advisors and E.A. Kratzman.*1
10.14    Form of Indemnification Agreement for Officers and Directors of the Company.*1
10.15    Execution Copy of Loan Funding and Servicing Agreement dated as of February 14, 2007, by and among Kohlberg Capital Funding LLC I, Kohlberg Capital Corporation, each of the conduit lenders and institutional lenders from time to time party thereto, each of the lender agents from time to time party thereto, BMO Capital Markets Corp., as the Agent, Lyon Financial Services, Inc. (d/b/a U.S. Bank Portfolio Services), as the Backup Services, and U.S. Bank National Association, as Trustee.
10.16    Execution Copy of Purchase and Sale Agreement dated as of February 14, 2007, by and among Kohlberg Capital Funding LLC I and Kohlberg Capital Corporation.**
14.1    Form of Code of Ethics.*
21.1    List of Subsidiaries.
23.1    Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm.
31.1    Chief Executive Officer Certification Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.


Table of Contents
Exhibit
Number
  

Description

31.2    Chief Financial Officer Certification Pursuant to Rule 13a-14 of the Securities Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1    Chief Executive Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Chief Financial Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Incorporated by reference to the exhibit filed as part the Company’s Registration Statement on Form N-2 filed with the SEC on August 18, 2006, as amended (Registration No. 333-136714).
** Incorporated by reference to the exhibit filed as part of the Company’s Current Report on Form 8-K filed with the SEC on February 16, 2007.
*** Incorporated by reference to the exhibit filed as part of the Company’s Registration Statement on Form N-2 filed with the SEC on March 16, 2007, as amended (Registration No. 333-141382)

1

Management contract or compensatory plan or arrangement.

Execution Copy of Loan Funding and Servicing Agreement

Exhibit 10.15

EXECUTION COPY

 


U.S.$200,000,000

LOAN FUNDING AND SERVICING AGREEMENT

by and among

KOHLBERG CAPITAL FUNDING LLC I,

as the Borrower

KOHLBERG CAPITAL CORPORATION,

as the Servicer

EACH OF THE CONDUIT LENDERS AND INSTITUTIONAL LENDERS FROM TIME

TO TIME PARTY HERETO,

as the Lenders

EACH OF THE LENDER AGENTS FROM TIME TO TIME PARTY HERETO

as the Lender Agents

BMO CAPITAL MARKETS CORP.,

as the Agent

LYON FINANCIAL SERVICES, INC.

(D/B/A U.S. BANK PORTFOLIO SERVICES),

as the Backup Servicer

and

U.S. BANK NATIONAL ASSOCIATION,

as the Trustee

Dated as of February 14, 2007

 



TABLE OF CONTENTS

 

         Page

ARTICLE I        DEFINITIONS

   1

        Section 1.1

  Certain Defined Terms    1

        Section 1.2

  Other Terms    51

        Section 1.3

  Computation of Time Periods    51

        Section 1.4

  Interpretation    51

        Section 1.5

  Section References    52

        Section 1.6

  Calculations    52

ARTICLE II        PURCHASE OF THE VARIABLE FUNDING NOTE

   52

        Section 2.1

  The Variable Funding Note    52

        Section 2.2

  Procedures for Advances by the Lenders    54

        Section 2.3

  Optional Changes in Facility Amount; Prepayments    55

        Section 2.4

  Deemed Collections    56

        Section 2.5

  Notations on Variable Funding Notes    57

        Section 2.6

  Principal Repayments    57

        Section 2.7

  Interest Payments    57

        Section 2.8

  Settlement Procedures    58

        Section 2.9

  Collections and Allocations    62

        Section 2.10

  Payments, Computations, Etc    63

        Section 2.11

  [Reserved]    63

        Section 2.12

  Fees    63

        Section 2.13

  Increased Costs; Capital Adequacy; Illegality    64

        Section 2.14

  Taxes    65

        Section 2.15

  Assignment of the Purchase Agreement    68

        Section 2.16

  Lien Release Dividend    68

        Section 2.17

  Appointment of Registrar and Duties    71

        Section 2.18

  Substitution of Loans; Repurchase or Substitution of Ineligible Loans    71

        Section 2.19

  Discretionary Sales of Loans    74

        Section 2.20

  Certain Trading Restrictions    76

ARTICLE III        CLOSING; CONDITIONS OF CLOSING AND ADVANCES

   76

        Section 3.1

  Conditions to Closing and Initial Advances    76

        Section 3.2

  Conditions Precedent to All Advances    77

ARTICLE IV        REPRESENTATIONS AND WARRANTIES

   79

        Section 4.1

  Representations and Warranties of the Borrower    79

        Section 4.2

  Representations and Warranties of the Borrower Relating to the Agreement and the Loans    87

ARTICLE V        GENERAL COVENANTS OF THE BORROWER

   88

        Section 5.1

  Covenants of the Borrower    88

        Section 5.2

  Hedging Agreements    93

 

i


         Page

        Section 5.3

  Delivery of Loan Files    95

ARTICLE VI        PERFECTION OF TRANSFER AND PROTECTION OF SECURITY INTERESTS

   96

        Section 6.1

  Custody of Transferred Loans    96

        Section 6.2

  Filing    96

        Section 6.3

  Changes in Name, Structure or Location    96

        Section 6.4

  Chief Executive Office    97

        Section 6.5

  Costs and Expenses    97

        Section 6.6

  Sale Treatment    97

        Section 6.7

  Separateness from the Borrower    97

ARTICLE VII        ADMINISTRATION AND SERVICING OF LOANS

   97

        Section 7.1

  Appointment of the Servicer    97

        Section 7.2

  Duties and Responsibilities of the Servicer    98

        Section 7.3

  Authorization of the Servicer    99

        Section 7.4

  Collection of Payments    100

        Section 7.5

  Servicer Advances    102

        Section 7.6

  Realization Upon Defaulted Loans    102

        Section 7.7

  Maintenance of Insurance Policies    103

        Section 7.8

  Representations and Warranties of the Servicer    103

        Section 7.9

  Covenants of the Servicer    106

        Section 7.10

  The Trustee    109

        Section 7.11

  Representations and Warranties of the Trustee    114

        Section 7.12

  Covenants of the Trustee    115

        Section 7.13

  The Backup Servicer    116

        Section 7.14

  Representations and Warranties of the Backup Servicer    119

        Section 7.15

  Covenants of the Backup Servicer    120

        Section 7.16

  Payment of Certain Expenses by the Servicer and the Borrower    121

        Section 7.17

  Reports    121

        Section 7.18

  Annual Statement as to Compliance    122

        Section 7.19

  Annual Independent Public Accountant’s Servicing Reports    122

        Section 7.20

  Limitation on Liability of the Servicer and Others    123

        Section 7.21

  The Servicer, the Backup Servicer and the Trustee Not to Resign    123

        Section 7.22

  Access to Certain Documentation and Information Regarding the Loans    124

        Section 7.23

  [Reserved]    124

        Section 7.24

  Identification of Records    124

        Section 7.25

  Servicer Termination Events    124

        Section 7.26

  Appointment of Successor Servicer    126

        Section 7.27

  Market Servicing Fee    128

ARTICLE VIII        SECURITY INTEREST

   129

        Section 8.1

  Grant of Security Interest    129

        Section 8.2

  Release of Lien on Loans    129

 

ii


         Page

        Section 8.3

  [Reserved]    130

        Section 8.4

  Further Assurances    130

        Section 8.5

  Remedies    130

        Section 8.6

  Waiver of Certain Laws    130

        Section 8.7

  Power of Attorney    131

ARTICLE IX        TERMINATION EVENTS

   131

        Section 9.1

  Termination Events    131

        Section 9.2

  Remedies    133

ARTICLE X        INDEMNIFICATION

   134

        Section 10.1

  Indemnities by the Borrower    134

        Section 10.2

  Indemnities by the Servicer    137

ARTICLE XI        THE AGENT

   138

        Section 11.1

  Authorization and Action    138

        Section 11.2

  Delegation of Duties    138

        Section 11.3

  Exculpatory Provisions    138

        Section 11.4

  Reliance    139

        Section 11.5

  Non-Reliance on Agent    139

        Section 11.6

  The Agent in its Individual Capacity    140

        Section 11.7

  Successor Agent    140

        Section 11.8

  Payments by the Agent    140

        Section 11.9

  Credit Decision with respect to the Agent    140

        Section 11.10

  Indemnification of the Agent    141

ARTICLE XII        MISCELLANEOUS

   141

        Section 12.1

  Amendments and Waivers    141

        Section 12.2

  Notices, Etc    142

        Section 12.3

  Liabilities to Obligors    142

        Section 12.4

  No Waiver, Rights and Remedies    142

        Section 12.5

  Binding Effect    142

        Section 12.6

  Term of this Agreement    143

        Section 12.7

  GOVERNING LAW; CONSENT TO JURISDICTION; WAIVER OF OBJECTION TO VENUE    143

        Section 12.8

  WAIVER OF JURY TRIAL    143

        Section 12.9

  Costs, Expenses and Taxes    143

        Section 12.10

  No Proceedings    144

        Section 12.11

  Recourse Against Certain Parties    144

        Section 12.12

  Protection of Security Interest; Appointment of Attorney-in-Fact    145

        Section 12.13

  Confidentiality    146

        Section 12.14

  Third Party Beneficiaries    147

        Section 12.15

  Execution in Counterparts; Severability; Integration    147

        Section 12.16

  Waiver of Setoff    147

 

iii


         Page

        Section 12.17

  Assignments by the Lenders    148

        Section 12.18

  Heading and Exhibits    148

        Section 12.19

  Sharing of Payments on Transferred Loans Subject to the Retained Interest Provisions    148

        Section 12.20

  Non-Confidentiality of Tax Treatment    149

        Section 12.21

  Representations and Warranties of the Lenders    149

        Section 12.22

  Lender Agents.    149

        Section 12.23

  Relationship    149

 

iv


ANNEXES

 

ANNEX A

  Notice Information

ANNEX B

  Commitments

ANNEX C

  Diversity Score

ANNEX D

  Lenders’ Accounts

EXHIBITS

 

EXHIBIT A-1

  Borrower Notice (Funding Request)

EXHIBIT A-2

  Borrower Notice (Reduction of Advances Outstanding and Reduction of Facility Amount)

EXHIBIT B

  Form of Variable Funding Note

EXHIBIT C

  Form of Operating Agreement

EXHIBIT D

  Form of Assignment and Acceptance

EXHIBIT E

  Form of Monthly Report

EXHIBIT F

  Form of Servicer’s Certificate

EXHIBIT G

  Credit and Collection Policy

EXHIBIT H-1

  Form of Hedging Agreement (including Schedule and Confirmation) Relating to Interest Rate Hedge Transactions

EXHIBIT H-2

  Form of Hedging Agreement (including Schedule and Confirmation) relating to Currency Hedge Transactions

EXHIBIT I

  Form of Certificate of Borrower’s Counsel

EXHIBIT J

  Form of Trust Receipt and Initial Certification

EXHIBIT K

  Form of Trust Receipt and Final Certification

EXHIBIT L

  Form of Request for Release of Loan Files and Receipt

EXHIBIT M

  Form of Assignment of Mortgage

EXHIBIT N

  Form of Reinvestment Certification

EXHIBIT O-1

  Officer’s Certificate as to Solvency from Originator

EXHIBIT O-2

  Officer’s Certificate as to Solvency from Borrower

EXHIBIT P-1

  Officer’s Closing Certificate from Originator

EXHIBIT P-2

  Officer’s Closing Certificate from Borrower

EXHIBIT Q-1

  Power of Attorney from Servicer

EXHIBIT Q-2

  Power of Attorney from Borrower

EXHIBIT R

  Form of Joinder Supplement

EXHIBIT S

  [Reserved]

EXHIBIT T

  Form of Agent and Intercreditor Provisions for Agented Loans

EXHIBIT U

  [Reserved]

EXHIBIT V

  Form of Transferee Letter
  SCHEDULES

SCHEDULE I

  Schedule of Documents

SCHEDULE II

  Advance Rate Matrices

SCHEDULE III

  [Reserved]

SCHEDULE IV

  Loan List

SCHEDULE V

  Location of Loan Files

 

v


PREAMBLE

THIS LOAN FUNDING AND SERVICING AGREEMENT (such agreement as amended, modified, waived, supplemented or restated from time to time, the “Agreement”) is made as of this 14th day of February, 2007, by and among:

(1) KOHLBERG CAPITAL FUNDING LLC I, a Delaware limited liability company, as the borrower (together with its successors and assigns in such capacity, the “Borrower”);

(2) KOHLBERG CAPITAL CORPORATION, a Delaware corporation (“Kohlberg Capital”), as the servicer (together with its successors and assigns in such capacity, the “Servicer”);

(3) EACH OF THE CONDUIT LENDERS AND INSTITUTIONAL LENDERS, which may from time to time become party hereto (each a “Lender”, and collectively, the “Lenders”);

(4) EACH OF THE LENDER AGENTS, which may from time to time become party hereto, as Lender Agent;

(5) BMO CAPITAL MARKETS CORP., a Delaware corporation (“BMO”), as the Agent (together with its successors and assigns in such capacity, the “Agent”);

(6) LYON FINANCIAL SERVICES, INC., (d/b/a U.S. Bank Portfolio Services), as the backup servicer (together with its successors and assigns in such capacity, the “Backup Servicer”; and

(7) U.S. BANK NATIONAL ASSOCIATION, a national banking association (“U.S. Bank”), not in its individual capacity, but solely as the trustee (together with its successors and assigns in such capacity, the “Trustee”).

IT IS AGREED as follows:

ARTICLE I

DEFINITIONS

 

  Section 1.1 Certain Defined Terms.

(a) Certain capitalized terms used throughout this Agreement are defined above or in this Section 1.1.

(b) As used in this Agreement and its schedules, exhibits and other attachments, unless the context requires a different meaning, the following terms shall have the following meanings:

1940 Act”: The Investment Company Act of 1940, as amended.


Accepted Servicing Practices”: The servicing practices and collection procedures of the Servicer that are in accordance with Applicable Law and which are consistent with whichever is the higher standard of (i) customary servicing practices of prudent institutions which service loans and other financial assets similar to the Transferred Loans for their own account or for the account of others and (ii) the same care, skill, prudence and diligence with which the Servicer services and administers loans or other financial assets which are similar to the Transferred Loans serviced or administered pursuant to this Agreement, for its own account or for the account of others.

Account Control Agreement”: The Securities Account Control Agreement, dated as of February 14, 2007, by and among U.S. Bank National Association as Trustee and Securities Intermediary, the Borrower, the Servicer and the Agent.

Accreted Interest”: The accrued interest on a PIK Loan that is added to the principal amount of such PIK Loan instead of being paid as it accrues.

Accrual Period”: With respect to each Advance (or portion thereof) (a) with respect to the first Payment Date, the period from and including the Closing Date to and including the last day of the calendar month in which the Closing Date occurs and (b) with respect to any subsequent Payment Date, the calendar month immediately preceding the month in which such Payment Date occurs.

Add-On Loan”: Any additional loan or extension of credit made subsequent to any Loan made by the Originator or one of its Subsidiaries to the Obligor of such Loan in accordance with the Credit and Collection Policy.

Adjusted Eurodollar Rate”: For any Accrual Period, an interest rate per annum equal to a fraction, expressed as a percentage and rounded upwards (if necessary), to the nearest 1/100 of 1%, (i) the numerator of which is equal to the LIBOR Rate for such Accrual Period and (ii) the denominator of which is equal to 100% minus the Eurodollar Reserve Percentage for such Accrual Period.

Advance”: Defined in Section 2.1(b).

Advance Rate”: A dynamic number that shall be determined on each Measurement Date by application of the Advance Rate Matrices set forth in Schedule II based on:

(a) in the case of the Weighted Average Moody’s Recovery Rate, (i) the actual level thereof (if such level is equal to any of the Weighted Average Moody’s Recovery Rate levels specified in the Advance Rate Matrices) or (ii) otherwise, the Weighted Average Moody’s Recovery Rate indicated in the Advance Rate Matrices that is arithmetically closest to, but less than the actual Weighted Average Moody’s Recovery Rate level;

(b) in the case of the Diversity Score, (i) the actual level thereof (if such level is equal to any of the Diversity Score levels specified in the Advance Rate Matrices) or (ii) otherwise, the Diversity Score indicated in the Advance Rate Matrices that is arithmetically closest to, but less than the actual Diversity Score level; and

 

2


(c) in the case of each of the Weighted Average Moody’s Rating Factor, (i) the actual level thereof (if such level is equal to any of the Weighted Average Moody’s Rating Factor levels specified in the Advance Rate Matrices) or (ii) otherwise, the Weighted Average Moody’s Rating Factor indicated in the Advance Rate Matrices that is arithmetically closest to, but less than the actual Weighted Average Moody’s Rating Factor level, in each case as of such Measurement Date.

Advances Outstanding”: On any day, the aggregate principal amount of Advances outstanding on such day, after giving effect to all repayments of Advances and makings of new Advances on such day.

Affected Party”: The Agent, each Lender, each Liquidity Bank, all assignees and participants of each Lender and each Liquidity Bank, any successor to BMO as Agent and any sub-agent of the Agent.

Affiliate”: With respect to a Person, means any other Person controlling, controlled by or under common control with such Person. For purposes of this definition, “control” when used with respect to any specified Person means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms “controlling” or “controlled” have meanings correlative to the foregoing; provided that (x) in the case of the Servicer or any Subsidiary, “Affiliate” shall not include any Person that is a Portfolio Investment and (y) the term Affiliate shall not include any Affiliate relationship which may exist solely as a result of direct or indirect ownership of, or control by (i) a Financial Sponsor, or (ii) a common owner which is a financial institution, fund or other investment vehicle which is in the business of making diversified investments.

Agent”: Defined in the Preamble.

Agented Loans”: Any Loan that has each of the following characteristics: (a) the Loan is originated or purchased by the Originator in accordance with the Credit and Collection Policy as a part of a syndicated loan transaction that has been fully consummated prior to such Loan becoming part of the Collateral, (b) upon an assignment of the Loan to the Borrower under the Purchase Agreement and the grant of a security interest in such Loan under this Agreement, the related Loan File shall have been delivered to the Trustee on behalf of the Secured Parties, and held by the Trustee, on behalf of the Secured Parties, (c) the Borrower, as assignee of the Loan, has all of the rights (but none of the obligations) of the Originator with respect to such Loan and the Related Property, including the right to receive and collect payments directly in its own name or through the agent described in clause (e) below and to enforce its rights against the Obligor thereof, (d) unless the Loan is an unsecured Loan, the Loan is secured by an undivided interest in the Related Property that also secures and is shared by, on a pro rata basis, all other holders of such Obligor’s indebtedness of equal priority and (e) the Originator is the agent for all lenders to such Obligor; provided that Agented Loans shall not include (1) the obligations, if any, of any agents under the Loan Documents evidencing such Agented Loans, and (2) the Retained Interests under the Loan Documents evidencing such Agented Loans that are retained by the Originator or are owned or owed by other lenders.

 

3


Aggregate Outstanding Loan Balance”: As of any date of determination, the sum of the Outstanding Loan Balances of all Eligible Loans included as part of the Collateral on such date that are not Defaulted Loans plus the Moody’s Collateral Value of each Defaulted Loan included as part of the Collateral on such date.

Aggregate Purchased Loan Balance”: As of any date of determination, the sum of the Purchased Loan Balances of all Eligible Loans included as part of the Collateral on such date minus (b) all amounts in excess of applicable Concentration Limits on such date.

Agreement”: Defined in the Preamble.

Alternative Rate”: An interest rate per annum equal to the Adjusted Eurodollar Rate; provided that the Alternative Rate shall be the Base Rate if a Eurodollar Disruption Event occurs; provided further that the Alternative Rate for the first two (2) Business Days following any Advance made by a Liquidity Bank shall be the Base Rate unless such Liquidity Bank has received at least two Business Days prior notice of such Advance.

Amortization Period”: The period beginning on the Termination Date and ending on the Collection Date.

Applicable Law”: For any Person or property of such Person, all existing and future applicable laws, rules, regulations (including proposed, temporary and final income tax regulations), statutes, treaties, codes ordinances, permits, certificates, orders and licenses of and interpretations by any Governmental Authority (including, without limitation, usury laws, predatory lending laws, the Federal Truth in Lending Act, and Regulation Z and Regulation B of the Federal Reserve Board), and applicable judgments, decrees, injunctions, writs, orders, or line action of any court, arbitrator or other administrative, judicial, or quasi-judicial tribunal or agency of competent jurisdiction.

Approved Pricing Service”: Any of LPC, LoanX, MarkIt or any other pricing service selected by the Servicer that is Independent of the Servicer and any of its Affiliates, such Approved Pricing Service to be confirmed by the Servicer to the Agent within two Business Days of such selection.

Assigned Moody’s Rating”: With respect to any Loan as of any date of determination, the monitored publicly available rating or the estimated rating expressly assigned to such Loan by Moody’s that addresses the full amount of the principal and interest payable on such Loan.

Assigned S&P Rating”: With respect to any Loan as of any date of determination, the monitored publicly available rating or the estimated rating expressly assigned to such Loan by S&P that addresses the full amount of the principal and interest payable on such Loan.

Assignment”: The Assignment entered into between the Originator and the Borrower in substantially the form of Exhibit A to the Purchase Agreement.

Assignment and Acceptance”: The Assignment and Acceptance, substantially in the form of Exhibit D hereto.

 

4


Assignment of Mortgage”: As to each Agented Loan secured by an interest in real property, one or more assignments, notices of transfer or equivalent instruments, each in recordable form and sufficient under the laws of the relevant jurisdiction to (a) reflect the transfer of the related mortgage, deed of trust, security deed or similar security instrument and all other documents related to such Loan and to the Borrower and (b) grant a perfected lien thereon by the Borrower in favor of the Trustee for the benefit of the Secured Parties, each such Assignment of Mortgage to be substantially in the form of Exhibit M hereto; provided that with respect to Agented Loans, Assignment of Mortgage shall mean such documents, including assignments, notices of transfer or equivalent instruments, each in recordable form as necessary, as are sufficient under the laws of the relevant jurisdiction to reflect the transfer to the Originator, as collateral agent for all lenders to the Obligor, of the related mortgage, deed of trust, security deed or other similar instrument securing such loans and all other documents relating to such loans and to grant a perfected lien thereon by the Obligor in favor of the Originator, as collateral agent for all such lenders.

Availability”: On any day, the excess, if any, of (a) the Maximum Availability over (b) the sum of (i) Advances Outstanding on such day and (ii) the aggregate outstanding principal amount of the unfunded portions of each of the Revolving Loans included in the Collateral on such day.

Available Funds”: With respect to any Payment Date, (a) all amounts in the Collection Account (including, without limitation, any Collections on any of the Collateral) as of the later of (i) the immediately preceding Determination Date or (ii) the date of the calculations set forth in the most recent Borrower Notice and (b) to the extent that the amounts in the preceding clause (a) of this definition are insufficient on any Payment Date to make the payments required by (A) Section 2.8(a)(1)(iii), (iv), (v), (vi), (vii) and (xvii), then amounts on deposit in the Reserve Account on such date, (B) Section 2.8(b)(iii), (iv), (v), (vi), (vii) and (x), then amounts on deposit in the Reserve Account on such date.

Backup Servicer”: Defined in the Preamble.

Backup Servicer Expenses”: The reasonable out-of-pocket expenses to be paid to the Backup Servicer under and in accordance with the Backup Servicer and Trustee Fee Letter.

Backup Servicer Fee”: The fee to be paid to the Backup Servicer under the terms of the Backup Servicer and Trustee Fee Letter.

Backup Servicer and Trustee Fee Letter”: The Backup Servicer and Trustee Fee Letter, dated as of the date hereof, among the Servicer, the Backup Servicer, the Trustee and the Agent.

Bank of Montreal”: The Bank of Montreal, a Canadian chartered bank, acting through its Chicago, Illinois branch.

Bankruptcy Code”: The United States Bankruptcy Reform Act of 1978 (11 U.S.C. §§ 101, et seq.), as amended from time to time.

Base Rate”: On any date, a fluctuating rate of interest per annum equal to the higher of (a) the Prime Rate or (b) the Federal Funds Rate plus 0.5%.

 

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Benefit Plan”: Any employee benefit plan as defined in Section 3.1(3) of ERISA in respect of which the Borrower or any ERISA Affiliate of the Borrower is, or at any time during the immediately preceding six years was, an “employer” as defined in Section 3.1(5) of ERISA.

BMO”: Defined in the Preamble.

Borrower”: Defined in the Preamble.

Borrowing Base”: On any date of determination, an amount equal to (a) the sum of (i) the Aggregate Purchased Loan Balance on such date and (ii) the Purchased Loan Balance of all Eligible Loans to become included as part of the Collateral on such date, minus (b) the aggregate outstanding principal amount of the unfunded portions of each of the Revolving Loans included in the Collateral on such date.

Borrowing Base Certificate”: A certificate of a Responsible Officer of the Servicer setting forth the current Borrowing Base as of the date set forth in such certificate and the manner of calculation thereof, to be delivered to the parties and at the times specified herein.

Borrower Notice”: A written notice, in the form of Exhibit A-1 or A-2, as applicable, to be used for each Advance, repayment of each Advance or termination or reduction of the Facility Amount or Prepayments of Advances or any reinvestment of Principal Collections under Section 2.8(a)(2).

Breakage Costs”: With respect to any Lender, any amount or amounts as shall compensate such Lender for any loss, cost or expense incurred by such Lender (as reasonably determined by such Lender) as a result of a prepayment by the Borrower of Advances Outstanding. All Breakage Costs shall be due and payable upon demand. The determination by a Lender of the amount of any such loss or expense shall be described and confirmed by such Lender to the Agent and set forth in a written notice from the Agent to the Borrower and shall be conclusive absent manifest error; provided that each Lender shall use commercially reasonable efforts to minimize Breakage Costs incurred by it.

Broadly Syndicated Loan”: Any Loan to an Obligor issued as part of a loan facility with an original loan size (including any first and second lien loans included in such facility) greater than $250,000,000, including for purposes of this definition the maximum available amount of commitments under any Revolving Loans.

Business Day”: Any day of the year other than a Saturday or a Sunday on which (a) banks are not required or authorized to be closed in Chicago, Illinois, Minneapolis, Minnesota, Florence, South Carolina, New York, New York or Boston, Massachusetts, and (b) if the term “Business Day” is used in connection with the Adjusted Eurodollar Rate, means the foregoing only if such day is also a day of year on which dealings in United States dollar deposits are carried on in the London interbank market.

Capital Expenditures”: With respect to any Person and for any period, the sum of capital expenditures and payments under Capitalized Leases of such Person for such period determined and consolidated in accordance with GAAP.

 

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Capitalized Leases”: With respect to any Person, leases of (or other agreements conveying the right to use) any property (whether real, personal or mixed) by such Person as lessee that, in accordance with GAAP, either would be required to be classified and accounted for as capital leases on a balance sheet of such Person or otherwise be disclosed as such in a note to such balance sheet.

Change in Control”: The date on which (a) in respect of the Originator or the initial Servicer, (i) any Person or “group” acquires any “beneficial ownership” (as such terms are defined under Rule 13d-3 of, and Regulation 13D under the Exchange Act), either directly or indirectly, of stock or other equity interests or any interest convertible into any such interest in the Originator or Servicer having more than fifty percent (50%) of the voting power for the election of directors of the Originator, or such Servicer, if any, under ordinary circumstances or (ii) (except in connection with any Permitted Securitization Transaction) the Originator or initial Servicer sells, transfers, conveys, assigns or otherwise disposes of all or substantially all of the assets of the Originator or Servicer or (b) in respect of the Borrower, Kohlberg Capital ceases to own 100% of the stock or other equity interests or any interest convertible into any such interest in the Borrower.

Closing Date”: February 14, 2007.

Code”: The Internal Revenue Code of 1986, as amended.

Collateral”: All right, title and interest, whether now owned or hereafter acquired or arising, and wherever located, of the Borrower in and to the property described in clauses (i) through (x) below and all accounts, cash and currency, chattel paper, tangible chattel paper, electronic chattel paper, copyrights, copyright licenses, equipment, fixtures, contract rights, general intangibles, instruments, certificates of deposit, certificated securities, uncertificated securities, financial assets, securities entitlements, commercial tort claims, deposit accounts, inventory, other goods, investment property, letter-of-credit rights, documents, software, supporting obligations, accessions, and all products and proceeds of any of the foregoing, and other property consisting of, arising out of, or related to any of the following (in each case excluding the Retained Interest and the Excluded Amounts):

(i) the Transferred Loans, and all monies due or to become due in payment of such Transferred Loans on and after the related Cut-Off Date, including but not limited to all Collections and all obligations owed to the Originator or, in the case of a Third Party Acquired Loan, to the Borrower in connection with such Loans;

(ii) any Related Property securing or purporting to secure the Transferred Loans, including the related security interest granted by the Obligor under such Transferred Loans, all proceeds from any sale or other disposition of such Related Property;

(iii) all security interests, Liens, guaranties, warranties, letters of credit, accounts, securities accounts, deposit accounts or other bank accounts, mortgages or other encumbrances and property subject thereto from time to time purporting to secure payment of any Transferred Loan, together with all UCC financing statements or similar filings relating thereto;

 

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(iv) all claims (including “claims” as defined in Bankruptcy Code § 101(5)), suits, causes of action, and any other right of the Borrower, whether known or unknown, against the related Obligors, if any, or any of their respective Affiliates, agents, representatives, contractors, advisors, or any other Person that in any way is based upon, arises out of or is related to any of the foregoing, including, to the extent permitted to be assigned under applicable law, all claims (including contract claims, tort claims, malpractice claims, and claims under any law governing the purchase and sale of, or indentures for, securities), suits, causes of action, and any other right of the Borrower against any attorney, accountant, financial advisor, or other Person arising under or in connection with the related Loan Documents;

(v) all Insurance Policies, to the extent of the Borrower’s rights thereto;

(vi) all cash, securities, or other property, and all setoffs and recoupments, received or effected by or for the account of the Borrower under such Transferred Loans (whether for principal, interest, fees, reimbursement obligations, or otherwise) after the related Cut-Off Date, including all distributions obtained by or through redemption, consummation of a plan of reorganization, restructuring, liquidation, or otherwise of any related Obligor or the related Loan Documents, and all cash, securities, interest, dividends, and other property that may be exchanged for, or distributed or collected with respect to, any of the foregoing;

(vii) the Loan Documents with respect to such Transferred Loans;

(viii) the Master Participation Agreement with respect to the initial Participations;

(ix) the Collection Account, the Reserve Account, and, to the extent that amounts on deposit therein or credited thereto relate to the Transferred Loans, the Concentration Account, together with all funds held in or credited to such accounts, and all certificates and instruments, if any, from time to time representing or evidencing each of the foregoing or such funds;

(x) any Hedging Agreement and any payment from time to time due thereunder;

(xi) the Purchase Agreement and the assignment to the Trustee on behalf of the Secured Parties of all UCC financing statements filed by the Borrower against the Originator under or in connection with the Purchase Agreement; and

(xii) all commitment fees received by or for the account of the Borrower under any Transferred Loans that are Revolving Loans.

In no event shall Collateral include Warrant Assets.

 

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Collateral Quality Test”: With respect to the Loans included in the Collateral, on any Measurement Date, a test that is satisfied so long as:

(i) the Diversity Score equal to or is greater than 10 as of such date;

(ii) the Weighted Average Spread is equal to or greater than 3% as of such date;

(iii) the Weighted Average Moody’s Recovery Rate is equal to or greater than 25% as of such date;

(iv) the Weighted Average Moody’s Rating Factor is equal to or less than 5000 as of such date; and

(v) the Weighted Average Life is a date equal to or less than 84 months as of such date.

Collection Account”: An account established in accordance with Section 7.4(e).

Collection Date”: The date following the Termination Date on which the Obligations have been reduced to zero and indefeasibly paid in full other than contingent indemnification obligations.

Collection Period”: Each calendar month, except in the case of the first Collection Period, the period beginning on the Closing Date to and including the last day of the calendar month in which the Closing Date occurs.

Collections”: (a) All cash collections or other cash proceeds received by the Borrower or by the Servicer or Originator on behalf of the Borrower from any source in payment of any amounts owed in respect of a Transferred Loan, including, without limitation, Interest Collections, Principal Collections, Deemed Collections, Insurance Proceeds, interest earnings in the Collection Account, all Recoveries, finance charges and all other charges, (b) all amounts received by the Borrower in connection with the repurchase of an Ineligible Loan pursuant to Section 2.18(b), (c) any other funds received by or on behalf of the Borrower with respect to any Transferred Loan or Related Property including, without limitation, insurance payments and net proceeds of sale or other disposition of repossessed goods, and (d) all payments received pursuant to any Hedging Agreement or Hedge Transaction, but excluding, in the case of clauses (a), (b) or (c), as applicable, amounts in respect of any Retained Interest and Excluded Amounts.

Commercial Paper Notes”: On any day, any short-term promissory notes issued by the Conduit Lenders in the commercial paper market.

Commitment”: With respect to each Conduit Lender or Institutional Lender, the commitment of such Lender to make Advances in accordance herewith in an amount not to exceed (a) prior to the Termination Date, the amount set forth opposite such Lender’s name in Annex B of this Agreement, under the heading “Commitment,” the amount set forth as such Lender’s “Commitment” on Schedule I to the Assignment and Acceptance relating to such Lender, or the amount set forth as such Lender’s “Commitment” on Schedule I to the Joinder

 

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Supplement relating to such Purchaser, as applicable, and (b) on and after the Termination Date, the Pro Rata Share of such Conduit Lender or Institutional Lender, as applicable, of the aggregate Advances Outstanding.

Commitment Termination Date”: With respect to each Lender, February 14, 2012, or such later date as to which the Commitment Termination Date for such Lender may be extended, as confirmed by such Lender to the Agent and by the Agent to the Borrower in writing following a request by the Borrower in accordance with Section 2.1(c).

Concentration Account”: Account number 1047-9006-3531 maintained in the name of “Kohlberg Capital Corporation” with the Concentration Account Bank for the purpose of receiving Collections.

Concentration Account Agreement”: The Concentration Account Agreement, dated as of February 14, 2007, by and among U.S. Bank, as Concentration Account Bank, and Kohlberg Capital, as such agreement may be amended, modified, waived, supplemented or restated from time to time.

Concentration Account Bank”: U.S. Bank, as Concentration Account Bank.

Concentration Limits”: On any day, each of the following (calculated on the basis of a percentage of the Aggregate Outstanding Loan Balance):

(a) the sum of the Outstanding Loan Balances of Eligible Loans included in the Collateral to any one Obligor shall not exceed $25,000,000;

(b) the sum of the Outstanding Loan Balances of Eligible Loans included in the Collateral that have interest due and payable no less frequently than quarterly shall not be less than 90%;

(c) the sum of the Outstanding Loan Balances of Eligible Loans included in the Collateral that are secured by a security interest in a material portion or all of the assets of the related Obligor shall not be less than 70%;

(d) the sum of the Outstanding Loan Balances of Eligible Loans included in the Collateral which are Subordinated Loans shall not exceed 55%;

(e) the sum of the Outstanding Loan Balances of Eligible Loans included in the Collateral the entire principal amount of which is due in a single installment at the maturity of such Loan shall not exceed 80%;

(f) the sum of the Outstanding Loan Balances of Eligible Loans included in the Collateral which are DIP Loans shall not exceed 10%;

(g) the sum of the Outstanding Loan Balances of Eligible Loans included in the Collateral that have at least a portion of the monthly or quarterly interest that is due under such Loans payable on a current basis by the Obligors thereof in cash (or such Obligors shall have other Loans included as part of the Collateral that pay current monthly or quarterly interest on a current basis in cash) shall not be less than 100%;

 

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(h) the sum of the Outstanding Loan Balances of Eligible Loans included in the Collateral which are Revolving Loans shall not exceed 20%;

(i) the sum of the Outstanding Loan Balances of Eligible Loans included in the Collateral to Obligors in which the Originator holds a direct or indirect ownership interest (on a fully-diluted basis) of 10% or greater shall not exceed 10%;

(j) the sum of the Outstanding Loan Balances of all Eligible Loans included in the Collateral which are Unrated Loans shall not exceed 10%; provided that the sum of the Outstanding Loan Balances of all Eligible Loans included in the Collateral which are unrated pending shadow rating shall not exceed 30%;

(k) the sum of the Outstanding Loan Balances of all Eligible Loans included in the Collateral which are purchased as part of a portfolio purchase of Loans and re-underwritten by the Servicer shall not exceed 30%;

(l) the sum of the Outstanding Loan Balances of all Eligible Loans included in the Collateral which have a Moody’s Rating below “Caa1” shall not exceed 20%;

(m) the sum of the Outstanding Loan Balances of all Eligible Loans included in the Collateral which have original terms to maturity of greater than 8 years shall not exceed 10%;

(n) the sum of the Outstanding Loan Balances of all Structured Finance Obligations included in the Collateral shall not exceed 5%;

(o) the sum of the Outstanding Loan Balances of all High Yield Bonds included in the Collateral shall not exceed 5%;

(p) the sum of the Outstanding Loan Balances of all Eligible Loans included in the Collateral, the Obligors of which are organized in Canada, the Netherlands, the Channel Islands or the United Kingdom shall not exceed 10%;

(q) the sum of the Outstanding Loan Balances of all Eligible Loans included in the Collateral that are Non-USD Loans shall not exceed 10%; provided that all Collections received on Non-USD Loans shall be converted into Dollars pursuant to the terms of one or more Currency Hedges Transactions in accordance with Section 5.2(b);

(r) the sum of the Outstanding Loan Balances of all Eligible Loans included in the Collateral, the Obligor of which is organized in Bermuda, shall not exceed 5%;

(s) the sum of the Outstanding Loan Balances of Eligible Loans included in the Collateral that are Real Estate Loans shall not exceed 25%; provided that the sum of the Outstanding Loan Balances of Eligible Loans included in the Collateral that are Real Estate Construction Loans shall not exceed 10%;

 

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(t) the sum of the Outstanding Loan Balances of all Participations (other than the Initial Participations) included in the Collateral shall not exceed (i) 0% at any time prior to the date that is the earlier of (A) the 60th day following the Closing Date and (B) the date on which no Initial Participations remain in the Collateral, and (ii) 5% at any time thereafter; and

(u) the sum of the Outstanding Loan Balances of all Initial Participations included in the Collateral shall not exceed an amount equal to (i) $50,000,000 at any time during the 30-day period following the Closing Date, (ii) $15,000,000 at any time during the 30-day period following the period specified in clause (i) and (iii) $0 at any time thereafter;

Conduit Lender”: Each Lender designated as such on its signature page hereto and each financial institution, other than an Institutional Lender, which may from time to time become a Lender hereunder by executing and delivering to the Agent, the Borrower and the Servicer (a) an Assignment and Acceptance and a Transferee Letter as contemplated by Section 12.17 or (b) a Joinder Supplement as contemplated by Section 2.1(e).

Contractual Obligation”: With respect to any Person, means any provision of any securities issued by such Person or any indenture, mortgage, deed of trust, contract, undertaking, agreement, instrument or other document to which such Person is a party or by which it or any of its property is bound or is subject.

Converted Coupon”: For each Loan (whether fixed or floating) that is a Non-USD Loan, as of any date of determination, a ratio (expressed as a percentage) of (a) the product of (i) the current cash interest coupon rate on such Loan, (ii) the Outstanding Loan Balance of such Loan in the applicable currency) and (iii) the Spot FX Exchange Rate to (b) the Outstanding Loan Balance of such Loan (in Dollars converted at the Spot FX Exchange Rate).

Converted Spread”: For each Floating Rate Loan that is a Non-USD Loan, as of any date of determination, the excess of (a) the Converted Coupon over (b) the Eurodollar Rate on the date of determination.

CP Payment Date”: Any maturity date of a tranche of Commercial Paper Notes, the proceeds of which are used by a Conduit Lender to fund Advances hereunder.

CP Rate”: With respect to any Conduit Lender, for any Accrual Period, means (a) the per annum rate equivalent to the weighted average of the per annum rates paid or payable by such Conduit Lender from time to time as interest on or otherwise in respect of those Commercial Paper Notes issued by such Conduit Lender that are allocated, in whole or in part, by such Conduit Lender’s agent to fund the purchase or maintenance of an Advance during an Accrual Period as determined by such Conduit Lender’s agent and reported to the Agent, the Borrower and the Servicer, which rates shall include and give effect to the commissions of placement agents and dealers in respect of such Commercial Paper Notes, incremental carrying costs incurred with respect to such Commercial Paper Notes maturing on dates other than those on which corresponding funds are received by such Conduit Lender, and any other costs associated with the issuance of Commercial Paper Notes, in each case to the extent such commissions and other costs are allocated, in whole or in part, to such Commercial Paper Notes by such Conduit Lender’s agent); provided that if any component of such rate is a discount rate,

 

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in calculating the “CP Rate” for such Accrual Period, the Conduit Lender (or its agent on its behalf) shall for such component use the rate resulting from converting such discount rate to an interest bearing equivalent rate per annum; provided further that notwithstanding anything in this Agreement or any other Transaction Document to the contrary, the Borrower agrees that any amounts payable to any Conduit Lender in respect of Interest for any Accrual Period with respect to any Advance funded by such Conduit Lender at the CP Rate shall include an amount equal to the portion of the face amount of the outstanding Commercial Paper Notes issued to fund or maintain such Advance that corresponds to the portion of the proceeds of such Commercial Paper Notes that was used to pay the interest component of maturing Commercial Paper Notes issued to fund or maintain such Advance, to the extent that such Conduit Lender had not received payments of interest in respect of such interest component prior to the maturity date of such maturing Commercial Paper Notes (for purposes of the foregoing, the “interest component” of promissory notes equals the excess of the face amount thereof over the net proceeds received by such Conduit Lender from the issuance of Commercial Paper Notes, except that if such Commercial Paper Notes are issued on an interest-bearing basis its “interest component” will equal the amount of interest accruing on such Commercial Paper Notes through maturity).

Credit and Collection Policy”: Those credit, collection, customer relation and service policies: (a) determined by the Borrower, the Originator and the initial Servicer as of the date hereof relating to the Loans and related Loan Documents, described in Exhibit G, as the same may be amended or modified from time to time in accordance with Section 7.9(g); and (b) with respect to any Successor Servicer, the collection procedures and policies of such person (as approved by the Agent) at the time such Person becomes Successor Servicer.

Currency Hedge Amount”: On any day, with respect to any Non-USD Loan being hedged pursuant to a Currency Hedge Transaction, an amount equal to the Outstanding Loan Balance of such Non-USD Loan.

Currency Hedge Transaction”: Each currency swap transaction, index rate swap or interest rate cap transaction or comparable derivative arrangements as the Agent may approve in its discretion between the Borrower and a Hedge Counterparty that is entered into pursuant to Section 5.2(b) and is governed by a Hedging Agreement.

Current Fixed Charges”: For any period, the sum of (i) total cash interest expense of an Obligor and its Subsidiaries in connection with Indebtedness and any other obligations required by GAAP to be shown as liabilities on the consolidated balance sheet of an Obligor and its Subsidiaries, plus (ii) all Scheduled Debt Amortization for such period plus (iii) all scheduled payments on Capitalized Leases for such period determined in accordance with GAAP; but including, in each case, as applicable, all commissions, discounts and other fees and charges in connection with letters of credit and bankers’ acceptances and net costs or benefits under Interest Rate Protection Agreements and excluding any original issue discount related to the issuance of Indebtedness pursuant to the applicable Loan Documents.

Cut-Off Date”: With respect to each Transferred Loan, the date on and after which Collections on such Transferred Loan become included as part of the Collateral.

Deemed Collection”: Defined in Section 2.4.

 

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Defaulted Loan”: Any Transferred Loan:

(a) as to which (i) a default in the payment of principal and/or interest has occurred and is continuing (having regard for any grace period applicable to such Loan pursuant to the related Loan Documents, subject to a maximum grace period of 30 days and without giving effect to any Servicer Advance thereon) or (ii) a default other than a default specified in clause (a)(i) above has occurred and payment of all or a portion of the principal of such Loan has been accelerated as a result thereof;

(b) the Obligor of which is an obligor with respect to an outstanding loan that is subject to a default as to the payment of principal and/or interest that is continuing, and such loan is pari passu or senior in right of payment with respect to the Transferred Loan;

(c) as to which an Insolvency Event has occurred with respect to the related Obligor;

(d) that the Servicer has, in its reasonable commercial discretion declared a “Defaulted Loan”;

(e) that is rated “Ca” or lower by Moody’s; or

(f) that has been assigned a risk rating of “Grade 5” on the Kohlberg Capital standard credit rating scale in accordance with the Credit and Collection Policy, or has been otherwise written off by the Servicer in accordance with the Credit and Collection Policy, it being understood that for purposes of determining the Weighted Average Rating Factor, Defaulted Loans shall be assigned a rating of “Ca”.

Default Ratio”: With respect to any Collection Period, the percentage equivalent of a fraction, calculated as of the Determination Date for such Collection Period, (a) the numerator of which is equal to the aggregate Outstanding Loan Balance of all Defaulted Loans and (b) the denominator of which is equal to the decimal equivalent of a fraction the numerator of which is equal to the sum of (i) the aggregate Outstanding Loan Balance of all Eligible Loans included as part of the Collateral as of the first day of such Collection Period plus (ii) the aggregate Outstanding Loan Balance of all Eligible Loans included as part of the Collateral as of the last day of such Collection Period and the denominator of which is 2.

Derivatives”: Any exchange-traded or over-the-counter (a) forward, future, option, swap, cap, collar, floor, foreign exchange contract, any combination thereof, whether for physical delivery or cash settlement, relating to any interest rate, interest rate index, currency, currency exchange rate, currency exchange rate index, debt instrument, debt price, debt index, depository instrument, depository price, depository index, equity instrument, equity price, equity index, commodity, commodity price or commodity index, (b) any similar transaction, contract, instrument, undertaking or security, or (c) any transaction, contract, instrument, undertaking or security containing any of the foregoing.

Determination Date”: The last day of each calendar month (whether or not a Business Day).

 

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DIP Loan”: A loan to an Obligor that is a “debtor-in-possession” as defined under the Bankruptcy Code or a trustee organized under the laws of the United States or any state thereof, the terms of which have been approved by a court of competent jurisdiction, which order provides that such DIP Loan is secured by liens of equal or senior priority on the property of the Obligor’s estate that is otherwise subject to a lien or is secured by liens on the Obligor’s otherwise unencumbered assets.

Discount Loan” means any Loan that is not a Defaulted Loan and is acquired by the Borrower for a purchase price of less than 90% of the outstanding principal amount (excluding any amount of principal attributable to interest paid in the form of additional principal in accordance with the terms of such Loan) of such Loan.

Discretionary Sale”: Defined in Section 2.19(a).

Discretionary Sale Date”: The Business Day specified by the Borrower to the Agent, the Trustee and each Hedge Counterparty in a Discretionary Sale Notice as the proposed date of a Discretionary Sale.

Discretionary Sale Notice”: Defined in Section 2.19(a).

Diversity Score”: The single number that indicates collateral concentration for Loans in terms of both Obligor and industry concentration, which is calculated as described in Annex C attached hereto.

Dollars”: Means, and the conventional “$” signifies, the lawful currency of the United States.

EBITDA”: For any period, EBIT plus the amount of all depreciation and amortization expense deducted in determining net income for such period, which will include adjustments deemed reasonable by the Servicer and in accordance with the Servicer’s underwriting methodology and in accordance with the Credit and Collection Policy.

EBIT”: For any period, net income for such period plus the interest on Indebtedness, provisions for taxes based on income, and any extraordinary losses for such period, minus any extraordinary gains for such period, but without adjustment for any noncash income or noncash charges that are classified as such under GAAP.

Eligible Loan”: On any date of determination, any Loan that satisfies each of the following requirements (it being understood that the determination of whether a Loan is an Eligible Loan shall be made on the Cut-Off Date for such Loan):

(i) the Loan (other than in the case of a Noteless Loan) is evidenced by a promissory note that has been duly authorized and that, together with the related Loan Documents, is in full force and effect and constitutes the legal, valid and binding obligation of the Obligor of such Loan to pay the stated amount of the Loan and interest thereon, and the related Loan Documents are enforceable against such Obligor in accordance with their respective terms;

 

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(ii) the Loan was (a) originated in accordance with the terms of the Credit and Collection Policy and arose in the ordinary course of the Originator’s business, (b) was purchased and re-underwritten by the Originator or (c) acquired by the Originator or Borrower directly from a third party;

(iii) the Loan has an original term to maturity of no more than 10 years, and is either fully amortizing in installments (which installments need not be in identical amounts) over such term or the principal amount thereof is due in a single installment at the end of such term, or the Loan is a Revolving Loan;

(iv) the Loan is not a loan or extension of credit made by the Originator or one of its Affiliates to an Obligor for the purpose of making any principal, interest (other than deferred interest) or other payment on a loan to the same Obligor necessary in order to keep such loan from becoming delinquent and such Loan is not being kept current by the Originator or one of its Affiliates making other Loans to the Obligor. For the avoidance of doubt, nothing in this clause (iv) shall restrict the Originator from refinancing Loans which it has originated or underwritten if such refinancing is in the ordinary course of the Originator’s business and does not result from the Originator’s inability to make timely payments of principal of, or interest on, the Loans;

(v) other than in the case of a Third Party Acquired Loan, the Obligor of such Loan has executed all appropriate documentation required by the Originator. The Obligor of such Loan (including any Third Party Agented Loan) has met all of the Originator’s eligibility requirements, in each case as required by, and in accordance with, the Credit and Collection Policy;

(vi) no right of rescission, set off, counterclaim, defense or other material dispute has been asserted with respect to such Loan;

(vii) the Loan was documented and closed (or, solely in the case of a Third Party Acquired Loan, acquired) in accordance with the Credit and Collection Policy, and, other than in the case of a Noteless Loan, there is only one current original promissory note representing the portion of such Loan constituting a Transferred Loan, which has been delivered to the Trustee, duly endorsed as collateral;

(viii) the Loan has not been modified or extended in any way unless in the normal course of business in accordance with the Originator’s or the Servicer’s policies and procedures and unless such modification did not materially adversely affect the Loan’s otherwise eligible status or its collectibility;

(ix) such Loan does not represent payment obligations relating to “put” rights relating to Margin Stock;

(x) the Loan, together with the Loan Documents related thereto, was originated (or, solely in the case of a Third Party Acquired Loan, acquired) in accordance with and does not contravene in any material respect any Applicable Law (including, without limitation, laws, rules and regulations relating to usury, predatory lending, truth in lending, fair credit billing, fair credit reporting, equal credit opportunity, fair debt

 

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collection practices and privacy) and with respect to which, to the Borrower’s or the Servicer’s knowledge, no party to the Loan Documents related thereto is in material violation of any such Applicable Law;

(xi) the Loan bears some current interest, which is due and payable monthly or quarterly;

(xii) for purposes of each Advance made with respect to such Loan, no payment of principal or interest or portion thereof is more than ten days past due as of the applicable Cut-Off Date;

(xiii) the Loan is denominated and payable only in a Permitted Currency;

(xiv) the Obligor with respect to such Loan is an Eligible Obligor;

(xv) the Loan Documents with respect to such Loan require the related Obligor to provide ongoing financial information to the Originator, including, without limitation, quarterly financial statements, annual audited financial statements audited by an Independent third-party auditor, and ongoing covenant compliance certificates;

(xvi) a third party audit or due diligence has been performed with respect to Agented Loans to the satisfaction of the Originator. With respect to all other Loans (including Loans where Kohlberg Capital is a member of the initial lending group), audit or due diligence has been performed by the relevant loan agent or equity sponsor to the satisfaction of the Originator. The Obligor has agreed to provide the Servicer or a Successor Servicer with rights to inspect any Records or Related Property;

(xvii) the Loan, if it is a PIK Loan, has a current cash coupon of not less than 5%;

(xviii) the Loan does not by its terms permit the payment obligation of the Obligor thereunder to be converted into or exchanged for equity capital of such Obligor;

(xix) the Loan is not a security or obligation whose repayment is subject to substantial non-credit related risk as determined by the Servicer in its reasonable business judgment;

(xx) the Loan, together with the Loan Documents related thereto, is a “general intangible”, an “instrument”, a “payment intangible”, an “account” or “chattel paper” within the meaning of the UCC of all jurisdictions that govern the perfection of the security interest granted therein;

(xxi) all material consents, licenses, approvals or authorizations of, or registrations or declarations with, any Governmental Authority required to be obtained, effected or given in connection with the making of such Loan have been duly obtained, effected or given and are in full force and effect;

 

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(xxii) any applicable taxes in connection with the transfer of such Loan have been paid and the Obligor has been given any assurances (including with respect to the payment of transfer taxes and compliance with securities laws) required by the Loan Documents in connection with the transfer of the Loan;

(xxiii) the Loan, together with the related Loan Documents, is fully assignable, (and, if such Loan is secured by an interest in real property, an Assignment of Mortgage has been delivered to the Trustee or to a collateral agent pursuant to the terms of such Loan);

(xxiv) the Loan and the Borrower’s interest in all related Collateral and Related Property are free of any Liens, except for Permitted Liens and all filings and other actions required to perfect the security interest of (a) the Trustee on behalf of the Secured Parties, in the Collateral have been made or taken and (b) in the case of Agented Loans, the collateral agent, as agent for all lenders to the related Obligor, in the Related Property, have been made or taken;

(xxv) any Related Property with respect to such Loan is insured in accordance with the Credit and Collection Policy;

(xxvi) the Obligor of such Loan is legally responsible for all taxes relating to the Related Property, and all payments in respect of the Loan are required to be made free and clear of, and without deduction or withholding for or on account of, any taxes, unless such withholding or deduction is required by Applicable Law in which case the Obligor thereof is required to make “gross-up” payments that cover the full amount of any such withholding taxes on an after-tax basis (taking into account all available credits or deductions attributable to the payment or accrual of such taxes);

(xxvii) neither the Loan nor any portion of the Related Property constitute Margin Stock;

(xxviii) the Obligor of such Loan has waived all rights of set-off and/or counterclaim against the originator of the Loan and all assignees thereof;

(xxix) the Loan has been determined by the Servicer to be, or, in accordance with the Credit and Collection Policy, should have been determined by the Servicer to be, classified as having a risk rating of “Grade 4” or better;

(xxx) as of the date on which such Loan becomes part of the Collateral, the Collateral Quality Test is satisfied; provided that if immediately prior to such date, the Collateral Quality Test was not satisfied, such test is maintained or improved after giving effect to the inclusion of such Loan in the Collateral;

(xxxi) the Loan is not a Project Finance Obligation;

(xxxii) in the case of a Real Estate Construction Loan, such Loan has a publicly available Assigned Moody’s Rating or a publicly available Assigned S&P Rating as of its Cut-Off Date;

 

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(xxxiii) with respect to Agented Loans, the related Loan Documents (a) shall include a note purchase agreement or loan agreement containing provisions relating to the appointment and duties of a payment agent and a collateral agent and intercreditor and (if applicable) subordination provisions substantially similar to the forms provided to and approved by the Agent and attached hereto as Exhibit T, and (b) are duly authorized, fully and properly executed and are the valid, binding and unconditional payment obligation of the Obligor thereof;

(xxxiv) with respect to Agented Loans, the Originator has been appointed the collateral agent of the security (if any) and the payment agent for all such loans prior to such Agented Loan becoming a part of the Collateral;

(xxxv) with respect to Agented Loans, if the entity serving as the collateral agent of the security for all syndicated loans of the Obligor has or will change from the time of the origination of the loans, all appropriate assignments of the collateral agent’s rights in and to the collateral on behalf of the lenders have been executed and filed or recorded as appropriate prior to such Agented Loan becoming a part of the Collateral;

(xxxvi) with respect to Agented Loans, all required notifications, if any, have been given to the collateral agent, the payment agent and any other parties required by the Loan Documents, and all required consents, if any, have been obtained with respect to, the Originator’s assignment of the Agented Loans and the Originator’s right, title and interest in the Related Property to the Borrower and the Trustee’s security interest therein on behalf of the Secured Parties;

(xxxvii) with respect to Agented Loans, the right to control the actions of and to replace the collateral agent and/or the paying agent of the syndicated loans is by the Loan Majority;

(xxxviii) with respect to Agented Loans, all syndicated loans of the Obligor of the same priority are cross-defaulted, the Related Property securing such loans is held by the collateral agent for the benefit of all holders of the syndicated loans and all holders of such loans (a) have an undivided interest in the collateral securing such loans, (b) share in the proceeds of the sale or other disposition of such collateral on a pro rata basis and (c) may transfer or assign their right, title and interest in the Related Property; and

(xxxix) all information on the Loan List delivered to the Agent with respect to such Loan is true, correct and complete.

Eligible Obligor”: On any day, any Obligor that satisfies each of the following requirements at all times:

(i) such Obligor’s primary business is not in the nuclear waste or bio-tech industries;

(ii) such Obligor is not a natural person and is a legal operating entity, duly organized and validly existing under the laws of a Moody’s Group I Country or Bermuda;

 

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(iii) such Obligor is not an Affiliate of any of the parties hereto;

(iv) such Obligor’s principal office and any Related Property are located in a Moody’s Group I Country;

(v) no other Loan of such Obligor with an Outstanding Loan Balance in excess of $1,000,000 is more than 45 days past due;

(vi) such Obligor is not a Governmental Authority;

(vii) such Obligor is in compliance with all material terms and conditions of its Loan Documents; and

(viii) either (a) such Obligor and/or its operating subsidiaries each have an Operating History in its primary business of at least three years from the date of its incorporation or formation or (b) the chief executive officer and/or president of such Obligor has individually at least three years of management-level experience in the primary business in which the Obligor operates.

Equity Contribution”: As of any date of determination, an amount equal to the excess, if any, of (a) the sum of (i) the Aggregate Purchased Loan Balance on such date plus (ii) all Principal Collections on deposit in the Principal Collection Account on such date, over (b) the Advances Outstanding on such date.

ERISA”: The U.S. Employee Retirement Income Security Act of 1974, as amended from time to time, and the regulations promulgated, and rulings and interpretations issued thereunder.

ERISA Affiliate”: (a) Any corporation that is a member of the same controlled group of corporations (within the meaning of Section 414(b) of the Code) as the Borrower; (b) a trade or business (whether or not incorporated) under common control (within the meaning of Section 414(c) of the Code) with the Borrower or (c) a member of the same affiliated service group (within the meaning of Section 414(m) of the Code) as the Borrower, any corporation described in clause (a) above or any trade or business described in clause (b) above.

Estimated Payment Amount”: As of each Determination Date, an amount (to be calculated by the Servicer in good faith in its reasonable judgment) equal to the sum of the following: (a) the Interest, (b) the Program Fee, (c) the Facility Fee, (d) the Servicing Fee, (e) the Backup Servicer Fee and (f) the Trustee Fee, each as estimated by the Servicer to be due and payable on the next succeeding Payment Date; provided that, notwithstanding the foregoing, in no event without the prior written approval of the Agent shall the Estimated Payment Amount be less than the product of (i) 1.1 and (ii) the sum of the Interest, the Program Fee, the Facility Fee, the Servicing Fee, the Backup Servicer Fee and the Trustee Fee actually due and payable on the Payment Date with respect to the preceding Collection Period.

Euro”: The lawful currency of the Participating Member States.

 

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Eurocurrency Liabilities”: Defined in Regulation D of the Board of Governors of the Federal Reserve System, as in effect from time to time.

Eurodollar Rate”: For any Accrual Period and any Advance, an interest rate per annum equal to:

(a) the rate appearing on Reuters Page 248 and 249, as applicable, for deposits in Euro as of 11:00 a.m. Brussels time two TARGET Days before the applicable Funding Date (with respect to the initial Accrual Period for such Advance) and two TARGET Days before the first day of the applicable Accrual Period (with respect to all subsequent Accrual Periods for such Advance); or

(b) if no rate appears on Reuters Page 248 and 249, as applicable, at such time and day, then the Eurodollar Rate shall be determined by the Agent as its rate (each such determination, absent manifest error, to be conclusive and binding on all parties hereto and their assignees) at which one-month deposits in Euro are being, have been, or would be offered or quoted by the Agent to major banks in the applicable interbank market for deposits in Euro at or about 11:00 a.m. Brussels time on such day.

Eurodollar Disruption Event”: The occurrence of any of the following: (a) any Liquidity Bank or any Institutional Lender shall have notified the Agent of a determination by such Liquidity Bank, any of its assignees or participants, or such Institutional Lender, that it would be contrary to law or to the directive of any central bank or other Governmental Authority (whether or not having the force of law) to obtain Dollars in the London interbank market to fund any Advance, (b) any Liquidity Bank or any Institutional Lender shall have notified the Agent of the inability, for any reason, of such Liquidity Bank, any of its assignees or participants, or such Institutional Lender, to determine the Adjusted Eurodollar Rate, (c) any Liquidity Bank or any Institutional Lender shall have notified the Agent of a determination by such Liquidity Bank, any of its assignees or participants, or such Institutional Lender, that the rate at which deposits of Dollars are being offered to such Liquidity Bank, any of its assignees or participants or such Institutional Lender in the London interbank market does not accurately reflect the cost to such Liquidity Bank, such assignee or such participant, or such Institutional Lender, of making, funding or maintaining any Advance or (d) any Liquidity Bank or Institutional Lender shall have notified the Agent of the inability of such Liquidity Bank, any of its assignees or participants, or such Institutional Lender, to obtain Dollars in the London interbank market to make, fund or maintain any Advance.

Eurodollar Reserve Percentage”: For any period, means the reserve percentage (expressed as a decimal, rounded upward to the next 1/100th of one percent (0.01%)), if any, applicable during such period (or, if more than one such percentage shall be so applicable, the daily average of such percentages for those days in such period during which any such percentage shall be so applicable) under regulations issued from time to time by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement (including, without limitation, any basic, emergency, supplemental, marginal or other reserve requirements) with respect to liabilities or assets consisting of or including Eurocurrency Liabilities having a term of one, two or three months.

 

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Exchange Act”: The Securities Exchange Act of 1934, as amended.

Excluded Amounts”: Any Collections received with respect to Repurchased Loans, Replaced Loans or Loans which are the subject of a Lien Release Dividend or a Discretionary Sale to the extent such Collections are attributable to a time after the effective date of such repurchase, substitution, Lien Release Dividend or Discretionary Sale.

Facility Amount”: $200,000,000, as such amount may vary from time to time upon the written agreement of the parties hereto; provided that on or after the Termination Date, the Facility Amount shall be $0.

Facility Fee”: Defined in the Fee Letter.

Fair Market Value”: As of any date of determination with respect to each Eligible Loan included in the Collateral, if such Eligible Loan has been reduced in value on such date of determination below the original principal amount (other than as a result of the allocation of a portion of the original principal amount to warrants), the fair market value of such Eligible Loan, as determined in accordance with the quarterly loan grading and asset valuation functions specified in the Credit and Collection Policy, and as required by, and in accordance with, the 1940 Act and any orders of the Securities and Exchange Commission issued to the Originator, to be determined by the Valuation Committee and approved by the Board of Directors of the Originator and as may be reviewed by its auditors.

Fairway”: Fairway Finance Company, LLC, as Conduit Lender hereunder.

FATF”: Defined in Section 4.1(jj).

Federal Funds Rate”: For any period, a fluctuating interest rate per annum equal for each day during such period to the weighted average of the federal funds rates as quoted by the Agent and confirmed in Federal Reserve Board Statistical Release H.15 (519) or any successor or substitute publication selected by the Agent (or, if such day is not a Business Day, for the preceding Business Day), or, if, for any reason, such rate is not available on any day, the rate determined, in the sole opinion of the Agent to be the rate at which federal funds are being offered for sale in the national federal funds market at 9:00 a.m. (New York City time)

Fee Letter”: The Fee Letter, dated as of the date hereof, among the Borrower, the Servicer, the Agent, as such letter may be amended, supplemented, modified, waived or restated from time to time.

Federal Reserve Board”: The Board of Governors of the Federal Reserve System.

Financial Sponsor”: Any Person, including any subsidiary of such person, whose principal business activity is acquiring, holding and selling investments (including controlling interests) in otherwise unrelated companies that are distinct legal entities with separate management, books, records and bank accounts, whose operations are not integrated with one another and whose financial condition and creditworthiness are independent of the other companies owned by such Person.

 

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Fixed Charge Coverage Ratio”: For any twelve-month period, the ratio of (i) EBITDA of an Obligor and its Subsidiaries on a consolidated basis during such period plus scheduled payments on Capitalized Leases included in the computation of EBITDA for such period minus Capital Expenditures during such period minus Taxes paid in cash during such period to (ii) the Current Fixed Charges during such period.

Fixed Rate Loan”: A Transferred Loan that is other than a Floating Rate Loan.

Fixed Rate Loan Percentage”: As of any date of determination, the percentage equivalent of a fraction (i) the numerator of which is equal to the sum of the Outstanding Loan Balances of all Fixed Rate Loans as of such date and (ii) the denominator of which is equal to the Aggregate Outstanding Loan Balance as of such date.

Floating Rate Loan”: A Transferred Loan where the interest rate payable by the Obligor thereof is based on the prime interest rate (daily rate) or the London interbank offered rate (one-month, two-month, three-month, six-month or twelve-month rate) plus some specified interest percentage in addition thereto, and such Transferred Loan provides that such interest rate will reset periodically upon any change in the related prime interest rate or London interbank offered rate.

Funding Date”: Any Business Day on which an Advance is made.

Funding Request”: A Borrower Notice requesting an Advance and including the items required by Section 2.2.

GAAP”: Generally accepted accounting principles in the United States of America. All ratios and computations based on GAAP contained in this Agreement shall be computed in conformity with GAAP as in effect on the date hereof.

Governmental Authority”: Any nation or government, any state or other political subdivision thereof, any central bank (or similar monetary or regulatory authority) thereof, any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government, any court or arbitrator and any accounting board or authority (whether or not a part of the government) which is responsible for the establishment or interpretation of national or international accounting principles.

Grant”: To grant, bargain, sell, warrant, alienate, remise, demise, release, convey, assign, transfer, mortgage, pledge, create and grant a security interest in and right of set-off against, deposit, set over and confirm. A Grant of any instrument, shall include all rights, powers and options (but none of the obligations) of the granting party thereunder, including without limitation, the immediate and continuing right to claim for, collect, receive and give receipt for principal and interest payments in respect thereof, and all other monies payable thereunder, to give and receive notices and other communications, to make waivers or other agreements, to exercise all rights and options, to bring any suit in equity, action at law or other judicial or administrative proceeding in the name of the granting party or otherwise, and generally to do and receive anything that the granting party may be entitled to do or receive thereunder or with respect thereto.

 

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Hedge Breakage Costs”: With respect to each Hedge Counterparty upon the early termination of any Hedge Transaction with such Hedge Counterparty, the net amount, if any, payable by the Borrower to such Hedge Counterparty for the early termination of that Hedge Transaction or any portion thereof.

Hedge Collateral”: Defined in Section 5.2(c).

Hedge Counterparty”: Means (a) Bank of Montreal and (b) any other entity that (i) on the date of entering into any Hedge Transaction (x) is an interest rate swap dealer that has been approved in writing by the Agent (which approval shall not be unreasonably withheld), and (y) has a long-term unsecured debt rating of not less than “A” by S&P and not less than “A2” by Moody’s (the “Long-term Rating Requirement”) and a short-term unsecured debt rating of not less than “A-1” by S&P and not less than “P-1” by Moody’s (the “Short-term Rating Requirement”), (ii) in a Hedging Agreement (x) consents to the assignment of the Borrower’s rights under the Hedging Agreement to the Trustee on behalf of the Secured Parties pursuant to Section 5.2(c) and (y) agrees that in the event that Moody’s or S&P reduces its long-term unsecured debt rating below the Long-term Rating Requirement, it shall either collateralize its obligations in a manner satisfactory to the Agent or transfer its rights and obligations under each Hedging Agreement (excluding, however, any right to net payments or Hedge Breakage Costs under any Hedge Transaction, to the extent accrued to such date or to accrue thereafter and owing to the transferring Hedge Counterparty as of the date of such transfer) to another entity that meets the requirements of clauses (b)(i) and (b)(ii) hereof and has entered into a Hedging Agreement with the Borrower on or prior to the date of such transfer, and (iii) is a QIB.

Hedge Percentage”: On any day (a) prior to the occurrence of an Interest Rate Hedge Trigger, 0%, and (b) on or after the day on which an Interest Rate Hedge Trigger occurs, 100%.

Hedge Transaction”: Each Interest Rate Hedge Transaction and each Currency Hedge Transaction.

Hedging Agreement”: Each agreement between the Borrower and a Hedge Counterparty that governs one or more Hedge Transactions entered into by the Borrower and such Hedge Counterparty pursuant to Section 5.2(a) or 5.2(b), as applicable, which agreement shall consist of a “Master Agreement” in a form published by the International Swaps and Derivatives Association, Inc., together with a “Schedule” thereto substantially in the form of Exhibit H-1 or H-2 hereto or such other forms as the Agent shall approve in writing, and each “Confirmation” thereunder confirming the specific terms of each such Hedge Transaction.

High Yield Bond”: A high yield debt obligation of corporations, partnerships or other entities that is unrated or rated below Investment Grade.

Increased Costs”: Any amounts required to be paid by the Borrower to an Affected Party pursuant to Section 2.13.

Indebtedness”: With respect to any Person as of any date, whether or not reflected on the balance sheet or comparable statement of financial position of such Person, (a) all indebtedness of such Person as well as any special purpose entity Subsidiaries of such Person for borrowed money or for the deferred purchase price of property or services (other than current

 

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liabilities incurred in the ordinary course of business and payable in accordance with customary trade practices) or that is evidenced by a note, bond, debenture or similar instrument (including, without limitation, any note, bond, debenture or similar instrument issued in connection with a securitization transaction), (b) all obligations of such Person under capital leases, (c) all obligations of such Person in respect of bank acceptances issued or created for the account of such Person, (d) all liabilities secured by any Lien on any property owned by such Person even though such Person has not assumed or otherwise become liable for the payment thereof, and (e) all indebtedness, obligations or liabilities of that Person in respect of Derivatives, determined as of such date on a net mark to market basis in accordance with customary market practice and (f) obligations under direct or indirect guaranties in respect of obligations (contingent or otherwise) to purchase or otherwise acquire, or to otherwise assure a creditor against loss in respect of, clauses (a) through (f) above.

Indemnified Amounts”: Defined in Section 10.1.

Indemnified Parties”: Defined in Section 10.1.

Independent”: As to any Person, any other Person (including, in the case of an accountant, or lawyer, a firm of accountants or lawyers and any member thereof or an investment bank and any member thereof) who (i) does not have and is not committed to acquire any material direct or any material indirect financial interest in such Person or in any Affiliate of such Person, and (ii) is not connected with such Person as an Officer, employee, promoter, underwriter, voting trustee, partner, director or Person performing similar functions. “Independent”, when used with respect to any accountant, may include an accountant who audited the books of such Person if in addition to satisfying the criteria set forth above the accountant is independent with respect to such Person within the meaning of Rule 101 of the Code of Ethics of the American Institute of Certified Public Accountants.

Independent Manager”: Defined in Section 4.1(t)(xxvii).

Industry”: The industry of an Obligor as determined by reference to the four digit standard industry classification (SIC) codes.

Ineligible Loan”: Defined in Section 2.18(b)(i).

Initial Advance”: The first Advance.

Initial Participation”: A participation interest, granted on or about the Closing Date by the Originator in all or a portion of an Eligible Loan held by the Originator as of such date, which shall be converted into a full assignment within 60 days following the Closing Date.

Insolvency Event”: With respect to a specified Person, (a) the filing of a decree or order for relief by a court having jurisdiction in the premises in respect of such Person or any substantial part of its property in an involuntary case under any applicable Insolvency Law now or hereafter in effect, or appointing a receiver, liquidator, assignee, custodian, trustee, sequestrator or similar official for such Person or for any substantial part of its property, or ordering the winding-up or liquidation of such Person’s affairs, and such decree or order shall remain unstayed and in effect for a period of 60 consecutive days; or (b) the commencement by

 

25


such Person of a voluntary case under any applicable Insolvency Law now or hereafter in effect, or the consent by such Person to the entry of an order for relief in an involuntary case under any such law, or the consent by such Person to the appointment of or taking possession by a receiver, liquidator, assignee, custodian, trustee, sequestrator or similar official for such Person or for any substantial part of its property, or the making by such Person of any general assignment for the benefit of creditors, or the failure by such Person generally to pay its debts as such debts become due, or the taking of action by such Person in furtherance of any of the foregoing.

Insolvency Laws”: The Bankruptcy Code and all other applicable liquidation, conservatorship, bankruptcy, moratorium, rearrangement, receivership, insolvency, reorganization, suspension of payments, or similar debtor relief laws from time to time in effect affecting the rights of creditors generally.

Insolvency Proceeding”: Any case, action or proceeding before any court or Governmental Authority relating to an Insolvency Event.

Institutional Lender”: Each Lender designated as such on its signature page hereto and each financial institution, other than a Conduit Lender, which may from time to time become a Lender hereunder by executing and delivering to the Agent, the Borrower and the Servicer (a) an Assignment and Acceptance and a Transferee Letter as contemplated by Section 12.17 or (b) a Joinder Supplement to the Agent and the Borrower as contemplated by Section 2.1(e).

Insurance Policy”: With respect to any Transferred Loan included in the Collateral, an insurance policy covering physical damage to or loss to any assets or Related Property of the Obligor securing such Transferred Loan.

Insurance Proceeds”: Any amounts payable or any payments made to the Borrower or to the Servicer on its behalf under any Insurance Policy.

Intercreditor Agreement”: The Intercreditor and Concentration Account Administration Agreement, dated as of February 14, 2007, among U.S. Bank, as the Concentration Account Bank and as the account custodian, each securitization agent that from time to time executes a joinder thereto, and Kohlberg Capital, as Originator, Original Servicer and Concentration Account Servicer, as such agreement may be amended, modified, waived, supplemented or restated from time to time.

Interest”: For each Accrual Period and each Advance outstanding during such Accrual Period, the sum of the products (for each day during such Accrual Period) of:

LOGO

where:

IR         =        the Interest Rate applicable on such day;

P          =        the principal amount of such Advance on such day; and

 

26


D          =        360 or, to the extent the Interest Rate is based on the Base Rate, 365 or 366 days, as applicable.

provided that (i) no provision of this Agreement shall require or permit the collection of Interest in excess of the maximum permitted by Applicable Law and (ii) Interest shall not be considered paid by any distribution if at any time such distribution is rescinded or must otherwise be returned for any reason.

Interest Collection Account”: The subaccount of the Collection Account into which all Interest Collections are deposited by the Borrower or the Servicer on behalf of the Borrower in accordance with Section 2.9.

Interest Collections”: Any and all amounts (not constituting Principal Collections) received on a Transferred Loan from or on behalf of any Obligors that are deposited into the Collection Account, or received by the Borrower or by the Servicer or Originator on behalf of the Borrower in respect of Transferred Loans and, solely for purposes of calculating the Portfolio Yield, any and all amounts accrued in respect of any fees and other charges (but only to the extent such fees are not part of the Retained Interest or were not received during such Collection Period) owed by any Obligor in respect of any Eligible Loan (net of any payment owed by the Borrower to, and including any receipts from, any Hedge counterparties).

Interest Rate”: For each Accrual Period and for each Advance outstanding for each day during such Accrual Period:

(a) to the extent the applicable Conduit Lender has funded the Advance through the issuance of Commercial Paper Notes, a rate equal to the applicable CP Rate; or

(b) to the extent the applicable Conduit Lender or Institutional Lender did not fund the Advance through the issuance of Commercial Paper Notes, a rate equal to the Alternative Rate;

provided that: (i) the Interest Rate shall be the Base Rate for any Accrual Period for any Advance as to which a Conduit Lender has funded the making or maintenance thereof by a sale of an interest therein to any Liquidity Bank under the applicable Liquidity Purchase Agreement on any day other than the first day of such Accrual Period and without giving such Liquidity Bank at least two Business Days’ prior notice of such assignment; (ii) the Interest Rate shall be the Base Rate if such Conduit Lender or Liquidity Bank shall have notified the Agent that a Eurodollar Disruption Event has occurred; and (iii) the Interest Rate shall be the applicable Prime Rate plus 0.75% for each day during any Accrual Period following the occurrence of a Termination Event that is continuing.

Interest Rate Hedge Amount”: On any day, an amount equal to the excess, if any, of (a) the aggregate Outstanding Loan Balance of all Eligible Loans in the Collateral that are Fixed Rate Loans over (b) the product of (i) 10% and (ii) the Aggregate Outstanding Loan Balance.

Interest Rate Hedge Amount Notional Band”: As of any date of determination, the maximum amount by which the Interest Rate Hedge Notional Amount may exceed or be less than the product of the Hedge Percentage and the Interest Rate Hedge Amount, as agreed by the

 

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Agent in its sole discretion; provided that such Interest Rate Hedge Amount Notional Band shall in no event permit the Interest Rate Hedge Notional Amount to exceed or be less than the product of the Hedge Percentage and the Interest Rate Hedge Amount by an amount greater than 10% of the aggregate Outstanding Loan Balance of all Eligible Loans in the Collateral that are Fixed Rate Loans as of such date.

Interest Rate Hedge Notional Amount”: The aggregate notional amount in effect on any day under all Interest Rate Hedge Transactions entered into pursuant to Section 5.2(a), that have not matured, been terminated or cancelled.

Interest Rate Hedge Transaction”: Each interest rate swap, index rate swap or interest rate cap transaction or comparable derivative arrangements as the Agent may approve in its discretion between the Borrower and a Hedge Counterparty that is entered into pursuant to Section 5.2(a) and is governed by an Interest Rate Hedging Agreement.

Interest Rate Hedge Trigger”: An event occurring when the Fixed Rate Loan Percentage is greater than 10%.

Interest Rate Protection Agreement”: Any interest rate swap, interest rate cap, interest rate collar or other interest rate hedging agreement or arrangement.

Investment”: With respect to any Person, any direct or indirect loan, advance or investment by such Person in any other Person, whether by means of share purchase, capital contribution, loan or otherwise, excluding the acquisition of assets pursuant to the Purchase Agreement and excluding commission, travel and similar advances to officers, employees and directors made in the ordinary course of business.

Investment Grade”: An S&P Rating of “BBB-” or better, or a Moody’s Rating of “Baa3” or better.

ISDA Definitions”: The 2000 ISDA Definitions, as published by the International Swaps and Derivatives Association, Inc.

Joinder Supplement”: An agreement among the Borrower, the Servicer, a Lender and the Agent in the form of Exhibit R to this Agreement (appropriately completed) delivered in connection with a Person becoming a Lender hereunder after the Closing Date, as contemplated by Section 2.1(e).

Junior Secured Loan”: Any Loan that (i) is secured by a second priority Lien on substantially all the obligor’s assets constituting collateral for the Loan and (ii) contains provisions that, upon the occurrence of an event of default under the related Loan Documents or in the case of any liquidation or foreclosure on the related collateral, the Borrower’s portion of such Loan would be paid only after certain other lenders party to such Loan and having a first priority Lien over the collateral securing such Loan are paid in full.

Kohlberg Capital”: Defined in the Preamble.

 

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Large Middle Market Loan”: Any Loan issued as part of a loan facility with an original loan size (including any first and second lien loans included in the facility) greater than $125,000,000 but less than $250,000,000, including for purposes of this definition the maximum available amount of commitments under any Revolving Loans.

Lender” and “Lenders”: Defined in the Preamble.

Lender’s Account”: The account specified by each Lender party hereto in Annex D, in any Assignment and Acceptance or in any Joinder Supplement.

Lender Agent”: With respect to (i) Fairway, BMO, (ii) Riverside Funding LLC, as Conduit Lender hereunder, Deutsche Bank AG, New York Branch and (iii) each Lender which may from time to time become a party hereto, the Person designated as the “Lender Agent” with respect to such Lender in the applicable Assignment and Acceptance or Joinder Supplement.

Leverage Ratio”: With respect to any person, the ratio of Indebtedness of such Person and its Affiliates to stockholders’ equity (as determined in accordance with GAAP) of such Person.

LIBOR Rate”: For any Accrual Period and any Advance, an interest rate per annum equal to:

(a) the posted rate for one-month deposits in Dollars, appearing on Telerate page 3750 as of 11:00 a.m. (London time) on the Business Day that is the second Business Day immediately preceding the applicable Funding Date (with respect to the initial Accrual Period for such Advance) and as of the second Business Day immediately preceding the first (1st) day of the applicable Accrual Period (with respect to all subsequent Accrual Periods for such Advance); or

(b) if no rate appears on Telerate page 3750 at such time and day, then the LIBOR Rate shall be determined by the Agent as its rate (each such determination, absent manifest error, to be conclusive and binding on all parties hereto and their assignees) at which one-month deposits in Dollars are being, have been, or would be offered or quoted by the Agent to major banks in the applicable interbank market for Eurodollar deposits at or about 11:00 a.m. (New York, New York time) on such day.

Lien”: With respect to any Collateral, (a) any mortgage, lien, pledge, charge, security interest or encumbrance of any kind in respect of such Collateral, or (b) the interest of a vendor or lessor under any conditional sale agreement, financing Loan or other title retention agreement relating to such Collateral.

Lien Release Dividend”: Defined in Section 2.16(a).

Lien Release Dividend Date”: The date specified by the Borrower, which date may be any Business Day, provided written notice is given in accordance with Section 2.16(a).

Liquidation Expenses”: With respect to any Defaulted Loan, the aggregate amount of all out-of-pocket expenses reasonably incurred by the Borrower or on behalf of the Borrower by the Servicer (including amounts paid to any subservicer) in connection with the repossession, refurbishing and disposition of any related assets securing such Transferred Loan including the attempted collection of any amount owing pursuant to such Transferred Loan.

 

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Liquidity Bank”: Each liquidity bank that is a party to a Liquidity Purchase Agreement.

Liquidity Purchase Agreement”: Any agreement entered into in connection with this Agreement pursuant to which a Liquidity Bank agrees to make purchases from or advances to, or purchase assets from, any Conduit Lender in order to provide liquidity support for such Conduit Lender’s Advances hereunder.

Loan”: Any (a) Senior Secured Loan, Junior Secured Loan or Subordinated Loan (i) arising from the extension of credit to an Obligor by the Originator, (ii) purchased and re-underwritten in the ordinary course of the Originator’s business or (iii) that is a Third Party Acquired Loan (which, in each case, may be a Broadly Syndicated Loan, Traditional Middle Market Loan or Large Middle Market Loan), including, without limitation, all Add-On Loans, Revolving Loans and PIK Loans (or a Participation in any of the foregoing), (b) Securities (as applicable) and (c) monies due and owing and all Interest Collections, Principal Collections and other amounts received from time to time with respect to such Security, loan or note receivable and all Proceeds thereof.

Loan Checklist”: With respect to any Loan, the index prepared by the Servicer identifying the type of Loan (including whether such Loan is a Noteless Loan or an Agented Loan and the identity of the agent) and each of the Loan Documents related thereto which are included in the related Loan File.

Loan Documents”:

(a) For each Loan (other than those described in clause (b) below), originals (except as otherwise indicated) of the following documents or instruments:

(i) other than in the case of a Noteless Loan or a Participation, the original or, in the case of a lost note accompanied by an affidavit and indemnity, a copy of the underlying promissory note, endorsed by the Borrower or the prior holder of record either in blank or to the Trustee (and evidencing an unbroken chain of endorsements from each prior holder thereof evidenced in the chain of endorsements to the Agent), with any endorsement to the Trustee to be in the following form: “U.S. Bank National Association, as Trustee”, (ii) in the case of a Noteless Loan, (x) a copy of each transfer document or instrument relating to such Noteless Loan evidencing the assignment of such Noteless Loan either (1) from the Originator to the Borrower and from the Borrower either to the Trustee or in blank, or (2) from the prior third party owner thereof directly to the Borrower (at the direction of the Originator) and from the Borrower either to the Trustee or in blank, and (y) a copy of the Loan Register with respect to such Noteless Loan and (iii) in the case of a Participation, a participation agreement;

(ii) originals or copies of each of the following, to the extent applicable to the related Loan: any related loan agreement, credit agreement, note purchase agreement, security agreement, sale and servicing agreement, acquisition agreement, subordination agreement, intercreditor agreement or similar instruments, guarantee, Insurance Policy

 

30


(where applicable), assumption or substitution agreement or similar material operative document, in each case together with any amendment or modification thereto, as set forth on the Loan Checklist;

(iii) if any Loan is secured by real property, an Assignment of Mortgage and of any other material recorded security documents in recordable form, executed by the Borrower or the prior holder of record, in blank or to the Agent (and evidencing an unbroken chain of assignments from the prior holder of record to the Agent), with any assignment to the Agent to be in the following form: “U.S. Bank National Association, as Trustee” unless such mortgage is held by a collateral agent for the benefit of the Lenders;

(iv) either, in each case as indicated on the Loan Checklist, (i) copies of the UCC-1 Financing Statements, if any, and any related continuation statements, each showing the Obligor as debtor and each with evidence of filing thereon, or (ii) copies of any such financing statements certified by the Servicer to be true and complete copies thereof in instances where the original financing statements have been sent to the appropriate public filing office for filing;

(b) for each Loan with respect to which the Originator does not act as Agent (or in a comparable capacity), originals (except as otherwise indicated) of the following documents or instruments:

(i) other than in the case of a Noteless Loan or a Participation, the original or, in the case of a lost note accompanied by an affidavit and indemnity, a copy of the underlying promissory note, endorsed by the Borrower or the prior holder of record either in blank or to the Trustee (and evidencing an unbroken chain of endorsements from each prior holder thereof evidenced in the chain of endorsements to the Agent), with any endorsement to the Agent to be in the following form: “U.S. Bank National Association, as Trustee”, (ii) in the case of a Noteless Loan, (x) a copy of each transfer document or instrument relating to such Noteless Loan evidencing the assignment of such Noteless Loan either (1) from the Originator to the Borrower and from the Borrower either to the Agent or in blank, or (2) from the prior third party owner thereof directly to the Borrower (at the direction of the Originator) and from the Borrower either to the Agent or in blank, and (y) a copy of the Loan Register with respect to such Noteless Loan and (iii) in the case of a Participation, a participation agreement;

(ii) copies or electronic versions of each of the following, to the extent applicable to the related Loan: any related loan agreement, credit agreement, note purchase agreement, participation agreement, security agreement, sale and servicing agreement, acquisition agreement, subordination agreement, intercreditor agreement or similar instruments, guarantee, Insurance Policy (where applicable), assumption or substitution agreement or similar material operative document, in each case together with any amendment or modification thereto, as set forth on the Loan Checklist.

Loan File”: With respect to any Loan, each of the Loan Documents related thereto (as identified on the Loan List).

 

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Loan List”: The Loan List provided by the Borrower to the Agent and the Trustee in connection with each Advance or as new Eligible Loans are added to the Collateral, initially as set forth in Schedule IV hereto (which shall set forth a description of each Transferred Loan, including, without limitation, the name of the Obligor of each such Transferred Loan, the related loan number (as set forth in the Servicer’s internal records), the maturity date and type of each such Transferred Loan), as the same may be amended, modified or supplemented from time to time in accordance with the provisions hereof.

Loan Majority”: With respect to Agented Loans, the holders of the loans evidencing not less than 66-2/3% of the outstanding amount of all such loans issued by the Obligor.

Loan Rate”: For each Loan, in a Collection Period, the current cash pay interest rate for such Loan in such period as specified in the related Loan Documents.

Loan Register”: Defined in Section 7.9(r).

Margin Stock”: Means “Margin Stock” as defined in Regulation U issued by the Board of Governors of the Federal Reserve System.

Market Servicing Fee”: Defined in Section 7.27.

Market Servicing Fee Differential”: On any date of determination, an amount equal to the excess, if any, of the Market Servicing Fee over the Servicing Fee.

Market Value”: As of any date of determination, for any Loan, the value of such Loan (expressed in Dollars) calculated by the Servicer and based upon:

(a) the valuation for such Loan obtained by the Servicer from an Approved Pricing Service; or

(b) if Market Value cannot be determined pursuant to clause (a) above because no Approved Pricing Service is available, then the Market Value of such Loan shall be determined as the average of the bid prices for such Loan obtained by the Servicer from two nationally recognized broker/dealers Independent of each other and of the Servicer and any of its Affiliates (provided that, in each case, any such bid prices must be for an amount of the Loan equal to the amount of the Loan to be sold or valued).

Master Participation Agreement”: The Master Participation Agreement, dated as of February 14, 2007, by and among Kohlberg Capital Corporation, as Seller, and Kohlberg Capital Funding LLC I, as Participant.

Material Adverse Change”: With respect to any Person, any material adverse change in the business, financial condition, operations, performance or properties of such Person.

Material Adverse Effect”: With respect to any event or circumstance, means a material adverse effect on, as applicable, (a) the business, financial condition, operations, performance or properties of the Servicer, the Borrower, the Backup Servicer or the Trustee, (b) the validity, enforceability or collectibility of this Agreement or any other Transaction Document or the

 

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validity, enforceability or collectibility of the Loans, (c) the rights and remedies of the Trustee on behalf of the Secured Parties, the Agent or any other Secured Party under this Agreement or any Transaction Document or (d) the ability of the Servicer, the Borrower, the Backup Servicer or the Trustee to perform its obligations under this Agreement or any other Transaction Document, or (e) the status, existence, perfection, priority, or enforceability of the Trustee’s, for the benefit of the Secured Parties, interest in the Collateral.

Maximum Availability”: On any day, the lesser of (i) the sum of (A) the excess of (1) the Borrowing Base over (2) the Minimum Overcollateralization Amount plus (B) the amount of Principal Collections on deposit in the Principal Collection Account and (ii) the Facility Amount; provided that during the Amortization Period, the Maximum Availability shall be equal to the Advances Outstanding.

Maximum Lawful Rate”: Defined in Section 2.7(c).

Measurement Date”: Each of the following: (i) the date of any Borrowing Notice; (ii) any Lien Release Dividend Date; (iii) any Discretionary Sale Date; (iv) any date on which a substitution or repurchase of a Loan occurs pursuant to Section 2.18; (v) the date as of which any Monthly Report, as provided for in Section 7.17(a), is calculated; and (vi) each Funding Date.

Minimum Overcollateralization Amount”: As of any date of determination, an amount equal to the greater of (a) the amount determined by multiplying (i) the Borrowing Base on such date times (ii) one minus the Advance Rate and (b) the Required Equity Contribution.

Monthly Report”: Defined in Section 7.17(a).

Moody’s”: Moody’s Investors Service, Inc., or any successor thereto.

Moody’s Collateral Value”: With respect to any Defaulted Loan as of any date of determination, (a) for a period not to exceed 18 months since the date such Loan was determined to be a Defaulted Loan, the lesser of (i) the Moody’s Recovery Amount of such Loan and (ii) the Market Value of such Loan and (b) zero thereafter.

Moody’s Derived Rating”: With respect to a Loan whose Moody’s Rating cannot otherwise be determined pursuant to the definition thereof, such Moody’s Rating shall be determined as set forth below:

(a) If the Obligor of such Loan has a long-term issuer rating by Moody’s, then such long-term issuer rating.

(b) If not determined pursuant to clause (a) above, if another obligation of the Obligor is rated by Moody’s, then by adjusting the rating of the related Moody’s rated obligation of the related Obligor by the number of rating sub-categories according to the table below:

 

Obligation Category of

Rated Obligation

 

Rating of

Rated Obligation

 

Number of

Subcategories Relative

to Rated Obligation

Rating

Senior secured obligation   greater than or equal to “B2”   -1
Senior secured obligation   less than “B2”   -2
Subordinated obligation   greater than or equal to “B3”   +1
Subordinated obligation   less than “B3”   0

 

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(c) If not determined pursuant to clause (a) or (b) above, if the Obligor of such Loan has a corporate family rating by Moody’s, then one subcategory below such corporate family rating;

(d) If not determined pursuant to clause (a), (b) or (c) above, then by using any one of the methods provided below:

(1) (i) If such Loan is rated by S&P, then by adjusting the S&P Rating by the number of rating sub-categories according to the table below:

 

S&P Rating

 

Obligation

Rated by S&P

 

Number of

Subcategories Relative

to Moody’s Equivalent

of S&P Rating

>“BBB-”   Security   -1
<“BB+”   Security   -2
  Loan (other than a Security) or Participation Interest in Loan   -2

(ii) if such Loan is not rated by S&P but another security or obligation of the obligor is rated by S&P (a “parallel security”), then the rating of such parallel security will at the election of the Servicer be determined in accordance with the table set forth in clause (1)(i) above, and the Moody’s Rating of such Loan will be determined in accordance with the methodology set forth in clause (a) above (for such purposes treating the parallel security as if it were rated by Moody’s at the rating determined pursuant to this clause (1)(ii)); or

(iii) if such Loan is a DIP Loan, no Moody’s Rating may be determined based on a rating by S&P or any other rating agency;

 

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(2) if such Loan is not rated by Moody’s or S&P and no other security or obligation of the issuer of such Loan is rated by Moody’s or S&P, and if Moody’s has been requested by the Borrower or the Servicer to assign a rating or rating estimate with respect to such Loan but such rating or rating estimate has not been received, pending receipt of such estimate, (A) “B3” for a period of up to 45 days from its Cut-Off Date if (x) the Servicer has certified to the Agent that, based on facts and information available to it, it believes (which belief shall not be called into question as a result of subsequent events or circumstances) that the Loan shall receive a rating of at least “B3” and (y) the issuer of such Loan is not in default under any of its debt or (B) otherwise, “Caa2”;

(3) if such Loan is an Unrated Loan, the Moody’s Rating for such Loan shall be deemed to be “Caa2”; provided that any such Loan shall be deemed to have a Moody’s Rating of “B3” for so long as (I) the Obligor thereof is current on any cumulative dividends, (II) the Fixed Charge Coverage Ratio for such Obligor exceeds 125% for each of the past two fiscal years and for the most recent quarter, (III) such Obligor recorded a net profit before tax for the immediately preceding fiscal year and the most recent quarter and (IV) the annual financial statements of such Obligor are unqualified and certified by a firm of Independent accountants or international reputation and such Obligor’s quarterly statements are unaudited but signed by a corporate officer of such Obligor; provided further that if such financial statements are unavailable for a period of more than 90 days, the Moody’s Rating of such Loan shall be deemed to be “Caa2”.

(4) if a debt security or obligation of the Obligor has been in default during the past two years, “Ca”;

provided that, for purposes of calculating a Moody’s Derived Rating, each applicable rating on credit watch by Moody’s with negative implication at the time of calculation will be treated as having been downgraded by one rating subcategory; provided further that the Moody’s Facility Rating for a DIP Loan may not be derived or implied but instead will be determined in accordance with clause (d)(2) above.

Moody’s Group I Country”: Any one of the United States, Canada, the Netherlands, the Channel Islands or the United Kingdom.

Moody’s Rating”: An Assigned Moody’s Rating or, if an Assigned Moody’s Rating is not available, a Moody’s Derived Rating.

Moody’s Rating Factor” means, for each Loan, the number set forth in the table below opposite the Moody’s Rating of such Loan:

 

Moody’s Rating

 

Moody’s

Rating Factor

 

Moody’s Rating

 

Moody’s

Rating Factor

Aaa   1   Ba1   940
Aa1   10   Ba2   1,350
Aa2   20   Ba3   1,766
Aa3   40   B1   2,220
A1   70   B2   2,720

 

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Moody’s Rating

 

Moody’s

Rating Factor

 

Moody’s Rating

 

Moody’s

Rating Factor

A2   120   B3   3,490
A3   180   Caa1   4,770
Baal