This prospectus supplement relates to an effective registration statement under the Securities Act of 1933, as amended, but is not complete and may be changed. This preliminary prospectus supplement and the accompanying prospectus are not an offer to sell and are not soliciting offers to buy these securities in any jurisdiction where such offer or sale is not permitted.

Filed Pursuant to Rule 497
Registration No. 333-187570

SUBJECT TO COMPLETION, DATED OCTOBER 6, 2014

PROSPECTUS SUPPLEMENT
(to Prospectus dated May 21, 2014)

KCAP Financial, Inc.

3,000,000 Shares
Common Stock

We are offering 3,000,000 shares of our common stock. We are an internally managed, non-diversified closed-end investment company that is regulated as a business development company, or BDC, under the Investment Company Act of 1940 (“1940 Act”). We have three principal areas of investments.

First, we originate, structure, and invest in senior secured term loans, mezzanine debt and selected equity securities primarily in privately-held middle market companies.

Second, we have invested in wholly-owned asset management companies (Katonah Debt Advisors, L.L.C. and Trimaran Advisors L.L.C., collectively the “Asset Manager Affiliates”) who manage collateralized loan obligation funds.

Third, we invest in debt and equity securities issued by CLO Funds managed by our Asset Manager Affiliates or by other asset managers.

Our investment objective is to generate current income and, to a lesser extent, capital appreciation from the investments made in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies. We also we expect to receive recurring dividend distributions and to generate capital appreciation from our Asset Manager Affiliates, including through the addition of new CLO Funds managed by them.

The underwriter has agreed to purchase our shares of common stock from us at a price of $       per share which will result in approximately $     million of net proceeds, after deducting estimated offering expenses, to us, or $     million assuming full exercise of the underwriter’s option to purchase additional shares described below. We expect that our expenses for this offering will be approximately $200,000. The underwriter may offer our shares of common stock on the Nasdaq Global Select Market, in the over-the-counter market or through negotiated transactions at market prices or at negotiated prices. See “Underwriting.” The underwriter has an option to purchase up to an additional 450,000 shares of our common stock at a price of $         per share within 30 days from the date of this prospectus supplement.

Our common stock is listed on the NASDAQ Global Select Market (“NASDAQ”), under the trading symbol “KCAP.” The last sale price, as reported on NASDAQ on October 3, 2014, was $8.52 per share. The net asset value per share of our common stock at June 30, 2014 (the last date prior to the date of this prospectus supplement on which we determined net asset value) was $7.67.

An investment in our common stock involves risks, including the risk of a total loss of investment. In addition, the companies in which we invest are subject to special risks. See the “Risk Factors” section beginning on page 15 of the accompanying prospectus to read about risks that you should consider before investing in our common stock, including the risk of leverage.

Shares of closed-end investment companies, including business development companies, frequently trade at a discount to their net asset value. If our shares trade at a discount to our net asset value, it will likely increase the risk of loss for purchasers in this offering. In this regard, on July 8, 2014, our stockholders voted to allow us to issue common stock at a price below net asset value per share for the period expiring on the earlier of the one-year anniversary of the date of the shareholder approval or the date of our 2015 annual meeting of shareholders. For the same period, the Company adopted a policy that it will not seek approval from our Board of Directors to sell or otherwise issue more than 15% of the Company’s then outstanding shares of common stock at a price below its then current net asset value. We cannot issue shares of our common stock below net asset value unless our board of directors determines that it would be in our and our stockholders’ best interests to do so. Sales of common stock at prices below net asset value per share dilute the interests of existing stockholders, have the effect of reducing our net asset value per share and may reduce our market price per share. In addition, continuous sales of common stock below net asset value may have a negative impact on total returns and could have a negative impact on the market price of our shares of common stock. See “Sales of Common Stock Below Net Asset Value” in the accompanying prospectus.

Please read this prospectus supplement, and the accompanying prospectus, before investing, and keep it for future reference. The prospectus supplement and the accompanying prospectus contain important information about us that a prospective investor should know before investing in our common stock. We file annual, quarterly and current reports, proxy statements and other information about us with the Securities and Exchange Commission (the “SEC”). This information is available free of charge by contacting us at 295 Madison Avenue, 6^th Floor, New York, New York 10017, by telephone at (212) 455-8300, or on our website at http://www.kcapinc.com. The information on our website is not incorporated by reference into this prospectus or the accompanying prospectus. The SEC also maintains a website at www.sec.gov that contains such information.

The underwriter expects to deliver the shares on or about October   , 2014.

Neither the SEC nor any state securities commission has approved or disapproved of these securities or determined if this prospectus supplement or the accompanying prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

We have granted the underwriter an option, exercisable at any time until 30 days after the date of this prospectus supplement, to purchase up to 450,000 additional shares of our common stock solely to cover over-allotments.

JMP Securities

The date of this prospectus supplement is October   , 2014.

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		Page
Prospectus Supplement
PROSPECTUS SUPPLEMENT SUMMARY			S-1
THE OFFERING			S-4
FEES AND EXPENSES			S-6
FORWARD-LOOKING STATEMENTS			S-8
USE OF PROCEEDS			S-9
CAPITALIZATION			S-10
SELECTED FINANCIAL AND OTHER DATA			S-11
INTERIM MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			S-12
UNDERWRITING			S-31
LEGAL MATTERS			S-32
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM			S-32
CHANGE IN INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM			S-33
AVAILABLE INFORMATION			S-33
INTERIM CONSOLIDATED FINANCIAL STATEMENTS			F-1
Prospectus
PROSPECTUS SUMMARY			1
THE OFFERING			9
FEES AND EXPENSES			11
SELECTED FINANCIAL AND OTHER DATA			13
RISK FACTORS			15
FORWARD-LOOKING STATEMENTS			36
USE OF PROCEEDS			37
PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS			38
RATIOS OF EARNINGS TO FIXED CHARGES			41
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			42
SENIOR SECURITIES TABLE			58
BUSINESS			59
DETERMINATION OF NET ASSET VALUE			67
PORTFOLIO COMPANIES			69
MANAGEMENT			76
EXECUTIVE COMPENSATION			85
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS			103
CONTROL PERSONS AND PRINCIPAL STOCKHOLDERS			103
SALES OF COMMON STOCK BELOW NET ASSET VALUE			105
DIVIDEND REINVESTMENT PLAN			111
REGULATION			112
MATERIAL UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS			115
DESCRIPTION OF OUR COMMON STOCK			123
DESCRIPTION OF OUR PREFERRED STOCK			126
DESCRIPTION OF OUR WARRANTS			127
DESCRIPTION OF OUR DEBT SECURITIES			129
PLAN OF DISTRIBUTION			142
BROKERAGE ALLOCATION AND OTHER PRACTICES			144
CUSTODIAN, TRANSFER AND DIVIDEND PAYING AGENT AND REGISTRAR			144

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		Page
LEGAL MATTERS			144
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM			144
CHANGE IN INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM			144
AVAILABLE INFORMATION			145
PRIVACY NOTICE			146
INDEX TO FINANCIAL STATEMENTS			F-1

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ABOUT THIS PROSPECTUS SUPPLEMENT

You should rely only on the information contained in this prospectus supplement and the accompanying prospectus. Neither we nor the underwriter has authorized any other person to provide you with different information from that contained in this prospectus supplement or the accompanying prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. This prospectus supplement and the accompanying prospectus do not constitute an offer to sell, or a solicitation of an offer to buy, any shares of our common stock by any person in any jurisdiction where it is unlawful for that person to make such an offer or solicitation or to any person in any jurisdiction to whom it is unlawful to make such an offer or solicitation. The information contained in this prospectus supplement and the accompanying prospectus is complete and accurate only as of their respective dates, regardless of the time of their delivery or sale of our common stock. This prospectus supplement supersedes the accompanying prospectus to the extent it contains information different from or additional to the information in that prospectus.

This document is in two parts. The first part is this prospectus supplement, which describes the terms of this offering and also adds to and updates information contained in the accompanying prospectus. The second part is the accompanying prospectus, which gives more general information and disclosure. To the extent the information contained in this prospectus supplement differs from the information contained in the accompanying prospectus, the information in this prospectus supplement shall control. You should read this prospectus supplement and the accompanying prospectus together with the additional information described under the heading, “Available Information” before investing in our common stock.

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PROSPECTUS SUPPLEMENT SUMMARY

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

Overview

We are an internally managed, non-diversified closed-end investment company that is regulated as a business development company (“BDC”) under the Investment Company Act of 1940 (the “1940 Act”). We have three principal areas of investment.

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

Second, we have invested in asset management companies (Katonah Debt Advisors and Trimaran Advisors, collectively the “Asset Manager Affiliates”) which manage collateralized loan obligation funds (“CLO Funds”).

Third, we invest in debt and equity securities issued by CLO Funds managed by our Asset Manager Affiliates or by other asset managers (the “CLO Fund Securities”).

Our investment objective is to generate current income and, to a lesser extent, capital appreciation from the investments made in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies. We define the middle market as comprising companies with earnings before interest, taxes, depreciation and amortization (“EBITDA”) of $10 million to $50 million and/or total debt of $25 million to $150 million. We primarily invest in first and second lien term loans which, because of their priority in a company’s capital structure, we expect will have lower default rates and higher rates of recovery of principal if there is a default and therefore we expect them to generate a stable stream of interest income. We also invest in mezzanine debt, which generally is subordinated to senior loans and is generally unsecured. While our primary investment focus is 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.

With respect to our Asset Manager Affiliates investment, we expect to receive recurring dividend distributions and to generate capital appreciation through the addition of new CLO Funds managed by our Asset Manager Affiliates. The Asset Manager Affiliates manage CLO Funds which invest in broadly syndicated loans, high-yield bonds and other credit instruments.

Our investments in CLO Fund Securities, which are primarily made up of a minority investment in the subordinated securities or preferred stock of CLO Funds raised and managed by our Asset Manager Affiliates, are anticipated to provide the Company with recurring cash distributions and complement the growth of our Asset Manager Affiliates.

Because 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, we do not pay investment advisory fees, but instead incur the operating costs associated with employing investment and portfolio management professionals. We believe that our internally managed structure provides us with a beneficial operating expense structure when compared to other publicly-traded and privately-held investment firms which are externally managed, and our internally managed structure allows us the opportunity to leverage our non-interest operating expenses as we grow our investment portfolio. For the year ended December 31, 2013, the ratio of

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our total operating expenses, excluding interest expense, as a percentage of our quarterly average total assets was 1%, compared to 2% for the year ended December 31, 2012.

As a BDC, we are required to comply with regulatory requirements, including limitations on our use of debt. We are permitted to, and expect to continue to, finance our investments through borrowings. However, as a BDC, we are only generally allowed to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such borrowing. The 1940 Act also generally prohibits us from declaring any cash dividend or distribution on any class of our capital stock if our asset coverage is below 200% at the time of the declaration of the dividend or distribution.

We intend to grow our portfolio of assets by raising additional capital, including through the prudent use of leverage available to us. Because we also 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. As a result, we may hold varying amounts of cash and other short-term investments from time-to-time for liquidity purposes.

The investments in our Debt Securities Portfolio are all or predominantly below investment grade, which are often referred to as “junk,” and have speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal.

We were formed in August 2006, as Kohlberg Capital Corporation. In December 2006, we completed our initial public offering (“IPO”), which raised net proceeds of approximately $200 million after the exercise of the underwriters’ over-allotment option. In connection with our IPO, we issued an additional 3,484,333 shares of our common stock in exchange for the ownership interests of Katonah Debt Advisors.

On February 29, 2012, the Company purchased Trimaran Advisors, a CLO manager similar to Katonah Debt Advisors, with assets under management of approximately $1.5 billion, for total consideration of $13.0 million in cash and 3,600,000 shares of the Company’s common stock. Contemporaneous with the acquisition of Trimaran Advisors, the Company acquired from Trimaran Advisors equity interests in certain CLO Funds managed by Trimaran Advisors for an aggregate purchase price of $12.0 million in cash. As of June 30, 2014, the Asset Manager Affiliates are the Company’s only wholly-owned portfolio companies and have approximately $3.3 billion of par value assets under management. The Asset Manager Affiliates are registered under the Investment Advisers Act of 1940 (the “Advisers Act”), and are managed independently from the Company by a separate portfolio management team.

On July 11, 2012, we changed our name from Kohlberg Capital Corporation to KCAP Financial, Inc.

On February 14, 2013, the Company completed a public offering of 5,232,500 shares of common stock, which included the underwriters’ full exercise of their option to purchase up to 682,500 shares of common stock, at a price of $9.75 per share, raising approximately $51.0 million in gross proceeds. In conjunction with this offering, the Company also sold 200,000 shares of common stock to a member of its Board of Directors, at a price of $9.31125 per share, raising approximately $1.9 million in gross proceeds.

Including employees of our Asset Manager Affiliates, we employ an experienced team of 16 investment professionals and 30 total staff members. Dayl W. Pearson, our President and Chief Executive Officer, and one of our directors, has been in the financial services industry for over 37 years. During the past 21 years, Mr. Pearson has focused almost exclusively on the middle market and has originated, structured and underwritten over $7 billion of debt and equity securities. R. Jon Corless, our Chief Investment Officer with primary responsibility for the Debt Securities Portfolio, has managed investment portfolios in excess of $4 billion at several institutions and has been responsible for managing portfolios of leveraged loans, high-yield bonds, mezzanine securities and middle market loans. Dominick J. Mazzitelli is the President and portfolio manager of the Asset Manager Affiliates. He has 20 years of experience within the credit markets, with most of his career focused on the leveraged finance markets. Edward U. Gilpin, our Chief Financial Officer, Secretary and Treasurer, has been in financial services for nearly 30 years, with significant experience in overseeing the financial operations and reporting for asset management businesses, including the fair value accounting of CLO securities owned by them.

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

Competitive Advantages

Recent Developments

On July 8, 2014, the Company reconvened its Special Meeting of Shareholders (the “Special Meeting”). The Special Meeting, originally scheduled for June 19, 2014, was adjourned in order to provide the Company with additional time to solicit additional votes to approve the one proposal submitted to the vote of the shareholders, which is described in detail in the Company’s proxy statement dated May 6, 2014. At the Special Meeting, the Company’s shareholders approved the proposal to authorize the Company, with approval of its Board of Directors, to sell shares of its common stock, par value $0.01 per share, at a price below the then current net asset value per share of such common stock. For the same period, the Company adopted a policy that it will not seek approval from our Board of Directors to sell or otherwise issue more than 15% of the Company’s then outstanding shares of common stock at a price below its then current net asset value.

On September 19, 2014, our Board of Directors approved a quarterly cash distribution of $0.25 per share of common stock for the quarter ended September 30, 2014. The distribution is payable on October 29, 2014 to shareholders of record at the close of business as of October 14, 2014.

Corporate Information

Our principal executive offices are located at 295 Madison Avenue, 6^th Floor, New York, New York 10017, and our telephone number is (212) 455-8300. We maintain a website on the Internet at http://www.kcapinc.com. Information contained in our website is not incorporated by reference into this prospectus supplement, and you should not consider that information to be part of this prospectus supplement.

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THE OFFERING

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FEES AND EXPENSES

The following table is intended to assist you in understanding the costs and expenses that an investor in our common stock will bear directly or indirectly. We caution you that some of the percentages indicated in the table below are estimates and may vary. Except where the context suggests otherwise, whenever this prospectus supplement contains a reference to fees or expenses paid by “us” or that “we” will pay fees or expenses, common stockholders will indirectly bear such fees or expenses.

Stockholder Transaction Expenses (as a percentage of the public offering price):
Sales load (as a percentage of offering price)(1)			%
Offering expenses			%(2)
Dividend reinvestment plan fees			—  (3)
Total stockholder transaction expenses (as a percentage of the public offering price)				%
Annual Expenses (as a percentage of net assets attributable to common stock):
Operating expenses			2.56%(4)
Interest Payments on Borrowed Funds			4.18%(5)
Other expenses			0.86%(6)
Acquired Fund Fees and Expenses			1.98%(7)
Total annual expenses			9.58%(7)

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Example

The following example demonstrates the projected dollar amount of total cumulative expenses that would be incurred over various periods with respect to a $1,000 hypothetical investment in our common stock, assuming (1) a 2.0% sales load (underwriting discounts and commissions) and offering expenses totaling 0.80%, (2) total net annual expenses of 9.58% of net assets attributable to common shares as set forth in the table above and (3) a 5% annual return. These amounts assume no additional leverage.

		1 Year				3 Years				5 Years				10 Years
You would pay the following expenses on a $1,000 investment, assuming a 5% annual return		$	126			$	309			$	474			$	822

The example and the expenses in the tables above should not be considered a representation of our future expenses, and actual expenses may be greater or lesser than those shown. Moreover, while the example assumes, as required by the applicable rules of the SEC, a 5% annual return, our performance will vary and may result in a return greater or lesser than 5%. In addition, while the example assumes reinvestment of all dividends and distributions at net asset value, participants in our dividend reinvestment plan may receive shares valued at the market price in effect at that time. This price may be at, above or below net asset value. See “Dividend Reinvestment Plan” in the accompanying prospectus for additional information regarding our dividend reinvestment plan.

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FORWARD-LOOKING STATEMENTS

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

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

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USE OF PROCEEDS

If we sell 3,000,000 shares of our common stock, we anticipate that our net proceeds to be approximately $     million (approximately $     million if the underwriter exercises its option to purchase additional shares in full), after deducting the underwriting discounts and commissions and estimated offering expenses of approximately $200,000 payable by us.

We intend to use the net proceeds from this offering for general corporate purposes, which includes investing in portfolio companies and CLO Fund Securities in accordance with our investment objective and strategies described elsewhere in this prospectus supplement and the accompanying prospectus. We anticipate that substantially all of the net proceeds of the offering of the common stock pursuant to this prospectus supplement will be used for the above purposes within six months of any such offering, depending on the availability of appropriate investment opportunities consistent with our investment objective and strategies and market conditions.

Pending the uses described above, we intend to invest the net proceeds of the offering in cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment. These securities may earn yields substantially lower than the income that we anticipate receiving once we are fully invested in accordance with our investment objective. See “Regulation — Temporary Investments” in the accompanying prospectus for additional information about temporary investments we may make while waiting to make longer-term investments in pursuit of our investment objective.

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CAPITALIZATION

The following table sets forth our capitalization:

This table should be read in conjunction with “Use of Proceeds” in this prospectus supplement, “Interim Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements in this prospectus supplement and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and notes thereto included in the accompanying prospectus. The adjusted information is illustrative only.

		As of June 30, 2014
		Actual (unaudited)				As Adjusted (unaudited)
Investments at fair value		$	437,425,888			$
Cash and cash equivalents		$	2,310,589			$
Liabilities:
Convertible Notes		$	49,008,000			$
7.375% Notes Due 2019		$	41,400,000			$
Notes issued by KCAP Senior Funding I, LLC (net of discount: 2014 – $2,956,750; 2013 – $3,065,627)		$	102,402,861			$
Other liabilities		$	7,246,332			$
Total liabilities		$	200,057,193			$
Stockholders’ equity:		$	258,514,055			$
Common stock, par value $0.01 per share; 100,000,000 common shares authorized (actual and as adjusted), 33,725,233 shares outstanding (actual),         shares outstanding (as adjusted)		$	337,252			$
Capital in excess of par value		$	371,640,022			$
Accumulated undistributed (excess distribution) net investment income		$	1,530,282			$
Accumulated net realized losses		$	(68,417,904	)		$
Net unrealized depreciation of investments		$	(46,575,597	)		$
Total stockholders’ equity		$	258,514,055			$
Total capitalization		$	451,324,916			$

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SELECTED FINANCIAL AND OTHER DATA

The following selected financial and other data at and for the years ended December 31, 2013, 2012, 2011, 2010, and 2009 is derived from our audited financial statements and for the six months ended June 30, 2014 and 2013 is derived from our unaudited financial statements. The data should be read in conjunction with our financial statements and notes thereto, “Interim Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included in this prospectus supplement and the accompanying prospectus. The historical data is not necessarily indicative of results to be expected for any future period.

		Six Months Ended June 30, 2014				Six Months Ended June 30, 2013				Year Ended December 31, 2013				Year Ended December 31, 2012				Year Ended December 31, 2011				Year Ended December 31, 2010				Year Ended December 31, 2009(1)
Income Statement Data:
Interest and related portfolio income:
Interest and Dividends		$	20,250,428			$	16,268,850			$	35,210,764			$	33,578,974			$	23,823,588			$	24,638,631			$	33,497,213
Fees and other income			352,199				59,326				305,376				304,882				86,057				215,233				399,338
Dividends from Asset Manager Affiliates			6,000,000				6,300,000				12,750,000				4,700,000				1,910,000				4,500,000				—
Other Income			0				0				—				—				2,000,000				—				—
Total interest and related portfolio income			26,602,627				22,628,176				48,266,140				38,583,856				27,819,645				29,353,864				33,896,551
Expenses:
Interest and amortization of debt issuance costs			5,883,972				4,510,309				10,116,271				6,976,018				4,588,482				7,088,202				9,276,563
Compensation			2,490,088				2,020,122				4,630,481				3,172,814				3,907,900				3,322,895				3,222,604
Other			2,332,187				2,569,875				4,563,749				4,344,611				3,490,939				7,045,648				3,066,729
Total operating expenses			10,706,247				9,100,306				19,310,501				14,493,443				11,987,321				17,456,745				15,565,896
Net Investment Income			15,896,380				13,527,870				28,955,639				24,090,413				15,832,324				11,897,119				18,330,655
Realized and unrealized gains (losses) on investments:
Net realized gains (losses)			244,785				(1,645,466	)			(12,627,314	)			(3,232,975	)			(18,476,608	)			(17,862,984	)			(15,782,121	)
Net change in unrealized gains (losses)			(446,909	)			3,859,701				894,647				5,268,341				10,293,828				(8,322,812	)			31,854,736
Total net gains (losses)			(202,124	)			2,214,235				(11,732,667	)			2,035,366				(8,182,780	)			(26,185,796	)			16,072,615
Net increase (decrease) in net assets resulting from operations		$	15,694,256			$	15,742,105			$	17,222,972			$	26,125,778			$	7,649,544			$	(14,288,677	)		$	34,403,270
Per Share:
Earnings per common share – basic		$	0.47			$	0.51			$	0.53			$	1.00			$	0.33			$	(0.63	)		$	1.56
Earnings per common share – diluted		$	0.45			$	0.48			$	0.53			$	0.95			$	0.33			$	(0.63	)		$	1.56
Net investment income per share – basic		$	0.48			$	0.43			$	0.90			$	0.93			$	0.69			$	0.53			$	0.83
Net investment income per share – diluted		$	0.46			$	0.42			$	0.86			$	0.89			$	0.69			$	0.53			$	0.83
Distributions per common share		$	0.25			$	0.28			$	1.06			$	0.94			$	0.69			$	0.68			$	0.92
Balance Sheet Data:
Investment assets at fair value		$	437,425,888			$	436,497,694			$	440,549,994			$	312,044,763			$	239,791,681			$	191,186,296			$	409,105,621
Total assets		$	458,571,248			$	541,498,488			$	459,172,388			$	319,260,473			$	248,133,661			$	279,822,686			$	439,416,057
Total debt outstanding		$	192,810,861			$	197,658,000			$	192,592,373			$	101,400,000			$	60,000,000			$	86,746,582			$	218,050,363
Stockholders' equity		$	258,514,055			$	274,307,840			$	250,369,693			$	207,875,659			$	180,525,942			$	186,925,667			$	213,895,724
Net asset value per common share		$	7.67			$	8.24			$	7.51			$	7.85			$	7.85			$	8.21			$	9.56
Common shares outstanding at end of year			33,725,223				33,298,674				33,332,123				26,470,408				22,992,211				22,767,130				22,363,281
Other Data:
Investments funded(2)			88,949,798				64,896,617				243,966,586				123,165,150				85,541,809				11,245,300				23,482,349
Principal collections related to investment repayments or sales(2)			86,648,332				40,933,096				94,197,886				104,556,500				81,681,314				223,103,170				84,503,183
Number of portfolio investments at period end(2)			122				110				126				88				68				58				124
Weighted average yield of income producing debt investments(3)			7.7	%			6.8	%			7.3	%			7.5	%			8.4	%			8.6	%			6.5	%

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INTERIM MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

GENERAL

We are an internally managed, non-diversified closed-end investment company that is regulated as a Business Development Company, or BDC under the Investment Act of 1940 (the “1940 Act”). We have three principal areas of investments: 

First, we originate, structure, and invest in senior secured term loans, mezzanine debt and selected equity securities primarily in privately-held middle market companies (the “Debt Securities Portfolio”).

Second, we have invested in wholly-owned asset management companies (Katonah Debt Advisors, L.L.C., and Trimaran Advisors, L.L.C., collectively the “Asset Manager Affiliates”).

Third, we invest in debt and equity securities issued by CLO Funds managed by our Asset Manager Affiliates or by other asset managers (the “CLO Fund Securities”).

In our Debt Securities Portfolio, our investment objective is to generate current income and, to a lesser extent 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. We define the middle market as comprising companies with EBITDA of $10 million to $50 million and/or total debt of $25 million to $150 million. We primarily invest in first and second lien term loans which, because of their priority in a company’s capital structure, we expect will have lower default rates and higher rates of recovery of principal if there is a default and which we expect will create a stable stream of interest income. 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 smaller companies or 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.

From our Asset Manager Affiliates investment, we expect to receive recurring dividend distributions and to generate capital appreciation through the addition of new collateralized loan obligation funds (“CLO Funds”) to manage. The Asset Manager Affiliates manage CLO Funds which invest in broadly syndicated loans, high-yield bonds and other credit instruments. Collectively the Asset Manager Affiliates have approximately $3.25 billion of par value assets under management as of June 30, 2014. The Asset Manager Affiliates are registered under the Investment Advisers Act of 1940, and are managed independently from the Company by a separate portfolio management team.

In addition, our investments in CLO Fund Securities, which are primarily made up of a minority investment in the subordinated securities or preferred stock of CLO Funds raised and managed by our Asset Manager Affiliates, are anticipated to provide the Company with recurring cash distributions and complement the growth of our Asset Manager Affiliates.

We intend to grow our entire portfolio of investments by raising additional capital, including through the prudent use of leverage available to us. As a BDC, we are limited in the amount of leverage we can incur under the 1940 Act. 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.

We have elected to be treated for U.S. federal income tax purposes as a Regulated Investment Company (“RIC”) and intend to operate in a manner to maintain our RIC status. As a RIC, we intend to distribute to our stockholders substantially all of our net ordinary income and the excess of realized net short-term capital gains over realized net long-term capital losses, if any, for each year. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. Pursuant to this election,

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we generally will not have to pay corporate-level U.S. federal income taxes on any income that we timely distribute to our stockholders. Our common stock is traded on The NASDAQ Global Select Market under the symbol “KCAP.” The net asset value per share of our common stock at June 30, 2014 was $7.67. On June 30, 2014, the last reported sale price of a share of our common stock on The NASDAQ Global Select Market was $8.49.

PORTFOLIO AND INVESTMENT ACTIVITY

Our primary investments are: (1) lending to and investing in middle-market businesses through investments in senior secured loans, junior secured loans, subordinated/mezzanine debt investments, and other equity investments, which may include warrants, (2) our investments in our Asset Manager Affiliates, which invest in broadly syndicated loans, high-yield bonds and other credit instruments, and (3) CLO Fund Securities.

Total portfolio investment activity (excluding activity in time deposit and money market investments) for the six months ended June 30, 2014 (unaudited) and for the year ended December 31, 2013 was as follows:

		Debt Securities				CLO Fund Securities				Equity Securities				Asset Manager Affiliates				Total Portfolio
Fair Value at December 31, 2012		$	111,037,882			$	83,257,507			$	8,020,716			$	77,242,000			$	279,558,105
2013 Activity:
Purchases / originations / draws			232,226,295				11,957,500				3,813,838				217,212				248,214,845
Pay-downs / pay-offs / sales			(80,089,537	)			(623,403	)			(2,882,106	)			—				(83,595,046	)
Net accretion of interest			238,554				216,444				—				—				454,998
Net realized losses			(11,538,868	)			—				(551,636	)			—				(12,090,504	)
Increase (decrease) in fair value			14,956,101				(15,355,828	)			2,605,586				(1,311,212	)			894,647
Fair Value at December 31, 2013			266,830,427				79,452,220				11,006,398				76,148,000				433,437,045
Purchases / originations /draws			74,490,079				12,521,847				1,051,643				545,979				88,609,548
Pay-downs / pay-offs / sales			(86,280,373	)			(612,370	)			(3,516,700	)			—				(90,409,443	)
Net accretion of interest			237,449				142,473				—				—				379,922
Net realized gains (losses)			246,177				—				(1,393	)			—				244,784
Increase (decrease) in fair value			499,319				226,728				219,023				(1,391,979	)			(446,909	)
Fair Value at June 30, 2014		$	256,023,078			$	91,730,898			$	8,758,971			$	75,302,000			$	431,814,947

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

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The following table shows the Company’s portfolio by security type at June 30, 2014 and December 31, 2013:

		June 30, 2014 (unaudited)												December 31, 2013
Security Type		Cost				Fair Value				%(1)				Cost				Fair Value				%(1)
Money Market Accounts(2)			5,610,941				5,610,941				2				7,112,949				7,112,949				3
Senior Secured Loan			159,600,198				153,304,076				60				175,021,272				168,188,453				67
Junior Secured Loan			47,500,076				45,264,099				18				50,831,407				48,443,384				19
Senior Unsecured Loan			27,013,567				27,013,567				10				23,000,000				23,000,000				9
First Lien Bond			2,952,225				2,398,500				1				2,948,332				2,546,400				2
Senior Subordinated Bond			4,272,110				4,293,098				2				1,037,707				1,051,540				—
Senior Unsecured Bond			10,946,659				11,433,738				4				10,855,804				11,381,100				5
Senior Secured Bond			1,517,375				1,605,000				1				1,519,072				1,619,550				1
CLO Fund Securities			113,748,903				91,730,898				35				101,696,950				79,452,220				32
Equity Securities			16,289,233				8,758,971				3				18,755,684				11,006,398				4
Preferred			10,104,717				10,711,000				4				10,000,000				10,600,000				4
Asset Manager Affiliates			83,924,720				75,302,000				29				83,378,741				76,148,000				30
Total		$	483,480,724			$	437,425,888				169	%		$	486,157,918			$	440,549,994				176	%

Debt Securities Portfolio

At June 30, 2014 and December 31, 2013, our investments in income producing loans and debt securities, excluding CLO Fund securities, had a weighted average interest rate of approximately 7.7% and 7.3%, respectively.

The investment portfolio (excluding the Company’s investment in Asset Manager Affiliates and CLO Funds) at June 30, 2014 was spread across 24 different industries and 86 different entities with an average balance per entity of approximately $3.6 million. As of June 30, 2014, all but four of our portfolio companies were current on their debt service obligations.

We may invest up to 30% of our investment portfolio in “Non-qualifying” opportunistic investments such as high-yield bonds, debt and equity securities of CLO Funds, foreign investments, and distressed debt or equity securities of public companies. The investments in our Debt Securities Portfolio are all or predominantly below investment grade, and therefore have speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal.

At June 30, 2014, our ten largest portfolio companies represented approximately 43% of the total fair value of our investments. Our largest investment, the Asset Manager Affiliates, which are our wholly-owned portfolio companies represented 17% of the total fair value of our investments. Excluding the Asset Manager Affiliates and CLO Fund Securities, our ten largest portfolio companies represent approximately 17% of the total fair value of our investments.

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The industry concentrations based on the fair value of the Company’s investment portfolio as of June 30, 2014 and December 31, 2013, were as follows:

		June 30, 2014 (unaudited)												December 31, 2013(3)
Industry Classification		Cost				Fair Value				%(1)				Cost				Fair Value				%(1)
Aerospace and Defense		$	9,238,709			$	8,331,245				3	%		$	9,244,538			$	8,100,895				3	%
Asset Management Company(2)			83,924,720				75,302,000				30				83,378,741				76,148,000				30
Automotive			14,929,935				14,980,721				6				15,248,090				15,306,403				6
Banking, Finance, Insurance & Real Estate			30,822,276				30,908,188				12				30,859,620				31,011,964				12
Beverage, Food and Tobacco			24,392,212				24,607,779				10				33,758,684				34,026,889				14
Capital Equipment			11,453,990				12,392,098				5				11,450,641				11,792,925				5
Chemicals, Plastics and Rubber			3,397,266				3,415,763				1				2,921,597				2,906,601				1
CLO Fund Securities			113,748,903				91,730,898				36				101,696,950				79,452,220				33
Construction & Building			18,152,025				119,659				—				18,224,720				190,244				—
Consumer goods: Durable			—				1,382,237				1				7,713,071				9,751,622				4
Consumer goods: Non-durable			20,587,792				20,086,205				8				18,864,695				18,266,939				7
Energy: Oil & Gas			2,486,078				3,816,887				1				11,734,558				12,930,563				5
Environmental Industries			10,866,389				10,913,691				4				6,937,663				6,965,896				3
Forest Products & Paper			5,931,335				5,930,000				2				—				—				—
Healthcare & Pharmaceuticals			31,935,545				32,208,851				12				24,146,383				24,061,764				10
Healthcare, Education and Childcare			—				—				—				6,908,414				7,199,856				3
High Tech Industries			15,279,291				15,388,010				6				17,989,624				17,989,034				7
Hotel, Gaming & Leisure			2,819,674				2,410,660				1				3,825,126				3,466,520				1
Media: Advertising, Printing & Publishing			13,565,775				13,841,894				5				12,797,615				13,035,590				5
Media: Broadcasting & Subscription			9,626,659				9,627,106				4				9,853,341				9,915,921				4
Metals & Mining			228,563				1,000				—				228,563				1,000				—
Retail			1,382,030				1,222,655				—				3,364,579				3,325,032				1
Services: Business			8,494,861				8,870,365				3				2,984,555				2,999,791				1
Services: Consumer			5,583,736				4,516,189				2				5,703,581				4,616,678				2
Telecommunications			13,120,855				13,178,590				5				17,251,743				17,337,834				7
Time Deposit and Money Market Accounts(4)			5,610,941				5,610,941				2				7,112,949				7,112,949				3
Transportation: Cargo			20,088,919				20,735,373				8				16,030,051				16,643,254				7
Utilities: Electric			5,812,245				5,896,883				2				5,927,826				5,993,610				2
Total		$	483,480,724			$	437,425,888				169	%		$	486,157,918			$	440,549,994				176	%

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 CLO Fund Securities

We typically make a minority investment in the subordinated securities or preferred stock of CLO Funds raised and managed by our Asset Manager Affiliates and may selectively invest in securities issued by CLO Funds managed by other asset management companies. As of June 30, 2014, we had approximately $92 million invested in CLO Fund Securities, issued primarily by funds managed by our Asset Manager Affiliates.

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

Our CLO Fund Securities as of June 30, 2014 and December 31, 2013 are as follows:

										June 30, 2014								December 31, 2013
CLO Fund Securities		Investment				%(1)				Cost				Fair Value				Cost				Fair Value
Grant Grove CLO, Ltd.			Subordinated Securities				22.2	%		$	4,701,455			$	738,158			$	4,715,553			$	1,052,164
Katonah III, Ltd.(3)			Preferred Shares				23.1				1,398,172				550,000				1,618,611				325,000
Katonah V, Ltd.(3)			Preferred Shares				26.7				3,320,000				1,000				3,320,000				1,000
Katonah VII CLO Ltd.(2)			Subordinated Securities				16.4				4,484,693				1,579,404				4,499,793				1,478,978
Katonah VIII CLO Ltd.(2)			Subordinated Securities				10.3				3,378,005				1,387,164				3,390,005				1,230,731
Katonah IX CLO Ltd.(2)			Preferred Shares				6.9				2,008,087				777,822				2,023,287				829,739
Katonah X CLO Ltd.(2)			Subordinated Securities				33.3				11,755,728				5,714,906				11,770,993				5,932,163
Katonah 2007-I CLO Ltd.(2)			Preferred Shares				100.0				31,095,297				27,991,513				31,064,973				27,758,379
Katonah 2007-I CLO Ltd.(2)			Class B-2L Notes				100.0				1,327,169				10,300,000				1,300,937				9,740,000
Trimaran CLO IV, Ltd.(2)			Preferred Shares				19.0				3,524,200				2,733,495				3,542,300				2,519,210
Trimaran CLO V, Ltd.(2)			Subordinated Notes				20.8				2,716,400				1,842,675				2,721,500				1,844,276
Trimaran CLO VI, Ltd.(2)			Income Notes				16.2				2,761,700				1,925,496				2,784,200				1,981,948
Trimaran CLO VII, Ltd.(2)			Income Notes				10.5				3,132,100				2,251,346				3,133,900				2,513,261
Catamaran CLO 2012-1 Ltd.(2)			Subordinated Notes				24.9				8,987,000				6,969,478				8,943,900				6,846,520
Catamaran CLO 2012-1 Ltd.(2)			Class F Notes				42.9				3,885,051				4,290,000				3,843,398				4,200,001
Catamaran CLO 2013-1 Ltd.(2)			Subordinated Notes								9,365,700				8,762,580				9,960,400				8,225,100
Dryden 30 Senior Loan Fund			Subordinated Notes				7.5				3,036,200				2,892,500				3,063,200				2,973,750
Catamaran CLO 2014-1 Ltd.(2)			Subordinated Notes				24.9				11,464,500				9,683,361				—				—
Catamaran CLO 2014-1 Ltd.(2)			Class E Notes				15.1				1,407,446				1,340,000				—				—
Total										$	113,748,903			$	91,730,898			$	101,696,950			$	79,452,220

Asset Manager Affiliates

The Asset Manager Affiliates are our wholly-owned asset management companies that manage CLO Funds that invest in broadly syndicated loans, high yield bonds and other credit instruments. The CLO Funds managed by our Asset Manager Affiliates consist primarily of credit instruments issued by corporations. As of June 30, 2014, our Asset Manager Affiliates had approximately $3.25 billion of par value of assets under management on which they earn management fees, and were valued at approximately $75 million. 

All CLO Funds managed by the Asset Manager Affiliates are currently paying all senior and subordinate management fees. In addition our Asset Manager Affiliates are currently receiving incentive fees from five funds.

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RESULTS OF OPERATIONS

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

Set forth below is a discussion of our results of operations for the three and six months ended June 30, 2014 and 2013.

 Revenue

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

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

Dividends and Interest from Investments in CLO Fund Securities.  We generate dividend income from our investments in the securities (typically preferred shares or subordinated securities) of CLO Funds managed by our Asset Manager Affiliates and selective investments in securities issued by CLO Funds managed by other asset management companies. CLO Funds managed by our Asset Manager Affiliates and those managed by non-affiliates invest primarily in broadly syndicated non-investment grade loans, high-yield bonds and other credit instruments of corporate issuers. The Company distinguishes CLO Funds managed by its Asset Manager Affiliates as “CLO Fund Securities Managed by Affiliates.” in its consolidated financial statements. The underlying assets in each of the CLO Funds in which we have an investment are generally diversified secured or unsecured corporate debt. Our CLO Fund Securities that are subordinated securities or preferred shares (“junior securities”) are subordinated to senior note holders who typically receive a return on their investment at a fixed spread relative to the LIBOR index. The CLO Funds are leveraged funds and any excess cash flow or “excess spread” (interest earned by the underlying securities in the fund less payments made to senior bond holders and less fund expenses and management fees) is paid to the holders of the CLO Fund’s subordinated securities or preferred shares. The level of excess spread from CLO Fund Securities can be impacted from the timing and level of the resetting of the benchmark interest rate for the underlying assets (which reset at various times throughout the quarter) in the CLO Fund and the related CLO Fund note liabilities (which reset at each quarterly distribution date); in periods of short-term and volatile changes in the benchmark interest rate, the levels of excess spread and distributions to us can vary significantly.

For non-junior class CLO Fund securities, such as our investment in the class B-2L notes of the Katonah 2007-I CLO of Class F notes of the Catamaran 2012-1, interest is earned at a fixed spread relative to the LIBOR index.

Distributions from Asset Manager Affiliates.  We receive distributions from our investment in our Asset Manager Affiliates, which are wholly-owned and manage CLO Funds that invest primarily in broadly syndicated non-investment grade loans, high yield bonds and other credit instruments issued by corporations. As managers of CLO Funds, our Asset Manager Affiliates receive contractual and recurring management fees from the CLO Funds for their management and advisory services. In addition, our Asset Manager Affiliates may also earn income related to net interest on assets accumulated for future CLO issuances on which they have provided a first loss guaranty in connection with loan warehouse arrangements for their CLO Funds. Our Asset Manager Affiliates generate annual operating income equal to the amount by which their fee income exceeds their operating expenses. The annual management fees which our Asset Manager Affiliates receive are generally based on a fixed percentage of the par value of assets under management and are recurring in nature for the term of the CLO Fund so long as the Asset Manager Affiliates manage the fund. As a result, the

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annual management fees earned by our Asset Manager Affiliates generally are not subject to market value fluctuations in the underlying collateral. Our Asset Manager Affiliates may also receive incentive fees provided such CLO Funds have achieved a minimum investment return to holders of their subordinated securities or preferred shares as per the terms of each CLO Fund management agreement.

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

 Investment Income

Investment income for the three months ended June 30, 2014 and 2013 was approximately $13.2 million and $11.2 million, respectively. Of these amounts, approximately $5.2 million and $3.0 million was attributable to interest income on our Debt Securities Portfolio. Increases in interest income from 2013 to 2014 were due to higher average invested assets stemming primarily from capital raising activities. 

Investment income for the six months ended June 30, 2014 and 2013 was approximately $26.6 million and $22.6 million, respectively. Of these amounts, approximately $10.4 million and $5.5 million was attributable to interest income on our Debt Securities Portfolio. Increases in interest income from 2013 to 2014 were due to higher average invested assets stemming primarily from capital raising activities.

The weighted average yield on the Debt Securities Portfolio was 7.7%, and 7.3%, as of June 30, 2014 and December 31, 2013, respectively.

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

For the three months ended June 30, 2014 and 2013, approximately $4.9 million of dividend income was attributable to investments in CLO Fund securities. For the six months ended June 30, 2014 and 2013, approximately $9.8 million and $10.8 million, respectively, of dividend income was attributable to investments in CLO Fund securities. Dividends from CLO Fund Securities are dependent on the performance of the underlying assets in each CLO Fund; interest payments, principal amortization and prepayments of the underlying loans in each CLO Fund are primary factors which determine the level of income on our CLO Fund Securities. The level of excess spread from CLO Fund Securities can be impacted by the timing and level of the resetting of the benchmark interest rate for the underlying assets (which reset at various times throughout the quarter) in the CLO Fund and the related CLO Fund bond liabilities (which reset at each quarterly distribution date); in periods of short-term and volatile changes in the benchmark interest rate, the levels of excess spread and distributions to us can vary significantly.

Distributions from our Asset Manager Affiliates are recorded as “Distributions from Asset Manager Affiliates” in our Statement of Operations. For the three months ended June 30, 2014 and 2013, we recognized distribution income of $3.0 million and $3.3 million from the Asset Manager Affiliates, respectively. For the six months ended June 30, 2014 and 2013, we recognized income of $6.0 million and $6.3 million from the Asset Manager Affiliates, respectively.

The Asset Manager Affiliates are expected to pay future dividends to the Company based upon their operating cash flow, which generally will be dependent upon the maintenance and growth in their assets under management. The fair value of our investment in our Asset Manager Affiliates decreased by $1.4 million during the six months ended June 30, 2014 and increased by $10.0 million during the six months ended June 30, 2013. CLO Funds typically have automatic orderly wind-down features following an initial period of reinvestment. Thus, with all else being equal, as managed CLO Fund portfolios age, projected future assets under management (and associated management fees) will naturally decline, resulting in a reduction in fair value of our Asset Manager Affiliates. On the other hand, mandates to manage new CLO Fund portfolios will generally result in an increase in the fair value of our investment in our Asset Manager Affiliates. The aggregate of par value assets under management by our Asset Manager Affiliates was $3.25 billion and $3.2 billion as of June 30, 2014 and December 31, 2013, respectively.

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Expenses

Because we are internally managed, we directly incur the cost of management and operations. As a result, we pay no investment management fees or other fees to an external advisor. Our expenses consist primarily of interest expense on outstanding borrowings, compensation expense and general and administrative expenses, including professional fees. Interest and compensation expense are typically our largest expenses each period.

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

Compensation Expense.  Compensation expense includes base salaries, bonuses, stock compensation, employee benefits and employer-related payroll costs. The largest components of total compensation costs are base salaries and bonuses; generally, base salaries are expensed as incurred and annual bonus expenses are estimated and accrued. Our compensation arrangements with our employees contain a significant profit sharing and/or performance based bonus component. Therefore, as our net revenues increase, our compensation costs may also rise. In addition, our compensation expenses may also increase to reflect increased investment in personnel as we grow our products and businesses.

Professional Fees and General and Administrative Expenses.  The balance of our expenses includes professional fees (primarily legal, accounting, valuation and other professional services), occupancy costs and general administrative and other costs.

Total expenses for the three months ended June 30, 2014 and 2013 were approximately $5.2 million and $4.7 million, respectively. Interest expense and amortization on debt issuance costs for the periods, were approximately $2.9 million and $2.3 million, respectively, on average debt outstanding of $196 million and $108 million, respectively.

For the three months ended June 30, 2014 and 2013, approximately $1.2 million and $1.1 million, respectively, of expenses were attributable to employee compensation, including salaries, bonuses, employee benefits, payroll taxes and stock-based compensation expense. For the three months ended June 30, 2014 and 2013, respectively, professional fees and insurance expenses totaled approximately $657,000 and $779,000. Administrative costs, which include occupancy expense, technology and other office expenses, totaled approximately $399,000 and $513,000 for the three months ended June 30, 2014 and 2013, respectively.

Total expenses for the six months ended June 30, 2014 and 2013 were approximately $10.7 million and $9.1 million, respectively. Interest expense and amortization on debt issuance costs for the periods, were approximately $5.9 million and $4.5 million, respectively, on average debt outstanding of $196 million and $105 million, respectively. 

For the six months ended June 30, 2014 and 2013, approximately $2.5 million and $2 million, respectively, of expenses were attributable to employee compensation, including salaries, bonuses, employee benefits, payroll taxes and stock-based compensation expense. The increase in compensation expense results from higher performance-based compensation and benefit plan expenses, as well as an increase in employee headcount. For the six months ended June 30, 2014 and 2013, respectively, professional fees and insurance expenses totaled approximately $1.5 million and $1.6 million. Administrative costs, which include occupancy expense, technology and other office expenses, totaled approximately $868,000 and $1 million for the six months ended June 30, 2014 and 2013, respectively.

 Net Investment Income and Net Realized Gains (Losses)

Net investment income and net realized gains (losses) represents the stockholder’s equity before net unrealized appreciation or depreciation on investments. For the three months ended June 30, 2014, net investment income and net realized losses were approximately $8.0 million, or $0.24 per share. For the three months ended June 30, 2013, net investment income and net realized losses were approximately $5.0 million or $0.15 per share. For the six months ended June 30, 2014, net investment income and net realized gains were approximately $16.1 million, or $0.48 per share. For the six months ended June 30, 2013, net investment

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income and net realized losses were approximately $11.9 million or $0.38 per share. Net investment income represents the income earned on our investments less operating and interest expense before net realized gains or losses and unrealized appreciation or depreciation on investments. For the three months ended June 30, 2014, net investment income was approximately $8.0 million, or $0.24 per share. For the six months ended June 30, 2014, net investment income was approximately $15.9 million, or $0.48 per share.

Generally, we seek to fund our distributions from net investment income. For the six months ended June 30, 2014, total distributions were $16.2 million, or $0.50 per share.

Net Unrealized (Depreciation) Appreciation on Investments

During the three months ended June 30, 2014, our total investments had net unrealized appreciation of approximately $4.3 million. During the three months ended June 30, 2013, our total investments had net unrealized appreciation of approximately $3.5 million. For the three months ended June 30, 2014, our Asset Manager Affiliates had net unrealized appreciation of approximately $1.2 million. For the three months ended June 30, 2013, our Asset Manager Affiliates had net unrealized appreciation of approximately $6.9 million. For the three months ended June 30, 2014, our middle market portfolio of debt securities and equity securities had net unrealized appreciation of approximately $1.6 million, compared with net unrealized appreciation of $1.2 million during the second quarter of 2013. For the three months ended June 30, 2014, our CLO Fund securities had net unrealized appreciation of approximately $1.4 million compared with net unrealized depreciation of $4.6 million during the second quarter of 2013.

During the six months ended June 30, 2014, our total investments had net unrealized depreciation of approximately $447,000. During the six months ended June 30, 2013, our total investments had net unrealized appreciation of approximately $3.9 million. For the six months ended June 30, 2014, our Asset Manager Affiliates had net unrealized depreciation of approximately $1.4 million. For the six months ended June 30, 2013, our Asset Manager Affiliates had net unrealized appreciation of approximately $10.0 million. For the six months ended June 30, 2014, our middle market portfolio of debt securities and equity securities had net unrealized appreciation of approximately $718,000, compared with net unrealized appreciation of $3.4 million during the six months ended June 30, 2013. For the six months ended June 30, 2014, our CLO Fund securities had net unrealized appreciation of approximately $227,000 compared with net unrealized depreciation of $9.5 million during the six months ended June 30, 2013.

Net Change in Stockholder’s Equity Resulting From Operations

The net increase in stockholders’ equity resulting from operations for the three months ended June 30, 2014 was $12.3 million, or $0.37 per share. Net increase in stockholders’ equity resulting from operations for the three months ended June 30, 2013 was $8.5 million, or $0.26 per share.

The net increase in stockholders’ equity resulting from operations for the six months ended June 30, 2014 was $15.7 million, or $0.47 per share. Net increase in stockholders’ equity resulting from operations for the six months ended June 30, 2013 was $15.7 million, or $0.51 per share.

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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 irregular and unexpected funding requirements. We plan to satisfy our liquidity needs through normal operations with the goal of avoiding unplanned sales of assets or emergency borrowing of funds.

As of June 30, 2014 and December 31, 2013 the fair value of investments and cash were as follows:

		Investments at Fair Value
Security Type		June 30, 2014				December 31, 2013
Cash		$	2,310,589			$	3,433,675
Money Market Accounts			5,610,941				7,112,949
Senior Secured Loan			153,304,076				168,188,453
Junior Secured Loan			45,264,099				48,443,384
Senior Unsecured Loan			27,013,567				23,000,000
First Lien Bond			2,398,500				2,546,400
Senior Subordinated Bond			4,293,098				1,051,540
Senior Secured Bond			1,605,000				1,619,550
Senior Unsecured Bond			11,433,738				11,381,100
CLO Fund Securities			91,730,898				79,452,220
Equity Securities			8,758,971				11,006,398
Preferred			10,711,000				10,600,000
Asset Manager Affiliates			75,302,000				76,148,000
Total		$	439,736,477			$	443,983,669

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. As of June 30, 2014, we had approximately $195.7 million of par value of outstanding borrowings and our asset coverage ratio of total assets to total borrowings was 231%, compliant with the minimum asset coverage level of 200% generally required for a BDC by the 1940 Act. We may also borrow amounts of up to 5% of the value of our total assets for temporary purposes.

On March 16, 2011, the Company issued $55 million in aggregate principal amount of unsecured 8.75% convertible notes due March 2016 (“Convertible Notes”). On March 23, 2011, pursuant to an over-allotment option, the Company issued an additional $5 million of such Convertible Notes for a total of $60 million in aggregate principal amount. The net proceeds from the sale of the Convertible Notes, following underwriting expenses, were approximately $57.7 million. Interest on the Convertible Notes is paid semi-annually in arrears on March 15 and September 15, at a rate of 8.75%, commencing September 15, 2011. The Convertible Notes mature on March 15, 2016 unless converted earlier. The Convertible Notes are senior unsecured obligations of the Company.

The Convertible Notes are convertible into shares of the Company’s common stock. As of June 30, 2014, the conversion rate was 128.6773 shares of common stock per $1,000 principal amount of Convertible Notes, which is equivalent to a conversion price of approximately $7.77 per share of common stock. The conversion rate is subject to adjustment upon certain events. Upon conversion, the Company would issue the full amount of common stock or settle the conversion cash, at its option, and retire the full amount of debt outstanding.

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On April 4, 2013, approximately $9 million of the Company’s 8.75% Convertible Notes were converted at a price per share of $8.159 into 1,102,093 shares of KCAP common stock. On September 4, 2013, the Company purchased $2 million face value of its own Convertible Notes at a price of $114.50, plus accrued interest. KCAP subsequently surrendered these notes to the note trustee for cancellation effective September 13, 2013. Due to the cash conversion option embedded in the Convertible Notes, the Company applied the guidance in ASC 470-40-20, Debt with Conversion and Other Options, and realized a loss on the extinguishment of this debt. For the six months ended June 30, 2014, there were no realized losses on extinguishment of debt. For the year ended December 31, 2013 total realized losses on extinguishment of debt were approximately $537,000. The indenture governing the Convertible Notes contains certain restrictive covenants, including compliance with certain provisions of the 1940 Act and conditions governing the undertaking of new debt.

In February 2012, the Company entered into a Note Purchase Agreement, under which it was able to obtain up to $30 million in financing (the “Facility”). The Facility was terminated on November 4, 2013 and remaining unamortized capitalized costs of approximately $203,000 related to the Facility were written-off and are included in Realized Losses on Extinguishments of Debt.

On October 10, 2012, the Company issued $41.4 million in aggregate principal amount of unsecured 7.375% Notes Due 2019. The net proceeds for the 7.375% Notes Due 2019, following underwriting expenses, were approximately $39.9 million. Interest on the 7.375% Notes Due 2019 is paid quarterly in arrears on March 30, June 30, September 30 and December 30, at a rate of 7.375%, commencing December 30, 2012. The 7.375% Notes Due 2019 mature on September 30, 2019, and are senior unsecured obligations of the Company. In addition, due to the coverage tests applicable to the Company as a BDC and a covenant that the Company agreed to in connection with the issuance of the 7.375% Notes Due 2019, the Company is limited in its ability to make distributions in certain circumstances. At June 30, 2014, the Company was in compliance with all of its debt covenants. The indenture governing the 7.375% Notes Due 2019 contains certain restrictive covenants, including compliance with certain provisions of the 1940 Act relating to borrowing and dividends.

On February 14, 2013, the Company completed a public offering of 5,232,500 shares of common stock, which included the underwriters’ full exercise of their option to purchase up to 682,500 shares of common stock, at a price of $9.75 per share, raising approximately $51.0 million in gross proceeds. In conjunction with this offering, the Company also sold 200,000 shares of common stock to a member of its Board of Directors, at a price of $9.31125 per share, raising approximately $1.9 million in gross proceeds.

On June 18, 2013, KCAP Senior Funding I, LLC, or Issuer, a specialty finance subsidiary of the Company, was capitalized through the issuance of $140 million of notes (the “KCAP Senior Funding I Notes”). The KCAP Senior Funding I Notes are backed by a diversified portfolio of bank loans. The Company invested in the most junior class of the notes, issued in the approximate amount of $35 million, representing the Company’s primary exposure to the performance of the assets acquired from the proceeds of the issuance of the KCAP Senior Funding I Notes. These junior notes eliminate in consolidation and the remaining notes with a par value of $105 million, net of $2.8 million of unamortized discount, are reflected on our consolidated balance sheet. The indenture governing the KCAP Senior Funding I Notes contains an event of default that is triggered in the event that certain coverage tests are not met.

Subject to prevailing market conditions, we intend to grow our portfolio of assets by raising additional capital, including through the prudent use of leverage available to us. As a result, we may seek to enter into new agreements with other lenders or into other financing arrangements as market conditions permit. From time to time, we may seek to retire, repurchase, or exchange debt securities in open market purchases or by other means dependent on market conditions, liquidity, contractual obligations, and other matters.

If our common stock trades below our net asset value per share, we will generally not be able to issue additional common stock at the market price unless our shareholders approve such a sale and our Board of Directors makes certain determinations. A proposal, approved by our stockholders (at a special stockholder meeting held on June 19, 2014 and continued on July 8, 2014) authorizes us to sell shares of our common stock below the then current net asset value per share of our common stock in one or more offerings for the period ending on the earlier of (i) July 8, 2015, or (ii) the date of our 2015 annual meeting of shareholders.

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For the same period, the Company adopted a policy that it will not seek approval from our Board of Directors to sell or otherwise issue more than 15% of the Company’s then outstanding shares of common stock at a price below its then current net asset value. We would need similar future approval from our shareholders to issue shares below the then current net asset value per share any time after the expiration of the current approval.

Stockholder Distributions

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

The amount of our declared distributions, as evaluated by management and approved by our Board of Directors, is based on our evaluation of both distributable income for tax purposes and GAAP net investment income (which excludes unrealized gains and losses). Generally, we seek to fund our distributions from GAAP current earnings, primarily from net interest and dividend income generated by our investment portfolio and without a return of capital or a high reliance on realized capital gains. Distributions to our stockholders during the years ended 2013 and 2012 included $5.8 million and $1.3 million, respectively, of tax-basis return of capital.

The following table sets forth the quarterly distributions declared by us for the two most recently completed fiscal years and the current fiscal year, including distributions from the Asset Manager Affiliates received by the Company, if any.

Distribution

Declaration Date

Record Date

Pay Date

2014:

Second quarter

0.25

6/20/2014

7/3/2014

7/25/2014

First quarter

$

0.25

3/21/2014

4/4/2014

4/25/2014

Total declared in 2014

$

0.50

2013:

Fourth quarter

0.25

12/13/2013

12/27/2013

1/27/2014

Third quarter

0.25

9/13/2013

10/8/2013

10/29/2013

Second quarter

0.28

6/17/2013

7/5/2013

7/26/2013

First quarter

$

0.28

3/15/2013

4/5/2013

4/26/2013

Total declared in 2013

$

1.06

2012:

Fourth quarter

$

0.28

12/17/2012

12/28/2012

1/28/2013

Third quarter

0.24

9/17/2012

10/10/2012

10/29/2012

Second quarter

0.24

6/18/2012

7/6/2012

7/27/2012

First quarter

0.18

3/16/2012

4/6/2012

4/27/2012

Total declared in 2012

$

0.94

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OFF-BALANCE SHEET ARRANGEMENTS

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 the Company’s investment objectives. 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 June 30, 2014 and December 31, 2013, we did not have any such outstanding commitments. 

CONTRACTUAL OBLIGATIONS

The following table summarizes our contractual cash obligations and other commercial commitments as of June 30, 2014:

		Payments Due by Period
Contractual Obligations		Total				Less than one year				1 – 3 years				3 – 5 years				More than 5 years
Long-term debt obligations(1)		$	192,810,861			$	—			$	49,008,000			$	—			$	143,802,861

CRITICAL ACCOUNTING POLICIES

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

 Valuation of Portfolio Investments

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

Value, as defined in Section 2(a)(41) of 1940 Act, is (1) the market price for those securities for which a market quotation is readily available and (2) for all other securities and assets, fair value as determined in good faith by our Board of Directors pursuant to procedures approved by our Board of Directors. 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.

Pursuant to the AICPA Guide, we reflect our investments on our balance sheet at their estimated fair value with unrealized gains and losses resulting from changes in fair value reflected as a component of unrealized gains or losses on our statements of operations. Fair value is the amount that would be received to sell the investments in an orderly transaction between market participants at the measurement date (i.e., the exit price).

See Note 4 to the consolidated financial statements for the additional information about the level of market observability associated with investments carried at fair value.

The Company follows the provisions of ASC 820: Fair Value, which among other matters, requires enhanced disclosures about investments that are measured and reported at fair value. This standard defines fair value and establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability used in measuring investments at fair value and expands disclosures about assets and liabilities measured at fair value. ASC 820: Fair Value defines “fair value” as the price that would be received to sell an

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asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This fair value definition focuses on an exit price in the principal, or most advantageous market, and prioritizes, within a measurement of fair value, the use of market-based inputs (which may be weighted or adjusted for relevance, reliability and specific attributes relative to the subject investment) over entity-specific inputs. Market price observability is affected by a number of factors, including the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. Subsequent to the adoption of ASC 820: Fair Value, the FASB has issued various staff positions clarifying the initial standard (see Note 2 to the consolidated financial statements: “Significant Accounting Policies — Investments”).

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

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

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

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

The Company’s investments in its wholly-owned asset management companies, the Asset Manager Affiliates, are carried at fair value, which is primarily determined utilizing a discounted cash flow model which incorporates different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance (“Discounted Cash Flow”). Such valuation takes into consideration an analysis of comparable asset management companies and a percentage of assets under management. The Asset Manager Affiliates are classified as a Level III investment (as described above). Any change in value from period to period is recognized as net change in unrealized appreciation or depreciation. 

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

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

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

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

 Interest Income

Interest income, including 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. As of June 30, 2014, four issuers representing less than 1% of our total investments at fair value were on non-accrual status. As of December 31, 2013, five issuers representing less than 1% of our total investments at fair value were on non-accrual status.

 Distributions from CLO Fund Securities

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

For non-junior class CLO Fund Securities, such as our investment in the class B-2L notes of Katonah 2007-I CLO and the class F notes of Catamaran 2012-1, interest is earned at a fixed spread relative to the LIBOR index.

 Distributions from Asset Manager Affiliates

We record distributions from our Asset Manager Affiliates on the declaration date, which represents the ex-dividend date.

 Payment in Kind Interest

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

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 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 or restricted stock, under the Equity Incentive Plan, to officers and employees for services rendered to us. We follow Accounting Standards Codification 718, Compensation — Stock Compensation, a method by which the fair value of options or restricted stock is determined and expensed. During the second quarter of 2014, the Board of Directors authorized a grant of restricted stock to officers and employees comprised of 357,281 shares of restricted stock with an aggregate fair value of of approximately $2.9 million on the date of grant.

 United States Federal Income Taxes

The Company has elected and intends to continue to qualify for the tax treatment applicable to RICs under Subchapter M of the Code and, among other things, intends to make the required distributions to its stockholders as specified therein. In order to qualify as a RIC, the Company is required to timely distribute to its stockholders at least 90% of 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.

 Distributions to Shareholders

Distributions to common stockholders are recorded on the ex-dividend date. The amount to be paid out is determined by the Board of Directors each quarter and is generally based upon the earnings estimated by management for the period and year.

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. Managing these risks is essential to our business. 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 June 30, 2014, approximately 95% of our debt securities portfolio were either fixed rate or floating rate with a spread to an interest rate index such as LIBOR or the prime rate. Most of these floating rate loans contain LIBOR floors ranging between 0.75% and 2.00%. We generally expect that future portfolio investments will predominately be floating rate investments.

As of June 30, 2014, we had $195.7 million of borrowings outstanding at a weighted average rate of 5.08%.

Because we borrow money to make investments, our net investment income is dependent upon the difference between our borrowing rate and the rate we earn on the invested proceeds borrowed. In periods of

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rising or lowering interest rates, the cost of the proportion of our debt associated with our Convertible Notes or Retail Notes would remain the same at 8.75% and 7.375%, respectively, given that this debt is at a fixed rate. The Notes issued by KCAP Senior Funding are floating rate based upon a LIBOR index plus a spread, which serves as a floor should LIBOR decrease to zero. Accordingly, our interest costs associated with this debt will fluctuate with changes in LIBOR.

We would expect that an increase in the base rate index for our floating rate investment assets would increase our gross investment income and that a decrease in the base rate index for such assets would decrease our gross investment income (in either case, such increase/decrease may be limited by interest rate floors/minimums for certain investment assets). Accordingly, there can be no assurance that a significant change in market interest rates will not have a material effect on our net investment income.

We have analyzed the potential impact of changes in interest rates on interest income net of interest expense. Assuming that our balance sheet at June 30, 2014 was to remain constant and no actions were taken to alter the existing interest rate sensitivity, the table below illustrates the impact on net investment income for various hypothetical increases in interest rates:

		Impact on net investment income:
		1%				2%				3%
Increase in interest rate		$	(574,868	)		$	212,087			$	1,105,241
Decrease in interest rate		$	189,710			$	189,710			$	189,710

As shown above, net investment income assuming a 1% increase in interest rates would decrease by approximately $575,000 on an annualized basis, reflecting the impact to investments in our portfolio that are either fixed rate or which have embedded floors that would be unaffected by a 1% change in the underlying interest rate while our interest expense would be increasing. However, if the increase in rates was more significant, such as 2% or 3%, the net effect on net investment income would be an increase of approximately $212,000 and $1.1 million, respectively. Since the LIBOR rate underlying certain investments, as well as certain of our borrowings, is currently very low, it is unlikely that the underlying rate will decrease by 1% or 2% or even 3%. If the underlying rate decreased to 0%, it would result in approximately a $190,000 increase in net investment income.

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 June 30, 2014.

 Portfolio Valuation

We carry our investments at fair value, as determined in good faith by our Board of Directors pursuant to a valuation methodology approved by our Board of Directors. Investments for which market quotations are generally readily available are generally valued at such market quotations. Investments for which there is not a readily available market value are valued at fair value as determined in good faith by our Board of Directors under a valuation policy and consistently applied valuation process. However, due to the inherent uncertainty of determining the fair value of investments that cannot be marked to market, the fair value of our investments may differ materially from the values that would have been used had a ready market existed for such investments. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the value 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.

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The Company has engaged an independent valuation firm to provide third party valuation consulting services to the Company’s Board of Directors. Each quarter, the independent valuation firm will perform third party valuations on the Company’s material investments in illiquid securities such that they are reviewed at least once during a trailing 12 month period. These third party valuation estimates were considered as one of the relevant data inputs in the Company’s determination of fair value. The Company intends to continue to engage an independent valuation firm in the future to provide certain valuation services, including the review of certain portfolio assets, as part of the quarterly and annual year-end valuation process.

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UNDERWRITING

JMP Securities LLC is acting as the sole underwriter of this offering and has agreed to purchase 3,000,000 shares of common stock at a price of $    per share.

The underwriter is committed to take and pay for all of the shares being offered, if any are taken, other than the shares being sold directly by us and those covered by the option described below unless and until this option is exercised.

The underwriter proposes to offer the shares of common stock offered hereby from time to time for sale in one or more transactions on the Nasdaq Global Select Market, in the over-the-counter-market, through negotiated transactions or otherwise at market prices prevailing at the time of sale, at prices related to prevailing market prices or at negotiated prices, subject to receipt and acceptance by the underwriter and subject to the underwriter’s right to reject any order in whole or in part. The underwriter may effect such transactions by selling the shares of common stock to or through dealers and such dealers may receive compensation in the form of discounts, concessions or commissions from the underwriter and/or purchasers of shares of common stock for whom they may act as agents or to whom they may sell as principal.

We estimate that the total expenses of this offering payable by us, exclusive of the underwriting discount or commission, will be approximately $200,000.

 Lock-up Agreements

We, our officers, directors, and holders of substantially all of our common stock, have agreed with the underwriter, subject to certain exceptions, not to dispose of or hedge any of their common stock or securities convertible into or exchangeable for shares of common stock during the period from the date of this prospectus continuing through the date 45 days after the date of this prospectus supplement, except with the prior written consent of JMP Securities LLC.

The 45 day restricted period described in the preceding paragraph will be automatically extended if: (1) during the last 17 days of the 45 day restricted period the Company issues an earnings release or announces material news or a material event; or (2) prior to the expiration of the 45 day restricted period, the Company announces that it will release earnings results during the 15-day period following the last day of the 45 day period, in which case the restrictions described in the preceding paragraph will continue to apply until the expiration of the 45 day period beginning on the issuance of the earnings release of the announcement of the material news or material event unless JMP Securities LLC waives in writing, such extension.

 NASDAQ Global Select Market

Our common stock is listed on the NASDAQ Global Select Market under the symbol “KCAP.”

 Price Stabilizations and Short Positions

In connection with the offering, the underwriter may purchase and sell shares of common stock in the open market. These transactions may include short sales, stabilizing transactions and purchases to cover positions created by short sales. Shorts sales involve the sale by the underwriter of a greater number of shares than it is required to purchase in the offering. “Covered” short sales are sales made in an amount not greater than the underwriter’s option to purchase additional shares from the Company in the offering. The underwriter may close out any covered short position by either exercising its option to purchase additional shares or purchasing shares in the open market. In determining the source of shares to close out the covered short position, the underwriter will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which it may purchase additional shares pursuant to the option granted to the underwriter. “Naked” short sales are any sales in excess of such option. The underwriter must close out any naked short position by purchasing shares in the open market. A naked short position is more likely to be created if the underwriter is concerned that there may be downward pressure on the price of the common stock in the open market after pricing that could adversely affect investors who purchase in the offering. Stabilizing transactions consist of various bids for or purchases of common stock made by the underwriter in the open market prior to the completion of the offering.

Purchases to cover a short position and stabilizing transactions, as well as other purchases by the underwriter for its own accounts, may have the effect of preventing or retarding a decline in the market price

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of the Company’s stock, and together with the imposition of the penalty bid, may stabilize, maintain or otherwise affect the market price of the common stock. As a result, the price of the common stock may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued at any time. These transactions may be effected on the NASDAQ Global Select Market, in the over-the-counter market or otherwise.

 Other

The Company has agreed to indemnify the underwriter against certain liabilities, including liabilities under the Securities Act.

The underwriter and its affiliates are full service financial institutions engaged in various activities, which may include securities trading, commercial and investment banking, financial advisory, investment management, investment research, principal investment, hedging, financing and brokerage activities. The underwriter and its respective affiliates have in the past and may in the future perform various financial advisory and investment banking services for us, for which they received or will receive customary fees and expenses.

In the ordinary course of their various business activities, the underwriter and its affiliates may make or hold a broad array of investments and actively trade debt and equity securities (or related derivative securities) and financial instruments (including bank loans) for their own account and for the accounts of their customers and such investment and securities activities may involve securities and/or instruments of the issuer. The underwriter and its affiliates may also make investment recommendations and/or publish or express independent research views in respect of such securities or instruments and may at any time hold, or recommend to clients that they acquire, long and/or short positions in such securities and instruments.

The principal business address of the JMP Securities LLC is 600 Montgomery Street, San Francisco, CA 94111.

LEGAL MATTERS

Certain legal matters in connection with the securities offered hereby will be passed upon for us by Sutherland Asbill & Brennan LLP, Washington, D.C. Certain legal matters in connection with the securities offered hereby will be passed upon for the underwriter by Fried, Frank, Harris, Shriver & Jacobson LLP, New York, New York.

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The audited financial statements and financial highlights, and management’s assessment of the effectiveness of internal control over financial reporting included in this prospectus and elsewhere in the registration statement have been so included in reliance upon the reports of Grant Thornton LLP, independent registered public accountants, upon the authority of said firm as experts in accounting and auditing in giving said reports. The principal business address of Grant Thornton LLP is 175 West Jackson Boulevard, Chicago, Illinois 60604.

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CHANGE IN INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

On March 21, 2014, our Board of Directors elected to not renew their engagement of Grant Thornton LLP as the Company’s independent registered public accounting firm. The Board’s decision was recommended by the Audit Committee of the Board.

Grant Thornton’s reports on the Company’s financial statements for the fiscal years ended December 31, 2013, 2012 and 2011, contained no adverse opinion or disclaimer of opinion, and were not qualified or modified as to uncertainty, audit scope or accounting principles.

During the fiscal years ended December 31, 2013, 2012 and 2011 through March 21, 2014, there were no (a) disagreements with Grant Thornton LLP on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Grant Thornton LLP, would have caused it to make reference to the subject matter of such disagreements in its reports on the financial statements for such years or (b) reportable events, as described under Item 304(a)(1)(v) of Regulation S-K.

On March 26, 2014, our Board of Directors engaged, upon the recommendation of the Audit Committee of the Board, Ernst & Young LLP to serve as the Company’s new independent registered public accounting firm to audit the Company’s consolidated financial statements for the fiscal year ending December 31, 2014, subject to ratification by our stockholders.

AVAILABLE INFORMATION

We have filed with the SEC a registration statement on Form N-2, together with all amendments and related exhibits, under the Securities Act, with respect to our securities offered by this prospectus supplement and the accompanying prospectus. The registration statement contains additional information about us and our securities being offered by this prospectus supplement and the accompanying prospectus.

We file annual, quarterly and current periodic reports, proxy statements and other information with the SEC under the Exchange Act. You may inspect and copy these reports, proxy statements and other information, as well as the registration statement of which this prospectus supplement and accompanying prospectus form a part and the related exhibits and schedules, at the Public Reference Room of the SEC at 100 F Street, N.E., Washington, D.C. 20549-0102. You may obtain information on the operation of the Public Reference Room by calling the SEC at 202-551-8090. The SEC maintains an Internet website that contains reports, proxy and information statements and other information filed electronically by us with the SEC which are available on the SEC’s Internet website at http://www.sec.gov. Copies of these reports, proxy and information statements and other information may be obtained, after paying a duplicating fee, by electronic request at the following E-mail address: publicinfo@sec.gov, or by writing the SEC’s Public Reference Section, Washington, D.C. 20549-0102.

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INTERIM CONSOLIDATED FINANCIAL STATEMENTS

UNAUDITED FINANCIAL STATEMENTS
Consolidated Balance Sheets as of June 30, 2014 (unaudited) and December 31, 2013			F-2
Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2014 and 2013			F-3
Consolidated Statements of Changes in Net Assets (unaudited) for the six months ended June 30, 2014 and 2013			F-4
Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2014 and 2013 Consolidated Schedules of Investments as of June 30, 2014 (unaudited) and December 31, 2013			F-5
Consolidated Financial Highlights (unaudited) for the six months ended June 30, 2014 and 2013			F-20
Notes to Consolidated Financial Statements (unaudited)			F-21

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KCAP FINANCIAL, INC.
 
CONSOLIDATED BALANCE SHEETS

		As of June 30, 2014				As of December 31, 2013
		(unaudited)
ASSETS
Investments at fair value:
Money market accounts (cost: 2014 – $5,610,941; 2013 – $7,112,949)		$	5,610,941			$	7,112,949
Debt securities (cost: 2014 – $263,906,927; 2013 – $275,213,594)			256,023,078				266,830,427
CLO Fund securities managed by affiliates (cost: 2014 – $101,293,076; 2013 – $88,979,585)			87,549,239				75,100,306
CLO Fund securities managed by non-affiliates (cost: 2014 – $12,455,827; 2013 – $12,717,365)			4,181,659				4,351,914
Equity securities (cost: 2014 – $16,289,233; 2013 – $18,755,684)			8,758,971				11,006,398
Asset Manager Affiliates (cost: 2014 – $83,924,720; 2013 – $83,378,741)			75,302,000				76,148,000
Total Investments at Fair Value (cost: 2014 – $483,480,724; 2013 – $486,157,918)			437,425,888				440,549,994
Cash			2,310,589				3,433,675
Restricted cash			4,777,960				4,078,939
Interest receivable			2,040,077				2,032,559
Receivable for open trades			2,943,835				—
Due from affiliates			3,218,927				3,125,259
Other assets			5,853,972				5,951,962
Total Assets		$	458,571,248			$	459,172,388
LIABILITIES
Convertible Notes		$	49,008,000			$	49,008,000
7.375% Notes Due 2019			41,400,000				41,400,000
Notes issued by KCAP Senior Funding I, LLC (net of discount: 2014 – $2,847,139; 2013 – $3,065,627)			102,402,861				102,184,373
Payable for open trades			3,940,000				3,980,000
Accounts payable and accrued expenses			3,306,332				3,897,291
Shareholder distribution payable			—				8,333,031
Total Liabilities			200,057,193				208,802,695
STOCKHOLDERS’ EQUITY
Common stock, par value $0.01 per share, 100,000,000 common shares authorized; 33,725,223 and 33,332,123 common shares issued and outstanding at June 30, 2014 and December 31, 2013, respectively			337,252				333,472
Capital in excess of par value			371,640,022				370,929,615
Accumulated undistributed (excess distribution) net investment income			1,530,282				(6,102,017	)
Accumulated net realized losses			(68,417,904	)			(68,662,689	)
Net unrealized depreciation on investments			(46,575,597	)			(46,128,688	)
Total Stockholders’ Equity			258,514,055				250,369,693
Total Liabilities and Stockholders’ Equity		$	458,571,248			$	459,172,388
NET ASSET VALUE PER COMMON SHARE		$	7.67			$	7.51

See accompanying notes to consolidated financial statements.

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KCAP FINANCIAL, INC.
 
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
Investment Income:
Interest from investments in debt securities		$	5,173,514			$	2,997,246			$	10,420,750			$	5,475,265
Interest from cash and time deposits			724				3,026				1,510				7,738
Distributions from investments in CLO Fund securities managed by affiliates			4,451,626				4,557,531				9,087,864				10,038,183
Distributions from investments in CLO Fund securities managed by non-affiliates			464,734				323,790				740,304				747,664
Distributions from Asset Manager Affiliates			3,000,000				3,300,000				6,000,000				6,300,000
Capital structuring service fees			125,116				52,753				352,199				59,326
Total investment income			13,215,714				11,234,346				26,602,627				22,628,176
Expenses:
Interest and amortization of debt issuance costs			2,893,806				2,250,063				5,883,972				4,510,309
Compensation			1,227,651				1,110,409				2,490,088				2,020,122
Professional fees			545,913				652,644				1,217,123				1,294,971
Insurance			111,507				126,632				247,467				255,348
Administrative and other			399,315				513,085				867,597				1,019,556
Total expenses			5,178,192				4,652,833				10,706,247				9,100,306
Net Investment Income			8,037,522				6,581,513				15,896,380				13,527,870
Realized And Unrealized Gains (Losses) On Investments:
Net realized (losses) gains from investment transactions			(64,797	)			(1,562,529	)			244,785				(1,645,466	)
Net change in unrealized (depreciation) appreciation on:
Debt securities			1,102,632				124,466				499,319				2,410,992
Equity securities			546,686				1,064,379				219,023				998,942
CLO Fund securities managed by affiliates			1,015,474				(3,768,238	)			135,445				(8,347,397	)
CLO Fund securities managed by non-affiliates			388,145				(820,826	)			91,283				(1,188,235	)
Asset Manager Affiliates investments			1,227,000				6,910,060				(1,391,979	)			9,985,399
Total net change in unrealized appreciation (depreciation)			4,279,937				3,509,841				(446,909	)			3,859,701
Net realized and unrealized appreciation (depreciation) on investments			4,215,140				1,947,312				(202,124	)			2,214,235
Net Increase In Stockholders’ Equity Resulting From Operations		$	12,252,662			$	8,528,825			$	15,694,256			$	15,742,105
Net Increase In Stockholders’ Equity Resulting from Operations per Common Share:
Basic:		$	0.37			$	0.26			$	0.47			$	0.51
Diluted:		$	0.34			$	0.25			$	0.45			$	0.48
Net Investment Income Per Common Share:
Basic:		$	0.24			$	0.20			$	0.48			$	0.43
Diluted:		$	0.24			$	0.20			$	0.46			$	0.42
Weighted Average Shares of Common Stock Outstanding – Basic			33,405,189				33,040,155				33,371,764				31,163,596
Weighted Average Shares of Common Stock Outstanding – Diluted			39,723,264				39,395,124				39,689,884				38,022,742

See accompanying notes to consolidated financial statements.

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KCAP FINANCIAL, INC.
 
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
(unaudited)

		Six Months Ended June 30,
		2014				2013
Operations:
Net investment income		$	15,896,380			$	13,527,870
Net realized gains (losses) from investment transactions			244,785				(1,645,466	)
Net change in unrealized (depreciation) appreciation on investments			(446,909	)			3,859,701
Net increase in net assets resulting from operations			15,694,256				15,742,105
Stockholder distributions:
Distribution of net investment income			(7,858,857	)			(6,946,356	)
Return of capital			(405,224	)			(2,304,764	)
Net decrease in net assets resulting from stockholder distributions			(8,264,081	)			(9,251,120	)
Capital transactions:
Issuance of common stock for:
Dividend reinvestment plan			300,813				394,275
Conversion of Convertible Notes			—				8,992,000
Issuance of Common Stock			—				50,404,236
Amortization of stock based compensation			413,375				150,687
Net increase in net assets resulting from capital transactions			714,188				59,941,198
Net assets at beginning of period			250,369,692				207,875,656
Net assets at end of period (including undistributed net investment income of $1,530,282 in 2014 and $4,380,234 in 2013)		$	258,514,055			$	274,307,839
Net asset value per common share		$	7.67			$	8.24
Common shares outstanding at end of period			33,725,223				33,298,674

See accompanying notes to consolidated financial statements.

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KCAP FINANCIAL, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

		Six Months Ended June 30,
		2014				2013
OPERATING ACTIVITIES:
Net increase in stockholder’s equity resulting from operations		$	15,694,256			$	15,742,105
Adjustments to reconcile net increase in stockholder’s equity resulting from operations to net cash provided by (used in) in operating activities:
Net realized (gains) losses on investment transactions			(244,785	)			1,645,466
Net change in unrealized depreciation (appreciation) on investments			446,909				(3,859,701	)
Net accretion of discount on debt securities			12,007				496,351
Amortization of original issue discount on indebtedness			218,488				—
Amortization of debt issuance costs			555,445				402,169
Payment-in-kind interest income			55,777				—
Stock-based compensation expense			413,375				150,687
Changes in operating assets and liabilities:
Purchases of investments			(88,665,326	)			(178,434,731	)
Proceeds from sales and redemptions of investments			91,519,522				53,756,852
(Increase) in receivable for open trades			(2,943,835	)			(3,515,052	)
Increase (Decrease) in payable for open trades			(40,000	)			66,840,035
(Increase) in interest and dividends receivable			(7,518	)			(466,795	)
Decrease in time deposit			—				1,942,834
(Increase) in other assets			(457,452	)			(3,902,160	)
(Increase) in due from affiliates			(93,668	)			(1,091,273	)
Increase (Decrease) in accounts payable and accrued expenses			(590,959	)			111,180
Net cash provided by (used in) operating activities			15,872,236				(50,182,033	)
FINANCING ACTIVITIES:
Proceeds from issuance of common stock			—				50,404,236
Distributions to stockholders			(16,296,300	)			(16,260,229	)
Proceeds from issuance of debt			—				101,954,525
(Increase) in restricted cash			(699,022	)			(78,985,473	)
Net cash (used in) provided by financing activities			(16,995,322	)			57,113,059
CHANGE IN CASH			(1,123,086	)			6,931,026
CASH, BEGINNING OF PERIOD			3,433,675				738,756
CASH, END OF PERIOD		$	2,310,589			$	7,669,782
Supplemental Information:
Interest paid during the period		$	4,985,509			$	4,193,151
Dividends paid during the period under the dividend reinvestment plan		$	300,813			$	393,297

See accompanying notes to consolidated financial statements.

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KCAP FINANCIAL, INC.
 
CONSOLIDATED SCHEDULE OF INVESTMENTS
As of June 30, 2014
(unaudited)

Debt Securities Portfolio

Portfolio Company/Principal Business		Investment Interest Rate(1)/Maturity				Principal				Cost				Fair Value(2)
4L Technologies Inc. (fka Clover Holdings, Inc.)(9), (11) Consumer goods: Non-durable			Senior Secured Loan — Term Loan 5.5% Cash, 1.0% Libor Floor, Due 5/20			$	2,800,000			$	2,772,640			$	2,805,502
Advanced Lighting Technologies, Inc.(9), (11) Consumer goods: Non-durable			First Lien Bond — 10.5% Cash, Due 6/19				3,000,000				2,952,225				2,398,501
Alaska Communications Systems Holdings, Inc.(9), (11) Telecommunications			Senior Secured Loan — Term Loan 6.3% Cash, 1.5% Libor Floor, Due 10/16				2,234,318				2,237,467				2,235,659
Anaren, Inc.(9), (11) High Tech Industries			Senior Secured Loan — Term Loan (First Lien) 5.5% Cash, 1.0% Libor Floor, Due 2/21				1,990,000				1,971,061				1,999,950
ARSloane Acquisition, LLC(9), (11) Services: Business			Senior Secured Loan — Tranche B Term Loan (First Lien) 7.5% Cash, 1.3% Libor Floor, Due 10/19				992,500				983,783				982,576
Asurion, LLC (fka Asurion Corporation)(9), (11) Banking, Finance, Insurance & Real Estate			Senior Secured Loan — Incremental Tranche B-1 Term Loan 5.0% Cash, 1.3% Libor Floor, Due 5/19				1,936,879				1,955,615				1,951,609
AZ Chem US Inc.(9), (11) Chemicals, Plastics and Rubber			Senior Secured Loan — Initial Term Loan (First Lien) 4.5% Cash, 1.0% Libor Floor, Due 6/21				492,466				490,014				490,003
Bankruptcy Management Solutions, Inc.(9) Banking, Finance, Insurance & Real Estate			Senior Secured Loan — Term B Loan 7.0% Cash, 1.0% Libor Floor, Due 6/18				709,091				709,091				704,340
BarBri, Inc. (Gemini Holdings, Inc.)(9), (11) Services: Consumer			Senior Secured Loan — Term Loan 4.5% Cash, 1.0% Libor Floor, Due 7/19				2,872,500				2,860,342				2,877,671
BBB Industries, LLC(9), (11) Automotive			Senior Secured Loan — Term Loan 5.5% Cash, 1.3% Libor Floor, Due 3/19				2,812,500				2,804,487				2,813,626
Bellisio Foods, Inc.(9), (11) Beverage, Food and Tobacco			Senior Secured Loan — U.S. Term B Loans 4.5% Cash, 1.0% Libor Floor, Due 8/19				3,754,678				3,737,995				3,754,302
Blue Coat Systems, Inc.(9), (11) High Tech Industries			Senior Secured Loan — New Term Loan 4.0% Cash, 1.0% Libor Floor, Due 5/19				470,003				471,498				471,080
Caribe Media Inc. (fka Caribe Information Investments Incorporated)(9) Media: Advertising, Printing & Publishing			Senior Secured Loan — Loan 10.0% Cash, 1.5% Libor Floor, Due 11/14				316,063				316,063				315,905
Carolina Beverage Group LLC(9) Beverage, Food and Tobacco			Senior Secured Bond — 10.625% –  08/2018 – 143818AA0 144A 10.6% Cash, Due 8/18				1,500,000				1,517,375				1,605,000
Cengage Learning Acquisitions, Inc. (fka TL Acquisitions, Inc.)(9), (11) Media: Advertising, Printing & Publishing			Senior Secured Loan — Term Loan 7.0% Cash, 1.0% Libor Floor, Due 3/20				997,500				1,011,940				1,010,128
Checkout Holding Corp.(9), (11) Media: Advertising, Printing & Publishing			Senior Secured Loan — Term B Loan (First Lien) 4.5% Cash, 1.0% Libor Floor, Due 4/21				2,000,000				1,990,302				2,004,580
CoActive Technologies LLC (fka CoActive Technologies, Inc.)(7), (9) Capital Equipment			Junior Secured Loan — Term Loan (Second Lien) 0.0% Cash, 7.0% PIK, Due 1/15				2,063,007				1,987,358				2,063,007
Crowley Holdings Preferred, LLC(9) Transportation: Cargo			Preferred Stock — 12.000% –  12/2049 – Series A Income Preferred Securities 10.0% Cash, 2.0% PIK, Due 12/49				10,104,717				10,104,717				10,711,000
CSM Bakery Supplies LLC(9) Beverage, Food and Tobacco			Junior Secured Loan — Term Loan (Second Lien) 8.5% Cash, 1.0% Libor Floor, Due 7/21				3,000,000				3,017,626				3,003,300