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Section 1: 497 (497)

497
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Index to Financial Statements

Filed Pursuant to Rule 497
Registration No. 333-214767

 

PROSPECTUS SUPPLEMENT

(To prospectus dated September 7, 2017)

 

LOGO

 

Up to 12,000,000 Shares

Common Stock

 

 

We have entered into an equity distribution agreement, dated September 8, 2017, or the Equity Distribution Agreement, with JMP Securities LLC, or JMP Securities, relating to the shares of common stock offered by this prospectus supplement and the accompanying prospectus. Our common stock is listed on the New York Stock Exchange, or NYSE, under the trading symbol “HTGC.” The last reported sale price on the NYSE on November 6, 2017 was $13.38 per share. The net asset value per share of our common stock at September 30, 2017 (the last date prior to the date of this prospectus supplement on which we determined net asset value) was $10.00.

We are an internally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company under the Investment Company Act of 1940, as amended, or the 1940 Act. Our investment objective is to maximize our portfolio total return by generating current income from our debt investments and capital appreciation from our warrant and equity-related investments.

The Equity Distribution Agreement provides that we may offer and sell up to 12,000,000 shares of our common stock from time to time through JMP Securities, as our sales agent. Sales of our common stock, if any, under this prospectus supplement and the accompanying prospectus may be made in negotiated transactions or transactions that are deemed to be “at the market,” as defined in Rule 415 under the Securities Act of 1933, as amended, or the Securities Act, including sales made directly on the NYSE or similar securities exchange or sales made to or through a market maker other than on an exchange, at prices related to the prevailing market prices or at negotiated prices. As of the date of this prospectus supplement, we have sold approximately 1.3 million shares of our common stock under the Equity Distribution Agreement

JMP Securities will receive a commission from us to be negotiated from time to time, but in no event in excess of 2.0% of the gross sales price of any shares of our common stock sold through JMP Securities under the Equity Distribution Agreement. JMP Securities is not required to sell any specific number or dollar amount of common stock, but will use its commercially reasonable efforts consistent with its sales and trading practices to sell the shares of our common stock offered by this prospectus supplement and the accompanying prospectus. See “Plan of Distribution” beginning on page S-19 of this prospectus supplement. The sales price per share of our common stock offered by this prospectus supplement and the accompanying prospectus, less JMP Securities’ commission, will not be less than the net asset value per share of our common stock at the time of such sale.

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, or the SEC. This information is available free of charge by contacting us at 400 Hamilton Avenue, Suite 310, Palo Alto, California 94301, or by telephone by calling collect at (650) 289-3060 or on our website at www.htgc.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.

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 14 of the accompanying prospectus to read about risks that you should consider before investing in our common stock, including the risk of leverage.

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.

JMP Securities

The date of this prospectus supplement is November 8, 2017.


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You should rely only on the information contained in this prospectus supplement and the accompanying prospectus. We have not, and JMP Securities has not, authorized any other person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and JMP Securities is not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information contained in this prospectus supplement and the accompanying prospectus is accurate only as of the date on the front cover of this prospectus supplement and the accompanying prospectus, as applicable. Our business, financial condition, results of operations and prospects may have changed since that date.

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.

TABLE OF CONTENTS

Prospectus Supplement

 

     Page  

Fees and Expenses

     S-1  

Forward-Looking Statements; Market Data

     S-3  

Prospectus Supplement Summary

     S-5  

The Offering

     S-12  

Selected Consolidated Financial Data

     S-13  

Use of Proceeds

     S-15  

Price Range of Common Stock

     S-16  

Ratio of Earnings to Fixed Charges

     S-17  

Capitalization

     S-18  

Plan of Distribution

     S-19  

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

     S-21  

Senior Securities

     S-72  

Management

     S-75  

Legal Matters

     S-76  

Experts

     S-76  

Available Information

     S-76  

Index to Financial Statements

     S-77  

Prospectus

 

     Page  

Summary

     1  

Fees and Expenses

     10  

Selected Consolidated Financial Data

     12  

Risk Factors

     14  

Forward-Looking Statements

     61  

Use of Proceeds

     62  

Price Range of Common Stock and Distributions

     63  

Ratio of Earnings to Fixed Charges

     66  

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

     67  

 

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     Page  

Business

     125  

Portfolio Companies

     138  

Senior Securities

     162  

Management

     165  

Corporate Governance

     176  

Executive Compensation

     181  

Control Persons and Principal Stockholders

     201  

Certain Relationships and Related Transactions

     203  

Certain United States Federal Income Tax Considerations

     204  

Regulation

     214  

Determination of Net Asset Value

     220  

Sales of Common Stock Below Net Asset Value

     224  

Dividend Reinvestment Plan

     229  

Description of Capital Stock

     230  

Description of Our Preferred Stock

     237  

Description of Our Subscription Rights

     239  

Description of Warrants

     241  

Description of Our Debt Securities

     243  

Plan of Distribution

     256  

Brokerage Allocation and Other Practices

     258  

Custodian, Transfer and Dividend Paying Agent and Registrar

     258  

Legal Matters

     258  

Experts

     258  

Available Information

     259  

Index to Financial Statements

     F-1  

 

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FEES AND EXPENSES

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

 

Stockholder Transaction Expenses (as a percentage of the public offering price):

  

Sales load (as a percentage of offering price)(1)

     2.00

Offering expenses

     0.18 %(2) 

Dividend reinvestment plan fees

     —   (3) 
  

 

 

 

Total stockholder transaction expenses (as a percentage of the public offering price)

     2.18
  

 

 

 

Annual Expenses (as a percentage of net assets attributable to common stock):(4)

  

Operating expenses

     5.67 %(5)(6) 

Interest and fees paid in connection with borrowed funds

     5.40 %(7) 
  

 

 

 

Total annual expenses

     11.07 %(8) 
  

 

 

 

 

(1) Represents the estimated commission with respect to the shares of common stock being sold in this offering. JMP Securities will be entitled to compensation up to 2.00% of the gross proceeds of the sale of any shares of our common stock under the Equity Distribution Agreement, with the exact amount of such compensation to be mutually agreed upon by the Company and JMP Securities from time to time. There is no guarantee that there will be any sales of our common stock pursuant to this prospectus supplement and the accompanying prospectus.
(2) The percentage reflects estimated offering expenses of approximately $291,000, assuming all shares are offered under this prospectus supplement.
(3) The expenses associated with the administration of our dividend reinvestment plan are included in “Operating expenses.” We pay all brokerage commissions incurred with respect to open market purchases, if any, made by the administrator under the plan. For more details about the plan, see “Dividend Reinvestment Plan” in the accompanying prospectus.
(4) “Net assets attributable to common stock” equals the weighted average net assets for the nine-months ended September 30, 2017, which is approximately $827.7 million.
(5) “Operating expenses” represent our estimated operating expenses by annualizing our actual operating expenses incurred for the nine-months ended September 30, 2017, including all fees and expenses of our consolidated subsidiaries and excluding interests and fees on indebtedness. This percentage for the year ended December 31, 2016 was 6.21%. See “Management’s Discussion and Analysis and Results of Operations,” “Management,” and “Executive Compensation” in the accompanying prospectus.
(6) We do not have an investment adviser and are internally managed by our executive officers under the supervision of our Board of Directors. As a result, we do not pay investment advisory fees, but instead we pay the operating costs associated with employing investment management professionals.
(7) “Interest and fees paid in connection with borrowed funds” represents our estimated interest, fees and credit facility expenses by annualizing our actual interest, fees and credit facility expenses incurred for the nine-months ended September 30, 2017, including our Wells Facility, Union Bank Facility, the 2024 Notes, the 2022 Convertible Notes, the 2021 Asset-Backed Notes and the SBA debentures, each of which is defined herein. This percentage for the year ended December 31, 2016 was 5.04%.
(8) “Total annual expenses” is the sum of “operating expenses,” and “interest and fees paid in connection with borrowed funds.” This percentage for the year ended December 31, 2016 was 11.25%. “Total annual expenses” is presented as a percentage of weighted average net assets attributable to common stockholders, because the holders of shares of our common stock (and not the holders of our debt securities or preferred stock, if any) bear all of our fees and expenses, including the fees and expenses of our wholly-owned consolidated subsidiaries, all of which are included in this fee table presentation.

 

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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 hypothetical investment in our common stock. These amounts are based upon our payment of annual operating expenses at the levels set forth in the table above and assume no additional leverage.

 

     1 Year      3 Years      5 Years      10 Years  

You would pay the following expenses on a $1,000 common stock investment, assuming a 5% annual return

   $ 127      $ 319      $ 489      $ 833  

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 distributions at net asset value (“NAV”), 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 NAV. 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 Hercules Capital, Inc., 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 expressions. Important assumptions include our ability to originate new investments, achieve certain margins and levels of profitability, the availability of additional capital, and the ability to maintain certain debt to asset ratios. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this 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:

 

   

our current and future management structure;

 

   

our future operating results;

 

   

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

 

   

the impact of investments that we expect to make;

 

   

our informal relationships with third parties including in the venture capital industry;

 

   

the expected market for venture capital investments and our addressable market;

 

   

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

 

   

our ability to access debt markets and equity markets;

 

   

the ability of our portfolio companies to achieve their objectives;

 

   

our expected financings and investments;

 

   

our regulatory structure and tax status;

 

   

our ability to operate as a business development company, a small business investment company, or SBIC, and a regulated investment company, or RIC;

 

   

the adequacy of our cash resources and working capital;

 

   

the timing of cash flows, if any, from the operations of our portfolio companies;

 

   

the timing, form and amount of any distributions;

 

   

the impact of fluctuations in interest rates on our business;

 

   

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

 

   

our ability to recover unrealized losses.

For a discussion of factors that could cause our actual results to differ from forward-looking statements contained in this prospectus supplement and the 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 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.

 

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Industry and Market Data

We have compiled certain industry estimates presented in this prospectus supplement and the accompanying prospectus from internally generated information and data. While we believe our estimates are reliable, they have not been verified by any independent sources. The estimates are based on a number of assumptions, including increasing investment in venture capital and private equity-backed companies. Actual results may differ from projections and estimates, and this market may not grow at the rates projected, or at all. If this market fails to grow at projected rates, our business and the market price of our securities, including our common stock, could be materially adversely affected.

 

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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. For a more complete understanding of this offering, we encourage you to read this entire prospectus supplement and the accompanying prospectus and the documents that are referenced in this prospectus supplement and the accompanying prospectus, together with any accompanying supplements. In this prospectus supplement and the accompanying prospectus, unless the context otherwise requires, the “Company,” “Hercules,” “HTGC,” “we,” “us” and “our” refer to Hercules Capital, Inc. and its wholly-owned subsidiaries and its affiliated securitization trusts.

Our Company

We are a specialty finance company focused on providing senior secured loans to high-growth, innovative venture capital-backed companies in a variety of technology, life sciences and sustainable and renewable technology industries. Our investment objective is to maximize our portfolio’s total return by generating current income from our debt investments and capital appreciation from our warrant and equity-related investments. We are an internally-managed, non-diversified closed-end investment company that has elected to be regulated as a business development company under the 1940 Act. Effective January 1, 2006, we elected to be treated for tax purposes as a RIC under the Internal Revenue Code of 1986, as amended, or the Code.

As of September 30, 2017, our total assets were approximately $1.6 billion, of which our investments comprised $1.4 billion at fair value and $1.5 billion at cost. Since inception through September 30, 2017, we have made debt and equity commitments of more than $7.0 billion to our portfolio companies.

We also make investments in qualifying small businesses through our two wholly-owned SBICs. Our SBIC subsidiaries, Hercules Technology II, L.P., or HT II, and Hercules Technology III, L.P., or HT III, hold approximately $107.9 million and $279.9 million in assets, respectively, and accounted for approximately 5.4% and 13.9% of our total assets, respectively, prior to consolidation at September 30, 2017. At September 30, 2017, we have issued $190.2 million in SBA-guaranteed debentures in our SBIC subsidiaries. See “Regulation—Small Business Administration Regulations” in the accompanying prospectus for additional information regarding our SBIC subsidiaries.

As of September 30, 2017, our investment professionals, including Manuel A. Henriquez, our co-founder, Chairman, President and Chief Executive Officer, are currently comprised of 34 professionals who have, on average, more than 15 years of experience in venture capital, structured finance, commercial lending or acquisition finance with the types of technology-related companies that we are targeting. We believe that we can leverage the experience and relationships of our management team to successfully identify attractive investment opportunities, underwrite prospective portfolio companies and structure customized financing solutions.

 



 

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Organizational Chart

The following chart summarizes our organizational structure as of November 6, 2017. This chart is provided for illustrative purposes only.

 

 

LOGO

Our Market Opportunity

We believe that technology-related companies compete in one of the largest and most rapidly growing sectors of the U.S. economy and that continued growth is supported by ongoing innovation and performance improvements in technology products as well as the adoption of technology across virtually all industries in response to competitive pressures. We believe that an attractive market opportunity exists for a specialty finance company focused primarily on investments in structured debt with warrants in technology-related companies for the following reasons:

 

   

Technology-related companies have generally been underserved by traditional lending sources;

 

   

Unfulfilled demand exists for structured debt financing to technology-related companies due to the complexity of evaluating risk in these investments; and

 

   

Structured debt with warrants products are less dilutive and complement equity financing from venture capital and private equity funds.

Technology-Related Companies are Underserved by Traditional Lenders. We believe many viable technology-related companies backed by financial sponsors have been unable to obtain sufficient growth financing from traditional lenders, including financial services companies such as commercial banks and finance companies because traditional lenders have continued to consolidate and have adopted a more risk-averse approach to lending. More importantly, we believe traditional lenders are typically unable to underwrite the risk associated with these companies effectively.

 



 

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The unique cash flow characteristics of many technology-related companies typically include significant research and development expenditures and high projected revenue growth thus often making such companies difficult to evaluate from a credit perspective. In addition, the balance sheets of these companies often include a disproportionately large amount of intellectual property assets, which can be difficult to value. Finally, the speed of innovation in technology and rapid shifts in consumer demand and market share add to the difficulty in evaluating technology-related companies.

Due to the difficulties described above, we believe traditional lenders generally refrain from entering the structured debt financing marketplace, instead preferring the risk-reward profile of asset based lending. Traditional lenders generally do not have flexible product offerings that meet the needs of technology-related companies. The financing products offered by traditional lenders typically impose on borrowers many restrictive covenants and conditions, including limiting cash outflows and requiring a significant depository relationship to facilitate rapid liquidation.

Unfulfilled Demand for Structured Debt Financing to Technology-Related Companies. Private debt capital in the form of structured debt financing from specialty finance companies continues to be an important source of funding for technology-related companies. We believe that the level of demand for structured debt financing is a function of the level of annual venture equity investment activity.

We believe that demand for structured debt financing is currently underserved. The venture capital market for the technology-related companies in which we invest has been active. Therefore, to the extent we have capital available, we believe this is an opportune time to be active in the structured lending market for technology-related companies.

Structured Debt with Warrants Products Complement Equity Financing From Venture Capital and Private Equity Funds. We believe that technology-related companies and their financial sponsors will continue to view structured debt securities as an attractive source of capital because it augments the capital provided by venture capital and private equity funds. We believe that our structured debt with warrants products provide access to growth capital that otherwise may only be available through incremental investments by existing equity investors. As such, we provide portfolio companies and their financial sponsors with an opportunity to diversify their capital sources. Generally, we believe many technology-related companies at all stages of development target a portion of their capital to be debt in an attempt to achieve a higher valuation through internal growth. In addition, because financial sponsor-backed companies have reached a more mature stage prior to reaching a liquidity event, we believe our investments could provide the debt capital needed to grow or recapitalize during the extended period sometimes required prior to liquidity events.

Our Business Strategy

Our strategy to achieve our investment objective includes the following key elements:

Leverage the Experience and Industry Relationships of Our Management Team and Investment Professionals. We have assembled a team of experienced investment professionals with extensive experience as venture capitalists, commercial lenders, and originators of structured debt and equity investments in technology-related companies.

Mitigate Risk of Principal Loss and Build a Portfolio of Equity-Related Securities. We expect that our investments have the potential to produce attractive risk-adjusted returns through current income, in the form of interest and fee income, as well as capital appreciation from warrant and equity-related securities. We believe that we can mitigate the risk of loss on our debt investments through the combination of loan principal

 



 

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amortization, cash interest payments, relatively short maturities (typically between 24—48 months), security interests in the assets of our portfolio companies, and on select investment covenants requiring prospective portfolio companies to have certain amounts of available cash at the time of our investment and the continued support from a venture capital or private equity firm at the time we make our investment.

Provide Customized Financing Complementary to Financial Sponsors’ Capital. We offer a broad range of investment structures and possess expertise and experience to effectively structure and price investments in technology-related companies.

Invest at Various Stages of Development. We provide growth capital to technology-related companies at all stages of development, including select publicly listed companies and select special opportunity lower middle market companies that require additional capital to fund acquisitions, recapitalizations and refinancings and established-stage companies.

Benefit from Our Efficient Organizational Structure. We believe that the perpetual nature of our corporate structure enables us to be a long-term partner for our portfolio companies in contrast to traditional investment funds, which typically have a limited life. In addition, because of our access to the equity markets, we believe that we may benefit from a lower cost of capital than that available to private investment funds.

Deal Sourcing Through Our Proprietary Database. We have developed a proprietary and comprehensive structured query language-based database system to track various aspects of our investment process including sourcing, originations, transaction monitoring and post-investment performance.

Recent Developments

Distribution Declaration

On October 25, 2017, our Board of Directors declared a cash distribution of $0.31 per share to be paid on November 20, 2017 to stockholders of record as of November 13, 2017. This distribution represented our forty-ninth consecutive distribution since our initial public offering, bringing the total cumulative distribution to date to $13.71 per share.

Closed and Pending Commitments

As of November 6, 2017, we have:

 

   

Closed debt and equity commitments of approximately $182.7 million to new and existing portfolio companies and funded approximately $176.1 million subsequent to September 30, 2017.

 

   

Pending commitments (signed non-binding term sheets) of approximately $137.0 million.

The table below summarizes our year-to-date closed and pending commitments as follows:

 

Closed Commitments and Pending Commitments (in millions)

  

January 1—September 30, 2017 Closed Commitments

   $ 551.4  

October 1—November 6, 2017 Closed Commitments(a)

   $ 182.7  

Pending Commitments (as of November 6, 2017)(b)

   $ 137.0  
  

 

 

 

Closed and Pending Commitments as of November 6, 2017

   $ 871.1  
  

 

 

 

 

a. Closed Commitments may include renewals of existing credit facilities. Not all Closed Commitments result in future cash requirements. Commitments generally fund over the two succeeding quarters from close.
b. Not all pending commitments (signed non-binding term sheets) are expected to close and they do not necessarily represent any future cash requirements.

 



 

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2022 Notes

On October 23, 2017, we issued $150.0 million in aggregate principal amount of 4.625% Notes due 2022 (the “2022 Notes”). The 2022 Notes were issued pursuant to an Indenture, dated October 23, 2017 (the “2022 Notes Indenture”), between us and U.S. Bank, National Association, as trustee (the “2022 Trustee”). The sale of the 2022 Notes generated net proceeds of approximately $147.9 million. Aggregate estimated offering expenses in connection with the transaction, including the underwriter’s discount of approximately $1.9 million, were approximately $2.1 million.

We intend to use the net proceeds from the offering (i) to repurchase or otherwise redeem a portion of our 6.25% Notes due 2024 (the “2024 Notes”), (ii) to fund investments in debt and equity securities in accordance with our investment objective and (iii) for working capital and other general corporate purposes. The 2022 Notes mature on October 23, 2022, unless previously repurchased in accordance with their terms. The 2022 Notes bear interest at a rate of 4.625% per year payable semiannually in arrears on April 23 and October 23 of each year, commencing on April 23, 2018.

The 2022 Notes are our unsecured obligations that rank senior in right of payment to all of our existing and future indebtedness that is expressly subordinated, or junior, in right of payment to the 2022 Notes. The 2022 Notes are not guaranteed by any of our current or future subsidiaries. The 2022 Notes rank pari passu, or equally, in right of payment with all of our existing and future liabilities that are not so subordinated, or junior. The 2022 Notes effectively rank subordinated, or junior, to any of our secured indebtedness (including unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness. The 2022 Notes rank structurally subordinated, or junior, to all existing and future indebtedness (including trade payables) incurred by our subsidiaries, financing vehicles or similar facilities.

We may redeem some or all of the 2022 Notes at any time, or from time to time, at the redemption price set forth under the terms of the 2022 Notes Indenture after September 23, 2022. No sinking fund is provided for the 2022 Notes. The 2022 Notes were issued in denominations of $2,000 and integral multiples of $1,000 thereof.

Redemption of 2024 Notes

On October 24, 2017, our Board of Directors approved a redemption of $75.0 million of our outstanding aggregate principal amount of the 2024 Notes, and notice for such redemption has been provided. We have publicly announced our intention to redeem this portion of the 2024 Notes on November 23, 2017.

Appointment of Directors

On October 25, 2017, our Board of Directors appointed Jorge Titinger and Brad Koenig as directors of the Company. There are no arrangements or understandings between Mr. Titinger or Mr. Koenig and any other persons pursuant to which they were appointed as directors of the Company. Both Mr. Titinger and Mr. Koenig will each be entitled to the applicable annual retainer pursuant to our director compensation arrangements, under terms consistent with those previously disclosed by the Company. They will also be entitled to enter an indemnification agreement with the Company.

Mr. Titinger’s Board appointment will be effective at the time of the 2017 Annual Meeting of Stockholders (the “Annual Meeting”) and he will fill the position vacated by Susanne Lyons who will be stepping down at the Annual Meeting. His appointment will be ratified at the Annual Meeting as a Class I director for a term expiring in 2020. At the time Mr. Titinger joins the Board, he will be appointed to the Compensation Committee and will serve as chairman of such committee.

 



 

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Mr. Koenig’s Board appointment was effective immediately and he will hold office as a Class II director for a term expiring in 2018. He will serve on the Audit Committee and Nominating and Corporate Governance Committee.

ATM Equity Program Issuances

Subsequent to September 30, 2017, and as of November 6, 2017, we sold 567,000 shares of common stock for total accumulated net proceeds of approximately $7.1 million, including $65,000 of offering expenses, under the Equity Distribution Agreement. As of November 6, 2017, approximately 10.7 million shares remain available for issuance and sale under the equity at-the-market (“ATM”) program.

Departure of Officer

On October 27, 2017, we and Mark Harris mutually agreed that Mr. Harris would separate from the Company and end his tenure as Chief Financial Officer and Chief Accounting Officer effective November 2, 2017. Mr. Harris’ separation did not result from any disagreements with the Company regarding its operations, policies, practices or any issues regarding financial disclosures, accounting or legal matters.

Appointment of Officers

Effective October 31, 2017, the Board of Directors appointed David Lund, our former Chief Financial Officer, as our Interim Chief Financial Officer and Gerard R. Waldt, Jr., our current Controller, as our Interim Chief Accounting Officer.

Asset Acquisition

On November 1, 2017, we, through a wholly owned subsidiary, Bearcub Acquisitions LLC, entered into, and consummated the transactions contemplated by, a definitive asset purchase agreement with Ares Capital Corporation to acquire select venture loan assets for approximately $125.8 million in cash.

Management Structure

We have decided to suspend our review of alternative investment management structures and will remain an internally managed business development company for the foreseeable future.

Portfolio Company Developments

As of November 6, 2017, we held warrants or equity positions in three companies that have filed registration statements on Form S-1 with the SEC in contemplation of potential initial public offerings. All three companies filed confidentially under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). There can be no assurance that these companies will complete their initial public offerings in a timely manner or at all. In addition, subsequent to September 30, 2017, our portfolio companies announced or completed the following liquidity events:

 

  1. In August 2017, our former portfolio company Cempra, Inc. and current portfolio company Melinta Therapeutics, Inc., announced that they had entered into a definitive agreement under which Melinta Therapeutics, Inc. will merge with a subsidiary of Cempra, Inc. The deal closed on November 6, 2017. Melinta Therapeutics commenced trading on November 6, 2017 on the NASDAQ Global Market under the symbol “MLNT.”

 

  2. In October 2017, our portfolio company Neothetics, Inc., announced they have entered into a definitive agreement under which privately-held Evofem Biosciences will merge with a wholly-owned subsidiary of Neothetics in an all-stock transaction. Upon closing of this transaction, Neothetics will be renamed Evofem Biosciences, Inc.

 



 

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Index to Financial Statements
  3. In October 2017, our portfolio company ForeScout Technologies, Inc. completed its initial public offering.

 

  4. In November 2017, our portfolio company Aquantia Corp. completed its initial public offering.

General Information

Our principal executive offices are located at 400 Hamilton Avenue, Suite 310, Palo Alto, California 94301, and our telephone number is (650) 289-3060. We also have offices in Boston, MA, New York, NY, Washington, DC, Santa Monica, CA, Hartford, CT, and San Diego, CA. We maintain a website on the Internet at www.htgc.com. We make available, free of charge, on our website our proxy statement, annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Information contained on our website is not incorporated by reference into this prospectus supplement or the accompanying prospectus, and you should not consider that information to be part of this prospectus supplement or the accompanying prospectus.

We file annual, quarterly and current periodic reports, proxy statements and other information with the SEC under the Securities Exchange Act of 1934, as amended, or the Exchange Act. This information is available at the SEC’s public reference room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information about the operation of the SEC’s public reference room by calling the SEC at (202) 551-8090. In addition, the SEC maintains an Internet website, at www.sec.gov, that contains reports, proxy and information statements, and other information regarding issuers, including us, who file documents electronically with the SEC.

 



 

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Index to Financial Statements

THE OFFERING

 

Common stock offered by us

Up to 12,000,000 shares of our common stock

 

Common stock outstanding prior to this
offering


84,136,766 shares

 

Manner of offering

“At the market” offering that may be made from time to time through JMP Securities, as sales agent, using commercially reasonable efforts. See “Plan of Distribution” in this prospectus supplement.

 

Use of proceeds

We expect to use the net proceeds from this offering to fund investments in debt and equity securities in accordance with our investment objectives, retire certain debt obligations and for other general corporate purposes.

 

  Pending such uses and investments, we will invest a portion of the net proceeds of this offering primarily in cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment. Our ability to achieve our investment objectives may be limited to the extent that the net proceeds of this offering, pending full investment, are held in lower yielding short-term instruments. See “Use of Proceeds” in this prospectus supplement.

 

Distribution

To the extent that we have income available, we intend to distribute quarterly distributions to our stockholders. The amount of our distributions, if any, will be determined by our Board of Directors. Any distributions to our stockholders will be declared out of assets legally available for distribution. See “Price Range of Common Stock and Distributions” in the accompanying prospectus.

 

Taxation

We have elected to be treated for federal income tax purposes as a RIC under Subchapter M of the Code. As a RIC, we generally do not have to pay corporate-level federal income taxes on any ordinary income or capital gains that we distribute to our stockholders as distributions. To maintain our RIC tax status, we must meet specified source-of-income and asset diversification requirements and distribute annually at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any. See “Price Range of Common Stock and Distributions” in the accompanying prospectus and “Certain United States Federal Income Tax Considerations” in the accompanying prospectus.

 

New York Stock Exchange symbol

“HTGC”

 

Risk factors

An investment in our common stock is subject to risks and involves a heightened risk of total loss of investment. In addition, the companies in which we invest are subject to special risks. See “Risk Factors” beginning on page 14 of the accompanying prospectus to read about factors you should consider, including the risk of leverage, before investing in our common stock.

 



 

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Index to Financial Statements

SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Senior Securities” and the consolidated financial statements and related notes included elsewhere herein. The selected balance sheet data as of the end of fiscal year 2016, 2015, 2014, 2013, and 2012 and the financial statement of operations data for fiscal years 2016, 2015, 2014, 2013, and 2012 has been derived from our audited financial statements, which have been audited by PricewaterhouseCoopers LLP, our independent registered public accounting firm, but not all of which are presented in this prospectus supplement. The historical data are not necessarily indicative of results to be expected for any future period. The selected financial and other data for the nine months ended September 30, 2017 and other quarterly financial information is derived from our unaudited financial statements, but in the opinion of management, reflects all adjustments (consisting only of normal recurring adjustments) that are necessary to present fairly the results of such interim periods. Interim results as of and for the nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.

 

     For the Nine Months
Ended September 30
(unaudited)
    For the Year Ended December 31,  

(in thousands, except per share amounts)

   2017     2016     2016     2015     2014     2013      2012  

Investment income:

               

Interest

   $ 125,802     $ 116,047     $ 158,727     $ 140,266     $ 126,618     $ 123,671      $ 87,603  

Fees

     14,880       11,532       16,324       16,866       17,047       16,042        9,917  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total investment income

     140,682       127,579       175,051       157,132       143,665       139,713        97,520  

Operating expenses:

               

Interest

     28,046       23,306       32,016       30,834       28,041       30,334        19,835  

Loan fees

     5,500       3,698       5,042       6,055       5,919       4,807        3,917  

General and administrative

     12,362       12,095       16,106       16,658       10,209       9,354        8,108  

Employee Compensation:

               

Compensation and benefits

     17,276       15,637       22,500       20,713       16,604       16,179        13,326  

Stock-based compensation

     5,573       5,616       7,043       9,370       9,561       5,974        4,227  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total employee compensation

     22,849       21,253       29,543       30,083       26,165       22,153        17,553  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total operating expenses

     68,757       60,352       82,707       83,630       70,334       66,648        49,413  

Loss on debt extinguishment (Long-term Liabilities—Convertible Senior Notes)

     —         —         8,000       (1     (1,581     —          —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net investment income

     71,925       67,227       100,344       73,501       71,750       73,065        48,107  

Net realized gain (loss) on investments

     (26,929     3,427       4,576       5,147       20,112       14,836        3,168  

Net change in unrealized appreciation (depreciation) on investments

     15,637       (16,072     (36,217     (35,732     (20,674     11,545        (4,516
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total net realized and unrealized gain (loss)

     (11,292     (12,645     (31,641     (30,585     (562     26,381        (1,348
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net increase in net assets resulting from operations

   $ 60,633     $ 54,582     $ 68,703     $ 42,916     $ 71,188     $ 99,446      $ 46,759  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Change in net assets per common share (basic)

   $ 0.73     $ 0.74     $ 0.91     $ 0.60     $ 1.12     $ 1.67      $ 0.93  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Distributions declared per common share

   $ 0.93     $ 0.93     $ 1.24     $ 1.24     $ 1.24     $ 1.11      $ 0.95  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

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Index to Financial Statements
    For the Nine Months
Ended September 30
(unaudited)
    For the Year Ended December 31,  

(in thousands, except per share amounts)

  2017      2016     2016     2015      2014      2013     2012  

Balance sheet data:

                

Investments, at value

  $ 1,417,114      $ 1,320,610     $ 1,423,942     $ 1,200,638      $ 1,020,737      $ 910,295     $ 906,300  

Cash and cash equivalents

    140,568        69,012       13,044       95,196        227,116        268,368       182,994  

Total assets

    1,582,997        1,419,424       1,464,204       1,334,761        1,299,223        1,221,715       1,123,643  

Total liabilities

    746,713        665,835       676,260       617,627        640,359        571,708       607,675  

Total net assets

    836,284        753,589       787,944       717,134        658,864        650,007       515,968  

Other Data:

                

Total debt investments, at value

    1,300,068        1,224,121       1,328,803       1,110,209        923,906        821,988       827,540  

Total warrant investments, at value

    32,729        27,738       27,485       22,987        25,098        35,637       29,550  

Total equity investments, at value

    84,317        68,751       67,654       67,442        71,733        52,670       49,210  

Unfunded Commitments (2)

    46,302        73,865       59,683       75,402        147,689        69,091       19,265  

Net asset value per share (1)

  $ 10.00      $ 9.86     $ 9.90     $ 9.94      $ 10.18      $ 10.51     $ 9.75  

 

(1) Based on common shares outstanding at period end.
(2) Amount represents unfunded commitments, including undrawn revolving facilities, which are available at the request of the portfolio company. Amount excludes unfunded commitments which are unavailable due to the borrower having not met certain milestones.

The following tables set forth certain quarterly financial information for each of the eight quarters up to and ending December 31, 2016 and the quarters ending March 31, 2017, June 30, 2017 and September 30, 2017. This information was derived from our unaudited consolidated financial statements. Results for any quarter are not necessarily indicative of results for the full year or for any future quarter.

 

     For the Quarter Ended
(unaudited)
 

(in thousands, except per share data)

   September 30,
2017
     June 30,
2017
     March 31,
2017
 

Total investment income

   $ 45,865      $ 48,452      $ 46,365  

Net investment income before investment gains and losses

     23,973        25,275        22,678  

Net increase (decrease) in net assets resulting from operations

     33,072        33,149        (5,588

Change in net assets per common share (basic)

   $ 0.40      $ 0.40      $ (0.07

 

     For the Quarter Ended  

(in thousands, except per share data)

   March 31,
2016
     June 30,
2016
     September 30,
2016
     December 31,
2016
 

Total investment income

   $ 38,939      $ 43,538      $ 45,102      $ 47,472  

Net investment income before investment gains and losses

     20,097        23,354        23,776        33,117  

Net increase (decrease) in net assets resulting from operations

     14,295        9,475        30,812        14,121  

Change in net assets per common share (basic)

   $ 0.20      $ 0.13      $ 0.41      $ 0.18  

 

     For the Quarter Ended  

(in thousands, except per share data)

   March 31,
2015
     June 30,
2015
     September 30,
2015
     December 31,
2015
 

Total investment income

   $ 32,494      $ 38,126      $ 47,132      $ 39,380  

Net investment income before investment gains and losses

     12,993        16,781        23,590        20,137  

Net increase (decrease) in net assets resulting from operations

     21,919        2,752        4,075        14,170  

Change in net assets per common share (basic)

   $ 0.33      $ 0.03      $ 0.05      $ 0.20  

 

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Index to Financial Statements

USE OF PROCEEDS

Overview

Sales of our common stock, if any, under this prospectus supplement and the accompanying prospectus may be made in negotiated transactions or transactions that are deemed to be “at the market” as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE or sales made to or through a market maker other than on an exchange. There is no guarantee that there will be any sales of our common stock pursuant to this prospectus supplement and the accompanying prospectus. Actual sales, if any, of our common stock under this prospectus supplement and the accompanying prospectus may be less than as set forth in this paragraph depending on, among other things, the market price of our common stock at the time of any such sale. As a result, the actual net proceeds we receive may be more or less than the amount of net proceeds estimated in this prospectus supplement. Assuming the sale of the remaining 10,664,642 shares of common stock offered under this prospectus supplement and the accompanying prospectus, at the last reported sale price of $13.38 per share for our common stock on the NYSE as of November 6, 2017, we estimate that the net proceeds of this offering will be approximately $139.6 million after deducting the estimated sales commission payable to JMP Securities and our estimated offering expenses.

We intend to use the net proceeds from this offering to fund investments in debt and equity securities in accordance with our investment objectives, retire certain debt obligations and for other general corporate purposes.

We intend to seek to invest the net proceeds received in this offering as promptly as practicable after receipt thereof consistent with our investment objective. We anticipate that substantially all of the net proceeds from any offering of our securities will be used as described above within three to six months, depending on market conditions. We anticipate that the remainder will be used for working capital and general corporate purposes, including potential payments or distributions to shareholders. Pending such uses and investments, we will invest a portion of the net proceeds of this offering primarily in cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment. Our ability to achieve our investment objectives may be limited to the extent that the net proceeds of this offering, pending full investment, are held in lower yielding short-term instruments.

Status of the Offering

On September 8, 2017, we established an ATM program to which this prospectus supplement relates and through which we may sell, from time to time and at our sole discretion up to 12,000,000 shares of our common stock. During the period from September 8, 2017 through the date of this prospectus supplement, approximately 1.3 million shares of common stock have been issued and sold pursuant to the Equity Distribution Agreement and approximately 10.7 million shares of common stock remain available for sale. Gross proceeds raised through the date of this prospectus were approximately $16.8 million based on an average sale price of $12.57 per share, offset by related underwriting fees and offering expenses of approximately $220,000 for net proceeds of approximately $16.6 million.

 

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Index to Financial Statements

PRICE RANGE OF COMMON STOCK

Our common stock is traded on the NYSE under the symbol “HTGC.”

The following table sets forth the range of high and low sales prices of our common stock, the sales price as a percentage of NAV and the distributions declared by us for each fiscal quarter. The stock quotations are interdealer quotations and do not include markups, markdowns or commissions.

 

           

 

 

Price Range

     Premium/
Discount of
High Sales
Price to NAV
    Premium/
Discount of
Low Sales
Price to NAV
    Cash
Distribution
per Share
 
     NAV(1)      High      Low         

2015

               

First quarter

   $ 10.47      $ 15.27      $ 13.47        45.8     28.7   $ 0.310  

Second quarter

   $ 10.26      $ 13.37      $ 11.25        30.3     9.6   $ 0.310  

Third quarter

   $ 10.02      $ 12.23      $ 9.99        22.1     -0.3   $ 0.310  

Fourth quarter

   $ 9.94      $ 12.44      $ 10.23        25.2     2.9   $ 0.310  

2016

               

First quarter

   $ 9.81      $ 12.39      $ 10.03        26.3     2.2   $ 0.310  

Second quarter

   $ 9.66      $ 12.43      $ 11.74        28.7     21.6   $ 0.310  

Third quarter

   $ 9.86      $ 14.00      $ 12.42        41.9     25.9   $ 0.310  

Fourth quarter

   $ 9.90      $ 14.25      $ 12.90        43.9     30.2   $ 0.310  

2017

               

First quarter

   $ 9.76      $ 15.43      $ 14.12        58.1     44.7   $ 0.310  

Second quarter

   $ 9.87      $ 15.56      $ 12.66        57.6     28.3   $ 0.310  

Third quarter

   $ 10.00      $ 13.50      $ 12.04        35.0     20.4   $ 0.310  

Fourth quarter (through November 6, 2017)

     *      $ 13.40      $ 12.44        *       *       **  

 

(1) Net asset value per share is generally determined as of the last day in the relevant quarter and therefore may not reflect the NAV per share on the date of the high and low sales prices. The NAVs shown are based on outstanding shares at the end of each period.
 * Net asset value has not yet been calculated for this period.
** Cash distribution per share has not yet been determined for this period.

The last reported price for our common stock on November 6, 2017 was $13.38 per share.

Shares of business development companies may trade at a market price that is less than the value of the net assets attributable to those shares. The possibility that our shares of common stock will trade at a discount from NAV or at premiums that are unsustainable over the long term are separate and distinct from the risk that our NAV will decrease. At times, our shares of common stock have traded at a premium to NAV and at times our shares of common stock have traded at a discount to the net assets attributable to those shares. It is not possible to predict whether the shares offered hereby will trade at, above, or below NAV.

 

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Index to Financial Statements

RATIO OF EARNINGS TO FIXED CHARGES

The following contains our ratio of earnings to fixed charges for the periods indicated, computed as set forth below. You should read these ratios of earnings to fixed charges in connection with our consolidated financial statements, including the notes to those statements, included in this prospectus supplement:

 

    For the nine
months ended
September 30,
2017
    For the year
ended
December 31,
2016
    For the year
ended
December 31,
2015
    For the year
ended
December 31,
2014
    For the year
ended
December 31,
2013
    For the year
ended
December 31,
2012
 

Earnings to Fixed Charges(1)

    2.81       2.85       2.16       3.10       3.83       2.97  

 

For purposes of computing the ratios of earnings to fixed charges, earnings represent net increase in stockholders’ equity resulting from operations plus fixed charges. Fixed charges include interest and credit facility fees expense and amortization of debt issuance costs.

 

(1) Earnings include net realized and unrealized gains or losses. Net realized and unrealized gains or losses can vary substantially from period to period.

 

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Index to Financial Statements

CAPITALIZATION

The Equity Distribution Agreement provides that we may offer and sell up to 12,000,000 shares of our common stock from time to time through JMP Securities, as our sales agent for the offer and sale of such common stock. The table below assumes that we will sell the remaining 10,664,642 shares at a price of $13.38 per share (the last reported sale price per share of our common stock on the NYSE on November 6, 2017) but there is no guarantee that there will be any sales of our common stock pursuant to this prospectus supplement and the accompanying prospectus. Actual sales, if any, of our common stock under this prospectus supplement and the accompanying prospectus may be less than as set forth in the table below. In addition, the price per share of any such sale may be greater or less than $13.38, depending on the market price of our common stock at the time of any such sale. The following table sets forth our capitalization as of September 30, 2017:

 

   

on an actual basis; and

 

   

on an as adjusted basis giving effect to the transactions noted above, the sale of 567,000 shares of common stock for total accumulated net proceeds of approximately $7.1 million subsequent to September 30, 2017, and as of November 6, 2017, and the assumed sale of 10,664,642 shares of our common stock at a price of $13.38 per share (the last reported sale price per share of our common stock on the NYSE on November 6, 2017) less commissions and expenses.

This table should be read in conjunction with “Use of Proceeds” 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 September 30, 2017  
     Actual     As
Adjusted
 
     (in thousands)  

Investments at fair value

   $ 1,417,114     $ 1,417,114  

Cash and cash equivalents

   $ 140,568     $ 287,332  

Debt:

    

Accounts payable and accrued liabilities

   $ 19,057     $ 19,057  

Long-term SBA debentures

     187,983       187,983  

Convertible Notes

     223,097       223,097  

2021 Asset-Backed Notes

     64,860       64,860  

2024 Notes

     251,716       251,716  
  

 

 

   

 

 

 

Total debt

   $ 746,713     $ 746,713  
  

 

 

   

 

 

 

Stockholders’ equity:

    

Common stock, par value $0.001 per share; 200,000,000 shares authorized; 83,614,624 shares issued and outstanding, actual, 94,846,266 shares issued and outstanding, as adjusted, respectively

   $ 84     $ 95  

Capital in excess of par value

     904,357       1,051,111  

Unrealized depreciation on investments

     (73,388     (73,388

Accumulated realized gains on investments

     10,674       10,674  

Distributions in excess of investment income

     (5,443     (5,443
  

 

 

   

 

 

 

Total stockholders’ equity

   $ 836,284     $ 983,049  
  

 

 

   

 

 

 

Total capitalization

   $ 1,582,997     $ 1,729,762  
  

 

 

   

 

 

 

 

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Index to Financial Statements

PLAN OF DISTRIBUTION

JMP Securities LLC is acting as our sales agent in connection with the offer and sale of shares of our common stock pursuant to this prospectus supplement and the accompanying prospectus. Upon written instructions from us, JMP Securities LLC will use its commercially reasonable efforts consistent with its sales and trading practices to sell, as our sales agent, our common stock under the terms and subject to the conditions set forth in the Equity Distribution Agreement. We will instruct JMP Securities LLC as to the amount of common stock to be sold by it. We may instruct JMP Securities LLC not to sell common stock if the sales cannot be effected at or above the price designated by us in any instruction. The sales price per share of our common stock offered by this prospectus supplement and the accompanying prospectus, less JMP Securities LLC’s commission, will not be less than the net asset value per share of our common stock at the time of such sale. We or JMP Securities LLC may suspend the offering of shares of common stock upon proper notice and subject to other conditions.

Sales of our common stock, if any, under this prospectus supplement and the accompanying prospectus may be made in negotiated transactions or transactions that are deemed to be “at the market,” as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE or similar securities exchange or sales made to or through a market maker other than on an exchange at prices related to the prevailing market prices or at negotiated prices.

JMP Securities LLC will provide written confirmation of a sale to us no later than the opening of the trading day on the NYSE following each trading day in which shares of our common stock are sold under the Equity Distribution Agreement. Each confirmation will include the number of shares of common stock sold on the preceding day, the net proceeds to us and the compensation payable by us to JMP Securities LLC in connection with the sales.

JMP Securities LLC will receive a commission from us to be negotiated from time to time but in no event in excess of 2.0% of the gross sales price of any shares of our common stock sold through JMP Securities LLC under the Equity Distribution Agreement. We estimate that the total expenses for the offering, excluding compensation payable to JMP Securities LLC under the terms of the Equity Distribution Agreement, will be approximately $291,000 assuming all shares are offered under this prospectus supplement (including up to $10,000 in reimbursement of the underwriters’ counsel fees in connection with the review of the terms of the offering by the Financial Industry Regulatory Authority, Inc.).

Settlement for sales of shares of common stock will occur on the third trading day following the date on which such sales are made, or on some other date that is agreed upon by us and JMP Securities LLC in connection with a particular transaction, in return for payment of the net proceeds to us. There is no arrangement for funds to be received in an escrow, trust or similar arrangement.

We will report at least quarterly the number of shares of our common stock sold through JMP Securities LLC under the Equity Distribution Agreement and the net proceeds to us.

In connection with the sale of the common stock on our behalf, JMP Securities LLC may be deemed to be an “underwriter” within the meaning of the Securities Act, and the compensation of JMP Securities LLC may be deemed to be underwriting commissions or discounts. We have agreed to provide indemnification and contribution to JMP Securities LLC against certain civil liabilities, including liabilities under the Securities Act.

The offering of our shares of common stock pursuant to the Equity Distribution Agreement will terminate upon the earlier of (i) the sale of all common stock subject to the Equity Distribution Agreement or (ii) the termination of the Equity Distribution Agreement. The Equity Distribution Agreement may be terminated by us in our sole discretion under the circumstances specified in the Equity Distribution Agreement by giving notice to JMP Securities LLC. In addition, JMP Securities LLC may terminate the Equity Distribution Agreement under the circumstances specified in the Equity Distribution Agreement by giving notice to us.

 

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Potential Conflicts of Interest

JMP Securities LLC and its affiliates have provided, or may in the future provide, various investment banking, commercial banking, financial advisory, brokerage and other services to us and our affiliates for which services they have received, and may in the future receive, customary fees and expense reimbursement. JMP Securities LLC and its affiliates may, from time to time, engage in transactions with and perform services for us in the ordinary course of their business for which they may receive customary fees and reimbursement of expenses. In the ordinary course of their various business activities, JMP Securities LLC 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 our company.

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

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our consolidated 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 supplement and the accompanying 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 herein and the accompanying prospectus. Capitalized terms used and not otherwise defined herein have the meaning given in the accompanying prospectus.

Overview

We are a specialty finance company focused on providing senior secured loans to high-growth, innovative venture capital-backed companies in a variety of technology, life sciences, and sustainable and renewable technology industries. We source our investments through our principal office located in Palo Alto, CA, as well as through our additional offices in Boston, MA, New York, NY, Washington, DC, Santa Monica, CA, Hartford, CT, and San Diego, CA.

Our goal is to be the leading structured debt financing provider for venture capital-backed companies in technology-related industries requiring sophisticated and customized financing solutions. Our strategy is to evaluate and invest in a broad range of technology-related industries including technology, drug discovery and development, biotechnology, life sciences, healthcare, and sustainable and renewable technology and to offer a full suite of growth capital products. We invest primarily in structured debt with warrants and, to a lesser extent, in senior debt and equity investments. We invest primarily in private companies but also have investments in public companies.

We use the term “structured debt with warrants” to refer to any debt investment, such as a senior or subordinated secured loan, that is coupled with an equity component, including warrants, options or other rights to purchase common or preferred stock. Our structured debt with warrants investments typically are secured by some or all of the assets of the portfolio company.

Our investment objective is to maximize our portfolio’s total return by generating current income from our debt investments and capital appreciation from our warrant and equity-related investments. Our primary business objectives are to increase our net income, net operating income and net asset value by investing in structured debt with warrants and equity of venture capital-backed companies in technology-related industries with attractive current yields and the potential for equity appreciation and realized gains. Our equity ownership in our portfolio companies may exceed 25% of the voting securities of such companies, which represents a controlling interest under the 1940 Act. In some cases, we receive the right to make additional equity investments in our portfolio companies in connection with future equity financing rounds. Capital that we provide directly to venture capital-backed companies in technology-related industries is generally used for growth and general working capital purposes as well as in select cases for acquisitions or recapitalizations.

We also make investments in qualifying small businesses through our two wholly owned SBICs. Our SBIC subsidiaries, HT II and HT III, hold approximately $107.9 million and $279.9 million in assets, respectively, and accounted for approximately 5.4% and 13.9% of our total assets, respectively, prior to consolidation at September 30, 2017. In aggregate, at September 30, 2017, with our net investment of $118.5 million, HT II and HT III have the capacity to issue a total of $190.2 million of SBA-guaranteed debentures, subject to SBA approval. At September 30, 2017, we have issued $190.2 million in SBA-guaranteed debentures in our SBIC subsidiaries.

 

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We have qualified as and have elected to be treated for tax purposes as a RIC under Subchapter M of the Code. Pursuant to this election, we generally will not be subject to corporate-level taxes on any income and gains that we distribute as dividends for federal income tax purposes to our stockholders. However, our qualification and election to be treated as a RIC requires that we comply with provisions contained in Subchapter M of the Code. For example, as a RIC we must earn 90% or more of our gross income during each taxable year from qualified sources, typically referred to as “good income,” as well as satisfy certain quarterly asset diversification and annual income distribution requirements.

We are an internally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company under the 1940 Act. As a business development company, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in “qualifying assets,” which includes securities of private U.S. companies, cash, cash equivalents and high-quality debt investments that mature in one year or less.

Our portfolio is comprised of, and we anticipate that our portfolio will continue to be comprised of, investments primarily in technology related companies at various stages of their development. Consistent with requirements under the 1940 Act, we invest primarily in United-States based companies and to a lesser extent in foreign companies.

We regularly engage in discussions with third parties with respect to various potential transactions. We may acquire an investment or a portfolio of investments or an entire company or sell a portion of our portfolio on an opportunistic basis. We, our subsidiaries or our affiliates may also agree to manage certain other funds that invest in debt, equity or provide other financing or services to companies in a variety of industries for which we may earn management or other fees for our services. We may also invest in the equity of these funds, along with other third parties, from which we would seek to earn a return and/or future incentive allocations. Some of these transactions could be material to our business. Consummation of any such transaction will be subject to completion of due diligence, finalization of key business and financial terms (including price) and negotiation of final definitive documentation as well as a number of other factors and conditions including, without limitation, the approval of our board of directors and required regulatory or third party consents and, in certain cases, the approval of our stockholders. Accordingly, there can be no assurance that any such transaction would be consummated. Any of these transactions or funds may require significant management resources either during the transaction phase or on an ongoing basis depending on the terms of the transaction.

Portfolio and Investment Activity

The total fair value of our investment portfolio was $1.4 billion at both September 30, 2017 and December 31, 2016. The fair value of our debt investment portfolio was approximately $1.3 billion at both September 30, 2017 and December 31, 2016. The fair value of the equity portfolio at September 30, 2017 was approximately $84.3 million, compared to a fair value of approximately $67.6 million at December 31, 2016. The fair value of the warrant portfolio at September 30, 2017 was approximately $32.7 million, compared to a fair value of approximately $27.5 million at December 31, 2016.

Portfolio Activity

Our investments in portfolio companies take a variety of forms, including unfunded contractual commitments and funded investments. From time to time, unfunded contractual commitments depend upon a portfolio company reaching certain milestones before the debt commitment is available to the portfolio company, which is expected to affect our funding levels. These commitments are subject to the same underwriting and ongoing portfolio maintenance as the on-balance sheet financial instruments that we hold. Debt commitments generally fund over the two succeeding quarters from close. Not all debt commitments represent future cash requirements. Similarly, unfunded contractual commitments may expire without being drawn and thus do not represent future cash requirements.

 

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Prior to entering into a contractual commitment, we generally issue a non-binding term sheet to a prospective portfolio company. Non-binding term sheets are subject to completion of our due diligence and final investment committee approval process, as well as the negotiation of definitive documentation with the prospective portfolio companies. These non-binding term sheets generally convert to contractual commitments in approximately 90 days from signing. Not all non-binding term sheets are expected to close and do not necessarily represent future cash requirements.

Our portfolio activity for the nine months ended September 30, 2017 and the year ended December 31, 2016 was comprised of the following:

 

(in millions)

   September 30, 2017      December 31, 2016  

Debt Commitments(1)

     

New portfolio company

   $ 467.0      $ 624.0  

Existing portfolio company

     79.9        171.8  
  

 

 

    

 

 

 

Total

   $ 546.9      $ 795.8  
  

 

 

    

 

 

 

Funded and Restructured Debt Investments(2)

     

New portfolio company

   $ 346.7      $ 479.0  

Existing portfolio company

     136.1        181.5  
  

 

 

    

 

 

 

Total

   $ 482.8      $ 660.5  
  

 

 

    

 

 

 

Funded Equity Investments

     

New portfolio company

   $ 3.8      $ 17.1  

Existing portfolio company

     0.7        3.1  
  

 

 

    

 

 

 

Total

   $ 4.5      $ 20.2  
  

 

 

    

 

 

 

Unfunded Contractual Commitments(3)

     

Total

   $ 46.3      $ 59.7  
  

 

 

    

 

 

 

Non-Binding Term Sheets

     

New portfolio company

   $ 60.0      $ 55.0  

Existing portfolio company

     12.0        —    
  

 

 

    

 

 

 

Total

   $ 72.0      $ 55.0  
  

 

 

    

 

 

 

 

(1) Includes restructured loans and renewals in addition to new commitments.
(2) Funded amounts include borrowings on revolving facilities.
(3) Amount represents unfunded commitments, including undrawn revolving facilities, which are available at the request of the portfolio company. Amount excludes unfunded commitments which are unavailable due to the borrower having not met certain milestones.

We receive principal payments on our debt investment portfolio based on scheduled amortization of the outstanding balances. In addition, we receive principal repayments for some of our loans prior to their scheduled maturity date. The frequency or volume of these early principal repayments may fluctuate significantly from period to period. During the nine months ended September 30, 2017, we received approximately $474.5 million in aggregate principal repayments. Of the approximately $474.5 million of aggregate principal repayments, approximately $93.1 million were scheduled principal payments and approximately $381.4 million were early principal repayments related to 38 portfolio companies. Of the approximately $381.4 million early principal repayments, approximately $74.2 million were early repayments due to merger and acquisition transactions for seven portfolio companies.

 

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Total portfolio investment activity (inclusive of unearned income and excluding activity related to taxes payable, escrow receivables and warrant participation liabilities) as of and for the nine months ended September 30, 2017 and the year ended December 31, 2016 was as follows:

 

(in millions)

   September 30, 2017     December 31, 2016  

Beginning portfolio

   $ 1,423.9     $ 1,200.6  

New fundings and restructures

     487.3       680.7  

Warrants not related to current period fundings

     0.4       0.6  

Principal payments received on investments

     (93.1     (111.2

Early payoffs

     (381.4     (324.0

Accretion of loan discounts and paid-in-kind principal

     27.5       43.6  

Net acceleration of loan discounts and loan fees due to early payoff or restructure

     (6.8     (6.3

New loan fees

     (7.5     (10.1

Warrants converted to equity

     —         0.3  

Sale of investments

     (10.4     (4.4

Loss on investments due to write offs

     (38.5     (10.0

Net change in unrealized appreciation (depreciation)

     15.7       (35.9
  

 

 

   

 

 

 

Ending portfolio

   $ 1,417.1     $ 1,423.9  
  

 

 

   

 

 

 

The following table shows the fair value of our investment portfolio by asset class as of September 30, 2017 and December 31, 2016:

 

     September 30, 2017     December 31, 2016  

(in thousands)

   Investments at
Fair  Value
     Percentage of Total
Portfolio
    Investments at
Fair  Value
     Percentage of Total
Portfolio
 

Senior Secured Debt with Warrants

   $ 838,253        59.1   $ 1,078,779        75.7

Senior Secured Debt

     494,544        34.9     277,509        19.5

Preferred Stock

     41,993        3.0     39,418        2.8

Common Stock

     42,324        3.0     28,236        2.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,417,114        100.0   $ 1,423,942        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

The increase in senior secured debt and the decrease in senior secured debt with warrants during the period is primarily due to an increase in new debt investments that do not include detachable equity enhancement features.

A summary of our investment portfolio as of September 30, 2017 and December 31, 2016 at value by geographic location is as follows:

 

     September 30, 2017     December 31, 2016  

(in thousands)

   Investments at
Fair Value
     Percentage of Total
Portfolio
    Investments at
Fair Value
     Percentage of Total
Portfolio
 

United States

   $ 1,292,617        91.2   $ 1,362,223        95.6

England

     66,598        4.7     18,395        1.3

Netherlands

     20,495        1.4     20,089        1.4

Cayman Islands

     14,925        1.1     —          0.0

Switzerland

     11,611        0.8     12,377        0.9

Canada

     10,868        0.8     8,095        0.6

Israel

     —          0.0     2,763        0.2
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,417,114        100.0   $ 1,423,942        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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As of September 30, 2017, we held warrants or equity positions in five companies that have filed registration statements on Form S-1 with the SEC in contemplation of potential initial public offerings. All five companies filed confidentially under the JOBS Act. There can be no assurance that companies that have yet to complete their initial public offerings will do so in a timely manner or at all.

Changes in Portfolio

We generate revenue in the form of interest income, primarily from our investments in debt securities, and commitment and facility fees. Interest income is recognized in accordance with the contractual terms of the loan agreement to the extent that such amounts are expected to be collected. Fees generated in connection with our debt investments are recognized over the life of the loan or, in some cases, recognized as earned. In addition, we generate revenue in the form of capital gains, if any, on warrants or other equity-related securities that we acquire from our portfolio companies. Our investments generally range from $12.0 million to $40.0 million, although we may make investments in amounts above or below that range. As of September 30, 2017, our debt investments have a term of between two and seven years and typically bear interest at a rate ranging from 4.2% to 13.0%. In addition to the cash yields received on our debt investments, in some instances, our debt investments may also include any of the following: exit fees, balloon payment fees, commitment fees, success fees, payment-in-kind (“PIK”) provisions or prepayment fees which may be required to be included in income prior to receipt.

Interest on debt securities is generally payable monthly, with amortization of principal typically occurring over the term of the investment. In addition, our loans may include an interest-only period ranging from three to eighteen months or longer. In limited instances in which we choose to defer amortization of the loan for a period of time from the date of the initial investment, the principal amount of the debt securities and any accrued but unpaid interest become due at the maturity date.

Loan origination and commitment fees received in full at the inception of a loan are deferred and amortized into fee income as an enhancement to the related loan’s yield over the contractual life of the loan. We recognize nonrecurring fees amortized over the remaining term of the loan commencing in the quarter relating to specific loan modifications. We had approximately $33.4 million of unamortized fees at September 30, 2017, of which approximately $30.2 million was included as an offset to the cost basis of our current debt investments and approximately $3.2 million was deferred contingent upon the occurrence of a funding or milestone. At December 31, 2016, we had approximately $38.2 million of unamortized fees, of which approximately $35.8 million was included as an offset to the cost basis of our current debt investments and approximately $2.4 million was deferred contingent upon the occurrence of a funding or milestone.

Loan exit fees to be paid at the termination of the loan are accreted into interest income over the contractual life of the loan. At September 30, 2017, we had approximately $26.1 million in exit fees receivable, of which approximately $22.8 million was included as a component of the cost basis of our current debt investments and approximately $3.3 million was a deferred receivable related to expired commitments. At December 31, 2016, we had approximately $32.8 million in exit fees receivable, of which approximately $30.3 million was included as a component of the cost basis of our current debt investments and approximately $2.5 million was a deferred receivable related to expired commitments.

We have debt investments in our portfolio that contain a PIK provision. The PIK interest, computed at the contractual rate specified in each loan agreement, is recorded as interest income and added to the principal balance of the loan on specified capitalization dates. To maintain our ability to be subject to tax as a RIC, this non-cash source of income must be distributed to stockholders with other sources of income in the form of dividend distributions even though we have not yet collected the cash. Amounts necessary to pay these distributions may come from available cash or the liquidation of certain investments. We recorded approximately $2.5 million and $2.1 million in PIK income in the three months ended September 30, 2017 and 2016, respectively. We recorded approximately $7.2 million and $5.7 million in PIK income in the nine months ended September 30, 2017 and 2016, respectively.

 

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The core yield on our debt investments, which excludes the effects of fee and income accelerations attributed to early payoffs, restructuring, loan modifications and other one-time events and includes income from expired commitments, was 12.6% and 13.2% during the three months ended September 30, 2017 and 2016, respectively. The effective yield on our debt investments, which includes the effects of fee and income accelerations attributed to early payoffs, restructuring, loan modifications and other one-time events, was 14.1% and 14.6% for the three months ended September 30, 2017 and 2016, respectively. The effective yield is derived by dividing total investment income by the weighted average earning investment portfolio assets outstanding during the quarter, excluding non-interest earning assets such as warrants and equity investments. Both the core yield and effective yield may be higher than what our common stockholders may realize as the core yield and effective yield do not reflect our expenses and any sales load paid by our common stockholders.

The total return for our investors was approximately -2.3% and 19.5% during the nine months ended September 30, 2017 and 2016, respectively. The total return equals the change in the ending market value over the beginning of the period price per share plus dividend distributions paid per share during the period, divided by the beginning price assuming the distribution is reinvested on the date of the distribution. The total return does not reflect any sales load that must be paid by investors. See “Note 9—Financial Highlights” included in the notes to our consolidated financial statements appearing elsewhere in this prospectus.

Portfolio Composition

Our portfolio companies are primarily privately held companies and public companies which are active in the drug discovery & development, software, media/content/info, sustainable and renewable technology, internet consumer & business services, drug delivery, medical devices & equipment, healthcare services, specialty pharmaceuticals, information services, consumer & business products, semiconductors, surgical devices, electronics & computer hardware, biotechnology tools, communications & networking and diagnostic industry sectors. These sectors are characterized by high margins, high growth rates, consolidation and product and market extension opportunities. Value for companies in these sectors is often vested in intangible assets and intellectual property.

As of September 30, 2017, approximately 73.5% of the fair value of our portfolio was composed of investments in five industries: 27.7% investments in the drug discovery & development industry, 20.0% investments in the software industry, 10.4% investments in the media/content/info industry, 7.9% investments in the sustainable and renewable technology industry, and 7.5% investments in the internet consumer & business services industry.

 

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The following table shows the fair value of our portfolio by industry sector at September 30, 2017 and December 31, 2016:

 

     September 30, 2017     December 31, 2016  

(in thousands)

   Investments at
Fair Value
     Percentage of Total
Portfolio
    Investments at
Fair Value
     Percentage of Total
Portfolio
 

Drug Discovery & Development

   $ 392,952        27.7   $ 422,550        29.7

Software

     283,419        20.0     219,559        15.4

Media/Content/Info

     146,956        10.4     137,567        9.7

Sustainable and Renewable Technology

     111,629        7.9     154,406        10.9

Internet Consumer & Business Services

     106,734        7.5     97,047        6.8

Drug Delivery

     97,866        6.9     109,834        7.7

Medical Devices & Equipment

     79,106        5.6     107,695        7.6

Healthcare Services, Other

     67,139        4.7     30,200        2.1

Specialty Pharmaceuticals

     37,875        2.7     38,944        2.7

Information Services

     23,998        1.7     6,091        0.4

Consumer & Business Products

     21,061        1.5     42,713        3.0

Semiconductors

     15,780        1.1     11,326        0.8

Surgical Devices

     12,767        0.9     12,553        0.9

Electronics & Computer Hardware

     7,606        0.5     7,664        0.5

Biotechnology Tools

     5,971        0.4     7,200        0.5

Communications & Networking

     5,547        0.4     18,019        1.3

Diagnostic

     708        0.1     574        0.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,417,114        100.0   $ 1,423,942        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Industry and sector concentrations vary as new loans are recorded and loans pay off. Loan revenue, consisting of interest, fees, and recognition of gains on equity and warrants or other equity-related interests, can fluctuate materially when a loan is paid off or a warrant or equity interest is sold. Revenue recognition in any given year can be highly concentrated in several portfolio companies.

For the nine months ended September 30, 2017 and the year ended December 31, 2016, our ten largest portfolio companies represented approximately 37.7% and 34.0% of the total fair value of our investments in portfolio companies, respectively. At September 30, 2017 and December 31, 2016, we had eight and seven investments, respectively, that represented 5% or more of our net assets. At September 30, 2017, we had eight equity investments representing approximately 62.2% of the total fair value of our equity investments, and each represented 5% or more of the total fair value of our equity investments. At December 31, 2016, we had seven equity investments which represented approximately 54.7% of the total fair value of our equity investments, and each represented 5% or more of the total fair value of our equity investments.

As of September 30, 2017 approximately 96.7% of the debt investment portfolio was priced at floating interest rates or floating interest rates with a Prime or LIBOR-based interest rate floor. As a result, we believe we are well positioned to benefit should market interest rates continue to rise.

As of September 30, 2017, 85.6% of our debt investments were in a senior secured first lien position, 14.1% were secured by a senior second priority security interest in all of the portfolio company’s assets, other than intellectual property, and the remaining 0.3% were unsecured as a result of the terms of the acquisition of one of our portfolio companies during the period. In the majority of cases, we collateralize our investments by obtaining a first priority security interest in a portfolio company’s assets, which may include its intellectual property. In other cases, we may obtain a negative pledge covering a company’s intellectual property.

At September 30, 2017, of the approximately 85.6% of our debt investments in a senior secured first lien position, 44.6% were secured by a first priority security in all of the assets of the portfolio company, including its

 

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intellectual property and 41.0% were secured by a first priority security in all of the assets of the portfolio company and the portfolio company was prohibited from pledging or encumbering its intellectual property. At September 30, 2017 we had no equipment only liens on material investments.

Our investments in senior secured debt with warrants have detachable equity enhancement features, typically in the form of warrants or other equity-related securities designed to provide us with an opportunity for capital appreciation. These features are treated as original issue discounts (“OID”) and are accreted into interest income over the term of the loan as a yield enhancement. Our warrant coverage generally ranges from 3% to 20% of the principal amount invested in a portfolio company, with a strike price generally equal to the most recent equity financing round. As of September 30, 2017, we held warrants in 128 portfolio companies, with a fair value of approximately $32.7 million. The fair value of our warrant portfolio increased by approximately $5.2 million, as compared to a fair value of $27.5 million at December 31, 2016 primarily related to the addition of warrants in 10 new and 8 existing portfolio companies during the period.

Our existing warrant holdings would require us to invest approximately $82.3 million to exercise such warrants as of September 30, 2017. Warrants may appreciate or depreciate in value depending largely upon the underlying portfolio company’s performance and overall market conditions. Of the warrants that we have monetized since inception, we have realized multiples in the range of approximately 1.02x to 29.06x based on the historical rate of return on our investments. However, our warrants may not appreciate in value and, in fact, may decline in value. Accordingly, we may experience losses from our warrant portfolio.

 

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As required by the 1940 Act, we classify our investments by level of control. “Control investments” are defined in the 1940 Act as investments in those companies that we are deemed to “control”, which, in general, includes a company in which we own 25% or more of the voting securities of such company or have greater than 50% representation on its board. “Affiliate investments” are investments in those companies that are “affiliated companies” of ours, as defined in the 1940 Act, which are not control investments. We are deemed to be an “affiliate” of a company in which we have invested if we own 5% or more, but generally less than 25%, of the voting securities of such company. “Non-control/non-affiliate investments” are investments that are neither control investments nor affiliate investments. The following table summarizes our realized gains and losses and changes in our unrealized appreciation and depreciation on control and affiliate investments for the three and nine months ended September 30, 2017 and 2016.

 

(in thousands)               For the Three Months Ended September 30, 2017     For the Nine Months Ended September 30, 2017  

Portfolio Company

  Type     Fair
Value at
September 30,
2017
    Investment
Income
    Net Change in
Unrealized
Appreciation/
(Depreciation)
    Reversal of
Unrealized
Appreciation /
(Depreciation)(1)
    Realized
Gain/
(Loss)
    Investment
Income
    Net Change in
Unrealized
Appreciation/
(Depreciation)
    Reversal of
Unrealized
Appreciation /
(Depreciation)(1)
    Realized
Gain/
(Loss)
 

Control Investments

                   

Achilles Technology Management Co II, Inc.

    Control     $ 242     $ 3     $ (46   $ —       $ (485   $ 155     $ (2,254   $ —       $ (486

HercGamma, Inc.

    Control       —         —         (523     —         —         —         (523     —         —    

SkyCross, Inc.

    Control       —         —         —         15,058       (15,058     —         1,842       15,452       (15,452

Tectura Corporation

    Control       23,140       462       2,995       —         —         1,361       2,995       51       (51

Second Time Around (Simplify Holdings, LLC)

    Control       —         —         140       —         —         —         140       —         —    
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Control Investments

 

  $ 23,382     $ 465     $ 2,566     $ 15,058     $ (15,543   $ 1,516     $ 2,200     $ 15,503     $ (15,989
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Affiliate Investments

                   

Optiscan BioMedical, Corp.

    Affiliate     $ 6,064     $ —       $ 72     $ —       $ —       $ —       $ 1,192     $ —       $ —    

Stion Corporation

    Affiliate       —         —         —         —         —         2       —         —         —    

Solar Spectrum Holdings LLC (p.k.a. Sungevity, Inc.)

    Affiliate       27,522       248       4,537       —         —         248       (48,678     —         —    
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Affiliate Investments

 

  $ 33,586     $ 248     $ 4,609     $ —       $ —       $ 250     $ (47,486   $ —       $ —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Control & Affiliate Investments

 

  $ 56,968     $ 713     $ 7,175     $ 15,058     $ (15,543   $ 1,766     $ (45,286   $ 15,503     $ (15,989
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(in thousands)               For the Three Months Ended September 30, 2016     For the Nine Months Ended September 30, 2016  

Portfolio Company

  Type     Fair
Value at
September 30,
2016
    Investment
Income
    Net Change in
Unrealized
Appreciation/
(Depreciation)
    Reversal of
Unrealized
Appreciation /
(Depreciation)(1)
    Realized
Gain/
(Loss)
    Investment
Income
    Net Change in
Unrealized
Appreciation/
(Depreciation)
    Reversal of
Unrealized
Appreciation /
(Depreciation)(1)
    Realized
Gain/
(Loss)
 

Control Investments

                   

SkyCross, Inc.

    Control     $ —       $ —       $ —       $ —       $ —       $ —       $ (3,421   $ —       $ —    

Achilles Technology Management Co II, Inc.

    Control       4,991       16       —         —         —         16       —         —         —    
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Control Investments

 

  $ 4,991     $ 16     $ —       $ —       $ —       $ 16     $ (3,421   $ —       $ —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Affiliate Investments

                   

Optiscan BioMedical, Corp.

    Affiliate     $ 5,102     $ —       $ 553     $ —       $ —       $ 12     $ (2,833   $ —       $ —    

Stion Corporation

    Affiliate       821       30       —         —         —         133       539       648       —    
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Affiliate Investments

 

  $ 5,923     $ 30     $ 553     $ —       $ —       $ 145     $ (2,294   $ 648     $ —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Control & Affiliate Investments

 

  $ 10,914     $ 46     $ 553     $ —       $ —       $ 161     $ (5,715   $ 648     $ —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Represents reversals of prior period net unrealized depreciation upon being realized as a loss due to write off.

 

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In July 2017, we acquired the primary assets of Second Time Around (Simplify Holdings, LLC) as part of an article 9 consensual foreclosure and public auction. These assets represent the remaining possible recovery on our debt and as such this investment is classified as a control investment as of September 30, 2017.

In June 2017, we acquired 100% ownership of the equity in HercGamma, Inc. and classified it as a control investment in accordance with the requirements of the 1940 Act. In June 2017, HercGamma, Inc. acquired the assets of a medical device company that develops advanced digital imaging to detect breast cancer, as part of an article 9 consensual foreclosure and public auction for consideration with an estimated fair value of $1.2 million. Our investment in HercGamma, Inc. is carried on the consolidated statement of assets and liabilities at fair value. In September 2017, we reduced the cost basis of its equity position by $646,000 with net proceeds from an asset sale.

In April 2017, our investment in Solar Spectrum Holdings LLC (p.k.a. Sungevity, Inc.) became classified as a control investment as a result of obtaining more than 25% of the portfolio company’s voting securities. In April 2017, under Section 363 of the Bankruptcy Code, Sungevity, Inc. entered into a $50.0 million asset purchase agreement and DIP financing facility with a group of investors, led by Northern Pacific Group and including us. On April 7, 2017, the U.S. Bankruptcy Court approved the DIP financing facility and on April 17, the U.S. Bankruptcy Court approved the asset purchase agreement. On April 26, 2017, Solar Spectrum Holdings LLC, a new company backed by the investment group, announced that it had acquired certain assets of Sungevity, Inc. as part of the bankruptcy court-approved sale. As a result, the cost basis of our debt investment in Sungevity, Inc. was converted to an equity position in Solar Spectrum Holdings LLC and our warrant and equity positions in Sungevity, Inc. were written off for a realized loss.

In August 2017, our ownership in Solar Spectrum Holdings LLC was diluted below 25% as a result of additional equity contributions by other investors to fund the acquisition of Horizon Solar Power, Inc. by Solar Spectrum Holdings LLC. We made a $15.0 million debt investment to fund the acquisition. Accordingly, our equity and new debt investment in Solar Spectrum Holdings LLC became classified as affiliate investments as of September 30, 2017.

In January 2017, our investment in Tectura Corporation became classified as a control investment as a result of obtaining more than 50% representation on the portfolio company’s board. In March 2017, our warrants in Tectura Corporation expired and were written off for a realized loss.

In June 2016, our investments in SkyCross, Inc. became classified as a control investment as a result of obtaining more than 50% representation on the portfolio company’s board. In September 2017, our investments were deemed wholly worthless and written off for a realized loss.

In June 2016, we also acquired 100% ownership of the equity of Achilles Technology Management Co II, Inc. and classified it as a control investment in accordance with the requirements of the 1940 Act. In June 2016, Achilles Technology Management Co II, Inc. acquired the assets of a global antenna company that produces radio frequency system solutions as part of an article 9 consensual foreclosure and public auction for total consideration in the amount of $4.0 million. In September and November 2016, we made a $1.0 million and $250,000 debt investment, respectively, in Achilles Technology Management II, Inc. to provide working capital under the terms of a loan servicing agreement.

In August 2017, our debt investment in Achilles Technology Management II, Inc. was fully repaid by net proceeds from sales of the portfolio company’s assets. In addition, our equity investment in Achilles Technology Management II, Inc. was reduced by $900,000 in lieu of a success fee on the repayment of our debt investment. The remaining equity investment in Achilles Technology Management II, Inc. is carried on the consolidated statement of assets and liabilities at fair value.

 

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Portfolio Grading

We use an investment grading system, which grades each debt investment on a scale of 1 to 5 to characterize and monitor our expected level of risk on the debt investments in our portfolio with 1 being the highest quality. The following table shows the distribution of our outstanding debt investments on the 1 to 5 investment grading scale at fair value as of September 30, 2017 and December 31, 2016, respectively:

 

(in thousands)

   September 30, 2017     December 31, 2016  

Investment Grading

   Number of
Companies
     Debt Investments
at Fair Value
     Percentage of
Total  Portfolio
    Number of
Companies
     Debt Investments
at Fair Value
     Percentage of
Total  Portfolio
 

1

     8      $ 189,995        14.6     15      $ 275,832        20.8

2

     33        696,165        53.6     32        590,547        44.4

3

     24        370,902        28.5     25        329,393        24.8

4

     5        43,006        3.3     8        58,874        4.4

5

     4        —          0.0     8        74,157        5.6
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 
     74      $ 1,300,068        100.0     88      $ 1,328,803        100.0
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

As of September 30, 2017, our debt investments had a weighted average investment grading of 2.24 on a cost basis, as compared to 2.41 at December 31, 2016. Our policy is to lower the grading on our portfolio companies as they approach the point in time when they will require additional equity capital. Additionally, we may downgrade our portfolio companies if they are not meeting our financing criteria or are underperforming relative to their respective business plans. Various companies in our portfolio will require additional funding in the near term or have not met their business plans and therefore have been downgraded until their funding is complete or their operations improve. The improvement in weighted average investment grading at September 30, 2017 from December 31, 2016 is primarily due to the conversion of our debt investment in Sungevity Inc. to an equity position in Solar Spectrum Holdings LLC during the period. This position was rated 5 and represented $44.6 million of the rated 5 debt investment fair value at December 31, 2016. In addition, four positions that were rated 5 as of December 31, 2016 were sold or liquidated during the period.

At September 30, 2017, we had five debt investments on non-accrual with a cumulative investment cost and fair value of approximately $14.0 million and $3.0 million, respectively. At December 31, 2016, we had five debt investments on non-accrual with cumulative investment cost and fair value of approximately $43.9 million and $6.2 million, respectively. The decrease in the cumulative cost and fair value of debt investments on non-accrual between September 30, 2017 and December 31, 2016 is the result of the liquidation of two debt investments that were on non-accrual at December 31, 2016, offset by placing two new debt investments on non-accrual status during the period. During the three and nine months ended September 30, 2017, the Company recognized a realized loss of approximately $23.8 million on the write off of two debt investments that were on non-accrual at December 31, 2016.

Results of Operations

Comparison of the three and nine months ended September 30, 2017 and 2016

Investment Income

Total investment income for the three months ended September 30, 2017 was approximately $45.9 million as compared to approximately $45.1 million for the three months ended September 30, 2016. Total investment income for the nine months ended September 30, 2017 was approximately $140.7 million as compared to approximately $127.6 million for the nine months ended September 30, 2016.

Interest and PIK interest income for the three months ended September 30, 2017 totaled approximately $42.4 million as compared to approximately $40.0 million for the three months ended September 30, 2016. Interest and PIK interest income for the nine months ended September 30, 2017 totaled approximately

 

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$125.8 million as compared to approximately $116.1 million for the nine months ended September 30, 2016. The increase in interest and PIK interest income for the three and nine months ended September 30, 2017 as compared to the same periods ended September 30, 2016 is primarily attributable to an increase in recurring interest and PIK interest income, along with an increase in interest accelerations due to early loan repayments and other one-time events.

Of the $42.4 million in interest and PIK interest income for the three months ended September 30, 2017, approximately $39.7 million represents recurring income from the contractual servicing of our loan portfolio and approximately $2.7 million represents income related to the acceleration of income due to early loan repayments and other one-time events during the period. Income from recurring interest and the acceleration of interest income due to early loan repayments represented $38.2 million and $1.8 million, respectively, of the $40.0 million interest and PIK interest income for the three months ended September 30, 2016.

Of the $125.8 million in interest and PIK interest income for the nine months ended September 30, 2017, approximately $117.6 million represents recurring income from the contractual servicing of our loan portfolio and approximately $8.2 million represents income related to the acceleration of income due to early loan repayments and other one-time events during the period. Income from recurring interest and the acceleration of interest income due to early loan repayments represented $111.8 million and $4.3 million, respectively, of the $116.1 million interest and PIK interest income for the nine months ended September 30, 2016.

The following table shows the PIK-related activity for the nine months ended September 30, 2017 and 2016, at cost:

 

     Nine Months
Ended September 30,
 

(in thousands)

   2017      2016  

Beginning PIK interest receivable balance

   $ 9,930      $ 5,149  

PIK interest income during the period

     7,172        5,676  

PIK accrued (capitalized) to principal but not recorded as income during the period

     —          (2,146

Payments received from PIK loans

     (2,349      (438

Realized loss

     (2,183      (266
  

 

 

    

 

 

 

Ending PIK interest receivable balance

   $ 12,570      $ 7,975  
  

 

 

    

 

 

 

The increase in PIK interest income during the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016 is due to an increase in the weighted average principal outstanding of loans which bear PIK interest, including an increase in newly originated loans bearing PIK interest. This increase is partially offset by an increase in the number of PIK loans that paid off during the period.

Fee income for the three months ended September 30, 2017 totaled approximately $3.4 million as compared to approximately $5.1 million for the three months ended September 30, 2016. Fee income for the nine months ended September 30, 2017 totaled approximately $14.9 million as compared to approximately $11.5 million for the nine months ended September 30, 2016. The decrease in fee income for the three months ended September 30, 2017 is primarily due to a decrease in the acceleration of unamortized fees due to early repayments and one-time fees between periods. The increase in fee income for the nine months ended September 30, 2017 is primarily attributable to an increase in the acceleration of unamortized fees due to early repayments and one-time fees between periods.

Of the $3.4 million in fee income for the three months ended September 30, 2017, approximately $1.3 million represents income from recurring fee amortization and approximately $2.1 million represents income related to the acceleration of unamortized fees due to early repayments and one-time fees for the

 

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period. Income from recurring fee amortization and the acceleration of unamortized fees due to early loan repayments represented $2.5 million and $2.6 million, respectively, of the $5.1 million in income for the three months ended September 30, 2016.

Of the $14.9 million in fee income for the nine months ended September 30, 2017, approximately $4.9 million represents income from recurring fee amortization and approximately $10.0 million represents income related to the acceleration of unamortized fees due to early repayments and one-time fees for the period. Income from recurring fee amortization and the acceleration of unamortized fees due to early loan repayments represented $7.2 million and $4.3 million, respectively, of the $11.5 million in income for the nine months ended September 30, 2016.

In certain investment transactions, we may earn income from advisory services; however, we had no income from advisory services in the three and nine months ended September 30, 2017 or 2016.

Operating Expenses

Our operating expenses are comprised of interest and fees on our borrowings, general and administrative expenses and employee compensation and benefits. Our operating expenses totaled approximately $21.9 million and $21.3 million during the three months ended September 30, 2017 and 2016, respectively. Our operating expenses totaled approximately $68.8 million and $60.4 million during the nine months ended September 30, 2017 and 2016, respectively.

Interest and Fees on our Borrowings

Interest and fees on our borrowings totaled approximately $10.5 million and $10.1 million for the three months ended September 30, 2017 and 2016, respectively, and approximately $33.5 million and $27.0 million during the nine months ended September 30, 2017 and 2016, respectively. Interest and fee expense for the three months ended September 30, 2017, as compared to September 30, 2016, increased due to a higher weighted average principal balance outstanding on our 2024 Notes and Convertible Notes, offset by a reduction in the weighted average principal balance outstanding on our 2019 Notes, which were fully redeemed in February 2017, and on our 2021 Asset Backed Notes, which are amortizing. Interest and fee expense for the nine months ended September 30, 2017, as compared to September 30, 2016, increased due to the onetime, non-cash acceleration of approximately $1.5 million of unamortized fees upon the redemption of our 2019 Notes in February 2017 and a higher weighted average principal balance outstanding on our 2024 Notes and Convertible Notes, partially offset by a reduction in interest expense on our 2019 Notes and 2021 Asset Backed Notes.

We had a weighted average cost of debt, comprised of interest and fees, of approximately 5.6% and 6.0% for the three months ended September 30, 2017 and 2016, respectively, and a weighted average cost of debt of approximately 5.8% and 5.8% for the nine months ended September 30, 2017 and 2016, respectively. The decrease in the weighted average cost of debt for the three months ended September 30, 2017 as compared to the same period ended September 30, 2016 is primarily attributable to the full redemption of our 2019 Notes between periods.

General and Administrative Expenses

General and administrative expenses include legal fees, consulting fees, accounting fees, printer fees, insurance premiums, rent, expenses associated with the workout of underperforming investments and various other expenses. Our general and administrative expenses decreased to $3.5 million from $4.1 million for the three months ended September 30, 2017 and 2016. Our general and administrative expenses increased to $12.4 million from $12.1 million for the nine months ended September 30, 2017 and 2016. The decrease for the three months ended September 30, 2017 was primarily attributable to a reduction in corporate legal and other expenses. The increase for the nine months ended September 30, 2017 was primarily attributable to an increase in excise tax accruals and charitable contributions, offset by a reduction in corporate legal and other expenses between periods.

 

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Employee Compensation

Employee compensation and benefits totaled $6.0 million for the three months ended September 30, 2017 as compared to $5.6 million for the three months ended September 30, 2016 and $17.3 million for the nine months ended September 30, 2017 as compared to $15.6 million for the nine months ended September 30, 2016. The increase for the three and nine month comparative periods was primarily due to increased salaries and changes in variable compensation expenses due to company performance objectives.

Employee stock-based compensation totaled $1.8 million for the three months ended September 30, 2017 as compared to $1.4 million for the three months ended September 30, 2016 and $5.6 million for the nine months ended September 30, 2017 as compared to $5.6 million for the nine months ended September 30, 2016. The increase for the three month comparative period was primarily related to restricted stock award vesting.

Net Investment Realized Gains and Losses and Net Unrealized Appreciation and Depreciation

Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the cost basis of an investment without regard to unrealized appreciation or depreciation previously recognized, and includes investments written off during the period, net of recoveries. Net change in unrealized appreciation or depreciation primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.

A summary of realized gains and losses for the three and nine months ended September 30, 2017 and 2016 is as follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in thousands)

   2017     2016     2017     2016  

Realized gains

   $ 1,345     $ 9,423     $ 12,898     $ 13,634  

Realized losses

     (25,799     (1,553     (39,827     (10,207
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized gains (losses)

   $ (24,454   $ 7,870     $ (26,929   $ 3,427  
  

 

 

   

 

 

   

 

 

   

 

 

 

During the three and nine months ended September 30, 2017 we recognized net realized losses of $24.5 million and $26.9 million, respectively. During the three months ended September 30, 2017, we recorded gross realized gains of $1.3 million primarily from the sale or acquisition of our holdings in three portfolio companies, including Axovant Sciences Ltd. ($460,000), CashStar, Inc. ($235,000), and Aveo Pharmaceuticals, Inc. ($227,000). These gains were offset by gross realized losses of $25.8 million primarily from the liquidation or write off of our warrant and equity investments in seven portfolio companies and companies and our debt investment in three portfolio companies.

During the nine months ended September 30, 2017, we recorded gross realized gains of $12.9 million primarily from the sale or acquisition of our holdings in four portfolio companies, including IronPlanet, Inc. ($5.1 million), Box, Inc. ($4.0 million) TPI Composites, Inc. ($1.2 million) and Edge Therapeutics, Inc. ($708,000). These gains were offset by gross realized losses of $39.8 million primarily from the liquidation or write off of our warrant and equity investments in nineteen portfolio companies and our debt investment in four portfolio companies.

During the three and nine months ended September 30, 2016, we recognized net realized gains of $7.9 and net realized losses of $3.4 million, respectively. During the three months ended September 30, 2016, we recorded gross realized gains of $9.4 million primarily from the acquisition of our holdings in three portfolio companies, including Box, Inc. ($7.8 million), Touchcommerce, Inc. ($698,000) and ReachLocal ($610,000). These gains were offset by gross realized losses of $1.5 million primarily from the liquidation or write off of our warrant and equity investments in one portfolio company and our debt investment in one portfolio company.

 

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During the nine months ended September 30, 2016, we recorded gross realized gains of $13.6 million primarily from the sale or acquisition of our holdings in five portfolio companies, including Box, Inc. ($8.9 million), Celator Pharmaceuticals, Inc. ($1.5 million), Ping Identity Corporation ($1.3 million), Touchcommerce, Inc. ($698,000) and ReachLocal ($610,000). These gains were partially offset by gross realized losses of $10.2 million primarily from the liquidation or write off of our warrant and equity investments in six portfolio companies and our debt investment in four portfolio companies, including the settlement of our outstanding debt investment in the Neat Company ($6.2 million).

The following table summarizes the change in net unrealized appreciation (depreciation) of investments for the three and nine months ended September 30, 2017 and 2016:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in thousands)

   2017     2016     2017     2016  

Gross unrealized appreciation on portfolio investments

   $ 26,421     $ 25,903     $ 114,287     $ 55,428  

Gross unrealized depreciation on portfolio investments

     (15,764     (21,309     (125,327     (76,801

Reversal of prior period net unrealized appreciation (depreciation) upon a realization event

     27,317       (7,161     41,447       (7,421

Reversal of prior period net unrealized appreciation (depreciation) upon a realization event

     (4,201     1,550       (14,720     12,803  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized appreciation (depreciation) on debt, equity, and warrant investments

     33,773       (1,017     15,687       (15,991

Other net unrealized appreciation (depreciation)

     (220     183       (50     (81
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net unrealized depreciation on investments

   $ 33,553     $ (834   $ 15,637     $ (16,072
  

 

 

   

 

 

   

 

 

   

 

 

 

During the three months ended September 30, 2017, we recorded $33.6 million of net unrealized appreciation, of which $33.7 million was net unrealized appreciation from our debt, equity and warrant investments. We recorded $22.2 million of net unrealized appreciation on our debt investments, which was primarily related to the reversal of $25.9 million of unrealized depreciation upon payoff or liquidation of our debt investments in three portfolio companies.

We recorded $8.8 million of net unrealized appreciation on our equity investments, which was primarily related to a $4.0 million reduction in the collateral based impairment on one portfolio company and $5.7 million of unrealized appreciation on our public equity portfolio related to portfolio company performance.

Finally, we recorded $2.7 million of net unrealized appreciation on our warrant investments, which was primarily due to $5.0 million and $411,000 of unrealized appreciation on our private and public warrant portfolios, respectively, related to portfolio company and industry performance. This unrealized appreciation was partially offset by the reversal of $2.5 million of net unrealized appreciation upon being realized as a gain or loss due to the acquisition or liquidation of our warrant investments.

During the three months ended September 30, 2016, we recorded $834,000 of net unrealized depreciation, of which $1.0 million was net unrealized depreciation from our debt, equity and warrant investments. We recorded $7.7 million of net unrealized depreciation on our debt investments, which was primarily related to $14.1 million of unrealized depreciation for collateral based impairments on eleven portfolio companies offset by the reversal of $1.3 million unrealized depreciation for the prior period collateral based impairments on one portfolio company and $4.8 million of unrealized appreciation from our market yield analysis related to industry performance.

We recorded $4.0 million of net unrealized appreciation on our equity investments, which was primarily related to $6.5 million unrealized appreciation on our public equity portfolio and $2.3 million of unrealized

 

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appreciation on our private portfolio companies related to portfolio company performance, offset by the reversal of approximately $4.7 million of net unrealized appreciation upon being realized as a gain on sales of Box, Inc.

Finally, we recorded $2.7 million of net unrealized appreciation on our warrant investments, which was primarily due to $5.8 million of unrealized appreciation on our private portfolio companies related to company performance, offset by the reversal of $2.0 million of unrealized appreciation upon being realized as a gain due to the acquisition of our warrant investments in two portfolio companies.

The following table summarizes the change in net unrealized appreciation (depreciation) in the investment portfolio by investment type, excluding other net unrealized appreciation (depreciation) for the three months ended September 30, 2017 and 2016:

 

     Three Months Ended
September 30, 2017
 

(in millions)

   Debt     Equity     Warrants     Total  

Collateral Based Impairments(1)

   $ (3.0   $ 4.0     $ (0.2   $ 0.8  

Reversals of Prior Period Collateral Based Impairments

     —         —         —         —    

Reversals due to Debt Payoffs & Warrant/Equity Sales

     25.9       (0.2     (2.5     23.2  

Fair Value Market/Yield Adjustments(2)

        

Level 1 & 2 Assets

     —         5.7       0.4       6.1  

Level 3 Assets

     (0.7     (0.7     5.0       3.6  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Fair Value Market/Yield Adjustments

     (0.7     5.0       5.4       9.7  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Unrealized Appreciation/(Depreciation)

   $ 22.2     $ 8.8     $ 2.7     $ 33.7  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     Three Months Ended
September 30, 2016
 

(in millions)

   Debt     Equity     Warrants     Total  

Collateral Based Impairments(1)

   $ (14.1   $ (0.1   $ (0.3   $ (14.5

Reversals of Prior Period Collateral Based Impairments

     1.3       —         —         1.3  

Reversals due to Debt Payoffs & Warrant/Equity Sales

     0.3       (4.7     (2.0     (6.4

Fair Value Market/Yield Adjustments(2)

        

Level 1 & 2 Assets

     0.3       6.5       (0.8     6.0  

Level 3 Assets

     4.5       2.3       5.8       12.6  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Fair Value Market/Yield Adjustments

     4.8       8.8       5.0       18.6  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Unrealized Appreciation/(Depreciation)

   $ (7.7   $ 4.0     $ 2.7     $ (1.0
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) The unrealized appreciation (depreciation) attributable to collateral based impairments include all changes in estimated fair value on positions whose fair value remains impaired relative to cost as of the balance sheet date. As such, this may include current period improvements in estimated fair value that do not represent reversals to prior period collateral based impairments.
(2) Level 1 assets are generally equities listed in active markets and level 2 assets are generally warrants held in a public company. Observable market prices are typically the primary input in valuing level 1 and 2 assets. Level 3 asset valuations require inputs that are both significant and unobservable. Generally, level 3 assets are debt investments and warrants and equities held in a private company. See Note 2 to the financial statements discussing ASC Topic 820 (“Fair Value Measurements”).

During the nine months ended September 30, 2017, we recorded $15.6 million of net unrealized appreciation, of which $15.7 million was net unrealized appreciation from our debt, equity and warrant investments. We recorded $41.9 million of net unrealized appreciation on our debt investments, which was primarily related to the reversal of prior period collateral based impairments of $52.0 million on three portfolio companies, including the reversal of the cumulative unrealized depreciation on our debt investment in Sungevity, Inc. upon its conversion to equity, and the reversal of $30.9 million of unrealized depreciation upon the payoff or liquidation of our debt investments during the period. This unrealized appreciation was offset by $41.6 million of unrealized depreciation for collateral based impairments on eight portfolio companies.

 

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We recorded $36.9 million of net unrealized depreciation on our equity investments, which was primarily due to $50.4 million of collateral based impairment on three portfolio companies, including impairment on our converted equity position in Solar Spectrum Holdings LLC. This unrealized depreciation was partially offset by $7.8 million and $3.8 million of unrealized appreciation on our public and private equity portfolio, respectively, related to portfolio company and industry performance.

Finally, we recorded $10.7 million of net unrealized appreciation on our warrant investments, which was primarily related to $10.6 million and $4.0 million of unrealized appreciation on our private and public warrant portfolio related to portfolio company and industry performance, respectively. This appreciation was offset by the reversal of approximately $3.4 million of unrealized appreciation upon being realized as a gain or loss due to the acquisition or liquidation of our warrant investments.

During the nine months ended September 30, 2016, we recorded $16.1 million of net unrealized depreciation, of which $15.9 million was net unrealized depreciation from our debt, equity and warrant investments. We recorded $9.7 million of net unrealized depreciation on our debt investments, which was primarily related to $34.7 million unrealized depreciation for collateral based impairments on eleven portfolio companies offset by the reversal of $12.5 million of unrealized depreciation upon payoff or settling of our debt investments and the reversal of $7.0 million of unrealized depreciation for prior period collateral based impairments on five portfolio companies.

We recorded $8.5 million of net unrealized depreciation on our equity investments, which was primarily related to $3.9 million of unrealized depreciation on our public equity portfolio with the largest concentration in our investment in Box, Inc. and the reversal of $4.6 million of net unrealized appreciation upon being realized as a gain on sale of Box, Inc. and the write off of three portfolio company investments.

Finally, we recorded $2.3 million of net unrealized appreciation on our warrant investments, which was primarily related to $5.4 million of net unrealized appreciation on our private portfolio companies related to portfolio company performance offset by the reversal of approximately $1.2 million of unrealized appreciation upon being realized as a gain due to the acquisition of our warrant investments in two portfolio companies and the write off of five portfolio company investments.

The following table summarizes the change in net unrealized appreciation (depreciation) in the investment portfolio by investment type, excluding other net unrealized appreciation (depreciation) for the nine months ended September 30, 2017 and 2016:

 

     Nine Months Ended September 30, 2017  

(in millions)

   Debt     Equity     Warrants     Total  

Collateral Based Impairments(1)

   $ (41.6   $ (50.4   $ (0.5   $ (92.5

Reversals of Prior Period Collateral Based Impairments

     52.0       —         —         52.0  

Reversals due to Debt Payoffs & Warrant/Equity Sales

     30.9       1.9       (3.4     29.4  

Fair Value Market/Yield Adjustments(2)

        

Level 1 & 2 Assets

     —         7.8       4.0       11.8  

Level 3 Assets

     0.6       3.8       10.6       15.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Fair Value Market/Yield Adjustments

     0.6       11.6       14.6       26.8  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Unrealized Appreciation/(Depreciation)

   $ 41.9     $ (36.9   $ 10.7     $ 15.7  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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     Nine Months Ended September 30, 2016  

(in millions)

   Debt     Equity     Warrants     Total  

Collateral Based Impairments(1)

   $ (34.7   $ (0.1   $ (0.4   $ (35.2

Reversals of Prior Period Collateral Based Impairments

     7.0       —         —         7.0  

Reversals due to Debt Payoffs & Warrant/Equity Sales

     12.5       (4.6     (1.2     6.7  

Fair Value Market/Yield Adjustments(2)

        

Level 1 & 2 Assets

     0.3       (3.9     (1.5     (5.1

Level 3 Assets

     5.2       0.1       5.4       10.7  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Fair Value Market/Yield Adjustments

     5.5       (3.8     3.9       5.6  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Unrealized Appreciation/(Depreciation)

   $ (9.7   $ (8.5   $ 2.3     $ (15.9
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) The unrealized appreciation (depreciation) attributable to collateral based impairments include all changes in estimated fair value on positions whose fair value remains impaired relative to cost as of the balance sheet date. As such, this may include current period improvements in estimated fair value that do not represent reversals to prior period collateral based impairments.
(2) Level 1 assets are generally equities listed in active markets and level 2 assets are generally warrants held in a public company. Observable market prices are typically the primary input in valuing level 1 and 2 assets. Level 3 asset valuations require inputs that are both significant and unobservable. Generally, level 3 assets are debt investments and warrants and equities held in a private company. See Note 2 to the financial statements discussing ASC Topic 820 (“Fair Value Measurements”).

Income and Excise Taxes

We account for income taxes in accordance with the provisions of Topic 740 of the FASB’s Accounting Standards Codification, as amended (“ASC”), “Income Taxes”, under which income taxes are provided for amounts currently payable and for amounts deferred based upon the estimated future tax effects of differences between the financial statements and tax basis of assets and liabilities given the provisions of the enacted tax law. Valuation allowances may be used to reduce deferred tax assets to the amount likely to be realized. Based upon our previous election and anticipated continued qualification to be subject to taxation as a RIC, we are typically not subject to a material level of federal income taxes. We intend to distribute 100% of our spillover earnings, which consists of ordinary income and long-term capital gains, from our taxable year ended December 31, 2016 to our stockholders in 2017.

Net Change in Net Assets Resulting from Operations and Earnings Per Share

For the three months ended September 30, 2017 and 2016, we had a net increase in net assets resulting from operations of approximately $33.1 million and $30.8 million, respectively. For the nine months ended September 30, 2017 and 2016, we had a net increase in net assets resulting from operations of approximately $60.6 million and $54.6 million, respectively.

Both the basic and fully diluted net change in net assets per common share were $0.40 per share for the three months ended September 30, 2017 and $0.73 per share for the nine months ended September 30, 2017. Both the basic and fully diluted net change in net assets per common share were $0.41 per share and $0.74 per share for the three and nine months ended September 30, 2016, respectively.

For the purpose of calculating diluted earnings per share for three and nine months ended September 30, 2017 and 2016, the effect of the 2022 Convertible Notes, outstanding options, and restricted stock units under the treasury stock method was considered. The effect of the 2022 Convertible Notes was excluded from these calculation for the three and nine months ended September 30, 2017 as our share price was less than the conversion price in effect which results in anti-dilution. The 2016 Convertible Notes were fully settled on or before their contractual maturity date of April 15, 2016, as such there was no potential additional dilutive effect for the three and nine months ended September 30, 2016.

 

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Financial Condition, Liquidity, and Capital Resources

Our liquidity and capital resources are derived from our Credit Facilities, SBA debentures, 2024 Notes, 2021 Asset-Backed Notes, Convertible Notes and cash flows from operations, including investment sales and repayments, and income earned. Our primary use of funds from operations includes investments in portfolio companies and payments of fees and other operating expenses we incur. We have used, and expect to continue to use, our borrowings and the proceeds from the turnover of our portfolio and from public and private offerings of securities to finance our investment objectives. We may also raise additional equity or debt capital through registered offerings off a shelf registration, ATM and private offerings of securities, by securitizing a portion of our investments, or by borrowing from the SBA through our SBIC subsidiaries.

On August 16, 2013, we entered into an ATM equity distribution agreement (the “Prior Equity Distribution Agreement”) with JMP Securities. On March 7, 2016, we renewed the Prior Equity Distribution Agreement and on December 21, 2016, we further amended the agreement to increase the total shares available under the program. The Prior Equity Distribution Agreement, as amended, provided that we may offer and sell up to 12.0 million shares of our common stock from time to time through JMP Securities, as our sales agent.

On September 8, 2017, we terminated the Prior Equity Distribution Agreement and entered into the Equity Distribution Agreement. As a result, the remaining shares that were available under the Prior Equity Distribution agreement are no longer available for issuance. The Equity Distribution Agreement provides that the Company may offer and sell up to 12.0 million shares of its common stock from time to time through JMP Securities, as its sales agent. Sales of the Company’s common stock, if any, may be made in negotiated transactions or transactions that are deemed to be “at the market,” as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE or similar securities exchange or sales made to or through a market maker other than on an exchange, at prices related to the prevailing market prices or at negotiated prices.

During the nine months ended September 30, 2017, we sold 4.1 million shares of common stock, of which 3.3 million shares and 768,000 shares were issued under the Prior Equity Distribution Agreement and the Equity Distribution Agreement, respectively. During the nine months ended September 30, 2017, we received total accumulated net proceeds of approximately $56.3 million, including $687,000 of offering expenses, from these sales, of which $46.9 million, including offering expenses of $532,000, was received under the Prior Equity Distribution Agreement and $9.4 million, including offering expenses of $155,000, was received under the Equity Distribution Agreement, respectively. As of September 30, 2017, approximately 11.2 million shares remain available for issuance and sale under the Equity Distribution Agreement. See “—Subsequent Events.”

On August 27, 2015, our Board of Directors authorized a stock repurchase plan permitting us to repurchase up to $50.0 million of our common stock until August 23, 2016, after which the plan expired. In January 2016, we repurchased 449,588 shares of our common stock at an average price per share of $10.64 per share and a total cost of approximately $4.8 million.

Our 2016 Convertible Notes were fully settled on or before their contractual maturity date of April 15, 2016. Throughout the life of the 2016 Convertible Notes, holders of approximately $74.8 million of our 2016 Convertible Notes exercised their conversion rights. These 2016 Convertible Notes were settled with a combination of cash equal to the outstanding principal amount of the converted notes and approximately 1.6 million shares of our common stock, or $24.3 million.

On May 2, 2016, we closed an underwritten public offering of an additional $72.9 million in aggregate principal amount of our 2024 Notes. The $72.9 million in aggregate principal amount includes $65.4 million from the initial offering on April 21, 2016 and $7.5 million as a result of underwriters exercising a portion of their option to cover overallotments on April 29, 2016. On June 27, 2016, we closed an underwritten public offering of an additional $60.0 million in aggregate principal amount of the 2024 Notes. On June 30, 2016, the underwriters exercised their option to purchase up to an additional $9.0 million in aggregate principal to cover

 

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overallotments, resulting in total aggregate principal of $69.0 million from the offering. The 2024 Notes rank equally in right of payment and form a single series of notes. We intend to invest the net proceeds of these public offerings to fund investments in debt and equity securities in accordance with its investment objective and for other general corporate purposes.

On May 5, 2016, we, through a special purpose wholly-owned subsidiary, Hercules Funding III LLC (“Hercules Funding III”), as borrower, entered into the credit facility (the “Union Bank Facility”) with MUFG Union Bank, as the arranger and administrative agent, and the lenders party to the Union Bank Facility from time to time. The Union Bank Facility replaced our credit facility (the “Prior Union Bank Facility”) entered into on August 14, 2014 (as amended and restated from time to time) with MUFG Union Bank, as the arranger and administrative agent, and the lenders party to the Prior Union Bank Facility from time to time. Any references to amounts related to the Union Bank Facility prior to May 5, 2016 were incurred and relate to the Prior Union Bank Facility.

On October 11, 2016, we entered into a debt distribution agreement, pursuant to which we may offer for sale, from time to time, up to $150.0 million in aggregate principal amount of 2024 Notes through FBR Capital Markets & Co. acting as our sales agent. Sales of the 2024 Notes, if any, may be made in negotiated transactions or transactions that are deemed to be “at the market offerings” as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE, or similar securities exchange or sales made through a market maker other than on an exchange at prices related to prevailing market prices or at negotiated prices.

During the nine months ended September 30, 2017, we sold 225,457 notes for approximately $5.6 million in aggregate principal amount. We did not sell any notes under the program during the three months ended September 30, 2017. During the year ended December 31, 2016, we sold 317,125 notes for approximately $7.9 million in aggregate principal amount. As of September 30, 2017, approximately $136.4 million in aggregate principal amount remains available for issuance and sale under the debt distribution agreement.

On January 25, 2017, we issued $230.0 million in aggregate principal amount of 2022 Convertible Notes, which amount includes the additional $30.0 million aggregate principal amount issued pursuant to the initial purchaser’s exercise in full of its overallotment option. The sale generated net proceeds of approximately $225.5 million, including $4.5 million of debt issuance costs. Aggregate issuances costs include the initial purchaser’s discount of approximately $5.2 million, offset by the reimbursement of $1.2 million by the initial purchaser. We intend to use the net proceeds from this offering (i) to repurchase or otherwise redeem all of our 2019 Notes, (ii) to fund investments in debt and equity securities in accordance with our investment objective and (iii) for working capital and other general corporate purposes.

On February 24, 2017, we redeemed the $110.4 million remaining outstanding balance of our 2019 Notes in full.

At September 30, 2017, we had $230.0 million of 2022 Convertible Notes, $258.5 million of 2024 Notes, $65.5 million of 2021 Asset-Backed Notes, and $190.2 million of SBA debentures payable. We had no borrowings outstanding under the Wells Facility or the Union Bank Facility. See “—Subsequent Events.”

At September 30, 2017, we had $335.6 million in available liquidity, including $140.6 million in cash and cash equivalents. We had available borrowing capacity of $120.0 million under the Wells Facility and $75.0 million under the Union Bank Facility, both subject to existing terms and advance rates and regulatory requirements. We primarily invest cash on hand in interest bearing deposit accounts.

At September 30, 2017, we had $118.5 million of capital outstanding in restricted accounts related to our SBIC that we may use to fund new investments in the SBIC. With our net investments of $44.0 million and $74.5 million in HT II and HT III, respectively, we have the combined capacity to issue a total of $190.2 million of SBA guaranteed debentures, subject to SBA approval. At September 30, 2017, we have issued $190.2 million in SBA guaranteed debentures in our SBIC subsidiaries.

 

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At September 30, 2017, we had approximately $7.8 million of restricted cash, which consists of collections of interest and principal payments on assets that are securitized. In accordance with the terms of the related securitized 2021 Asset-Backed Notes, based on current characteristics of the securitized debt investment portfolios, the restricted funds may be used to pay monthly interest and principal on the securitized debt and are not distributed to us or available for our general operations.

During the nine months ended September 30, 2017, we principally funded our operations from (i) cash receipts from interest, dividend and fee income from our investment portfolio and (ii) cash proceeds from the realization of portfolio investments through the repayments of debt investments and the sale of debt and equity investments.

During the nine months ended September 30, 2017, our operating activities provided $76.6 million of cash and cash equivalents, compared to $58.5 million used during the nine months ended September 30, 2016. This $135.1 million increase in cash provided by operating activities is primarily related to an increase in investment repayments of $146.4 million and an increase in net realized losses on investments of $30.4 million, partially offset by an increase in investment purchases of $25.5 million and an increase in net unrealized appreciation of $31.7 million.

During the nine months ended September 30, 2017, our investing activities provided approximately $382,000 of cash, compared to $16,000 used during the nine months ended September 30, 2016. The $398,000 increase in cash provided in investing activities was primarily due to a decrease of approximately $298,000 in cash, classified as restricted cash, on assets that are securitized.

During the nine months ended September 30, 2017, our financing activities provided $50.5 million of cash, compared to $32.3 million provided during the nine months ended September 30, 2016. The $18.2 million increase in cash provided by financing activities was primarily due to the net issuance of $225.5 million of the 2022 Convertible Notes and a reduction in the use of our credit facilities between periods, offset by the repayment of $110.4 million of 2019 Notes and the decrease in 2024 Notes issuance during the nine months ended September 30, 2017.

As of September 30, 2017, net assets totaled $836.3 million, with a NAV per share of $10.00. We intend to continue to operate in order to generate cash flows from operations, including income earned from investments in our portfolio companies. Our primary use of funds will be investments in portfolio companies and cash distributions to holders of our common stock.

As required by the 1940 Act, our asset coverage must be at least 200% after each issuance of senior securities. As of September 30, 2017 our asset coverage ratio under our regulatory requirements as a business development company was 250.4% excluding our SBA debentures as a result of our exemptive order from the SEC that allows us to exclude all SBA leverage from our asset coverage ratio. As a result of the SEC exemptive order, our ratio of total assets on a consolidated basis to outstanding indebtedness may be less than 200%, which while providing increased investment flexibility, also may increase our exposure to risks associated with leverage. Total asset coverage ratio when including our SBA debentures was 212.0% at September 30, 2017.

 

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Outstanding Borrowings

At September 30, 2017 and December 31, 2016, we had the following available borrowings and outstanding amounts:

 

     September 30, 2017      December 31, 2016  

(in thousands)

   Total
Available
     Principal      Carrying
Value(1)
     Total
Available
     Principal      Carrying
Value(1)
 

SBA Debentures(2)

   $ 190,200      $ 190,200      $ 187,983      $ 190,200      $ 190,200      $ 187,501  

2019 Notes(3)

     —          —          —          110,364        110,364        108,818  

2024 Notes

     258,510        258,510        251,716        252,873        252,873        245,490  

2021 Asset-Backed Notes

     65,476        65,476        64,860        109,205        109,205        107,972  

2022 Convertible Notes

     230,000        230,000        223,097        —          —          —    

Wells Facility(4)

     120,000        —          —          120,000        5,016        5,016  

Union Bank Facility(4)

     75,000        —          —          75,000        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 939,186      $ 744,186      $ 727,656      $ 857,642      $ 667,658      $ 654,797  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Except for the Wells Facility and Union Bank Facility, all carrying values represent the principal amount outstanding less the remaining unamortized debt issuance costs and unaccreted discount, if any, associated with the loan as of the balance sheet date. See below for the amount of debt issuance cost associated with each borrowing.
(2) At both September 30, 2017 and December 31, 2016, the total available borrowings under the SBA debentures were $190.2 million, of which $41.2 million was available in HT II and $149.0 million was available in HT III.
(3) The 2019 Notes were redeemed in full on February 24, 2017.
(4) Availability subject to us meeting the borrowing base requirements.

Debt issuance costs are fees and other direct incremental costs we incur in obtaining debt financing and are recognized as prepaid expenses and amortized over the life of the related debt instrument using the effective yield method or the straight line method, which closely approximates the effective yield method. In accordance with ASC Subtopic 835-30 (“Interest—Imputation of Interest”), debt issuance costs are presented as a reduction to the associated liability balance on the Consolidated Statement of Assets and Liabilities, except for debt issuance costs associated with line-of-credit arrangements. Debt issuance costs, net of accumulated amortization, as of September 30, 2017 and December 31, 2016 were as follows:

 

(in thousands)

   September 30, 2017      December 31, 2016  

SBA Debentures

   $ 2,217      $ 2,699  

2019 Notes

     —          1,546  

2024 Notes

     6,889        7,482  

2021 Asset-Backed Notes

     616        1,233  

2022 Convertible Notes

     3,938        —    

Wells Facility(1)

     271        501  

Union Bank Facility(1)

     453        768  
  

 

 

    

 

 

 

Total

   $ 14,384      $ 14,229  
  

 

 

    

 

 

 

 

(1) As the Wells Facility and Union Bank Facility are line-of-credit arrangements, the debt issuance costs associated with these instruments are presented separately as an asset on the Consolidated Statement of Assets and Liabilities in accordance with ASC Subtopic 835-30.

Refer to “Note 4—Borrowings” included in the notes to our consolidated financial statements appearing elsewhere in this prospectus for a discussion of the contract terms, interest expense, and fees associated with each outstanding borrowing as of and for the three and nine months ended September 30, 2017.

Commitments

In the normal course of business, we are party to financial instruments with off-balance sheet risk. These consist primarily of unfunded contractual commitments to extend credit, in the form of loans, to our portfolio

 

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companies. Unfunded contractual commitments to provide funds to portfolio companies are not reflected on our balance sheet. Our unfunded contractual commitments may be significant from time to time. A portion of these unfunded contractual commitments are dependent upon the portfolio company reaching certain milestones before the debt commitment becomes available. Furthermore, our credit agreements contain customary lending provisions which allow us relief from funding obligations for previously made commitments in instances where the underlying company experiences materially adverse events that affect the financial condition or business outlook for the company. These commitments will be subject to the same underwriting and ongoing portfolio maintenance as are the on-balance sheet financial instruments that we hold. Since these commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. As such, our disclosure of unfunded contractual commitments includes only those which are available at the request of the portfolio company and unencumbered by milestones.

At September 30, 2017, we had approximately $46.3 million of unfunded commitments, including undrawn revolving facilities, which were available at the request of the portfolio company and unencumbered by milestones. We intend to use cash flow from normal and early principal repayments, and proceeds from borrowings and notes to fund these commitments.

We also had approximately $72.0 million of non-binding term sheets outstanding to three new companies, which generally convert to contractual commitments within approximately 90 days of signing. Non-binding outstanding term sheets are subject to completion of our due diligence and final investment committee approval process, as well as the negotiation of definitive documentation with the prospective portfolio companies. Not all non-binding term sheets are expected to close and do not necessarily represent future cash requirements.

The fair value of our unfunded commitments is considered to be immaterial as the yield determined at the time of underwriting is expected to be materially consistent with the yield upon funding, given that interest rates are generally pegged to market indices and given the existence of milestones, conditions and/or obligations imbedded in the borrowing agreements.

As of September 30, 2017, our unfunded contractual commitments available at the request of the portfolio company, including undrawn revolving facilities, and unencumbered by milestones are as follows:

 

(in thousands)       

Portfolio Company

   Unfunded
Commitments(1)
 

NewVoiceMedia Limited

   $ 15,000  

Evernote Corporation

     10,000  

Aquantia Corp.

     6,500  

Wrike, Inc.

     5,000  

MDX Medical, Inc.

     4,500  

908 DEVICES INC.

     2,500  

Verastem, Inc.

     2,500  

RedSeal Inc.

     302  
  

 

 

 

Total

   $ 46,302  
  

 

 

 

 

(1) Amount represents unfunded commitments, including undrawn revolving facilities, which are available at the request of the portfolio company. Amount excludes unfunded commitments which are unavailable due to the borrower having not met certain milestones.

 

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Contractual Obligations

The following table shows our contractual obligations as of September 30, 2017:

 

     Payments due by period (in thousands)  

Contractual Obligations(1)

   Total      Less than
1 year
     1 - 3 years      3 - 5 years      After 5
years
 

Borrowings(2)(3)(5)

   $ 744,186      $ 140,476      $ 51,200      $ 344,250      $ 208,260  

Operating Lease Obligations(4)

     4,370        1,831        1,149        1,145        245  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 748,556      $ 142,307      $ 52,349      $ 345,395      $ 208,505  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Excludes commitments to extend credit to our portfolio companies.
(2) Includes $190.2 million in principal outstanding under the SBA debentures, $258.5 million of the 2024 Notes, $230.0 million of the Convertible Notes and $65.5 million of the 2021 Asset-Backed Notes as of September 30, 2017.
(3) Amounts represent future principal repayments and not the carrying value of each liability. See Note 4 to our consolidated financial statements.
(4) Facility leases.
(5) Reflects announced redemption of a portion of the 2024 Notes in November 2017. See “—Subsequent Events.”

Certain premises are leased under agreements which expire at various dates through February 2023. Total rent expense amounted to approximately $443,000 and $1.3 million during the three and nine months ended September 30, 2017. Total rent expense amounted to approximately $420,000 and $1.3 million during the same periods ended September 30, 2016.

Indemnification Agreements

We have entered into indemnification agreements with our directors and executive officers. The indemnification agreements are intended to provide our directors and executive officers the maximum indemnification permitted under Maryland law and the 1940 Act. Each indemnification agreement provides that we shall indemnify the director or executive officer who is a party to the agreement, or an “Indemnitee,” including the advancement of legal expenses, if, by reason of his or her corporate status, the Indemnitee is, or is threatened to be, made a party to or a witness in any threatened, pending, or completed proceeding, to the maximum extent permitted by Maryland law and the 1940 Act.

We and our executives and directors are covered by Directors and Officers Insurance, with the directors and officers being indemnified by us to the maximum extent permitted by Maryland law subject to the restrictions in the 1940 Act.

Borrowings

Long-Term SBA Debentures

On September 27, 2006, HT II received a license to operate as a SBIC under the SBIC program and is able to borrow funds from the SBA against eligible investments and additional contributions to regulatory capital. Under the Small Business Investment Company Act and current SBA policy applicable to SBICs, a SBIC can have outstanding at any time SBA guaranteed debentures up to twice the amount of its regulatory capital. With the Company’s net investment of $44.0 million in HT II as of September 30, 2017, HT II has the capacity to issue a total of $41.2 million of SBA guaranteed debentures, subject to SBA approval, of which $41.2 million was outstanding as of September 30, 2017. As of September 30, 2017, HT II has paid the SBA commitment fees and facility fees of approximately $1.5 million and $3.6 million, respectively. As of September 30, 2017 the Company held investments in HT II in 32 companies with a fair value of approximately $77.0 million, accounting for approximately 5.4% of the Company’s total investment portfolio at September 30, 2017. HT II held approximately $107.9 million in assets and accounted for approximately 5.4% of the Company’s total assets prior to consolidation at September 30, 2017.

 

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On May 26, 2010, HT III received a license to operate as a SBIC under the SBIC program and is able to borrow funds from the SBA against eligible investments and additional contributions to regulatory capital. With the Company’s net investment of $74.5 million in HT III as of September 30, 2017, HT III has the capacity to issue a total of $149.0 million of SBA guaranteed debentures, subject to SBA approval, of which $149.0 million was outstanding as of September 30, 2017. As of September 30, 2017, HT III has paid the SBA commitment fees and facility fees of approximately $1.5 million and $3.6 million, respectively. As of September 30, 2017, the Company held investments in HT III in 45 companies with a fair value of approximately $200.8 million, accounting for approximately 14.2% of the Company’s total investment portfolio at September 30, 2017. HT III held approximately $279.9 million in assets and accounted for approximately 13.9% of the Company’s total assets prior to consolidation at September 30, 2017.

SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under present SBA regulations, eligible small businesses include businesses that have a tangible net worth not exceeding $19.5 million and have average annual fully taxed net income not exceeding $6.5 million for the two most recent fiscal years. In addition, SBICs must devote 25.0% of its investment activity to “smaller” enterprises as defined by the SBA. A smaller enterprise is one that has a tangible net worth not exceeding $6.0 million and has average annual fully taxed net income not exceeding $2.0 million for the two most recent fiscal years. SBA regulations also provide alternative size standard criteria to determine eligibility, which depend on the industry in which the business is engaged and are based on such factors as the number of employees and gross sales. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory services. Through the Company’s wholly owned subsidiaries HT II and HT III, the Company plans to provide long-term loans to qualifying small businesses, and in connection therewith, make equity investments.

HT II and HT III are periodically examined and audited by the SBA’s staff to determine their compliance with SBA regulations. If HT II or HT III fails to comply with applicable SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibit HT II’s or HT III’s use of debentures, declare outstanding debentures immediately due and payable, and/or limit HT II or HT III from making new investments. In addition, HT II or HT III may also be limited in their ability to make distributions to the Company if they do not have sufficient capital in accordance with SBA regulations. Such actions by the SBA would, in turn, negatively affect the Company because HT II and HT III are the Company’s wholly owned subsidiaries. HT II and HT III were in compliance with the terms of the SBIC’s leverage as of September 30, 2017 as a result of having sufficient capital as defined under the SBA regulations.

The rates of borrowings under various draws from the SBA beginning in March 2009 are set semiannually in March and September and range from 2.25% to 4.62% excluding annual fees. Interest payments on SBA debentures are payable semiannually. There are no principal payments required on these issues prior to maturity and no prepayment penalties. Debentures under the SBA generally mature ten years after being borrowed. Based on the initial draw down date of March 2009, the initial maturity of SBA debentures will occur in March 2019. In addition, the SBA charges a fee that is set annually, depending on the Federal fiscal year the leverage commitment was delegated by the SBA, regardless of the date that the leverage was drawn by the SBIC. The annual fees related to HT II debentures that pooled on September 22, 2010 were 0.406% and 0.285%, depending upon the year in which the underlying commitment was closed. The annual fees on other debentures have been set at 0.906%. The annual fees related to HT III debentures that pooled on March 27, 2013 were 0.804%. The annual fees on other debentures have been set at 0.515%. The rates of borrowings on the Company’s SBA debentures range from 3.05% to 5.53% when including these annual fees.

The average amount of debentures outstanding for the three and nine months ended September 30, 2017 for HT II was approximately $41.2 million with an average interest rate of approximately 4.56% and 4.51%, respectively. The average amount of debentures outstanding for the three and nine months ended September 30, 2017 for HT III was approximately $149.0 million with an average interest rate of approximately 3.46% and 3.42%, respectively.

 

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For the three and nine months ended September 30, 2017 and 2016, the components of interest expense and related fees and cash paid for interest expense for the SBA debentures are as follows:

 

     Three Months
Ended September 30,
     Nine Months Ended
September 30,
 

(in thousands)

   2017      2016      2017      2016  

Interest expense

   $ 1,757      $ 1,757      $ 5,212      $ 5,231  

Amortization of debt issuance cost (loan fees)

     158        168        482        504  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense and fees

   $ 1,915      $ 1,925      $ 5,694      $ 5,735  
  

 

 

    

 

 

    

 

 

    

 

 

 

Cash paid for interest expense and fees

   $ 3,499      $ 3,499      $ 6,942      $ 6,961  

In aggregate, at September 30, 2017, with the Company’s net investment of $118.5 million, HT II and HT III have the capacity to issue a total of $190.2 million of SBA-guaranteed debentures, subject to SBA approval. At September 30, 2017, the Company has issued $190.2 million in SBA-guaranteed debentures in the Company’s SBIC subsidiaries.

The Company reported the following SBA debentures outstanding principal balances as of September 30, 2017 and December 31, 2016:

 

(in thousands)

Issuance/Pooling Date

   Maturity Date      Interest
Rate(1)
    September 30,
2017
     December 31,
2016
 

March 25, 2009

     March 1, 2019        5.53   $ 18,400      $ 18,400  

September 23, 2009

     September 1, 2019        4.64     3,400        3,400  

September 22, 2010

     September 1, 2020        3.62     6,500        6,500  

September 22, 2010

     September 1, 2020        3.50     22,900        22,900  

March 29, 2011

     March 1, 2021        4.37     28,750        28,750  

September 21, 2011

     September 1, 2021        3.16     25,000        25,000  

March 21, 2012

     March 1, 2022        3.28     25,000        25,000  

March 21, 2012

     March 1, 2022        3.05     11,250        11,250  

September 19, 2012

     September 1, 2022        3.05     24,250        24,250  

March 27, 2013

     March 1, 2023        3.16     24,750        24,750  
       

 

 

    

 

 

 

Total SBA Debentures

        $ 190,200      $ 190,200  
       

 

 

    

 

 

 

 

(1) Interest rate includes annual charge

2019 Notes

In April and July 2012, the Company issued $84.5 million in aggregate principal amount of 7.00% notes due 2019 (the “April 2019 Notes”). In September and October 2012, the Company issued $85.9 million in aggregate principal amount of 7.00% notes due 2019 (the “September 2019 Notes”). The April 2019 Notes and September 2019 Notes are together referred to as the “2019 Notes”.

In April 2015, the Company redeemed $20.0 million of the $84.5 million issued and outstanding aggregate principal amount of April 2019 Notes, as previously approved by the Board of Directors. In December 2015, the Company redeemed $40.0 million of the $85.9 million issued and outstanding aggregate principal amount of September 2019 Notes, as previously approved by the Board of Directors. The remaining 2019 Notes were fully redeemed on February 24, 2017.

 

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As of December 31, 2016, the 2019 Notes payable outstanding principal balance consisted of:

 

(in thousands)

   December 31, 2016  

April 2019 Notes

   $ 64,490  

September 2019 Notes

     45,874  
  

 

 

 

Total 2019 Notes principal outstanding

   $ 110,364  
  

 

 

 

The April 2019 Notes bore interest at a rate of 7.00% per year and traded on the NYSE under the trading symbol “HTGZ.” The September 2019 Notes bore interest at a rate of 7.00% per year and traded on the NYSE under the trading symbol “HTGY.” For the three and nine months ended September 30, 2017 and 2016, the components of interest expense and related fees and cash paid for interest expense for the 2019 Notes are as follows:

 

     Three Months
Ended September 30,
     Nine Months
Ended September 30,
 

(in thousands)

       2017              2016              2017              2016      

Interest expense

   $ —        $ 1,931      $ 1,159      $ 5,794  

Amortization of debt issuance cost (loan fees)

     —          160        1,546        480  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense and fees

   $ —        $ 2,091      $ 2,705      $ 6,274  
  

 

 

    

 

 

    

 

 

    

 

 

 

Cash paid for interest expense and fees

   $ —        $ 1,931      $ 1,911      $ 5,794  

2024 Notes

On July 14, 2014, the Company and U.S. Bank, N.A. (the “2024 Trustee”), entered into the Third Supplemental Indenture (the “Third Supplemental Indenture”) to the Base Indenture between the Company and the 2024 Trustee, dated July 14, 2014, relating to the Company’s issuance, offer and sale of $100.0 million aggregate principal amount of 2024 Notes. On August 6, 2014, the underwriters issued notification to exercise their over-allotment option for an additional $3.0 million in aggregate principal amount of the 2024 Notes.

On May 2, 2016, the Company closed an underwritten public offering of an additional $72.9 million in aggregate principal amount of the 2024 Notes. The $72.9 million in aggregate principal amount includes $65.4 million from the initial offering on April 21, 2016 and $7.5 million as a result of underwriters exercising a portion of their option to purchase up to an additional $9.8 million in aggregate principal to cover overallotments on April 29, 2016.

On June 27, 2016, the Company closed an underwritten public offering of an additional $60.0 million in aggregate principal amount of the 2024 Notes. On June 30, 2016, the underwriters exercised their option to purchase up to an additional $9.0 million in aggregate principal to cover overallotments, resulting in total aggregate principal of $69.0 million from the offering.

On October 11, 2016, the Company entered into a debt distribution agreement, pursuant to which it may offer for sale, from time to time, up to $150.0 million in aggregate principal amount of 2024 Notes through FBR Capital Markets & Co. acting as its sales agent (the “2024 Notes Agent”). Sales of the 2024 Notes may be made in negotiated transactions or transactions that are deemed to be “at the market offerings” as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE, or similar securities exchange or sales made through a market maker other than on an exchange at prices related to prevailing market prices or at negotiated prices.

The 2024 Notes Agent receives a commission from the Company equal to up to 2.00% of the gross sales of any 2024 Notes sold through the 2024 Notes Agent under the debt distribution agreement. The 2024 Notes Agent is not required to sell any specific principal amount of 2024 Notes, but will use its commercially reasonable

 

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efforts consistent with its sales and trading practices to sell the 2024 Notes. The 2024 Notes are expected to trade “flat,” which means that purchasers in the secondary market will not pay, and sellers will not receive, any accrued and unpaid interest on the 2024 Notes that is not reflected in the trading price.

During the nine months ended September 30, 2017, the Company sold 225,457 notes for approximately $5.6 million in aggregate principal amount. The Company did not sell any notes under the debt distribution agreement during the three months ended September 30, 2017. During the year ended December 31, 2016, the Company sold 317,125 notes for approximately $7.9 million in aggregate principal amount. As of September 30, 2017 approximately $136.4 million in aggregate principal amount remains available for issuance and sale under the debt distribution agreement.

All issuances of 2024 Notes rank equally in right of payment and form a single series of notes.

The 2024 Notes will mature on July 30, 2024 and may be redeemed in whole or in part at the Company’s option at any time or from time to time on or after July 30, 2017, upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to but not including the date fixed for redemption. The 2024 Notes bear interest at a rate of 6.25% per year payable quarterly on January 30, April 30, July 30 and October 30 of each year, commencing on July 30, 2014, and trade on the NYSE under the trading symbol “HTGX”.

The 2024 Notes are the Company’s direct unsecured obligations and rank: (i) pari passu with the Company’s other outstanding and future senior unsecured indebtedness; (ii) senior to any of the Company’s future indebtedness that expressly provides it is subordinated to the 2024 Notes; (iii) effectively subordinated to all the Company’s existing and future secured indebtedness (including indebtedness that is initially unsecured to which the Company subsequently grants security), to the extent of the value of the assets securing such indebtedness; (iv) structurally subordinated to all existing and future indebtedness and other obligations of any of the Company’s subsidiaries.

The Base Indenture, as supplemented by the Third Supplemental Indenture, contains certain covenants including covenants requiring the Company to comply with (regardless of whether it is subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) of the 1940 Act as modified by Section 61(a)(1) of the 1940 Act and to comply with the restrictions on dividends and other distributions as well as the purchase of capital stock set forth in Section 18(a)(1)(B) of the 1940 Act as modified by Section 61(a)(1) of the 1940 Act. These covenants are subject to important limitations and exceptions that are described in the Base Indenture, as supplemented by the Third Supplemental Indenture. The Base Indenture, as supplemented by the Third Supplemental Indenture, also contains certain reporting requirements, including a requirement that the Company provide financial information to the holders of the 2024 Notes and the 2024 Trustee if the Company should no longer be subject to the reporting requirements under the Exchange Act. The Base Indenture provides for customary events of default and further provides that the 2024 Trustee or the holders of 25% in aggregate principal amount of the outstanding 2024 Notes in a series may declare such 2024 Notes immediately due and payable upon the occurrence of any event of default after expiration of any applicable grace period. As of September 30, 2017, the Company was in compliance with the terms of the Base Indenture as supplemented by the Third Supplemental Indenture.

 

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As of September 30, 2017 and December 31, 2016, the components of the carrying value of the 2024 Notes were as follows:

 

(in thousands)

   September 30,
2017
     December 31,
2016
 

Principal amount of debt

   $ 258,510      $ 252,873  

Unamortized debt issuance cost

     (6,889      (7,482

Original issue premium, net of amortization

     95        99  
  

 

 

    

 

 

 

Carrying value of 2024 Notes

   $ 251,716      $ 245,490  
  

 

 

    

 

 

 

For the three and nine months ended September 30, 2017 and 2016, the components of interest expense and related fees and cash paid for interest expense for the 2024 Notes are as follows:

 

     Three Months
Ended September 30,
     Nine Months Ended
September 30,
 

(in thousands)

       2017              2016          2017      2016  

Interest expense

   $ 4,039      $ 3,926      $ 12,065      $ 7,910  

Amortization of debt issuance cost (loan fees)

     252        229        752        448  

Amortization of original issue premium

     (13      —          (43      —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense and fees

   $ 4,278      $ 4,155      $ 12,774      $ 8,358  
  

 

 

    

 

 

    

 

 

    

 

 

 

Cash paid for interest expense and fees

   $ 4,053      $ 3,827      $ 12,069      $ 7,046  

2021 Asset-Backed Notes

On November 13, 2014, the Company completed a $237.4 million term debt securitization in connection with which an affiliate of the Company made an offer of $129.3 million in aggregate principal amount of fixed rate asset-backed notes (the “2021 Asset-Backed Notes”), which were rated A(sf) by Kroll Bond Rating Agency, Inc. The 2021 Asset-Backed Notes were sold by Hercules Capital Funding Trust 2014-1 pursuant to a note purchase agreement, dated as of November 13, 2014, by and among the Company, Hercules Capital Funding 2014-1, LLC as trust depositor (the “2014 Trust Depositor”), Hercules Capital Funding Trust 2014-1 as issuer (the “2014 Securitization Issuer”), and Guggenheim Securities, LLC, as initial purchaser, and are backed by a pool of senior loans made to certain of the Company’s portfolio companies and secured by certain assets of those portfolio companies and are to be serviced by the Company. The securitization has an 18-month reinvestment period during which time principal collections may be reinvested into additional eligible loans. Interest on the 2021 Asset-Backed Notes is paid, to the extent of funds available, at a fixed rate of 3.524% per annum. The 2021 Asset-Backed Notes have a stated maturity of April 16, 2021.

As part of this transaction, the Company entered into a sale and contribution agreement with the 2014 Trust Depositor under which the Company has agreed to sell or have contributed to the 2014 Trust Depositor certain senior loans made to certain of the Company’s portfolio companies (the “2014 Loans”). The Company has made customary representations, warranties and covenants in the sale and contribution agreement with respect to the 2014 Loans as of the date of their transfer to the 2014 Trust Depositor.

In connection with the issuance and sale of the 2021 Asset-Backed Notes, the Company has made customary representations, warranties and covenants in the note purchase agreement. The 2021 Asset-Backed Notes are secured obligations of the 2014 Securitization Issuer and are non-recourse to the Company. The 2014 Securitization Issuer also entered into an indenture governing the 2021 Asset-Backed Notes, which includes customary representations, warranties and covenants. The 2021 Asset-Backed Notes were sold without being registered under the Securities Act (A) in the United States to “qualified institutional buyers” as defined in Rule 144A under the Securities Act and to institutional “accredited investors” (as defined in Rules 501(a)(1), (2), (3) or (7) under the Securities Act) who in each case, are “qualified purchasers” as defined in Section 2(a)(51)(A) of

 

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the 1940 Act and pursuant to an exemption under the Securities Act and (B) to non-U.S. purchasers acquiring interest in the 2021 Asset-Backed Notes outside the United States in accordance with Regulation S under the Securities Act. The 2014 Securitization Issuer is not registered under the 1940 Act in reliance on an exemption provided by Section 3(c)(7) thereof and Rule 3a-7 thereunder. In addition, the 2014 Trust Depositor entered into an amended and restated trust agreement in respect of the 2014 Securitization Issuer, which includes customary representation, warranties and covenants.

The 2014 Loans are serviced by the Company pursuant to a sale and servicing agreement, which contains customary representations, warranties and covenants. The Company performs certain servicing and administrative functions with respect to the 2014 Loans. The Company is entitled to receive a monthly fee from the 2014 Securitization Issuer for servicing the 2014 Loans. This servicing fee is equal to the product of one-twelfth (or in the case of the first payment date, a fraction equal to the number of days from and including October 5, 2014 through and including December 5, 2014 over 360) of 2.00% and the aggregate outstanding principal balance of the 2014 Loans plus collections on deposit in the 2014 Securitization Issuer’s collections account, as of the first day of the related collection period (the period from the 5th day of the immediately preceding calendar month through the 4th day of the calendar month in which a payment date occurs, and for the first payment date, the period from and including October 5, 2014, to the close of business on December 5, 2014).The Company also serves as administrator to the 2014 Securitization Issuer under an administration agreement, which includes customary representations, warranties and covenants.

At September 30, 2017 and December 31, 2016, the 2021 Asset-Backed Notes had an outstanding principal balance of $65.5 million and $109.2 million, respectively.

For the three and nine months ended September 30, 2017 and 2016, the components of interest expense and related fees and cash paid for interest expense for the 2021 Asset-Backed Notes are as follows:

 

     Three Months
Ended September 30,
     Nine Months Ended
September 30,
 

(in thousands)

       2017              2016          2017      2016  

Interest expense

   $ 632      $ 1,103      $ 2,327      $ 3,381  

Amortization of debt issuance cost (loan fees)

     197        366        618        832  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense and fees

   $ 829      $ 1,469      $ 2,945      $ 4,213  
  

 

 

    

 

 

    

 

 

    

 

 

 

Cash paid for interest expense and fees

   $ 697      $ 1,110      $ 2,485      $ 3,388  

Under the terms of the 2021 Asset-Backed Notes, the Company is required to maintain a reserve cash balance, funded through interest and principal collections from the underlying securitized debt portfolio, which may be used to pay monthly interest and principal payments on the 2021 Asset-Backed Notes. The Company has segregated these funds and classified them as restricted cash. There was approximately $7.8 million and $8.3 million of restricted cash as of September 30, 2017 and December 31, 2016, respectively, funded through interest collections.

Convertible Notes

2016 Convertible Notes

In April 2011, the Company issued $75.0 million in aggregate principal amount of 6.00% convertible notes due 2016 (the “2016 Convertible Notes”). The 2016 Convertible Notes were fully settled on or before their contractual maturity date of April 15, 2016.

Prior to the close of business on October 14, 2015, holders were able to convert their 2016 Convertible Notes only under certain circumstances set forth in the indenture governing the 2016 Convertible Notes. On or after October 15, 2015 until the close of business on the scheduled trading day immediately preceding the

 

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maturity date, holders were able to convert their 2016 Convertible Notes at any time. Throughout the life of the 2016 Convertible Notes, holders of approximately $74.8 million of the 2016 Convertible Notes exercised their conversion rights. These 2016 Convertible Notes were settled with a combination of cash equal to the outstanding principal amount of the 2016 Convertible Notes and approximately 1.6 million shares of the Company’s common stock, or $24.3 million.

The 2016 Convertible Notes were accounted for in accordance with ASC Subtopic 470-20 (“Debt Instruments with Conversion and Other Options”). In accounting for the 2016 Convertible Notes, the Company estimated at the time of issuance that the values of the debt and the embedded conversion feature of the 2016 Convertible Notes were approximately 92.8% and 7.2%, respectively. The original issue discount of 7.2% attributable to the conversion feature of the 2016 Convertible Notes was recorded in “capital in excess of par value” in the Consolidated Statement of Assets and Liabilities. As a result, the Company recorded interest expense comprised of both stated interest expense as well as accretion of the original issue discount resulting in an estimated effective interest rate of approximately 8.1%.

For the three and nine months ended September 30, 2016, the components of interest expense, fees and cash paid for interest expense for the 2016 Convertible Notes were as follows:

 

     Three Months
Ended September 30,
     Nine Months
Ended September 30,
 

(in thousands)

       2017              2016              2017              2016      

Interest expense

   $ —        $ —        $ —        $ 352  

Amortization of debt issuance cost (loan fees)

     —          —          —          44  

Accretion of original issue discount

     —          —          —          82  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense and fees

   $ —        $ —        $ —        $ 478  
  

 

 

    

 

 

    

 

 

    

 

 

 

Cash paid for interest expense and fees

   $ —        $ —        $ —        $ 440  

The estimated effective interest rate of the debt component of the 2016 Convertible Notes, equal to the stated interest of 6.0% plus the accretion of the original issue discount, was approximately 8.1% for the three and nine months ended September 30, 2016.

2022 Convertible Notes

On January 25, 2017, the Company issued $230.0 million in aggregate principal amount of 4.375% Convertible Notes due 2022 (the “2022 Convertible Notes”), which amount includes the additional $30.0 million aggregate principal amount of 2022 Convertible Notes issued pursuant to the initial purchaser’s exercise in full of its overallotment option. The 2022 Convertible Notes were issued pursuant to an Indenture, dated January 25, 2017 (the “2022 Convertible Notes Indenture”), between the Company and U.S. Bank, National Association, as trustee (the “2022 Trustee”). The sale of the 2022 Convertible Notes generated net proceeds of approximately $225.5 million, including $4.5 million of debt issuance costs.

The 2022 Convertible Notes mature on February 1, 2022, unless previously converted or repurchased in accordance with their terms. The 2022 Convertible Notes bear interest at a rate of 4.375% per year payable semiannually in arrears on February 1 and August 1 of each year, commencing on August 1, 2017.

The 2022 Convertible Notes are unsecured obligations of the Company and rank senior in right of payment to the Company’s future indebtedness that is expressly subordinated in right of payment to the 2022 Convertible Notes; equal in right of payment to the Company’s existing and future indebtedness that is not so subordinated; effectively junior in right of payment to any of the Company’s secured indebtedness (including unsecured indebtedness that the Company later secures) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by the Company’s subsidiaries, financing vehicles or similar facilities.

 

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Prior to the close of business on the business day immediately preceding August 1, 2021, holders may convert their 2022 Convertible Notes only under certain circumstances set forth in the 2022 Convertible Notes Indenture. On or after August 1, 2021 until the close of business on the scheduled trading day immediately preceding the maturity date, holders may convert their 2022 Convertible Notes at any time. Upon conversion, the Company will pay or deliver, as the case may be, at its election, cash, shares of its common stock or a combination of cash and shares of its common stock. The conversion rate is initially 60.9366 shares of common stock per $1,000 principal amount of 2022 Convertible Notes (equivalent to an initial conversion price of approximately $16.41 per share of common stock). The conversion rate will be subject to adjustment in some events but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the maturity date, the Company will increase the conversion rate for a holder who elects to convert its 2022 Convertible Notes in connection with such a corporate event in certain circumstances. As of September 30, 2017, the conversion rate was 60.9366 shares of common stock per $1,000 principal amount of Convertible Senior Notes (equivalent to an adjusted conversion price of approximately $16.41 per share of common stock).

The Company may not redeem the 2022 Convertible Notes at its option prior to maturity. No sinking fund is provided for the 2022 Convertible Notes. In addition, if certain corporate events occur, holders of the 2022 Convertible Notes may require the Company to repurchase for cash all or part of their 2022 Convertible Notes at a repurchase price equal to 100% of the principal amount of the 2022 Convertible Notes to be repurchased, plus accrued and unpaid interest through, but excluding, the required repurchase date.

The 2022 Convertible Notes Indenture contains certain covenants, including covenants requiring the Company to comply with Section 18(a)(1)(A) of the 1940 Act as modified by Section 61(a)(1) of the 1940 Act and to provide financial information to the holders of the 2022 Convertible Notes and the 2022 Trustee if the Company ceases to be subject to the reporting requirements of the Exchange Act. These covenants are subject to important limitations and exceptions that are described in the 2022 Convertible Notes Indenture. The Company offered and sold the 2022 Convertible Notes to the initial purchaser in reliance on the exemption from registration provided by Section 4(a)(2) of the Securities Act, for resale by the initial purchaser to qualified institutional buyers (as defined in the Securities Act) pursuant to the exemption from registration provided by Rule 144A under the Securities Act. The Company relied on these exemptions from registration based in part on representations made by the initial purchaser in connection with the sale of the 2022 Convertible Notes.

The 2022 Convertible Notes are accounted for in accordance with ASC Subtopic 470-20 (“Debt Instruments with Conversion and Other Options”). In accounting for the 2022 Convertible Notes, the Company estimated at the time of issuance that the values of the debt and the embedded conversion feature of the 2022 Convertible Notes were approximately 98.5% and 1.5%, respectively. The original issue discount of 1.5%, or $3.4 million, attributable to the conversion feature of the 2022 Convertible Notes was recorded in “capital in excess of par value” in the Consolidated Statement of Assets and Liabilities. As a result, the Company records interest expense comprised of both stated interest expense as well as accretion of the original issue discount resulting in an estimated effective interest rate of approximately 4.76%.

As of September 30, 2017, the components of the carrying value of the 2022 Convertible Notes were as follows:

 

(in thousands)

   September 30,
2017
 

Principal amount of debt

   $ 230,000  

Unamortized debt issuance cost

     (3,938

Original issue discount, net of accretion

     (2,965
  

 

 

 

Carrying value of 2022 Convertible Notes

   $ 223,097  
  

 

 

 

 

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For the three and nine months ended September 30, 2017, the components of interest expense, fees and cash paid for interest expense for the 2022 Convertible notes were as follows:

 

     Three Months
Ended September 30,
     Nine Months
Ended September 30,
 

(in thousands)

       2017              2016              2017              2016      

Interest expense

   $ 2,602      $ —        $ 6,876      $ —    

Amortization of debt issuance cost (loan fees)

     213        —          558        —    

Accretion of original issue discount

     168        —          448        —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense and fees

   $ 2,983      $ —        $ 7,882      $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Cash paid for interest expense and fees

   $ 5,199      $ —        $ 5,199      $ —    

The estimated effective interest of the debt component of the 2022 Convertible Notes, equal to the stated interest rate of 4.375% plus the accretion of the original issue discount, was approximately 4.76% for the three and nine months ended September 30, 2017. As of September 30, 2017, the Company is in compliance with the terms of the indentures governing the 2022 Convertible Notes.

Credit Facilities

As of September 30, 2017 and December 31, 2016, the Company has two available credit facilities, the Wells Facility and the Union Bank Facility.

Wells Facility

On June 29, 2015, the Company, through a special purpose wholly owned subsidiary, Hercules Funding II LLC (“Hercules Funding II”), entered into an Amended and Restated Loan and Security Agreement (the “Wells Facility”) with Wells Fargo Capital Finance, LLC, as a lender and as the arranger and the administrative agent, and the lenders party thereto from time to time.

The Wells Facility matures on August 2, 2019, unless terminated sooner in accordance with its terms.

Under the Wells Facility, Wells Fargo Capital Finance, LLC made commitments of $75.0 million, Alostar Bank of Commerce made commitments of $20.0 million, and Everbank Commercial Finance Inc. made commitments of $25.0 million. The Wells Facility contains an accordion feature, in which the Company can increase the credit line up to an aggregate of $300.0 million, funded by additional lenders and with the agreement of Wells Fargo and subject to other customary conditions. The Company expects to continue discussions with various other potential lenders to join the facility; however, there can be no assurances that additional lenders will join the Wells Facility. Borrowings under the Wells Facility generally bear interest at a rate per annum equal to LIBOR plus 3.25%, and the Wells Facility has an advance rate of 50% against eligible debt investments. The Wells Facility is secured by all of the assets of Hercules Funding II. The Wells Facility requires payment of a non-use fee on a scale of 0.0% to 0.50% depending on the average monthly outstanding balance under the facility relative to the maximum amount of commitments at such time. For the three and nine months ended September 30, 2017, this non-use fee was $153,000 and $450,000, respectively. For the three and nine months ended September 30, 2016, this non-use fee was $155,000 and $336,000, respectively.

The Wells Facility also includes various financial and other covenants applicable to the Company and the Company’s subsidiaries, in addition to those applicable to Hercules Funding II, including covenants relating to certain changes of control of the Company and Hercules Funding II. Among other things, these covenants also require the Company to maintain certain financial ratios, including a maximum debt to worth ratio, minimum interest coverage ratio, minimum portfolio funding liquidity, and a minimum tangible net worth in an amount, when added to outstanding subordinated indebtedness, that is in excess of $500.0 million plus 90% of the

 

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cumulative amount of equity raised after June 30, 2014. As of September 30, 2017, the minimum tangible net worth covenant increased to $727.2 million as a result of the March 2015 follow-on public offering of 7.6 million shares of common stock for total gross proceeds of approximately $100.4 million, the issuance of 7.3 million shares of common stock issued under the Prior Equity Distribution Agreement for gross proceeds of $95.0 million during the year ended December 31, 2016, and the issuance of 4.1 million shares of common stock issued under the Prior Equity Distribution Agreement and the Equity Distribution Agreement for gross proceeds of $57.0 million during the nine months ended September 30, 2017. See “Note 6—Stockholder’s Equity.”

The Wells Facility provides for customary events of default, including, without limitation, with respect to payment defaults, breach of representations and covenants, certain key person provisions, cross acceleration provisions to certain other debt, lien and judgment limitations, and bankruptcy.

On June 20, 2011, the Company paid $1.1 million in structuring fees in connection with the original Wells Facility. In connection with an amendment to the original Wells Facility in August 2014, the Company paid an additional $750,000 in structuring fees and in connection with the amendment in December 2015, the Company paid an additional $188,000 in structuring fees. These fees are being amortized through the end of the term of the Wells Facility.

The Company had aggregate draws of $8.5 million on the available facility during the nine months ended September 30, 2017 offset by repayments of $13.5 million. The Company had aggregate draws of $168.3 million on the available facility during the nine months ended September 30, 2016 offset by repayments of $218.3 million. At December 31, 2016 there was $5.0 million, respectively, of borrowings outstanding on this facility. There were no borrowings outstanding on the facility as of September 30, 2017.

For the three and nine months ended September 30, 2017 and 2016, the components of interest expense and related fees and cash paid for interest expense for the Wells Facility are as follows:

 

     Three Months
Ended September 30,
     Nine Months
Ended September 30,
 

(in thousands)

       2017              2016              2017              2016      

Interest expense

   $ —        $ —        $ 2      $ 501  

Amortization of debt issuance cost (loan fees)

     66        115        280        341  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense and fees

   $ 66      $ 115      $ 282      $ 842  
  

 

 

    

 

 

    

 

 

    

 

 

 

Cash paid for interest expense and fees

   $ 207      $ —        $ 677      $ 577  

Union Bank Facility

On May 5, 2016, the Company, through a special purpose wholly owned subsidiary, Hercules Funding III, as borrower, entered into the Union Bank Facility. The Union Bank Facility replaced the Prior Union Bank Facility. Any references to amounts related to the Union Bank Facility prior to May 5, 2016 were incurred and relate to the Prior Union Bank Facility.

On July 18, 2016, the Company entered into the First Amendment to the Loan and Security Agreement, dated as of May 5, 2016 with MUFG Union Bank, N.A. The Amendment amends certain definitions relating to borrowings which accrue interest based on the London Interbank Offered Rate (“LIBOR Loans”) and (ii) the method(s) for calculating interest on and the paying of certain fees related to such LIBOR Loans.

Under the Union Bank Facility, MUFG Union Bank made commitments of $75.0 million. The Union Bank Facility contains an accordion feature, in which the Company can increase the credit line up to an aggregate of $200.0 million, funded by additional lenders and with the agreement of MUFG Union Bank and subject to other customary conditions. There can be no assurances that additional lenders will join the Union Bank Facility to

 

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increase available borrowings. Borrowings under the Union Bank Facility generally bear interest at either (i) if such borrowing is a base rate loan, a base rate per annum equal to the federal funds rate plus 1.00%, LIBOR plus 1.00% or MUFG Union Bank’s prime rate, in each case, plus a margin of 1.25% or (ii) if such borrowing is a LIBOR loan, a rate per annum equal to LIBOR plus 3.25%, and the Union Bank Facility generally has an advance rate of 50% against eligible debt investments. The Union Bank Facility is secured by all of the assets of Hercules Funding III.

The Company paid a one-time $562,500 structuring fee in connection with the Union Bank Facility. The Union Bank Facility requires payment of a non-use fee during the revolving credit availability period on a scale of 0.25% to 0.50% depending on the average monthly outstanding balance under the facility relative to the maximum amount of commitments at such time. For the three and nine months ended September 30, 2017, the company incurred non-use fees of $96,000 and $284,000, respectively. For the three and nine months ended September 30, 2016, the company incurred non-use fees under the Prior Union Bank Facility of $96,000 and $277,000, respectively.

The Union Bank Facility also includes various financial and other covenants applicable to the Company and its subsidiaries, in addition to those applicable to Hercules Funding III, including covenants relating to certain changes of control of the Company and Hercules Funding III. Among other things, these covenants also require the Company to maintain certain financial ratios, including a maximum debt to worth ratio, minimum interest coverage ratio, minimum portfolio funding liquidity, and a minimum tangible net worth in an amount that is in excess of $500.0 million plus 90% of the cumulative amount of equity raised after June 30, 2014. As of September 30, 2017, the minimum tangible net worth covenant increased to $774.3 million as a result of the March 2015 follow-on public offering of 7.6 million shares of common stock for total net proceeds of approximately $100.1 million, the issuance of 7.3 million shares of common stock issued under the Prior Equity Distribution Agreement for net proceeds of $92.8 million during the year ended December 31, 2016, and the issuance of 4.1 million shares of common stock issued under the Prior Equity Distribution Agreement and the Equity Distribution Agreement for net proceeds of $56.3 million during the nine months ended September 30, 2017. See “Note 6—Stockholder’s Equity.”

The Union Bank Facility provides for customary events of default, including with respect to payment defaults, breach of representations and covenants, servicer defaults, certain key person provisions, cross default provisions to certain other debt, lien and judgment limitations, and bankruptcy.

The Union Bank Facility matures on May 5, 2020, unless terminated sooner in accordance with its terms.

In connection with the Union Bank Facility, the Company and Hercules Funding III also entered into the Sale Agreement, by and among Hercules Funding III, as borrower, the Company, as originator and servicer, and MUFG Union Bank, as agent. Under the Sale Agreement, the Company agrees to (i) sell or transfer certain loans to HT III under the MUFG Union Bank Facility and (ii) act as servicer for the loans sold or transferred.

The Company did not make any draws or repayments on the available facility during the nine months ended September 30, 2017. The Company had aggregate draws of $25.0 million on the available facility during the nine months ended September 30, 2016 offset by repayments of $25.0 million. At September 30, 2017 and December 31, 2016, there were no borrowings outstanding on the Union Bank Facility.

 

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For the three and nine months ended September 30, 2017 and 2016, the components of interest expense and related fees and cash paid for interest expense for the previous and current Union Bank Facility are as follows:

 

     Three Months
Ended September 30,
     Nine Months
Ended September 30,
 

(in thousands)

       2017              2016              2017              2016      

Interest expense

   $ —        $ —        $ —        $ 55  

Amortization of debt issuance cost (loan fees)

     91        112        315        244  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense and fees

   $ 91      $ 112      $ 315      $ 299  
  

 

 

    

 

 

    

 

 

    

 

 

 

Cash paid for interest expense and fees

   $ 114      $ —     &