Toggle SGML Header (+)


Section 1: 497 (497)

497
Table of Contents
Index to Financial Statements

Filed Pursuant to Rule 497
Registration No. 333-214767

 

PROSPECTUS SUPPLEMENT

(To prospectus dated September 7, 2017)

 

 

LOGO

$75,000,000

5.25% Notes due 2025

 

 

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’s total return by generating current income from our debt investments and capital appreciation from our warrant and equity-related investments.

We are offering $75,000,000 in aggregate principal amount of 5.25% notes due 2025, or the “Notes.” The Notes will mature on April 30, 2025. We will pay interest quarterly on the Notes on January 30, April 30, July 30 and October 30 of each year, beginning on July 30, 2018. We may redeem the Notes in whole or in part at any time or from time to time, at the redemption price set forth under “Specific Terms of the Notes and the Offering—Optional Redemption” in this prospectus supplement. The Notes will be issued in minimum denominations of $25 and integral multiples of $25 in excess thereof.

The Notes will be our direct unsecured obligations and rank pari passu, or equally in right of payment, with all outstanding and future unsecured unsubordinated indebtedness issued by Hercules Capital, Inc.

We intend to apply to list the Notes on the New York Stock Exchange, or NYSE, and we expect trading in the Notes on the NYSE to begin within 30 days of the original issue date under the symbol “HCXZ.” The Notes are expected to trade “flat,” which means that purchasers will not pay, and sellers will not receive, any accrued and unpaid interest on the Notes that is not reflected in the trading price. Currently, there is no public market for the Notes.

 

 

An investment in the Notes involves risks that are described in the “Supplementary Risk Factors” section beginning on page S-14 in this prospectus supplement and the “Risk Factors” section beginning on page 14 of the accompanying prospectus.

This prospectus supplement and the accompanying prospectus contain important information you should know before investing in the Notes. Please read this prospectus supplement and the accompanying prospectus before investing and keep it for future reference. We file annual, quarterly and current reports, proxy statements and other information about us with the Securities and Exchange Commission. This information is available free of charge by contacting us at 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 the websites referred to herein is not incorporated by reference into this prospectus supplement or the accompanying prospectus. The SEC also maintains a website at www.sec.gov that contains information about us.

 

     Per Note      Total  

Public offering price

   $ 25.0000      $ 75,000,000  

Sales load (underwriting discounts and commissions)(1)

   $ 0.6733      $ 2,020,000  

Proceeds to us (before expenses)(2)

   $ 24.3267      $ 72,980,000  

 

(1) Reflects an underwriting discount of $0.7500 per Note sold to retail investors and $0.2500 per Note sold to institutional investors, for which the underwriters received a weighted average underwriting discount of $0.6733 per Note.
(2) Before deducting expenses payable by us related to this offering, estimated at $250,000. See “Underwriting” in this prospectus supplement for complete details of underwriters’ compensation.

The underwriters may also purchase up to an additional $11,250,000 total aggregate principal amount of Notes offered hereby, to cover overallotments, if any, within 30 days of the date of this prospectus supplement. If the underwriters exercise this option in full, the total public offering price will be $86,250,000, the total sales load (underwriting discounts and commissions) paid by us will be $2,357,500, and total proceeds, before expenses, will be $83,892,500.

THE NOTES ARE NOT DEPOSITS OR OTHER OBLIGATIONS OF A BANK AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY OTHER GOVERNMENT AGENCY.

Neither the Securities and Exchange Commission 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.

 

 

Delivery of the Notes in book-entry form only through The Depository Trust Company will be made on or about April 26, 2018.

Joint Book-Running Managers

 

Keefe, Bruyette & Woods,

                         A Stifel Company

  Morgan Stanley   Wells Fargo Securities

Lead Manager

Janney Montgomery Scott

Co-Managers

 

B. Riley FBR  

Compass Point

  MUFG

The date of this prospectus supplement is April 23, 2018.


Table of Contents
Index to Financial Statements

You should rely only on the information contained in this prospectus supplement and the accompanying prospectus. We have not, and the underwriters have 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 the underwriters are 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 or such 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 Notes.

TABLE OF CONTENTS

Prospectus Supplement

 

     Page  

Prospectus Supplement Summary

       S-1  

Specific Terms of the Notes and the Offering

       S-7  

Forward-Looking Statements

     S-12  

Industry and Market Data

     S-13  

Supplementary Risk Factors

     S-14  

Use of Proceeds

     S-27  

Selected Consolidated Financial Data

     S-28  

Capitalization

     S-30  

Senior Securities

     S-31  

Ratio of Earnings to Fixed Charges

     S-34  

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

     S-35  

Management

     S-89  

Underwriting

     S-91  

Certain United States Federal Income Tax Considerations

     S-95  

Legal Matters

     S-99  

Experts

     S-99  

Available Information

     S-99  

Index to Financial Statements

     S-100  

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  


Table of Contents
Index to Financial Statements
     Page  

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

     67  

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  


Table of Contents
Index to Financial Statements

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 regulated investment company, or RIC, under the Internal Revenue Code of 1986, as amended, or the Code.

As of December 31, 2017, our total assets were approximately $1.7 billion, of which our investments comprised $1.5 billion at fair value and $1.6 billion at cost. Since inception through December 31, 2017, we have made debt and equity commitments of almost $7.3 billion to our portfolio companies.

We also make investments in qualifying small businesses through our two wholly-owned small business investment companies, or SBICs. Our SBIC subsidiaries, Hercules Technology II, L.P., or HT II, and Hercules Technology III, L.P., or HT III, hold approximately $111.8 million and $284.0 million in assets, respectively, and accounted for approximately 5.4% and 13.8% of our total assets, respectively, prior to consolidation at December 31, 2017. At December 31, 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 December 31, 2017, our investment professionals, including Manuel A. Henriquez, our co-founder, Chairman, President and Chief Executive Officer, are currently comprised of 35 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.



 

S-1


Table of Contents
Index to Financial Statements

Organizational Chart

The following chart summarizes our organizational structure as of April 19, 2018. 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.



 

S-2


Table of Contents
Index to Financial Statements

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



 

S-3


Table of Contents
Index to Financial Statements

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 February 14, 2018 our Board of Directors declared a cash distribution of $0.31 per share, which was paid on March 12, 2018 to shareholders of record as of March 5, 2018. This distribution represents our fiftieth consecutive distribution since our initial public offering, bringing the total cumulative distribution to date to $14.02 per share.

Closed and Pending Commitments

As of April 19, 2018, we have:

 

   

Closed debt and equity commitments of approximately $305.5 million to new and existing portfolio companies and funded approximately $271.3 million subsequent to December 31, 2017.

 

   

Pending commitments (signed non-binding term sheets) of approximately $280.0 million.

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

 

Closed Commitments and Pending Commitments (in millions)

  

January 1—March 31, 2018 Closed Commitments

   $ 266.0  

April 1—April 19, 2018 Closed Commitments(a)

   $ 39.5  

Pending Commitments (as of April 19, 2018)(b)

   $ 280.0  

Closed and Pending Commitments as of April 19, 2018

   $ 585.5  


 

S-4


Table of Contents
Index to Financial Statements

 

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.

Redemption of 2024 Notes

On February 9, 2018, our Board of Directors approved a redemption of $100.0 million of our outstanding aggregate principal amount of 6.25% notes due 2024 (the “2024 Notes”), which were redeemed on April 2, 2018.

Restricted Stock Unit Grants

In January 2018, we granted 746,684 restricted stock units pursuant to the amended 2004 Plan.

ATM Equity Program Issuances

Subsequent to December 31, 2017 and as of April 19, 2018, we sold 1,112,600 shares of common stock for total accumulated net proceeds of approximately $13.8 million, including $125,700 of offering expenses, under our at-the-market, or ATM, equity distribution agreement, dated September 8, 2017, or the Equity Distribution Agreement, with JMP Securities LLC, or JMP. As of April 19, 2018 approximately 9.3 million shares remain available for issuance and sale under the Equity Distribution Agreement.

Portfolio Company Developments

As of April 19, 2018, we held warrants or equity positions in four companies that have filed registration statements on Form S-1 with the Securities and Exchange Commission (the “SEC”) in contemplation of potential initial public offerings. Three companies filed confidentially under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”) and one company filed a Form S-1 Registration with the SEC. 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 December 31, 2017, our portfolio companies announced or completed the following liquidity events:

 

  1. In September 2017, our portfolio company Inotek Pharmaceuticals Corporation announced they had entered into a definitive merger agreement with Rocket Pharmaceuticals Ltd. The deal was completed on January 4, 2018. The combined company will be named Rocket Pharmaceuticals, Inc. and is now listed on the NASDAQ Global Market under the symbol “RCKT” and began trading on January 5, 2018.

 

  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. In January 2018, Evofem Biosciences completed the reverse merger acquisition of Neothetics and its stock began trading on the NASDAQ Capital Market under the ticker symbol “EVFM.”

 

  3. In March 2018, our portfolio company IntegenX Inc., the market leader of rapid human DNA identification technology for use in forensics and law enforcement applications, announced that they have been acquired by Thermo Fisher Scientific Inc., the world leader in serving science. Terms of the transaction were not disclosed.


 

S-5


Table of Contents
Index to Financial Statements

Corporate 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, 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.



 

S-6


Table of Contents
Index to Financial Statements

SPECIFIC TERMS OF THE NOTES AND THE OFFERING

This prospectus supplement sets forth certain terms of the Notes that we are offering pursuant to this prospectus supplement and supplements the accompanying prospectus that is attached to the back of this prospectus supplement. This section outlines the specific legal and financial terms of the Notes. You should read this section together with the more general description of the Notes in the accompanying prospectus under the heading “Description of Our Debt Securities” before investing in the Notes. Capitalized terms used in this prospectus supplement and not otherwise defined shall have the meanings ascribed to them in the accompanying prospectus or in the indenture governing the Notes (as amended from time to time, the “indenture”).

 

Issuer

Hercules Capital, Inc.

 

Title of the securities

5.25% Notes due 2025

 

Aggregate principal amount being offered

$75,000,000

 

Overallotment option

The underwriters may also purchase from us up to an additional $11,250,000 aggregate principal amount of Notes to cover overallotments, if any, within 30 days of the date of this prospectus supplement.

 

Initial public offering price

100% of the aggregate principal amount.

 

Principal payable at maturity

100% of the aggregate principal amount; the principal amount of each Note will be payable on its stated maturity date at the office of the Trustee in The City of New York or at such other office designated by the Trustee.

 

Type of Note

Fixed rate note

 

Listing

We intend to apply to list the Notes on the New York Stock Exchange within 30 days of the original issue date under the symbol “HCXZ.”

 

Interest rate

5.25% per year

 

Day count basis

360-day year of twelve 30-day months

 

Original issue date of the Notes

April 26, 2018

 

Stated maturity date

April 30, 2025

 

Date interest starts accruing on the Notes

April 26, 2018

 

Interest payment dates for the Notes

Each January 30, April 30, July 30, and October 30, commencing July 30, 2018. If an interest payment date falls on a non-business day, the applicable interest payment will be made on the next business day and no additional interest will accrue as a result of such delayed payment.


 

S-7


Table of Contents
Index to Financial Statements

Interest periods for the Notes

The initial interest period will be the period from and including April 26, 2018, to, but excluding, the initial interest payment date, and the subsequent interest periods will be the periods from and including an interest payment date to, but excluding, the next interest payment date or the stated maturity date, as the case may be.

 

Regular record dates for interest

Each January 15, April 15, July 15 and October 15.

 

Specified currency

U.S. Dollars

 

Place of payment

New York City or such other office designated by the Trustee

 

Ranking of Notes

The Notes will be our general unsecured obligations and will rank:

 

   

pari passu with our other outstanding and future unsecured indebtedness, including, without limitation, approximately $150.0 million in aggregate principal amount of 4.625% notes due 2022 (the “2022 Notes”), approximately $183.5 million in aggregate principal amount of the 2024 Notes and approximately $230.0 million in aggregate principal amount of 4.375% convertible notes due 2022 (the “2022 Convertible Notes”), each as of December 31, 2017.

 

   

senior to any of our future indebtedness that expressly provides it is subordinated to the Notes.

 

   

effectively subordinated to all our existing and future secured indebtedness (including indebtedness that is initially unsecured to which we subsequently grant security), to the extent of the value of the assets securing such indebtedness.

 

   

structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries, including, without limitation, the indebtedness of HT II and HT III, borrowings under the $120.0 million revolving senior credit facility with Wells Fargo Capital Finance, LLC (the “Wells Facility”), borrowings under the $75.0 million revolving senior secured credit facility with MUFG Union Bank, N.A. (the “Union Bank Facility”, and together with the Wells Facility, the “Credit Facilities”), and approximately $49.2 million of fixed rate asset-backed notes, or the 2021 Asset-Backed Notes, each as of December 31, 2017. Note that there were no borrowings outstanding under the Wells Facility or Union Bank Facility as of December 31, 2017.

 

Denominations

We will issue the Notes in denominations of $25 and integral multiples of $25 in excess thereof.

 

Business day

Each Monday, Tuesday, Wednesday, Thursday and Friday that is not a day on which banking institutions in New York City, or in such other place of payment designated by the Trustee, are authorized or required by law or executive order to close.


 

S-8


Table of Contents
Index to Financial Statements

Optional redemption

We may redeem in whole or in part at any time, or from time to time, at our option on or after April 30, 2021 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.

 

  You may be prevented from exchanging or transferring the Notes when they are subject to redemption. In case any Notes are to be redeemed in part only, the redemption notice will provide that, upon surrender of such Note, you will receive, without a charge, a new Note or Notes of authorized denominations representing the principal amount of your remaining unredeemed Notes. Any exercise of our option to redeem the Notes will be done in compliance with the indenture and the 1940 Act.

 

  If we redeem only some of the Notes, the Trustee or The Depository Trust Company, or DTC, as applicable, will determine the method for selection of the particular Notes to be redeemed, in accordance with the indenture and the 1940 Act, in each case, to the extent applicable. Unless we default in payment of the redemption price, on and after the date of redemption, interest will cease to accrue on the Notes called for redemption.

 

Sinking fund

The Notes will not be subject to any sinking fund.

 

Repayment at option of Holders

Holders will not have the option to have the Notes repaid prior to the stated maturity date.

 

Defeasance and covenant defeasance

The Notes are subject to defeasance by us.

 

  The Notes are subject to covenant defeasance by us.

 

Form of Notes

The Notes will be represented by global securities that will be deposited and registered in the name of DTC or its nominee. Except in limited circumstances, you will not receive certificates for the Notes. Beneficial interests in the Notes will be represented through book-entry accounts of financial institutions acting on behalf of beneficial owners as direct and indirect participants in DTC. Investors may elect to hold interests in the Notes through either DTC, if they are a participant, or indirectly through organizations which are participants in DTC.

 

Trustee, Paying Agent and Security Registrar

U.S. Bank National Association


 

S-9


Table of Contents
Index to Financial Statements

Other covenants

In addition to the covenants described in the prospectus attached to this prospectus supplement, the following covenants shall apply to the Notes:

 

   

We agree that for the period of time during which the Notes are outstanding, we will not violate Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but giving effect to any exemptive relief granted to us by the SEC. Currently, these provisions generally prohibit us from making additional borrowings, including through the issuance of additional debt or the sale of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals at least 200% (or 150%, subject to certain approval and disclosure requirements) after such borrowings. See “Supplementary Risk Factors—Risks Related to our Business Structure—Recently passed legislation may allow us to incur additional leverage”, in this prospectus supplement.

 

   

We agree that for the period of time during which the Notes are outstanding, we will not violate Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions, giving effect to (i) any exemptive relief granted to us by the SEC and (ii) no-action relief granted by the SEC to another BDC (or to us if we determine to seek such similar no-action or other relief) permitting the BDC to declare any cash dividend or distribution notwithstanding the prohibition contained in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act in order to maintain the BDC’s status as a regulated investment company under Subchapter M of the Code. Currently, these provisions generally prohibit us from declaring any cash dividend or distribution upon any class of our capital stock, or purchasing any such capital stock if our asset coverage, as defined in the 1940 Act, is below 200% (or 150%, subject to certain approval and disclosure requirements) at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such dividend, distribution or purchase. See “Supplementary Risk Factors—Risks Related to our Business Structure—Recently passed legislation may allow us to incur additional leverage”, in this prospectus supplement.

 

   

If, at any time, we are not subject to the reporting requirements of Sections 13 or 15(d) of the Exchange Act to file any periodic reports with the SEC, we agree to furnish to holders of the Notes and the Trustee, for the period of time during which the Notes are outstanding, our audited annual consolidated financial statements, within 90 days of our fiscal year end, and unaudited interim consolidated financial statements, within 45 days of our fiscal quarter end (other than our fourth fiscal quarter). All such financial statements will be prepared, in all material respects, in accordance with applicable United States generally accepted accounting principles, as applicable.



 

S-10


Table of Contents
Index to Financial Statements

Modifications to events of default

The following events of default, as described in the prospectus attached to this prospectus supplement:

 

   

We do not pay the principal of, or any premium on, a debt security of the series on its due date, and do not cure this default within 5 days.

 

   

On the last business day of each of 24 consecutive calendar months, we have an asset coverage of less than 100%.

 

  with respect to the Notes has been revised to read as follows:

 

   

We do not pay the principal of, or any premium on, any Note on its due date.

 

   

On the last business day of each of 24 consecutive calendar months, we have an asset coverage of less than 100%, giving effect to any exemptive relief granted to us by the SEC.

 

Global Clearance and Settlement Procedures

Interests in the Notes will trade in DTC’s Same Day Funds Settlement System, and any permitted secondary market trading activity in such Notes will, therefore, be required by DTC to be settled in immediately available funds. None of the issuer, the Trustee or the paying agent will have any responsibility for the performance by DTC or its participants or indirect participants of their respective obligations under the rules and procedures governing their operations.

 

Further issuances

We have the ability to issue additional debt securities under the indenture with terms different from the Notes and, without the consent of the holders thereof, to reopen the Notes and issue additional Notes.

 

Use of Proceeds

We estimate that the net proceeds we receive from the sale of the $75.0 million aggregate principal amount of Notes in this offering will be approximately $72.7 million after deducting the underwriting discount of approximately $2.0 million payable by us and estimated offering expenses of approximately $250,000 payable by us. We expect to use the net proceeds from this offering (i) to fund investments in debt and equity securities in accordance with our investment objective, (ii) to make acquisitions, (iii) to retire certain debt obligations (which may include the 2024 Notes), and (iv) for other general corporate purposes.

 

Governing Law

The Notes and the indenture are governed by and construed in accordance with the laws of the State of New York.


 

S-11


Table of Contents
Index to Financial Statements

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 SBIC and a 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 “Supplementary Risk Factors” in this prospectus supplement and “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 and are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933, or the Securities Act. We undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date of this prospectus supplement.

 

S-12


Table of Contents
Index to Financial Statements

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 the Notes, could be materially adversely affected.

 

S-13


Table of Contents
Index to Financial Statements

SUPPLEMENTARY RISK FACTORS

Investing in our securities involves a number of significant risks. Before you invest in our securities, you should be aware of various risks, including those described below and those set forth in the accompanying prospectus. You should carefully consider these risk factors, together with all of the other information included in this prospectus supplement and the accompanying prospectus, before you decide whether to make an investment in our securities. The risks set out below and in the accompanying prospectus are not the only risks we face. Additional risks and uncertainties not presently known to us or not presently deemed material by us may also impair our operations and performance. If any of the following events occur, our business, financial condition, results of operations and cash flows could be materially and adversely affected which could materially adversely affect our ability to repay principal and interest on the Notes. In addition, the market price of the Notes and our net asset value could decline, and you may lose all or part of your investment. The risk factors described below, together with those set forth in the accompanying prospectus, are the principal risk factors associated with an investment in our securities, including the Notes, as well as those factors generally associated with an investment company with investment objectives, investment policies, capital structure or trading markets similar to ours.

Risks Related to the Notes

The Notes will be unsecured and therefore will be effectively subordinated to any secured indebtedness we have currently incurred or may incur in the future.

The Notes will not be secured by any of our assets or any of the assets of our subsidiaries. As a result, the Notes are effectively subordinated to any secured indebtedness we or our subsidiaries have currently incurred and may incur in the future (or any indebtedness that is initially unsecured to which we subsequently grant security) to the extent of the value of the assets securing such indebtedness. In any liquidation, dissolution, bankruptcy or other similar proceeding, the holders of any of our existing or future secured indebtedness and the secured indebtedness of our subsidiaries may assert rights against the assets pledged to secure that indebtedness in order to receive full payment of their indebtedness before the assets may be used to pay other creditors, including the holders of the Notes. As of December 31, 2017, we had no outstanding borrowings under our Union Bank Facility, which is secured by debt investments in our portfolio companies and related assets, and no outstanding borrowings under our Wells Facility, which is secured by loans in the borrowing base for the Wells Facility.

The Notes will be structurally subordinated to the indebtedness and other liabilities of our subsidiaries.

The Notes are obligations exclusively of Hercules Capital, Inc. and not of any of our subsidiaries. None of our subsidiaries is a guarantor of the Notes and the Notes are not required to be guaranteed by any subsidiaries we may acquire or create in the future. A significant portion of the indebtedness required to be consolidated on our balance sheet is held through our SBIC subsidiaries. For example, at December 31, 2017, we have issued $190.2 million in SBA-guaranteed debentures in our SBIC subsidiaries. The assets of such subsidiaries are not directly available to satisfy the claims of our creditors, including holders of the Notes. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition, Liquidity and Capital Resources” in this prospectus supplement for more detail on the SBA-guaranteed debentures.

Except to the extent we are a creditor with recognized claims against our subsidiaries, all claims of creditors (including trade creditors), if any, of our subsidiaries will have priority over our equity interests in such subsidiaries (and therefore the claims of our creditors, including holders of the Notes) with respect to the assets of such subsidiaries. Even if we are recognized as a creditor of one or more of our subsidiaries, our claims would still be effectively subordinated to any security interests in the assets of any such subsidiary and to any indebtedness or other liabilities of any such subsidiary senior to our claims. Consequently, the Notes will be structurally subordinated to all indebtedness and other liabilities (including trade payables) of any of our subsidiaries and any subsidiaries that we may in the future acquire or establish as financing vehicles or otherwise.

 

S-14


Table of Contents
Index to Financial Statements

As of December 31, 2017, we had no outstanding borrowings under our Wells Facility, no outstanding borrowings under our Union Bank Facility, and approximately $190.2 million of indebtedness outstanding incurred by our SBIC subsidiaries, HT II and HT III. All of such indebtedness would be structurally senior to the Notes. In addition, our subsidiaries may incur substantial additional indebtedness in the future, all of which would be structurally senior to the Notes.

The indenture under which the Notes will be issued contains limited protection for holders of the Notes.

The indenture under which the Notes will be issued offers limited protection to holders of the Notes. The terms of the indenture and the Notes do not restrict our or any of our subsidiaries’ ability to engage in, or otherwise be a party to, a variety of corporate transactions, circumstances or events that could have an adverse impact on your investment in the Notes. In particular, the terms of the indenture and the Notes will not place any restrictions on our or our subsidiaries’ ability to:

 

   

issue securities or otherwise incur additional indebtedness or other obligations, including (1) any indebtedness or other obligations that would be equal in right of payment to the Notes, (2) any indebtedness or other obligations that would be secured and therefore rank effectively senior in right of payment to the Notes to the extent of the values of the assets securing such debt, (3) indebtedness of ours that is guaranteed by one or more of our subsidiaries and which therefore is structurally senior to the Notes and (4) securities, indebtedness or obligations issued or incurred by our subsidiaries that would be senior to our equity interests in our subsidiaries and therefore rank structurally senior to the Notes with respect to the assets of our subsidiaries, in each case other than an incurrence of indebtedness or other obligation that would cause a violation of Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions, whether or not we continue to be subject to such provisions of the 1940 Act, but giving effect to any exemptive relief granted to us by the SEC (currently, these provisions generally prohibit us from making additional borrowings, including through the issuance of additional debt or the sale of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals at least 200% (or 150%, subject to certain approval and disclosure requirements) after such borrowings);

 

   

pay distributions on, or purchase or redeem or make any payments in respect of, capital stock or other securities ranking junior in right of payment to the Notes, in each case other than dividends, purchases, redemptions or payments that would cause a violation of Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act or any successor provisions, giving effect to (i) any exemptive relief granted to us by the SEC and (ii) no-action relief granted by the SEC to another BDC (or to us if we determine to seek such similar no-action or other relief) permitting the BDC to declare any cash dividend or distribution notwithstanding the prohibition contained in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act in order to maintain the BDC’s status as a regulated investment company under Subchapter M of the Code (currently, these provisions generally prohibit us from declaring any cash dividend or distribution upon any class of our capital stock, or purchasing any such capital stock if our asset coverage, as defined in the 1940 Act, is below 200% (or 150%, subject to certain approval and disclosure requirements) at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such dividend, distribution or purchase);

 

   

sell assets (other than certain limited restrictions on our ability to consolidate, merge or sell all or substantially all of our assets);

 

   

enter into transactions with affiliates;

 

   

create liens (including liens on the shares of our subsidiaries) or enter into sale and leaseback transactions;

 

   

make investments; or

 

   

create restrictions on the payment of distributions or other amounts to us from our subsidiaries.

 

S-15


Table of Contents
Index to Financial Statements

In addition, the indenture will not require us to purchase the Notes in connection with a change of control or any other event.

Furthermore, the terms of the indenture and the Notes do not protect holders of the Notes in the event that we experience changes (including significant adverse changes) in our financial condition, results of operations or credit ratings, as they do not require that we or our subsidiaries adhere to any financial tests or ratios or specified levels of net worth, revenues, income, cash flow, or liquidity.

Our ability to recapitalize, incur additional debt and take a number of other actions that are not limited by the terms of the Notes may have important consequences for you as a holder of the Notes, including making it more difficult for us to satisfy our obligations with respect to the Notes or negatively affecting the trading value of the Notes.

Certain of our current debt instruments include more protections for their holders than the indenture and the Notes. See “Risk Factors—In addition to regulatory requirements that restrict our ability to raise capital, our 2022 Notes, 2024 Notes, 2022 Convertible Notes, and Credit Facilities contain various covenants which, if not complied with, could require accelerated repayment under the facility or require us to repurchase the 2022 Notes, 2024 Notes, 2022 Convertible Notes thereby materially and adversely affecting our liquidity, financial condition, results of operations and ability to pay distributions” in the accompanying prospectus. In addition, other debt we issue or incur in the future could contain more protections for its holders than the indenture and the Notes, including additional covenants and events of default. The issuance or incurrence of any such debt with incremental protections could affect the market for, and trading levels and prices of, the Notes.

Our amount of debt outstanding may increase as a result of this offering. Our current indebtedness could adversely affect our business, financial condition and results of operations and our ability to meet our payment obligations under the Notes and our other debt.

The use of debt could have significant consequences on our future operations, including:

 

   

making it more difficult for us to meet our payment and other obligations under the Notes and our other outstanding debt;

 

   

resulting in an event of default if we fail to comply with the financial and other restrictive covenants contained in our financing arrangements, which event of default could result in substantially all of our debt becoming immediately due and payable;

 

   

reducing the availability of our cash flow to fund investments, acquisitions and other general corporate purposes, and limiting our ability to obtain additional financing for these purposes;

 

   

subjecting us to the risk of increased sensitivity to interest rate increases on our indebtedness with variable interest rates, including borrowings under our financing arrangements; and

 

   

limiting our flexibility in planning for, or reacting to, and increasing our vulnerability to, changes in our business, the industry in which we operate and the general economy.

Any of the above-listed factors could have an adverse effect on our business, financial condition and results of operations and our ability to meet our payment obligations under the Notes and our other debt.

Our ability to meet our payment and other obligations under our financing arrangements depends on our ability to generate significant cash flow in the future. This, to some extent, is subject to general economic, financial, competitive, legislative and regulatory factors as well as other factors that are beyond our control. We cannot assure you that our business will generate cash flow from operations, or that future borrowings will be available to us under our financing arrangements or otherwise, in an amount sufficient to enable us to meet our payment obligations under the Notes and our other debt and to fund other liquidity needs. If we are not able to generate sufficient cash flow to service our debt obligations, we may need to refinance or restructure our debt,

 

S-16


Table of Contents
Index to Financial Statements

including the Notes, sell assets, reduce or delay capital investments, or seek to raise additional capital. If we are unable to implement one or more of these alternatives, we may not be able to meet our payment obligations under the Notes and our other debt.

The optional redemption provision may materially adversely affect your return on the Notes.

The Notes will be redeemable in whole or in part upon certain conditions at any time, or from time to time, at our option on or after April 30, 2021. We may choose to redeem the Notes at times when prevailing interest rates are lower than the interest rate paid on the Notes. In this circumstance, you may not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as the Notes being redeemed.

An active trading market for the Notes may not develop or be maintained, which could limit the market price of the Notes or your ability to sell them.

The Notes are a new issue of debt securities for which there currently is no trading market. We intend to apply to list the Notes on the NYSE within 30 days of the original issue date. Although we expect the Notes to be listed on the NYSE, we cannot provide any assurances that an active trading market will develop for the Notes or that you will be able to sell your Notes. If the Notes are traded after their initial issuance, they may trade at a discount from their initial offering price depending on prevailing interest rates, the market for similar securities, our credit ratings, general economic conditions, our financial condition, performance and prospects and other factors. The underwriters have advised us that they intend to make a market in the Notes, but they are not obligated to do so. The underwriters may discontinue any market-making in the Notes at any time at their sole discretion. Accordingly, we cannot assure you that an active trading market will develop for the Notes, that you will be able to sell your Notes at a particular time or that the price you receive when you sell will be favorable. To the extent an active trading market does not develop, the liquidity and trading price for the Notes may be harmed. Accordingly, you may be required to bear the financial risk of an investment in the Notes for an indefinite period of time.

A downgrade, suspension or withdrawal of a credit rating assigned by a rating agency to us or our unsecured debt, if any, or change in the debt markets could cause the liquidity or market value of the Notes to decline significantly.

Our credit ratings are an assessment by rating agencies of our ability to pay our debts when due. Consequently, real or anticipated changes in our credit ratings will generally affect the market value of the Notes. These credit ratings may not reflect the potential impact of risks relating to the structure or marketing of the Notes. Credit ratings are not a recommendation to buy, sell or hold any security, and may be revised or withdrawn at any time by the issuing organization in its sole discretion. Neither we nor any underwriter undertakes any obligation to maintain our credit ratings or to advise holders of Notes of any changes in our credit ratings. There can be no assurance that our credit ratings will remain for any given period of time or that such credit ratings will not be lowered or withdrawn entirely by the rating agencies if in their judgment future circumstances relating to the basis of the credit ratings, such as adverse changes in our company, so warrant. The conditions of the financial markets and prevailing interest rates have fluctuated in the past and are likely to fluctuate in the future, which could have an adverse effect on the market prices of the Notes.

If we Default on our obligations to pay our other indebtedness, we may not be able to make payments on the Notes.

Any default under the agreements governing our indebtedness, including a default under the Wells Facility, the Union Bank Facility, the 2022 Notes, the 2024 Notes, the 2022 Convertible Notes, and the 2021 Asset-Backed Notes or other indebtedness to which we may be a party, that is not waived by the required lenders or holders, and the remedies sought by the holders of such indebtedness, could make us unable to pay principal, premium, if any, and interest on the Notes and substantially decrease the market value of the Notes. If we are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required

 

S-17


Table of Contents
Index to Financial Statements

payments of principal, premium, if any, and interest on our indebtedness, or if we otherwise fail to comply with the various covenants, including financial and operating covenants, in the instruments governing our indebtedness, we could be in default under the terms of the agreements governing such indebtedness. In the event of such default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under the Wells Facility and the Union Bank Facility or other debt we may incur in the future could elect to terminate their commitments, cease making further loans and institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation. If our operating performance declines, we may in the future need to seek to obtain waivers from the required lenders under the Wells Facility or Union Bank Facility or the required holders of our 2022 Notes, our 2024 Notes, 2022 Convertible Notes, 2021 Asset-Backed Notes or other debt that we may incur in the future to avoid being in default. If we breach our covenants under the Wells Facility, Union Bank Facility, the 2022 Notes, the 2024 Notes, the 2022 Convertible Notes, the 2021 Asset-Backed Notes or other debt and seek a waiver, we may not be able to obtain a waiver from the required lenders or holders. If this occurs, we would be in default under the Wells Facility or Union Bank Facility, the 2022 Notes, the 2024 Notes, the 2022 Convertible Notes, the 2021 Asset-Backed Notes or other debt, as applicable, the lenders or holders could exercise their rights as described above, and we could be forced into bankruptcy or liquidation. If we are unable to repay debt, lenders having secured obligations, including the lenders under the Wells Facility and the Union Bank Facility, could proceed against the collateral securing the debt. Because the Wells Facility and the Union Bank Facility have, and any future credit facilities will likely have, customary cross-default provisions, if the indebtedness under the Notes, the Wells Facility, Union Bank Facility, the 2022 Notes, the 2024 Notes, the 2022 Convertible Notes or the 2021 Asset-Backed Notes or under any future credit facility is accelerated, we may be unable to repay or finance the amounts due. See “Specific Terms of the Notes and the Offering” in this prospectus supplement.

FATCA withholding may apply to payments to certain foreign entities.

Payments made under the Notes to a foreign financial institution or non-financial foreign entity (including such an institution or entity acting as an intermediary) may be subject to a U.S. withholding tax of 30% under U.S. Foreign Account Tax Compliance Act provisions of the Code (commonly referred to as “FATCA”). This U.S. withholding tax generally applies to payments of interest on the Notes as well as, after December 31, 2018, to any payments of gross proceeds (including principal payments) from the sale, redemption, retirement or other disposition of the Notes, unless the foreign financial institution or non-financial foreign entity complies with certain information reporting, withholding, identification, certification and related requirements imposed by FATCA. Depending upon the status of a holder and the status of an intermediary through which any Notes are held, the holder could be subject to this 30% U.S. withholding tax in respect of any interest paid on the Notes as well as any proceeds from the sale, redemption, retirement or other disposition of the Notes. Persons located in jurisdictions that have entered into an intergovernmental agreement with the United States to implement FATCA may be subject to different rules. You should consult your own tax advisors regarding FATCA and how it may affect your investment in the Notes. See “Certain United States Federal Income Tax Considerations—Taxation of Note Holders—FATCA” in this prospectus supplement for further information.

Risks Related to our Business Structure

As an internally managed business development company, we are subject to certain restrictions that may adversely affect our business.

As an internally managed business development company, the size and categories of our assets under management is limited, and we are unable to offer as wide a variety of financial products to prospective portfolio companies and sponsors (potentially limiting the size and diversification of our asset base). We therefore may not achieve efficiencies of scale and greater management resources available to externally managed business development companies.

Additionally, as an internally managed business development company, our ability to offer more competitive and flexible compensation structures, such as offering both a profit sharing plan and an equity incentive plan, is subject to the limitations imposed by the 1940 Act, which limits our ability to attract and retain

 

S-18


Table of Contents
Index to Financial Statements

talented investment management professionals. As such, these limitations could inhibit our ability to grow, pursue our business plan and attract and retain professional talent, any or all of which may have a negative impact on our business, financial condition and results of operations.

As an internally managed business development company, we are dependent upon key management personnel for their time availability and for our future success, particularly Manuel A. Henriquez, and if we are not able to hire and retain qualified personnel, or if we lose any member of our senior management team, our ability to implement our business strategy could be significantly harmed.

As an internally managed business development company, our ability to achieve our investment objectives and to make distributions to our stockholders depends upon the performance of our senior management. We depend upon the members of our senior management, particularly Mr. Henriquez, as well as other key personnel for the identification, final selection, structuring, closing and monitoring of our investments. These employees have critical industry experience and relationships on which we rely to implement our business plan. If we lose the services of Mr. Henriquez or any senior management members, we may not be able to operate the business as we expect, and our ability to compete could be harmed, which could cause our operating results to suffer. Furthermore, we do not have an employment agreement with Mr. Henriquez or our senior management that restricts them from creating new investment vehicles subject to compliance with applicable law. We believe our future success will depend, in part, on our ability to identify, attract and retain sufficient numbers of highly skilled employees. If we do not succeed in identifying, attracting and retaining such personnel, we may not be able to operate our business as we expect. In connection with our recruiting, branding and marketing efforts, we may, among other things, make charitable contributions in amounts we believe to be immaterial. We believe that many of these contributions help us raise our profile in the communities and benefit us in attracting and retaining talent and investment opportunities.

As an internally managed business development company, our compensation structure is determined and set by our Board of Directors. This structure currently includes salary and bonus and incentive compensation, which is issued through grants and subsequent vesting of restricted stock. We are not generally permitted by the 1940 Act to employ an incentive compensation structure that directly ties performance of our investment portfolio and results of operations to compensation owing to our granting of restricted stock as incentive compensation.

Members of our senior management may receive offers of more flexible and attractive compensation arrangements from other companies, particularly from investment advisers to externally managed business development companies that are not subject to the same limitations on incentive-based compensation that we, as an internally managed business development company are subject to. We do not currently have agreements with certain members of our senior management that prohibit them from leaving and competing with our business and certain States limit our ability to have such agreements. In addition, the evaluation of alternative management structures discussed above may lead to changes in our management structure. A departure by one or more members of our senior management could have a negative impact on our business, financial condition and results of operations.

Because we have substantial indebtedness, there could be increased risk in investing in our company.

Lenders have fixed dollar claims on our assets that are superior to the claims of stockholders, and we have granted, and may in the future grant, lenders a security interest in our assets in connection with borrowings. In the case of a liquidation event, those lenders would receive proceeds before our stockholders. In addition, borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increase the risks associated with investing in our securities. Leverage is generally considered a speculative investment technique. If the value of our assets increases, then leverage would cause the NAV attributable to our common stock to increase more than it otherwise would have had we not leveraged. Conversely, if the value of our assets decreases, leverage would cause the NAV attributable to our common stock to decline more than it otherwise would have had we not used leverage. Similarly, any increase in our revenue in excess of interest

 

S-19


Table of Contents
Index to Financial Statements

expense on our borrowed funds would cause our net income to increase more than it would without the leverage. Any decrease in our revenue would cause our net income to decline more than it would have had we not borrowed funds and could negatively affect our ability to make distributions on common stock. Our ability to service any debt that we incur will depend largely on our financial performance and will be subject to prevailing economic conditions and competitive pressures. We and, indirectly, our stockholders will bear the cost associated with our leverage activity. If we are not able to service our substantial indebtedness, our business could be harmed materially.

Our Credit Facilities, our 2022 Notes, our 2024 Notes, our 2021 Asset-Backed Notes, and our 2022 Convertible Notes contain financial and operating covenants that could restrict our business activities, including our ability to declare dividend distributions if we default under certain provisions.

As of December 31, 2017, we had no borrowings outstanding under the Wells Facility and the Union Bank Facility. In addition, as of December 31, 2017, we had approximately $190.2 million of indebtedness outstanding incurred by our SBIC subsidiaries, approximately $150.0 million in aggregate principal amount of 2022 Notes, approximately $183.5 million in aggregate principal amount of 2024 Notes, approximately $49.2 million in aggregate principal amount of 2021 Asset-Backed Notes in connection with our $237.4 million debt securitization (the “2014 Debt Securitization”) and approximately $230.0 million in aggregate principal amount of 2022 Convertible Notes.

There can be no assurance that we will be successful in obtaining any additional debt capital on terms acceptable to us or at all. If we are unable to obtain debt capital, then our equity investors will not benefit from the potential for increased returns on equity resulting from leverage to the extent that our investment strategy is successful and we may be limited in our ability to make new commitments or fundings to our portfolio companies.

As a business development company, under the 1940 Act, generally, we are not permitted to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). In addition, we may not be permitted to declare any cash distribution on our outstanding common shares, or purchase any such shares, unless, at the time of such declaration or purchase, we have asset coverage of at least 200% after deducting the amount of such distribution or purchase price. If this ratio declines below 200%, we may not be able to incur additional debt and may need to sell a portion of our investments to repay some debt when it is disadvantageous to do so, and we may not be able to make distributions. The Small Business Credit Availability Act, which was signed into law in March 2018, modifies this section of the 1940 Act and decreases this percentage from 200% to 150% (subject to either stockholder approval or approval of both a majority of the board of directors and a majority of directors who are not interested persons). As a result of this new law, we may be able to incur additional indebtedness subject to relevant approval and disclosure requirements and, therefore, your risk of an investment in us may increase. Rating agencies may also decide to review our credit ratings and those of other business development companies in light of this new law as well as any corresponding changes to asset coverage ratios and consider downgrading such ratings, including a downgrade from an investment grade rating to a non-investment grade rating. Such a downgrade in our credit ratings may adversely affect the Notes and our other securities. See “Supplementary Risk Factors—Risks Related to the Notes—A downgrade, suspension or withdrawal of a credit rating assigned by a rating agency to us or our unsecured debt, if any, or change in the debt markets could cause the liquidity or market value of the Notes to decline significantly” in this prospectus supplement.

As of December 31, 2017 our asset coverage ratio under our regulatory requirements as a business development company was 236.7% excluding our SBIC debentures as a result of our exemptive order from the SEC that allows us to exclude all SBA leverage from our asset coverage ratio and was 204.3% when including all SBA leverage.

 

S-20


Table of Contents
Index to Financial Statements

Based on assumed leverage equal to 95.5% of our net assets as of December 31, 2017, our investment portfolio would have been required to experience an annual return of at least 2.9% to cover annual interest payments on our additional indebtedness.

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

 

     Annual Return on Our Portfolio
(Net of Expenses)
 
     -10%     -5%     0%     5%     10%  

Corresponding return to stockholder(1)

     (25.31 %)      (15.48 %)      (5.64 %)      4.20     14.04

 

(1) Assumes $1.7 billion in total assets, $802.9 million in debt outstanding, $841.0 million in stockholders’ equity, and an average cost of funds of 5.9%, which is the approximate average cost of borrowed funds, including our SBA debentures, 2022 Notes, 2024 Notes, 2021 Asset-Backed Notes, 2022 Convertible Notes, and Credit Facilities for the period ended December 31, 2017. Actual interest payments may be different.

Acquisitions or investments that we may pursue could be unsuccessful, consume significant resources and require the incurrence of additional indebtedness.

We regularly consider acquisitions and investments that complement our existing business. These possible acquisitions and investments involve or may involve significant cash expenditures, debt incurrence, operating losses and expenses that could have a material effect on our financial condition and operating results.

In particular, if we incur additional debt, our liquidity and financial stability could be impaired as a result of using a significant portion of available cash or borrowing capacity to finance an acquisition. Moreover, we may face an increase in interest expense or financial leverage if additional debt is incurred to finance an acquisition, which may, among other things, adversely affect our various financial ratios and our compliance with the conditions of our existing indebtedness. In addition, such additional indebtedness may be secured by liens on our assets.

Acquisitions involve numerous other risks, including:

 

   

diversion of management time and attention;

 

   

failures to identify material problems and liabilities of acquisition targets or to obtain sufficient indemnification rights to fully offset possible liabilities related to the acquired businesses;

 

   

difficulties integrating the operations, technologies and personnel of the acquired businesses;

 

   

inefficiencies and complexities that may arise due to unfamiliarity with new assets, businesses or markets;

 

   

disruptions to our ongoing business;

 

   

inaccurate estimates of fair value made in the accounting for acquisitions and amortization of acquired intangible assets which would reduce future reported earnings;

 

   

the inability to obtain required financing for the new acquisition or investment opportunities and our existing business;

 

   

the need or obligation to divest portions of an acquired business;

 

   

challenges associated with operating in new geographic regions;

 

   

difficulties in achieving anticipated cost savings, synergies, business opportunities and growth prospects;

 

S-21


Table of Contents
Index to Financial Statements
   

potential loss of our or the acquired business’ key employees, contractual relationships, suppliers or customers; and

 

   

inability to obtain required regulatory approvals.

To the extent we pursue an acquisition that causes us to incur unexpected costs or that fails to generate expected returns, our financial position, results of operations and cash flows may be adversely affected, and our ability to service indebtedness, including our outstanding notes, may be negatively impacted.

In addition, we may fail in our pursuit of an acquisition and, instead, one of our competitors may successfully obtain the target and deprive us of an important opportunity and allow them to grow larger giving them the ability to have a lower cost of capital and competitive advantage in the market (including by being able to offer better pricing and larger loans) and, as a larger company, potentially giving them more valuable equity currency to do other transactions.

The Wells Facility and the Union Bank Facility mature in August 2019 and May 2020, respectively, and any inability to renew, extend or replace our Credit Facilities could adversely impact our liquidity and ability to find new investments or maintain distributions to our stockholders.

As of December 31, 2017, we had two available secured credit facilities, the Wells Facility and the Union Bank Facility, which mature in August 2019 and May 2020, respectively. There can be no assurance that we will be able to renew, extend or replace our Credit Facilities upon maturity on terms that are favorable to us, if at all. Our ability to renew, extend or replace the Credit Facility will be constrained by then-current economic conditions affecting the credit markets. In the event that we are not able to renew, extend or replace either Credit Facility at the time of its maturity, this could have a material adverse effect on our liquidity and ability to fund new investments, our ability to make distributions to our stockholders and our ability to qualify as a RIC.

Regulations governing our operations as a business development company may affect our ability to, and the manner in which, we raise additional capital, which may expose us to risks.

Our business will require a substantial amount of capital. We may acquire additional capital from the issuance of senior securities, including borrowings, securitization transactions or other indebtedness, or the issuance of additional shares of our common stock. However, we may not be able to raise additional capital in the future on favorable terms or at all. We may issue debt securities, other evidences of indebtedness or preferred stock, and we may borrow money from banks or other financial institutions, which we refer to collectively as “senior securities,” up to the maximum amount permitted by the 1940 Act. Under the 1940 Act, we are not permitted to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). In addition, we may not be permitted to declare any cash distribution on our outstanding common shares, or purchase any such shares, unless, at the time of such declaration or purchase, we have asset coverage of at least 200% after deducting the amount of such distribution or purchase price. Our ability to pay distributions or issue additional senior securities would be restricted if our asset coverage ratio were not at least 200%. The Small Business Credit Availability Act, which was signed into law in March 2018, modifies this section of the 1940 Act and decreases this percentage from 200% to 150% (subject to either stockholder approval or approval of both a majority of the board of directors and a majority of directors who are not interested persons). As a result of this new law, we may be able to incur additional indebtedness subject to relevant approval and disclosure requirements and, therefore, your risk of an investment in us may increase. Rating agencies may also decide to review our credit ratings and those of other business development companies in light of this new law as well as any corresponding changes to asset coverage ratios and consider downgrading such ratings, including a downgrade from an investment grade rating to a non-investment grade rating. Such a downgrade in our credit ratings may adversely affect the Notes and our other securities. See “Supplementary Risk Factors—Risks Related to the Notes—A downgrade, suspension or withdrawal of a credit rating assigned by a rating agency to us or our unsecured debt, if any, or change in the debt markets could cause the liquidity or market value of the Notes to decline significantly” in this prospectus supplement.

 

S-22


Table of Contents
Index to Financial Statements

If the value of our assets declines, we may be unable to satisfy this test. If that happens, we may be required to liquidate a portion of our investments and repay a portion of our indebtedness at a time when such transaction may be disadvantageous. As a result of issuing senior securities, we would also be exposed to risks associated with leverage, including an increased risk of loss. If we issue preferred stock, the preferred stock would rank “senior” to common stock in our capital structure, preferred stockholders would have separate voting rights and might have rights, preferences, or privileges more favorable than those of our common stockholders and the issuance of preferred stock could have the effect of delaying, deferring, or preventing a transaction or a change of control that might involve a premium price for holders of our common stock or otherwise be in your best interest. It is likely that any senior securities or other indebtedness we issue will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Additionally, some of these securities or other indebtedness may be rated by rating agencies, and in obtaining a rating for such securities and other indebtedness, we may be required to abide by operating and investment guidelines that further restrict operating and financial flexibility.

To the extent that we are constrained in our ability to issue debt or other senior securities, we will depend on issuances of common stock to finance operations. Other than in certain limited situations such as rights offerings, as a business development company, we are generally not able to issue our common stock at a price below NAV without first obtaining required approvals from our stockholders and our independent directors. If we raise additional funds by issuing more common stock or senior securities convertible into, or exchangeable for, our common stock, then the percentage ownership of our stockholders at that time will decrease, and you might experience dilution. Moreover, we can offer no assurance that we will be able to issue and sell additional equity securities in the future, on favorable terms or at all.

Recently passed legislation may allow us to incur additional leverage.

Historically, as a business development company, under the 1940 Act generally we are not permitted to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). The Small Business Credit Availability Act, which was signed into law in March 2018, modifies this section of the 1940 Act and decreases this percentage from 200% to 150% (subject to either stockholder approval or approval of both a majority of the board of directors and a majority of directors who are not interested persons). As a result of this new law, we may be able to incur additional indebtedness subject to relevant approval and disclosure requirements and, therefore, your risk of an investment in us may increase. Rating agencies may also decide to review our credit ratings and those of other business development companies in light of this new law as well as any corresponding changes to asset coverage ratios and consider downgrading such ratings, including a downgrade from an investment grade rating to a non-investment grade rating. Such a downgrade in our credit ratings may adversely affect the Notes and our other securities. See “Supplementary Risk Factors—Risks Related to the Notes—A downgrade, suspension or withdrawal of a credit rating assigned by a rating agency to us or our unsecured debt, if any, or change in the debt markets could cause the liquidity or market value of the Notes to decline significantly” in this prospectus supplement.

Significant U.S. federal tax legislation was recently enacted and the impact of this new legislation on us and on entities in which we may invest is uncertain.

Significant U.S. federal tax reform legislation was recently enacted that, among many other changes, permanently reduces the maximum federal corporate income tax rate, reduces the maximum individual income tax rate (effective for taxable years 2018 through 2025), restricts the deductibility of business interest expense, changes the rules regarding the calculation of net operating loss deductions that may be used to offset taxable income, and, under certain circumstances, requires accrual method taxpayers to recognize income for U.S. federal income tax purposes no later than the income is taken into account as revenue in an applicable financial statement. The new legislation also makes extensive changes to the U.S. international tax system. The impact of this new legislation on us and on entities in which we may invest is uncertain. Prospective investors are urged to consult their tax advisors regarding the effects of the new legislation on an investment in us.

 

S-23


Table of Contents
Index to Financial Statements

Risks Related to Current Economic and Market Conditions

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

The global capital markets have experienced a period of disruption as evidenced by a lack of liquidity in the debt capital markets, write-offs in the financial services sector, the re-pricing of credit risk and the failure of certain major financial institutions. While the capital markets have improved, these conditions could deteriorate again in the future. During such market disruptions, we may have difficulty raising debt or equity capital, especially as a result of regulatory constraints.

Market conditions may in the future make it difficult to extend the maturity of or refinance our existing indebtedness and any failure to do so could have a material adverse effect on our business. The illiquidity of our investments may make it difficult for us to sell such investments if required. As a result, we may realize significantly less than the value at which we have recorded our investments. In addition, significant changes in the capital markets, including the disruption and volatility, have had, and may in the future have, a negative effect on the valuations of our investments and on the potential for liquidity events involving our investments. An inability to raise capital, and any required sale of our investments for liquidity purposes, could have a material adverse impact on our business, financial condition and results of operations.

Various social and political tensions in the United States and around the world, including in the Middle East, Eastern Europe North Korea, and Russia, may continue to contribute to increased market volatility, may have long-term effects on the United States and worldwide financial markets, and may cause further economic uncertainties or deterioration in the United States and worldwide. In addition, uncertainty regarding the United Kingdom referendum decision to leave the European Union (“Brexit”), continuing signs of deteriorating sovereign debt conditions in Europe and an economic slowdown in China create uncertainty that could lead to further disruptions, instability and weakening consumer, corporate and financial confidence. We may in the future have difficulty accessing debt and equity capital markets, and a severe disruption in the global financial markets, deterioration in credit and financing conditions or uncertainty regarding U.S. government spending and deficit levels, Brexit, European sovereign debt, Chinese economic slowdown or other global economic conditions could have a material adverse effect on our business, financial condition and results of operations.

The broader fundamentals of the United States economy remain mixed. In the event that the United States economy contracts, it is likely that the financial results of small to mid-sized companies, like many of our portfolio companies, could experience deterioration or limited growth from current levels, which could ultimately lead to difficulty in meeting their debt service requirements and an increase in defaults. In addition, declines in oil and natural gas prices could adversely affect the credit quality of our debt investments and the underlying operating performance of our equity investments in energy-related businesses. In addition, volatility in the equity markets could impact our portfolio companies’ access to the debt and equity capital markets, which could ultimately limit their ability to grow, satisfy existing financing and other arrangements and impact their ability to perform. Volatility in the equity markets could also impact our ability to liquidate or achieve value from warrants and other equity investments we have in our portfolio companies. Consequently, we can provide no assurance that the performance of certain portfolio companies will not be negatively impacted by economic cycles, industry cycles or other conditions, which could also have a negative impact on our future results.

These market and economic disruptions affect, and these and other similar market and economic disruptions may in the future affect, the U.S. capital markets, which could adversely affect our business and that of our portfolio companies. We cannot predict the duration of the effects related to these or similar events in the future on the United States economy and securities markets or on our investments. We monitor developments and seek to manage our investments in a manner consistent with achieving our investment objective, but there can be no assurance that we will be successful in doing so.

 

S-24


Table of Contents
Index to Financial Statements

Risks Related to Our Investments

Our financial results could be negatively affected if a significant portfolio investment fails to perform as expected.

Our total investment in companies may be significant individually or in the aggregate. As a result, if a significant investment in one or more companies fails to perform as expected, our financial results could be more negatively affected and the magnitude of the loss could be more significant than if we had made smaller investments in more companies. The following table shows the fair value of the totals of investments held in portfolio companies at December 31, 2017 that represent greater than 5% of our net assets:

 

     December 31, 2017  

(in thousands)

   Fair Value      Percentage of
Net Assets
 

Machine Zone, Inc.

   $ 110,384        13.1

Paratek Pharmaceuticals, Inc. (p.k.a. Transcept Pharmaceuticals, Inc.)

     61,261        7.3

Insmed, Incorporated

     57,117        6.8

Axovant Sciences Ltd.

     54,155        6.4

Fuze, Inc.

     50,473        6.0

Emma, Inc.

     48,565        5.8

Snagajob.com, Inc.

     42,293        5.0

 

   

Machine Zone, Inc. is a technology company that is best known for building mobile Massively Multiplayer Online games with a focus on community-based gameplay.

 

   

Paratek Pharmaceuticals, Inc. is a biopharmaceutical company focused on the development and commercialization of innovative therapies based upon its expertise in novel tetracycline chemistry

 

   

Insmed, Incorporated is a biopharmaceutical company that focuses on the development of inhaled pharmaceuticals for the site-specific treatment of serious lung diseases.

 

   

Axovant Sciences Ltd. is a clinical-stage biopharmaceutical company focused on acquiring, developing and commercializing novel therapeutics for the treatment of dementia.

 

   

Fuze, Inc. is a technology company that provides a cloud-based unified communications-as-a-service platform to server message block, mid-market, and small enterprise customers worldwide.

 

   

Emma, Inc. is a technology company that offers software to enable organizations to create, send and track email marketing campaigns and online surveys.

 

   

Snagajob.com, Inc. is a technology company that offers an array of services designed to simplify the hourly job recruiting process for both job seekers and employers.

Our financial results could be materially adversely affected if these portfolio companies or any of our other significant portfolio companies encounter financial difficulty and fail to repay their obligations or to perform as expected.

Risks Related to Our Securities

Terms relating to redemption may materially adversely affect your return on any debt securities that we may issue.

If you are holding debt securities issued by the Company and such securities are redeemable at our option, we may choose to redeem your debt securities at times when prevailing interest rates are lower than the interest rate paid on your debt securities. In addition, if you are holding debt securities issued by the Company and such securities are subject to mandatory redemption, we may be required to redeem your debt securities at times when

 

S-25


Table of Contents
Index to Financial Statements

prevailing interest rates are lower than the interest rate paid on your debt securities. In this circumstance, you may not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as your debt securities being redeemed.

On October 24, 2017, our Board of Directors approved a redemption of $75.0 million of the outstanding aggregate principal amount of the 2024 Notes, which were redeemed on November 23, 2017. Further, on February 9, 2018, our Board of Directors approved a redemption of $100.0 million of the remaining outstanding aggregate principal amount of the 2024 Notes, which were redeemed on April 2, 2018. We may redeem the remaining 2024 Notes at any time prior to maturity and the 2022 Notes after September 23, 2022 at a redemption price of 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments. If we choose to redeem the 2022 Notes or 2024 Notes when the fair market value of the 2022 Notes or 2024 Notes is above par value, you would experience a loss of any potential premium.

 

S-26


Table of Contents
Index to Financial Statements

USE OF PROCEEDS

We estimate that the net proceeds we will receive from the sale of the $75.0 million aggregate principal amount of Notes in this offering will be approximately $72.7 million (or approximately $83.6 million if the underwriters fully exercise their overallotment option) based on a public offering of 100% of par, after deducting the underwriting discount of approximately $2.0 million (or approximately $2.4 million if the underwriters fully exercise their overallotment option) payable by us and estimated offering expenses of approximately $250,000 payable by us.

We expect to use the net proceeds from this offering (i) to fund investments in debt and equity securities in accordance with our investment objective, (ii) to make acquisitions, (iii) to retire certain debt obligations (which may include the 2024 Notes), and (iv) for other general corporate purposes.

As of December 31, 2017, the aggregate principal balance of the 2024 Notes was approximately $183.5 million. On February 9, 2018, our Board of Directors approved a redemption of $100.0 million of the remaining outstanding aggregate principal amount of the 2024 Notes, which were redeemed on April 2, 2018. The 2024 Notes bear interest at a rate of 6.25% per year, payable quarterly and mature, unless earlier repurchased or redeemed, on July 30, 2024.

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 use, we will invest a portion of the net proceeds of this offering in short-term investments, such as cash and cash equivalents, which we expect will earn yields substantially lower than the interest income that we anticipate receiving in respect of investments in accordance with our investment objective.

The amount of net proceeds may be more or less than the amount described in this preliminary prospectus supplement depending on the amount of Notes we sell in the offering, which will be determined at pricing. To the extent that we receive more than the amount described in this preliminary prospectus supplement, we intend to use the net proceeds for investment in portfolio companies in accordance with our investment objective and strategies and for working capital and general corporate purposes. To the extent we receive less, the amount we have available for such purposes will be reduced.

 

S-27


Table of Contents
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 2017, 2016, 2015, 2014, and 2013 and the financial statement of operations data for fiscal years 2017, 2016, 2015, 2014, and 2013 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.

 

     For the Year Ended December 31,  

(in thousands, except per share amounts)

   2017     2016     2015     2014     2013  

Investment income:

          

Interest

   $ 172,196     $ 158,727     $ 140,266     $ 126,618     $ 123,671  

Fees

     18,684       16,324       16,866       17,047       16,042  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     190,880       175,051       157,132       143,665       139,713  

Operating expenses:

          

Interest

     37,857       32,016       30,834       28,041       30,334  

Loan fees

     8,728       5,042       6,055       5,919       4,807  

General and administrative:

          

Legal expenses

     4,572       4,823       3,079       1,366       1,440  

Other expenses

     11,533       11,283       13,579       8,843       7,914  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total general and administrative

     16,105       16,106       16,658       10,209       9,354  

Employee Compensation:

          

Compensation and benefits

     24,555       22,500       20,713       16,604       16,179  

Stock-based compensation

     7,191       7,043       9,370       9,561       5,974  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total employee compensation

     31,746       29,543       30,083       26,165       22,153  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     94,436       82,707       83,630       70,334       66,648  

Other income (loss)

     —         8,000       (1     (1,581     —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

     96,444       100,344       73,501       71,750       73,065  

Net realized gain (loss) on investments

     (26,711     4,576       5,147       20,112       14,836  

Net change in unrealized appreciation (depreciation) on investments

     9,265       (36,217     (35,732     (20,674     11,545  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net realized and unrealized gain (loss)

     (17,446     (31,641     (30,585     (562     26,381  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase in net assets resulting from operations

   $ 78,998     $ 68,703     $ 42,916     $ 71,188     $ 99,446  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in net assets per common share (basic)

   $ 0.95     $ 0.91     $ 0.60     $ 1.12     $ 1.67  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Distributions declared per common share:

   $ 1.24     $ 1.24     $ 1.24     $ 1.24     $ 1.11  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     For the Year Ended December 31,  

(in thousands, except per share amounts)

   2017     2016     2015     2014     2013  

Balance sheet data:

          

Investments, at value

   $ 1,542,214     $ 1,423,942     $ 1,200,638     $ 1,020,737     $ 910,295  

Cash and cash equivalents

     91,309       13,044       95,196       227,116       268,368  

Total assets

     1,654,715       1,464,204       1,334,761       1,299,223       1,221,715  

Total liabilities

     813,748       676,260       617,627       640,359       571,708  

Total net assets

     840,967       787,944       717,134       658,864       650,007  

Other Data:

          

Total return(3)

     1.47     26.87     (9.70 %)      (1.75 %)      58.49

Total debt investments, at value

     1,415,984       1,328,803       1,110,209       923,906       821,988  

Total warrant investments, at value

     36,869       27,485       22,987       25,098       35,637  

Total equity investments, at value

     89,361       67,654       67,442       71,733       52,670  

Unfunded Commitments(2)

     73,604       59,683       75,402       147,689       69,091  

Net asset value per share(1)

   $ 9.96     $ 9.90     $ 9.94     $ 10.18     $ 10.51  

 

(1) Based on common shares outstanding at period end.

 

S-28


Table of Contents
Index to Financial Statements
(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.
(3) The total return equals the change in the ending market value over the beginning of the period price per share plus distributions paid per share during the period, divided by the beginning price assuming the distribution is reinvested on the date of the issuance. The total return does not reflect any sales load that must be paid by investors.

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

 

     Quarter Ended  

(in thousands, except per share data)

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

Total investment income

   $ 46,365     $ 48,452      $ 45,865      $ 50,198  

Net investment income

     22,678       25,275        23,973        24,518  

Net increase (decrease) in net assets resulting from operations

     (5,588     33,149        33,072        18,365  

Change in net assets resulting from operations per common share (basic)

   $ (0.07   $ 0.40      $ 0.40      $ 0.22  
     Quarter Ended  
     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

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

Net increase in net assets resulting from operations

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

Change in net assets resulting from operations per common share (basic)

   $ 0.20     $ 0.13      $ 0.41      $ 0.18  

 

S-29


Table of Contents
Index to Financial Statements

CAPITALIZATION

The following table sets forth (i) our actual capitalization as of December 31, 2017, and (ii) our capitalization as adjusted to give effect to the sale of $75.0 million aggregate principal amount of Notes in this offering (assuming no exercise of the overallotment option), excluding accrued interest, after deducting the underwriting discounts and commissions of approximately $2.0 million payable by us and estimated offering expenses of approximately $250,000 payable by us. You should read this table together with the “Use of Proceeds” section and our statement of assets and liabilities included elsewhere in this prospectus supplement.

 

     As of December 31, 2017  
     Actual     As
Adjusted(2)
 
     (in thousands)  

Investments at fair value

   $ 1,542,214     $ 1,542,214  

Cash and cash equivalents

   $ 91,309     $ 164,039  

Debt(1):

    

Accounts payable and accrued liabilities

   $ 26,896     $ 26,896  

Long-term SBA debentures

     188,141       188,141  

2022 Convertible Notes

     223,488       223,488  

2021 Asset-Backed Notes

     48,650       48,650  

2022 Notes

     147,572       147,572  

2024 Notes

     179,001       79,001  

Notes offered herein

     —         72,730  
  

 

 

   

 

 

 

Total debt

   $ 813,748     $ 786,478  
  

 

 

   

 

 

 

Stockholders’ equity:

    

Common stock, par value $0.001 per share; 200,000,000 shares authorized; 84,423,669 shares issued and outstanding

   $ 85     $ 85  

Capital in excess of par value

     908,501       908,501  

Unrealized depreciation on investments

     (79,760     (79,760

Accumulated realized gains (losses) on investments

     (20,374     (20,374

Distributions in excess of investment income

     32,515       32,515  
  

 

 

   

 

 

 

Total stockholders’ equity

   $ 840,967     $ 840,967  
  

 

 

   

 

 

 

Total capitalization

   $ 1,654,715     $ 1,627,445  
  

 

 

   

 

 

 

 

(1) The above table reflects the principal amount of indebtedness outstanding net of the associated debt issuance costs as of December 31, 2017. As of April 19, 2018, indebtedness under the Wells Facility, the Union Bank Facility, the 2022 Notes, the 2022 Convertible Notes, the 2024 Notes, and the 2021 Asset-Backed Notes were $50.0 million, $0 million, $150.0 million, $230.0 million, $83.5 million and $32.9 million, respectively. The net proceeds from the sale of the Notes in this offering are expected to be used to fund investments in debt and equity securities in accordance with our investment objective, to make acquisitions, to retire certain debt obligations (which may include the 2024 Notes), and for other general corporate purposes. See “Use of Proceeds.”
(2) The as adjusted amount reflects the April 2, 2018 redemption of $100.0 million of our outstanding aggregate principal amount of the 2024 Notes.

 

S-30


Table of Contents
Index to Financial Statements

SENIOR SECURITIES

Information about our senior securities is shown in the following table for the periods as of December 31, 2017, 2016, 2015, 2014, 2013, 2012, 2011, 2010, 2009, and 2008. The information as of December 31, 2017, 2016, 2015, 2014, 2013, 2012, 2011 and 2010 has been derived from our audited financial statements for these periods, which have been audited by PricewaterhouseCoopers LLP, our independent registered public accounting firm. The report of PricewaterhouseCoopers LLP on the senior securities table as of December 31, 2017 is attached as an exhibit to the registration statement of which this prospectus is a part. The “—” indicates information that the SEC expressly does not require to be disclosed for certain types of senior securities.

 

Class and Year

  Total Amount
Outstanding
Exclusive of
Treasury Securities(1)
    Asset Coverage
per Unit(2)
    Average
Market
Value
per Unit(3)
 

Securitized Credit Facility with Wells Fargo Capital Finance

     

December 31, 2008

  $ 89,582,000     $ 6,689       N/A  

December 31, 2009(6)

    —         —         N/A  

December 31, 2010(6)

    —         —         N/A  

December 31, 2011

  $ 10,186,830     $ 73,369       N/A  

December 31, 2012(6)

    —         —         N/A  

December 31, 2013(6)

    —         —         N/A  

December 31, 2014(6)

    —         —         N/A  

December 31, 2015

  $ 50,000,000     $ 26,352       N/A  

December 31, 2016

  $ 5,015,620     $ 290,234       N/A  

December 31, 2017(6)

    —         —         N/A  

Securitized Credit Facility with Union Bank, NA

     

December 31, 2009(6)

    —         —         N/A  

December 31, 2010(6)

    —         —         N/A  

December 31, 2011(6)

    —         —         N/A  

December 31, 2012(6)

    —         —         N/A  

December 31, 2013(6)

    —         —         N/A  

December 31, 2014(6)

    —         —         N/A  

December 31, 2015(6)

    —         —         N/A  

December 31, 2016(6)

    —         —         N/A  

December 31, 2017(6)

    —         —         N/A  

Small Business Administration Debentures (HT II)(4)

     

December 31, 2008

  $ 127,200,000     $ 4,711       N/A  

December 31, 2009

  $ 130,600,000     $ 3,806       N/A  

December 31, 2010

  $ 150,000,000     $ 3,942       N/A  

December 31, 2011

  $ 125,000,000     $ 5,979       N/A  

December 31, 2012

  $ 76,000,000     $ 14,786       N/A  

December 31, 2013

  $ 76,000,000     $ 16,075       N/A  

December 31, 2014

  $ 41,200,000     $ 31,535       N/A  

December 31, 2015

  $ 41,200,000     $ 31,981       N/A  

December 31, 2016

  $ 41,200,000     $ 35,333       N/A  

December 31, 2017

  $ 41,200,000     $ 39,814       N/A  

Small Business Administration Debentures (HT III)(5)

     

December 31, 2010

  $ 20,000,000     $ 29,564       N/A  

December 31, 2011

  $ 100,000,000     $ 7,474       N/A  

December 31, 2012

  $ 149,000,000     $ 7,542       N/A  

December 31, 2013

  $ 149,000,000     $ 8,199       N/A  

December 31, 2014

  $ 149,000,000     $ 8,720       N/A  

 

S-31


Table of Contents
Index to Financial Statements

Class and Year

  Total Amount
Outstanding
Exclusive of
Treasury Securities(1)
    Asset Coverage
per Unit(2)
    Average
Market
Value
per Unit(3)
 

December 31, 2015

  $ 149,000,000     $ 8,843       N/A  

December 31, 2016

  $ 149,000,000     $ 9,770       N/A  

December 31, 2017

  $ 149,000,000     $ 11,009       N/A  

2016 Convertible Notes

     

December 31, 2011

  $ 75,000,000     $ 10,623     $ 885  

December 31, 2012

  $ 75,000,000     $ 15,731     $ 1,038  

December 31, 2013

  $ 75,000,000     $ 16,847     $ 1,403  

December 31, 2014

  $ 17,674,000     $ 74,905     $ 1,290  

December 31, 2015

  $ 17,604,000     $ 74,847     $ 1,110  

December 31, 2016

    —         —         —    

April 2019 Notes

     

December 31, 2012

  $ 84,489,500     $ 13,300     $ 986  

December 31, 2013

  $ 84,489,500     $ 14,460     $ 1,021  

December 31, 2014

  $ 84,489,500     $ 15,377     $ 1,023  

December 31, 2015

  $ 64,489,500     $ 20,431     $ 1,017  

December 31, 2016

  $ 64,489,500     $ 22,573     $ 1,022  

December 31, 2017

    —         —         —    

September 2019 Notes

     

December 31, 2012

  $ 85,875,000     $ 13,086     $ 1,003  

December 31, 2013

  $ 85,875,000     $ 14,227     $ 1,016  

December 31, 2014

  $ 85,875,000     $ 15,129     $ 1,026  

December 31, 2015

  $ 45,875,000     $ 28,722     $ 1,009  

December 31, 2016

  $ 45,875,000     $ 31,732     $ 1,023  

December 31, 2017

    —         —         —    

2024 Notes

     

December 31, 2014

  $ 103,000,000     $ 12,614     $ 1,010  

December 31, 2015

  $ 103,000,000     $ 12,792     $ 1,014  

December 31, 2016

  $ 252,873,175     $ 5,757     $ 1,016  

December 31, 2017

  $ 183,509,600     $ 8,939     $ 1,025  

2017 Asset-Backed Notes

     

December 31, 2012

  $ 129,300,000     $ 8,691     $ 1,000  

December 31, 2013

  $ 89,556,972     $ 13,642     $ 1,004  

December 31, 2014

  $ 16,049,144     $ 80,953     $ 1,375  

December 31, 2015

    —         —         —    

2021 Asset-Backed Notes

     

December 31, 2014

  $ 129,300,000     $ 10,048     $ 1,000  

December 31, 2015

  $ 129,300,000     $ 10,190     $ 996  

December 31, 2016

  $ 109,205,263     $ 13,330     $ 1,002  

December 31, 2017

  $ 49,152,504     $ 33,372     $ 1,001  

2022 Convertible Notes

     

December 31, 2017

  $ 230,000,000     $ 7,132     $ 1,028  

2022 Notes

     

December 31, 2017

  $ 150,000,000     $ 10,935     $ 1,014  

Total Senior Securities(7)

     

December 31, 2008

  $ 216,782,000     $ 2,764       N/A  

December 31, 2009

  $ 130,600,000     $ 3,806       N/A  

December 31, 2010

  $ 170,000,000     $ 3,478       N/A  

December 31, 2011

  $ 310,186,830     $ 2,409       N/A  

December 31, 2012

  $ 599,664,500     $ 1,874       N/A  

 

S-32


Table of Contents
Index to Financial Statements

Class and Year

  Total Amount
Outstanding
Exclusive of
Treasury Securities(1)
    Asset Coverage
per Unit(2)
    Average
Market
Value
per Unit(3)
 

December 31, 2013

  $ 559,921,472     $ 2,182       N/A  

December 31, 2014

  $ 626,587,644     $ 2,073       N/A  

December 31, 2015

  $ 600,468,500     $ 2,194       N/A  

December 31, 2016

  $ 667,658,558     $ 2,180       N/A  

December 31, 2017

  $ 802,862,104     $ 2,043       N/A  

 

(1) Total amount of each class of senior securities outstanding at the end of the period presented.
(2) The asset coverage ratio for a class of senior securities representing indebtedness is calculated as our consolidated total assets, less all liabilities and indebtedness not represented by senior securities, including senior securities not subject to asset coverage requirements under the 1940 Act due to exemptive relief from the SEC, divided by senior securities representing indebtedness. This asset coverage ratio is multiplied by $1,000 to determine the Asset Coverage per Unit.
(3) Not applicable because senior securities are not registered for public trading.
(4) Issued by HT II, one of our SBIC subsidiaries, to the SBA. These categories of senior securities were not subject to the asset coverage requirements of the 1940 Act as a result of exemptive relief granted to us by the SEC.
(5) Issued by HT III, one of our SBIC subsidiaries, to the SBA. These categories of senior securities were not subject to the asset coverage requirements of the 1940 Act as a result of exemptive relief granted to us by the SEC.
(6) The Company’s Wells Facility and Union Bank Facility had no borrowings outstanding during the periods noted above.
(7) The total senior securities and Asset Coverage per Unit shown for those securities do not represent the asset coverage ratio requirement under the 1940 Act because the presentation includes senior securities not subject to the asset coverage requirements of the 1940 Act as a result of exemptive relief granted to us by the SEC. As of December 31, 2017, our asset coverage ratio under our regulatory requirements as a business development company was 236.7% excluding our SBA debentures as a result of our exemptive order from the SEC which allows us to exclude all SBA leverage from our asset coverage ratio.

 

S-33


Table of Contents
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 year
ended
December 31,
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)

     2.70        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.

 

S-34


Table of Contents
Index to Financial Statements

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 “Supplementary Risk Factors” in this prospectus supplement and “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, 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 NAV 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 $111.8 million and $284.0 million in assets, respectively, and accounted for approximately 5.4% and 13.8% of our total assets, respectively, prior to consolidation at December 31, 2017. In aggregate, at December 31, 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 December 31, 2017, we have issued $190.2 million in SBA-guaranteed debentures in our SBIC subsidiaries.

 

S-35


Table of Contents
Index to Financial Statements

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 U.S. 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 approximately $1.5 billion at December 31, 2017 as compared to approximately $1.4 billion at December 31, 2016. The fair value of our debt investment portfolio at December 31, 2017 was approximately $1.4 billion, compared to a fair value of approximately $1.3 billion at December 31, 2016. The fair value of the equity portfolio at December 31, 2017 was approximately $89.4 million, compared to a fair value of approximately $67.6 million at December 31, 2016. The fair value of the warrant portfolio at December 31, 2017 was approximately $36.8 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.

 

S-36


Table of Contents
Index to Financial Statements

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 years ended December 31, 2017 and 2016 was comprised of the following:

 

(in millions)

   December 31, 2017      December 31, 2016  

Debt Commitments(1)

     

New portfolio company

   $ 773.2      $ 624.0  

Existing portfolio company

     98.8        171.8  
  

 

 

    

 

 

 

Total

   $ 872.0      $ 795.8  
  

 

 

    

 

 

 

Funded and Restructured Debt Investments(2)

     

New portfolio company

   $ 578.9      $ 479.0  

Existing portfolio company

     175.9        181.5  
  

 

 

    

 

 

 

Total

   $ 754.8      $ 660.5  
  

 

 

    

 

 

 

Funded Equity Investments

     

New portfolio company

   $ 7.1      $ 17.1  

Existing portfolio company

     2.9        3.1  
  

 

 

    

 

 

 

Total

   $ 10.0      $ 20.2  
  

 

 

    

 

 

 

Unfunded Contractual Commitments(3)

     

Total

   $ 73.6      $ 59.7  
  

 

 

    

 

 

 

Non-Binding Term Sheets

     

New portfolio company

   $ 122.0      $ 55.0  

Existing portfolio company

     —          —    
  

 

 

    

 

 

 

Total

   $ 122.0      $ 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 year ended December 31, 2017, we received approximately $625.1 million in aggregate principal repayments. Of the approximately $625.1 million of aggregate principal repayments, approximately $119.5 million were scheduled principal payments, and approximately $505.6 million were early principal repayments related to 47 portfolio companies. Of the approximately $505.6 million early principal repayments, approximately $74.2 million were early repayments due to merger and acquisition transactions for seven portfolio companies.

 

S-37


Table of Contents
Index to Financial Statements

Total portfolio investment activity (inclusive of unearned income and excluding activity related to taxes payable and escrow receivables) as of and for each of the years ended December 31, 2017 and 2016 was as follows:

 

(in millions)

   December 31, 2017     December 31, 2016  

Beginning portfolio

   $ 1,423.9     $ 1,200.6  

New fundings and restructures

     764.8       680.7  

Warrants not related to current period fundings

     0.6       0.6  

Principal payments received on investments

     (119.5     (111.2

Early payoffs

     (505.6     (324.0

Accretion of loan discounts and paid-in-kind principal

     36.5       43.6  

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

     (8.1     (6.3

New loan fees

     (9.8     (10.1

Warrants converted to equity

     —         0.3  

Sale of investments

     (11.0     (4.4

Loss on investments due to write offs

     (39.6     (10.0

Net change in unrealized depreciation

     10.0       (35.9
  

 

 

   

 

 

 

Ending portfolio

   $ 1,542.2     $ 1,423.9  
  

 

 

   

 

 

 

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

 

     December 31, 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

   $ 880,115        57.1   $ 1,078,779        75.7

Senior Secured Debt

     572,738        37.1     277,509        19.5

Preferred Stock

     40,683        2.6     39,418        2.8

Common Stock

     48,678        3.2     28,236        2.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,542,214        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 at value by geographic location as of December 31, 2017 and December 31, 2016 is as follows:

 

     December 31, 2017     December 31, 2016  

(in thousands)

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

United States

   $ 1,404,235        91.1   $ 1,362,223        95.6

United Kingdom

     91,105        5.9     18,395        1.3

Netherlands

     20,783        1.3     20,089        1.4

Cayman Islands

     14,954        1.0     —          0.0

Switzerland

     10,581        0.7     12,377        0.9

Canada

     556        0.0     8,095        0.6

Israel

     —          0.0     2,763        0.2
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,542,214        100.0   $ 1,423,942        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

S-38


Table of Contents
Index to Financial Statements

As of December 31, 2017, we held warrants or equity positions in two companies that have filed registration statements on Form S-1 with the SEC in contemplation of potential IPOs. Both companies filed confidentially under the JOBS Act. There can be no assurance that companies that have yet to complete their IPO 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 December 31, 2017, our debt investments have a term of between two and seven years and typically bear interest at a rate ranging from approximately 4.6% to approximately 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, 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 $33.3 million of unamortized fees at December 31, 2017, of which approximately $29.3 million was included as an offset to the cost basis of our current debt investments and approximately $4.0 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 December 31, 2017, we had approximately $27.5 million in exit fees receivable, of which approximately $23.9 million was included as a component of the cost basis of our current debt investments and approximately $3.6 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 $10.0 million and $7.8 million in PIK income in the years ended December 31, 2017 and December 31, 2016, respectively.

 

S-39


Table of Contents
Index to Financial Statements

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 12.4% and 13.1% during the years ended December 31, 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 14.2% and 14.1% for the years ended December 31, 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 year, 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 1.5% and 26.9% during the years ended December 31, 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 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 supplement.

Portfolio Composition

Our portfolio companies are primarily privately held companies and public companies which are active in the drug discovery & development, software, internet consumer & business services, media/content/info, sustainable and renewable technology, medical devices & equipment, drug delivery, healthcare services, specialty pharmaceuticals, information services, consumer & business products, surgical devices, semiconductors, electronics & computer hardware, communications & networking, biotechnology tools 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 December 31, 2017, approximately 74.9% of the fair value of our portfolio was composed of investments in five industries: 23.9% was composed of investments in the drug discovery and development industry, 23.4% was composed of investments in the software industry, 10.0% was composed of investments in the internet consumer and business services industry, 9.9% was composed of investments in the media/content/info industry and 7.7% was composed of investments in the sustainable and renewable technology industry.

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

 

     December 31, 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

   $ 369,173        23.9   $ 422,550        29.7

Software

     360,123        23.4     219,559        15.4

Internet Consumer & Business Services

     154,909        10.0     97,047        6.8

Media/Content/Info

     152,998        9.9     137,567        9.7

Sustainable and Renewable Technology

     118,432        7.7     154,406        10.9

Medical Devices & Equipment

     94,595        6.1     107,695        7.6

Drug Delivery

     91,214        5.9     109,834        7.7

Healthcare Services, Other

     72,337        4.7     30,200        2.1

Specialty Pharmaceuticals

     37,501        2.4     38,944        2.7

Information Services

     24,618        1.6     6,091        0.4

Consumer & Business Products

     19,792        1.3     42,713        3.0

 

S-40


Table of Contents
Index to Financial Statements
     December 31, 2017     December 31, 2016  

(in thousands)

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

Surgical Devices

     13,161        0.9     12,553        0.9

Semiconductors

     10,406        0.7     11,326        0.8

Electronics & Computer Hardware

     9,982        0.6     7,664        0.5

Communications & Networking

     6,649        0.4     18,019        1.3

Biotechnology Tools

     5,604        0.4     7,200        0.5

Diagnostic

     720        0.1     574        0.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,542,214        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 years ended December 31, 2017 and 2016, our ten largest portfolio companies represented approximately 34.6% and 34.0% of the total fair value of our investments in portfolio companies, respectively. At December 31, 2017 and December 31, 2016, we had seven investments that represented 5% or more of our net assets. At December 31, 2017 and December 31, 2016, we had nine and seven equity investments representing approximately 67.1% and 54.7%, respectively, of the total fair value of our equity investments, and each represented 5% or more of the total fair value of our equity investments. No single portfolio investment represents more than 10% of the fair value of our total investments as of December 31, 2017 and 2016.

As of December 31, 2017, approximately 96.4% 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 December 31, 2017, 79.9% of our debt investments were in a senior secured first lien position, 19.8% 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 December 31, 2017, of the approximately 79.9% of our debt investments in a senior secured first lien position, 45.1% were secured by a first priority security in all of the assets of the portfolio company, including its intellectual property and 34.8% 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, or subject to a negative pledge. At December 31, 2017, we had no equipment only liens on material investments in our portfolio companies.

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 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 December 31, 2017, we held warrants in 137 portfolio companies, with a fair value of approximately $36.8 million. The fair value of our warrant portfolio increased by approximately $9.3 million, as compared to a fair value of $27.5 million at December 31, 2016, primarily related to the addition of warrants in 20 new and 8 existing portfolio companies during the year.

 

S-41


Table of Contents
Index to Financial Statements

Our existing warrant holdings would require us to invest approximately $87.6 million to exercise such warrants as of December 31, 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.

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 gain and loss and changes in our unrealized appreciation and depreciation on control and affiliate investments for the years ended December 31, 2017, 2016, and affiliate investments for the year ended December 2015. We did not hold any control investments at December 31, 2015.

 

(in thousands)               Year Ended December 31, 2017  

Portfolio Company

  Type     Fair Value at
December 31,
2017
    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     $ 155     $ (2,254   $ —       $ (486

HercGamma, Inc.

    Control       —         —         (523     523       (487

SkyCross, Inc.

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

Tectura Corporation

    Control       19,219       1,827       (1,079     51       (51

Second Time Around (Simplify Holdings, LLC)

    Control       —         —         140       —         —    
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Control Investments

 

  $ 19,461     $ 1,982     $ (1,874   $ 16,026     $ (16,476
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Affiliate Investments

           

Optiscan BioMedical, Corp.

    Affiliate     $ 6,291     $ —       $ 1,419     $ —       $ —    

Stion Corporation

    Affiliate       —         2       —         —         —    

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

    Affiliate       25,004       842       (50,102     —         —    
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Affiliate Investments

 

  $ 31,295     $ 844     $ (48,683   $ —       $ —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Control & Affiliate Investments

 

  $ 50,756     $ 2,826     $ (50,557   $ 16,026     $ (16,476
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(in thousands)               Year Ended December 31, 2016  

Portfolio Company

  Type     Fair Value at
December 31,
2016
    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       4,700       84       (604     —         —    
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Control Investments

 

  $ 4,700     $ 84     $ (4,025   $ —       $ —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Affiliate Investments

           

Optiscan BioMedical, Corp.

    Affiliate     $ 4,699     $ 12     $ (3,409   $ —       $ —    

Stion Corporation

    Affiliate       333       148       539       648       —    
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Affiliate Investments

 

  $ 5,032     $ 160     $ (2,870   $ 648     $ —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Control & Affiliate Investments

 

  $ 9,732     $ 244     $ (6,895   $ 648     $ —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

S-42


Table of Contents
Index to Financial Statements
(in thousands)                  Year Ended December 31, 2015  

Portfolio Company

   Type      Fair
Value at
December 31,
2015
     Investment
Income
     Net Change in
Unrealized
Appreciation/
(Depreciation)
     Reversal of
Unrealized
Appreciation/
(Depreciation)(1)
     Realized
Gain/
(Loss)
 

Optiscan BioMedical, Corp.

     Affiliate      $ 6,973      $ —        $ 901      $ —        $ —    

Stion Corporation

     Affiliate        1,013        348        206        —          —    
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

 

   $ 7,986      $ 348      $ 1,107      $ —        $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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

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 became 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. In September 2017, we reduced the cost basis of our equity position by $646,000 with net proceeds from an asset sale and by $36,000 from a final distribution in October 2017. Subsequent to the distributions, our investments were deemed wholly worthless and written off for a realized loss.

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

 

S-43


Table of Contents
Index to Financial Statements

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.

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. See “Business—Investment Process—Loan and Compliance Administration” in the accompanying prospectus. The following table shows the distribution of our outstanding debt investments on the 1 to 5 investment grading scale at fair value as of December 31, 2017 and 2016, respectively:

 

(in thousands)    December 31, 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

     12      $ 345,191        24.4     15      $ 275,832        20.8

2

     32        583,017        41.2     32        590,547        44.4

3

     32        443,775        31.3     25        329,393        24.8

4

     4        41,744        2.9     8        58,874        4.4

5

     5        2,257        0.2     8        74,157        5.6
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 
     85      $ 1,415,984        100.0     88      $ 1,328,803        100.0
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

As of December 31, 2017, our debt investments had a weighted average investment grading of 2.17, 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 December 31, 2017 from December 31, 2016 is primarily due to the upgrade of Machine Zone, Inc. from a credit rating 2 to a credit rating 1 as well as 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 December 31, 2017, we had five debt investments on non-accrual with a cumulative investment cost and fair value of approximately $14.8 million and $340,000, respectively. At December 31, 2016, we had five debt investments on non-accrual with a 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 December 31, 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. For the year ended December 31, 2017, we recognized a realized loss of approximately $24.2 million on the write off of two debt investments that were on non-accrual at December 31, 2016 and one investment placed on non-accrual and written-off during 2017.

 

S-44


Table of Contents
Index to Financial Statements

Results of Operations

Comparison of periods ended December 31, 2017 and 2016

Investment Income

Interest Income

Total investment income for the year ended December 31, 2017 was approximately $190.9 million as compared to approximately $175.1 million for the year ended December 31, 2016.

Interest income for the year ended December 31, 2017 totaled approximately $172.2 million as compared to approximately $158.7 million for the year ended December 31, 2016. The increase in interest income for the year ended December 31, 2017 as compared to the year ended December 31, 2016 is primarily attributable to debt investment portfolio growth and an increase in the weighted average principal outstanding between the periods, the acceleration of income due to early repayments and other one-time events during the period and changes in various interest rates, including LIBOR and Prime rates, to the extent our debt investments include variable interest rates. As of December 31, 2017, approximately, 96.4% of the loans in our portfolio had variable rates based on floating Prime or LIBOR rates with a floor.

Of the $172.2 million in interest income for the year ended December 31, 2017, approximately $160.3 million represents recurring income from the contractual servicing of our loan portfolio and approximately $11.9 million represents income related to the acceleration of income due to early loan repayments and other one-time events during the period. Income from the contractual servicing of our loan portfolio and the acceleration of interest income due to early loan repayments and other one-time events represented $152.1 million and $6.6 million, respectively, of the $158.7 million interest income for the year ended December 31, 2016.

The following table shows the PIK-related activity, for the years ended December 31, 2017 and 2016, at cost:

 

     Year Ended
December 31,
 

(in thousands)

   2017      2016  

Beginning PIK interest receivable balance

   $ 9,930      $ 5,149  

PIK interest income during the period

     9,960        7,825  

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

     129        (2,146

Payments received from PIK loans

     (2,349      (632

Realized loss

     (2,183      (266
  

 

 

    

 

 

 

Ending PIK interest receivable balance

   $ 15,487      $ 9,930  
  

 

 

    

 

 

 

The increase in PIK interest income during the year ended December 31, 2017 as compared to the year ended December 31, 2016 is due to overall portfolio growth, or more specifically, an increase in the weighted average principal outstanding for loans which bear PIK interest. PIK receivable represents approximately 1% of total debt investments as of December 31, 2017 and December 31, 2016, respectively.

Fee Income

Income from commitment, facility and loan related fees for the year ended December 31, 2017 totaled approximately $18.7 million as compared to approximately $16.3 million for the year ended December 31, 2016. The increase in fee income is primarily attributable to an increase in the acceleration of unamortized fees due to early repayments and one-time fees during the period.

 

S-45


Table of Contents
Index to Financial Statements

Of the $18.7 million in income from commitment, facility and loan related fees for the year ended December 31, 2017, approximately $6.4 million represents income from recurring fee amortization and approximately $12.3 million represents income related to the acceleration of unamortized fees during the period. Income from recurring fee amortization and the acceleration of unamortized fees due to early loan repayments represented $9.5 million and $6.8 million, respectively, of the $16.3 million income for the year ended December 31, 2016.

In certain investment transactions, we may earn income from advisory services; however, we had no income from advisory services in the years ended December 31, 2017 and 2016, respectively.

Operating Expenses

Our operating expenses are comprised of interest and fees on our borrowings, general and administrative expenses and employee compensation and benefits. Operating expenses totaled approximately $94.4 million and $82.7 million during the years ended December 31, 2017 and 2016, respectively.

Interest and Fees on our Borrowings

Interest and fees on our borrowings totaled approximately $46.6 million and $37.1 million for the years ended December 31, 2017 and 2016, respectively. Interest and fee expense for the year ended December 31, 2017 as compared to December 31, 2016 increased primarily due to higher weighted average principal balances outstanding due to the issuance of our 2022 Convertible Notes and 2022 Notes. The increase in interest and fee expense was partially 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. The increase was further offset by a partial redemption of our 2024 Notes in November 2017.

We had a weighted average cost of debt, comprised of interest and fees, of approximately 5.9% and 5.8% for the years ended December 31, 2017 and 2016, respectively. The slight increase between comparative periods was primarily driven by an increase in the weighted average principal outstanding compared to the prior period, specifically the issuance of our 2022 Convertible Notes and 2022 Notes, partially offset by the accelerations of unamortized deferred financing costs from the full and partial redemptions on our 2019 Notes, and 2024 Notes, and the principal amortization of our 2021 Asset Backed Notes, respectively, during the period.

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 were $16.1 million for both the years ended December 31, 2017 and 2016, respectively.

Employee Compensation

Employee compensation and benefits totaled approximately $24.6 million for the year ended December 31, 2017 as compared to approximately $22.5 million for the year ended December 31, 2016. The increase between comparative periods was primarily due to changes in variable incentive compensation related to the achievement of origination and strategic corporate objectives.

Employee stock-based compensation totaled approximately $7.2 million for the year ended December 31, 2017 as compared to approximately $7.0 million for the year ended December 31, 2016. The increase between comparative periods was primarily related to the number and amount of restricted stock award vesting.

 

S-46


Table of Contents
Index to Financial Statements

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 years ended December 31, 2017 as and 2016 is as follows:

 

     Year Ended
December 31,
 

(in thousands)

   2017      2016  

Realized gains

   $ 14,163      $ 15,202  

Realized losses

     (40,874      (10,626
  

 

 

    

 

 

 

Net realized gains (losses)

   $ (26,711    $ 4,576  
  

 

 

    

 

 

 

During the year ended December 31, 2017, we recognized net realized losses of approximately $26.7 million on the portfolio. These net realized losses included gross realized losses of approximately $40.9 million, primarily from the liquidation or write off of our debt investments in five portfolio companies and our warrant and equity investments in twenty-one portfolio companies. These losses were offset by gross realized gains of approximately $14.2 million, primarily from the sale of investments in five portfolio companies.

During the year ended December 31, 2016, we recognized net realized gains of approximately $4.6 million on the portfolio. These net realized gains included gross realized gains of approximately $15.2 million from the sale of investments in six portfolio companies. These gains were partially offset by gross realized losses of approximately $10.6 million, primarily from the liquidation or write off of our warrant and equity investments in eight portfolio companies and our debt investments in five portfolio companies, including the settlement of our outstanding debt investment in one portfolio company.

The net unrealized appreciation and depreciation of our investments is based on the fair value of each investment determined in good faith by our Board of Directors. The following table summarizes the change in net unrealized appreciation/depreciation of investments for the years ended December 31, 2017, and 2016:

 

     Year Ended December 31,  

(in thousands)

   2017     2016  

Gross unrealized appreciation on portfolio investments

   $ 130,272     $ 75,264  

Gross unrealized depreciation on portfolio investments

     (148,345     (115,867

Reversal of prior period net unrealized appreciation upon a realization event

     42,967       (8,525

Reversal of prior period net unrealized depreciation upon a realization event

     (14,925     13,186  
  

 

 

   

 

 

 

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

     9,969       (35,942

Other net unrealized appreciation (depreciation)

     (704     (275
  

 

 

   

 

 

 

Net unrealized appreciation (depreciation) on portfolio investments

   $ 9,265     $ (36,217
  

 

 

   

 

 

 

During the year ended December 31, 2017, we recorded approximately $9.3 million of net unrealized appreciation, of which $10.0 million is net unrealized appreciation from our debt, equity and warrant investments. We recorded $32.1 million of net unrealized appreciation on our debt investments, which primarily relates to the reversal of $53.7 million of prior period collateral based impairments on four portfolio companies and the reversal of $31.0 million of prior period unrealized depreciation upon payoff or liquidation of our debt investments, offset by $49.6 million of unrealized depreciation for collateral based impairments on eight portfolio companies during the period.

 

S-47


Table of Contents
Index to Financial Statements

We recorded $32.8 million of net unrealized depreciation on our equity investments, which primarily relates to $51.9 million of unrealized depreciation for collateral based impairments on two portfolio companies, offset by $9.7 million and $6.6 million of unrealized appreciation on our public and private equity portfolios, respectively, related to portfolio company and industry performance.

Finally, we recorded $10.7 million of unrealized appreciation on our warrant investments, which primarily relates to $9.4 million and $5.2 million of unrealized appreciation on our private and public portfolio companies, respectively, related to portfolio company and industry performance. This unrealized appreciation was offset by the reversal of $3.4 million of unrealized appreciation upon being recognized as a gain or loss due to the acquisition or liquidation of our warrant investments.

During the year ended December 31, 2016, we recorded approximately $36.2 million of net unrealized depreciation, of which $35.9 million is net unrealized depreciation from our debt, equity and warrant investments. Of the $35.9 million, approximately $14.0 million is attributed to net unrealized depreciation on our debt investments which primarily relates to $50.0 million unrealized depreciation for collateral based impairments on eight portfolio companies, offset by the reversal of prior period collateral based impairments of $17.3 million on six portfolio companies and the reversal of $13.1 million of prior period unrealized depreciation upon payoff or settling of our debt investments. Approximately $22.2 million is attributed to net unrealized depreciation on our equity investments which primarily relates to approximately $7.4 million of unrealized depreciation for collateral based impairments on two portfolio companies, $6.6 million of unrealized depreciation on our public equity portfolio, with the largest concentration in our investment in Box, Inc. and the reversal of $5.4 million of prior period net unrealized appreciation upon being realized as a gain for our sale of shares of Box, Inc. This unrealized depreciation was partially offset by approximately $245,000 of unrealized appreciation on our warrant investments, which primarily related to $4.8 million of unrealized appreciation on our private portfolio companies, offset by $2.9 million unrealized depreciation on our public portfolio companies related to individual portfolio company performance.

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 years ended December 31, 2017 and December 31, 2016:

 

     Year Ended December 31, 2017  

(in millions)

   Debt     Equity     Warrants     Total  

Collateral Based Impairments(1)

   $ (49.6   $ (51.9   $ (0.6   $ (102.1

Reversals of Prior Period Collateral Based Impairments

     53.7       —         0.1       53.8  

Reversals due to Debt Payoffs & Warrant/Equity Sales

     31.0       2.8       (3.4     30.4  

Fair Value Market/Yield Adjustments(2)

        

Level 1 & 2 Assets

     —         9.7       5.2       14.9  

Level 3 Assets

     (3.0     6.6       9.4       13.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Fair Value Market/Yield Adjustments

     (3.0     16.3       14.6       27.9  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Unrealized Appreciation (Depreciation)

   $ 32.1     $ (32.8   $ 10.7     $ 10.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

S-48


Table of Contents
Index to Financial Statements
     Year Ended December 31, 2016  

(in millions)

   Debt     Equity     Warrants     Total  

Collateral Based Impairments(1)

   $ (50.0   $ (7.4   $ (1.1   $ (58.5

Reversals of Prior Period Collateral Based Impairments

     17.3       —         0.5       17.8  

Reversals due to Debt Payoffs & Warrant/Equity Sales

     13.1       (5.4     (1.0     6.7  

Fair Value Market/Yield Adjustments(2)

        

Level 1 & 2 Assets

     (1.3     (6.6     (2.9     (10.8

Level 3 Assets

     6.9       (2.8     4.8       8.9  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Fair Value Market/Yield Adjustments

     5.6       (9.4     1.9       (1.9
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Unrealized Appreciation (Depreciation)

   $ (14.0   $ (22.2   $ 0.3     $ (35.9
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(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 period end 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 Financial Accounting Standards Board’s (“FASB”) 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 from ordinary income for our taxable year ended December 31, 2017 to our stockholders during 2018.

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

For the years ended December 31, 2017 and 2016, we had a net increase in net assets resulting from operations totaling approximately $79.0 million and approximately $68.7 million, respectively.

The basic and fully diluted net change in net assets per common share for the year ended December 31, 2017 was $0.95, whereas the basic and fully diluted net change in net assets per common share for the year ended December 31, 2016 was $0.91.

For the purpose of calculating diluted earnings per share for year ended December 31, 2017, the dilutive 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 calculations for the year ended December 31, 2017 as our share price was less than the conversion price in effect which results in anti-dilution.

Comparison of periods ended December 31, 2016 and 2015

Investment Income

Interest Income

Total investment income for the year ended December 31, 2016 was approximately $175.1 million as compared to approximately $157.1 million for the year ended December 31, 2015.

 

S-49


Table of Contents
Index to Financial Statements

Interest income for the year ended December 31, 2016 totaled approximately $158.7 million as compared to approximately $140.3 million for the year ended December 31, 2015. The increase in interest income for the year ended December 31, 2016 as compared to the year ended December 31, 2015 is primarily attributable to debt investment portfolio growth, specifically an increase in the weighted average principal outstanding between the periods, slightly offset by a reduction in the acceleration of income due to early repayments and other one-time events during the period.

Of the $158.7 million in interest income for the year ended December 31, 2016, approximately $152.1 million represents recurring income from the contractual servicing of our loan portfolio and approximately $6.6 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 $130.4 million and $9.9 million, respectively, of the $140.3 million interest income for the year ended December 31, 2015.

The following table shows the PIK-related activity, for the years ended December 31, 2016 and 2015, at cost:

 

     Year Ended
December 31,
 

(in thousands)

   2016      2015  

Beginning PIK interest receivable balance

   $ 5,149      $ 6,250  

PIK interest income during the period

     7,825        4,658  

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

     (2,146      —    

Payments received from PIK loans

     (632      (5,483

Realized loss

     (266      (276
  

 

 

    

 

 

 

Ending PIK interest receivable balance

   $ 9,930      $ 5,149  
  

 

 

    

 

 

 

The increase in PIK interest income during the year ended December 31, 2016 as compared to the year ended December 31, 2015 is due to overall portfolio growth, or more specifically, an increase in the weighted average principal outstanding for loans which bear PIK interest and a decrease in the number of PIK loans which paid-off during the period. PIK receivable represents less than 1% of total debt investments as of December 31, 2016 and December 31, 2015, respectively

Fee Income

Income from commitment, facility and loan related fees for the year ended December 31, 2016 totaled approximately $16.3 million as compared to approximately $16.9 million for the year ended December 31, 2015. The decrease in fee income is primarily attributable to a decrease in the acceleration of unamortized fees due to early repayments and one-time fees during the period.

Of the $16.3 million in income from commitment, facility and loan related fees for the year ended December 31, 2016, approximately $9.5 million represents income from recurring fee amortization and approximately $6.8 million represents income related to the acceleration of unamortized fees during the period. Income from recurring fee amortization and the acceleration of unamortized fees due to early loan repayments represented $5.8 million and $11.1 million, respectively, of the $16.9 million income for the year ended December 31, 2015.

In certain investment transactions, we may earn income from advisory services; however, we had no income from advisory services in the years ended December 31, 2016 and 2015, respectively.

 

S-50


Table of Contents
Index to Financial Statements

Operating Expenses

Our operating expenses are comprised of interest and fees on our borrowings, general and administrative expenses and employee compensation and benefits. Operating expenses totaled approximately $82.7 million and $83.6 million during the years ended December 31, 2016 and 2015, respectively.

Interest and Fees on our Borrowings

Interest and fees on our borrowings totaled approximately $37.1 million and $36.9 million for the years ended December 31, 2016 and 2015, respectively. Interest and fee expense for the year ended December 31, 2016 as compared to December 31, 2015 increased primarily due to higher weighted average principal balances outstanding on our 2024 Notes related to the issuance of $149.9 million of aggregate principal during the period. The increase in interest and fee expense incurred related to our 2024 notes was partially offset by principal pay-offs and paydowns on our 2016 Convertible Notes, Asset Backed Notes and Credit Facilities during the period.

We had a weighted average cost of debt, comprised of interest and fees and loss on debt extinguishment (long-term liabilities—convertible notes), of approximately 5.8% and 6.0% for the years ended December 31, 2016 and 2015, respectively. The decrease between comparative periods was primarily driven by a reduction in the weighted average principal outstanding on our higher yielding debt instruments compared to the prior period, specifically due to the full impact of redemptions on our 2019 Notes and 2016 Convertible Notes which occurred in the prior period, offset by the incremental issuance of our 2024 Notes in fiscal year 2016.

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 $16.1 million from $16.7 million for the years ended December 31, 2016 and 2015, respectively. This decrease was primarily attributable to a reduction in costs related to strategic hiring objectives and travel and entertainment, slightly offset by an increase in corporate legal and other expenses.

Employee Compensation

Employee compensation and benefits totaled approximately $22.5 million for the year ended December 31, 2016 as compared to approximately $20.7 million for the year ended December 31, 2015. The increase between comparative periods was primarily due to changes in variable incentive compensation related to the achievement of origination and strategic corporate objectives.

Employee stock-based compensation totaled approximately $7.0 million for the year ended December 31, 2016 as compared to approximately $9.4 million for the year ended December 31, 2015. The decrease between comparative periods was primarily related to the number and amount of restricted stock award vesting, specifically the vesting of retention grants issued in 2014 which occurred in the first half of 2016.

Other Income (Loss)

Other income (loss) generally consists of income or losses generated from sources other than our investment portfolio. For the years ended December 31, 2016 and December 31, 2015 it consists of $8.0 million of litigation settlement proceeds and $1,000 of loss on extinguishment of debt, respectively.

Litigation Settlement Proceeds

On December 19, 2016, we entered into a Confidential Settlement Agreement (the “Settlement Agreement”) with all defendants in connection with a litigation matter (“the Action”) filed in November 2014. In connection

 

S-51


Table of Contents
Index to Financial Statements

with the Settlement Agreement, the Action was settled among the parties and we received a settlement payment in the amount of $8.0 million. The Settlement Agreement also provides a mutual release by us and the defendants of any and all claims and cross-claims that were asserted in the Action, the circumstances and events underlying the Action and attorney’s fees and costs related thereto. The Settlement Agreement does not constitute an admission of liability, fault, or wrongdoing by any party. The settlement payment was classified as a component of net investment income in our Consolidated Statement of Operations.

Loss on Extinguishment of Convertible Notes

Our 6.00% convertible notes due 2016 (the “2016 Convertible Notes”) were fully settled on or before their contractual maturity date of April 15, 2016. Throughout their life, 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 2016 Convertible Notes and approximately 1.6 million shares of our common stock, or $24.3 million.

We recorded a loss on extinguishment of debt for the proportionate amount of unamortized debt issuance costs and OID. The loss was partially offset by a gain in the amount of the difference between the outstanding principal balance of the converted notes and the fair value of the debt instrument. The net loss on extinguishment of debt we recorded for the year ended December 31, 2015 was approximately $1,000. We did not record a loss on extinguishment of debt for the year ended December 31, 2016. The loss on extinguishment of debt was classified as a component of net investment income in our Consolidated Statements of Operations.

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 years ended December 31, 2016 and 2015 is as follows:

 

     Year Ended
December 31,
 

(in thousands)

   2016      2015  

Realized gains

   $ 15,202      $ 12,677  

Realized losses

     (10,626      (7,530
  

 

 

    

 

 

 

Net realized gains

   $ 4,576      $ 5,147  
  

 

 

    

 

 

 

During the year ended December 31, 2016, we recognized net realized gains of approximately $4.6 million on the portfolio. These net realized gains included gross realized gains of approximately $15.2 million, primarily from the sale of investments in six portfolio companies. These gains were partially offset by gross realized losses of approximately $10.6 million, primarily from the liquidation or write off of our warrant and equity investments in eight portfolio companies and our debt investments in five portfolio companies, including the settlement of our outstanding debt investment in one portfolio company.

During the year ended December 31, 2015, we recognized net realized gains of approximately $5.1 million on the portfolio. These net realized gains included gross realized gains of approximately $12.6 million from the sale of investments in seven portfolio companies and $1.5 million from subsequent recoveries on two previously written-off debt investments. These gains were partially offset by gross realized losses of approximately $7.5 million primarily from the liquidation or write off of our investments in sixteen portfolio companies.

 

S-52


Table of Contents
Index to Financial Statements

The net unrealized appreciation and depreciation of our investments is based on the fair value of each investment determined in good faith by our Board of Directors. The following table summarizes the change in net unrealized appreciation/depreciation of investments for the years ended December 31, 2016 and 2015:

 

     Year Ended
December 31,
 

(in thousands)

   2016     2015  

Gross unrealized appreciation on portfolio investments

   $ 75,264     $ 78,991  

Gross unrealized depreciation on portfolio investments

     (115,867     (111,926

Reversal of prior period net unrealized appreciation upon a realization event

     (8,525     (8,707

Reversal of prior period net unrealized depreciation upon a realization event

     13,186       4,599  
  

 

 

   

 

 

 

Net unrealized depreciation on debt, equity, and warrant investments

     (35,942     (37,043

Other net unrealized appreciation (depreciation)

     (275     1,311  
  

 

 

   

 

 

 

Net unrealized depreciation on portfolio investments

   $ (36,217   $ (35,732
  

 

 

   

 

 

 

During the year ended December 31, 2016, we recorded approximately $36.2 million of net unrealized depreciation, of which $35.9 million is net unrealized depreciation from our debt, equity and warrant investments. Of the $35.9 million, approximately $14.0 million is attributed to net unrealized depreciation on our debt investments which primarily relates to $50.0 million unrealized depreciation for collateral based impairments on eight portfolio companies, offset by the reversal of prior period collateral based impairments of $17.3 million on six portfolio companies and the reversal of $13.1 million of prior period unrealized depreciation upon payoff or settling of our debt investments. Approximately $22.2 million is attributed to net unrealized depreciation on our equity investments which primarily relates to approximately $7.4 million of unrealized depreciation for collateral based impairments on two portfolio companies, $6.6 million of unrealized depreciation on our public equity portfolio, with the largest concentration in our investment in Box, Inc. and the reversal of $5.4 million of prior period net unrealized appreciation upon being realized as a gain for our sale of shares of Box, Inc. This unrealized depreciation was partially offset by approximately $245,000 of unrealized appreciation on our warrant investments, which primarily related to $4.8 million of unrealized appreciation on our private portfolio companies, offset by $2.9 million unrealized depreciation on our public portfolio companies related to individual portfolio company performance.

During the year ended December 31, 2015, we recorded approximately $35.7 million of net unrealized depreciation, of which $37.1 million is net unrealized depreciation from our debt, equity and warrant investments. Of the $37.1 million, approximately $14.0 million is attributed to net unrealized depreciation on our debt investments which primarily related to $20.4 million unrealized depreciation for collateral based impairments on ten portfolio companies offset by the reversal of collateral based impairments of $5.6 million on three portfolio companies. Approximately $19.1 million is attributed to net unrealized depreciation on our equity investments which primarily related to $11.4 million unrealized depreciation on our public equity portfolio with the largest concentration in our investment in Box, Inc. and the reversal of $7.8 million of prior period net unrealized appreciation upon being realized as a gain for our sale of shares of Box, Inc., Atrenta, Inc., Cempra, Inc. Celladon Corporation, Egalet Corporation, Everyday Health, and Identiv, Inc. as discussed above. Finally, approximately $4.0 million is attributed to net unrealized depreciation on our warrant investments which primarily related to $6.0 million of unrealized depreciation on our private portfolio companies related to declining industry performance offset by the reversal of $3.2 million of prior period net unrealized depreciation upon being realized as a loss on the liquidation of our investments in thirteen portfolio companies.

 

S-53


Table of Contents
Index to Financial Statements

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 years ended December 31, 2016 and December 31, 2015:

 

     Year Ended December 31, 2016  

(in millions)

   Debt     Equity     Warrants     Total  

Collateral Based Impairments(1)

   $ (50.0   $ (7.4   $ (1.1   $ (58.5

Reversals of Prior Period Collateral based impairments

     17.3       —         0.5       17.8  

Reversals due to Debt Payoffs & Warrant/Equity sales

     13.1       (5.4     (1.0     6.7  

Fair Value Market/Yield Adjustments(2)

        

Level 1 & 2 Assets

     (1.3     (6.6     (2.9     (10.8

Level 3 Assets

     6.9       (2.8     4.8       8.9  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Fair Value Market/Yield Adjustments

     5.6       (9.4     1.9       (1.9
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Unrealized Appreciation (Depreciation)

   $ (14.0   $ (22.2   $ 0.3     $ (35.9
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     Year Ended December 31, 2015  

(in millions)

   Debt     Equity     Warrants     Total  

Collateral Based Impairments(1)

   $ (20.4   $ (0.2   $ (0.4   $ (21.0

Reversals of Prior Period Collateral based impairments

     5.6       —         0.4       6.0  

Reversals due to Debt Payoffs & Warrant/Equity sales

     6.2       (7.8     3.2       1.6  

Fair Value Market/Yield Adjustments(2)

        

Level 1 & 2 Assets

     (1.1     (11.4     (1.2     (13.7

Level 3 Assets

     (4.3     0.3       (6.0     (10.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Fair Value Market/Yield Adjustments

     (5.4     (11.1     (7.2     (23.7
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Unrealized Appreciation (Depreciation)

   $ (14.0   $ (19.1   $ (4.0   $ (37.1
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(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 period end 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 ASC Topic 740, 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 distributed 100% of our spillover earnings, which consisted of ordinary income and long-term capital gains, from our taxable year ended December 31, 2016 to our stockholders during 2017.

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

For the years ended December 31, 2016 and 2015, the net increase in net assets resulting from operations totaled approximately $68.7 million and approximately $42.9 million, respectively.

 

S-54


Table of Contents
Index to Financial Statements

The basic and fully diluted net change in net assets per common share for the year ended December 31, 2016 was $0.91, whereas the basic and fully diluted net change in net assets per common share for the year ended December 31, 2015 were $0.60 and $0.59, respectively.

For the purpose of calculating diluted earnings per share for year ended December 31, 2015, the dilutive effect of the 2016 Convertible Notes under the treasury stock method is included in this calculation as our share price was greater than the conversion price in effect ( $11.03 as of December 31, 2015) for the 2016 Convertible Notes for such period. The 2016 Convertible Notes were fully settled on or before their contractual maturity date of April 15, 2016, as such, there is no potential additional dilutive effect for the year ended December 31, 2016.

Financial Condition, Liquidity, and Capital Resources

Our liquidity and capital resources are derived from our SBA debentures, 2022 Notes, 2024 Notes, 2021 Asset-Backed Notes, 2022 Convertible Notes, Credit Facilities 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. 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, as our sales agent.

On September 7, 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 we may offer and sell up to 12.0 million shares of its common stock from time to time through JMP, as its sales agent. Sales of our 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 year ended December 31, 2017 we sold 4.9 million shares of common stock, of which 3.3 million shares and 1.6 million shares were issued under the Prior Equity Distribution Agreement and the Equity Distribution Agreement, respectively. During the year ended December 31, 2017, we received total accumulated net proceeds of approximately $66.9 million, including $962,000 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 $20.0 million, including offering expenses of $380,000, was received under the Equity Distribution Agreement, respectively. As of December 31, 2017, approximately 10.4 million shares remained available for issuance and sale under the Equity Distribution Agreement.

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. We did not repurchase additional shares in subsequent months during 2016. During the year ended December 31, 2015, we repurchased 437,006 shares of our common stock at an average price per share of $10.61 per share and a total cost of approximately $4.6 million.

 

S-55


Table of Contents
Index to Financial Statements

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 purchase up to an additional $9.8 million in aggregate principal 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 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.

On May 5, 2016, we, through a special purpose wholly-owned subsidiary, Hercules Funding III, as borrower, entered into the Union Bank Facility with MUFG Union Bank, as the arranger and administrative agent, and the lenders party thereto 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.

As of December 31, 2017, we sold 225,457 shares of our 2024 Notes for approximately $5.6 million in aggregate principal amount. During the year ended December 31, 2016, we sold 317,125 shares of our 2024 Notes for approximately $7.9 million in aggregate principal amount. As of December 31, 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.

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

On October 23, 2017, we issued $150.0 million in aggregate principal amount of the 2022 Notes. The 2022 Notes were issued pursuant to an Indenture, dated September 7, 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 $147.5 million, including a public offering discount of $826,500. Aggregate estimated offering expenses in connection with the transaction, including the underwriter’s discount and commissions of approximately $975,000, were approximately $1.7 million.

 

S-56


Table of Contents
Index to Financial Statements

On November 23, 2017, we redeemed $75.0 million of the $258.5 million issued and outstanding aggregate principal amount of our 2024 Notes. On February 9, 2018, our Board of Directors approved a redemption of $100.0 million of the remaining outstanding aggregate principal amount of the 2024 Notes, which were redeemed on April 2, 2018.

At December 31, 2017, we had $190.2 million of SBA debentures, $150.0 million of 2022 Notes, $183.5 million of 2024 Notes, $49.2 million of 2021 Asset-Backed Notes, and $230.0 million of 2022 Convertible Notes payable. We had no borrowings outstanding under the Wells Facility or the Union Bank Facility.

At December 31, 2017, we had $286.3 million in available liquidity, including $91.3 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, subject to existing terms and advance rates and regulatory requirements. We primarily invest cash on hand in interest bearing deposit accounts.

At December 31, 2017, 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 December 31, 2017, we have issued $190.2 million in SBA guaranteed debentures in our SBIC subsidiaries.

At December 31, 2017, we had approximately $3.7 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 portfolio, 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 year ended December 31, 2017, we principally funded our operations from (i) cash receipts from interest 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 year ended December 31, 2017, our operating activities used $18.4 million of cash and cash equivalents, compared to $138.4 million used during the year ended December 31, 2016. The $120.0 million reduction in cash used by operating activities is primarily due to an increase in investment repayments of $196.3 million, offset by increases in investment purchases of $83.8 million.

During the year ended December 31, 2017, our investing activities provided $4.4 million of cash, compared to approximately $617,000 provided during the year ended December 31, 2016. The $3.8 million increase in cash provided by investing activities is primarily related to a decrease in restricted cash on securitized assets.

During the year ended December 31, 2017, our financing activities provided $92.3 million of cash, compared to $55.6 million provided during the year ended December 31, 2016. The $36.7 million increase in cash provided by financing activities was primarily due to the net issuance of $147.5 million and $225.5 million in 2022 Notes and 2022 Convertible Notes, respectively, in the current period. The increase was offset by the repayments of $110.4 million on our 2019 Notes, the principal repayment of $75.0 million in our 2024 Notes and principal amortization of $60.1 million on our 2021 Asset-Backed Notes.

As of December 31, 2017, net assets totaled $841.0 million, with a NAV per share of $9.96. We intend to generate additional cash primarily from 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% (or 150%, subject to certain approval and disclosure requirements) after each issuance of senior securities. As of December 31, 2017, our asset

 

S-57


Table of Contents
Index to Financial Statements

coverage ratio under our regulatory requirements as a business development company was 236.7%, 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% (or 150%, subject to certain approval and disclosure requirements), which while providing increased investment flexibility, also may increase our exposure to risks associated with leverage. Total asset coverage when including our SBA debentures was 204.3% at December 31, 2017.

Outstanding Borrowings

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

 

     December 31, 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      $ 188,141      $ 190,200      $ 190,200      $ 187,501  

2019 Notes(3)

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

2022 Notes

     150,000        150,000        147,572        —          —          —    

2024 Notes

     183,510        183,510        179,001        252,873        252,873        245,490  

2021 Asset-Backed Notes

     49,153        49,153        48,650        109,205        109,205        107,972  

2022 Convertible Notes

     230,000        230,000        223,488        —          —          —    

Wells Facility(4)

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

Union Bank Facility(4)

     75,000        —          —          75,000        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 997,863      $ 802,863      $ 786,852      $ 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 December 31, 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 December 31, 2017 and December 31, 2016 were as follows:

 

(in thousands)

   December 31, 2017      December 31, 2016  

SBA Debentures

   $ 2,059      $ 2,699  

2019 Notes(1)

     —          1,546  

2022 Notes

     1,633        —    

2024 Notes

     4,591        7,482  

2021 Asset-Backed Notes

     503        1,233  

2022 Convertible Notes

     3,715        —    

Wells Facility(2)

     227        501  

Union Bank Facility(2)

     379        768  
  

 

 

    

 

 

 

Total

   $ 13,107      $ 14,229  
  

 

 

    

 

 

 

 

S-58


Table of Contents
Index to Financial Statements

 

(1) 2019 Notes were redeemed in full on February 24, 2017.
(2) 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.

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 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 December 31, 2017, we had approximately $73.6 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 $122.0 million of non-binding term sheets outstanding to five 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 December 31, 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)
 

Myovant Sciences

   $ 15,000  

Chemocentryx, Inc.

     10,000  

Evernote Corporation

     10,000  

Proterra, Inc.

     10,000  

Verastem, Inc.

     10,000  

Impact Radius Holdings, Inc.

     7,500  

Wrike, Inc.

     5,000  

MDX Medical, Inc.

     4,500  

Lithium Technologies, Inc.

     878  

Achronix Semiconductor Corporation

     726  
  

 

 

 

Total

   $ 73,604  
  

 

 

 

 

S-59


Table of Contents
Index to Financial Statements

 

(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.

Contractual Obligations

The following table shows our contractual obligations as of December 31, 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)

   $ 802,863      $ 149,153      $ 51,200      $ 494,250      $ 108,260  

Operating Lease Obligations(4)

     17,869        1,997        5,195        5,871        4,806  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 820,732      $ 151,150      $ 56,395      $ 500,121      $ 113,066  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Excludes commitments to extend credit to our portfolio companies.
(2) Includes $190.2 million principal outstanding under the SBA debentures, $150.0 million of the 2022 Notes, $183.5 million of the 2024 Notes, $49.2 million of the 2021 Asset-Backed Notes and $230.0 million of the Convertible Notes as of December 31, 2017. There are no outstanding borrowings on the Wells Facility or Union Facility as of December 31, 2017.
(3) Amounts represent future principal repayments and not the carrying value of each liability. See “—Outstanding Borrowings” in this prospectus supplement.
(4) Facility leases.
(5) Reflects announced redemption of a portion of the 2024 Notes in April 2018. See “—Subsequent Events” in this prospectus supplement.

Certain premises are leased under agreements which expire at various dates through June 2027. Total rent expense amounted to approximately $1.8 million, $1.7 million and $1.7 million during the years ended December 31, 2017, 2016, and 2015, respectively.

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 our net investment of $44.0 million in HT II as of December 31, 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 December 31, 2017. As of December 31, 2017, HT II has paid the SBA commitment fees and facility fees of approximately $1.5 million and $3.6 million, respectively. As of December 31, 2017, we held investments in

 

S-60


Table of Contents
Index to Financial Statements

HT II in 34 companies with a fair value of approximately $90.3 million, accounting for approximately 5.8% of our total investment portfolio. HT II held approximately $111.8 million in assets and accounted for approximately 5.4% of our total assets prior to consolidation at December 31, 2017.

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 our net investment of $74.5 million in HT III as of December 31, 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 December 31, 2017. As of December 31, 2017, HT III has paid the SBA commitment fees and facility fees of approximately $1.5 million and $3.6 million, respectively. As of December 31, 2017, we held investments in HT III in 48 companies with a fair value of approximately $229.1 million accounting for approximately 14.9% of our total portfolio. HT III held approximately $284.0 million in assets and accounted for approximately 13.8% of our total assets prior to consolidation at December 31, 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 our wholly-owned subsidiaries HT II and HT III, we plan 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 us if they do not have sufficient capital in accordance with SBA regulations. Such actions by the SBA would, in turn, negatively affect us because HT II and HT III are our wholly owned subsidiaries. HT II and HT III were in compliance with the terms of the SBIC’s leverage as of December 31, 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 our SBA debentures range from 3.05% to 5.53% when including these annual fees.

The average amount of debentures outstanding for the year ended December 31, 2017 for HT II was approximately $41.2 million with an average interest rate of approximately 4.49%. The average amount of

 

S-61


Table of Contents
Index to Financial Statements

debentures outstanding for the year ended December 31, 2017 for HT III was approximately $149.0 million with an average interest rate of approximately 3.41%.

For the years ended December 31, 2017, 2016 and 2015, the components of interest expense and related fees and cash paid for interest expense for the SBA debentures are as follows:

 

<
      Year Ended December 31,  

(in thousands)

       2017              2016              2015      

Interest expense

   $ 6,969      $ 6,988      $ 6,969  

Amortization of debt issuance cost (loan fees)

     640        671        667  
  

 

 

    

 

 

    

 

 

 

Total interest expense and fees

   $ 7,609      $ 7,659