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Section 1: 497 (497)

497
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Index to Financial Statements

Filed Pursuant to Rule 497
Registration No. 333-224281

 

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

 

SUBJECT TO COMPLETION, DATED SEPTEMBER 18, 2018

PRELIMINARY PROSPECTUS SUPPLEMENT

(To prospectus dated June 5, 2018)

 

 

LOGO

$            

    % Notes due 2033

 

 

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 $        in aggregate principal amount of     % notes due 2033, or the “Notes.” The Notes will mature on October 30, 2033. We will pay interest quarterly on the Notes on January 30, April 30, July 30 and October 30 of each year, beginning on October 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 the NYSE, and we expect trading in the Notes on the NYSE to begin within 30 days of the original issue date under the symbol “HCXY.” 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, or the SEC. This information is available free of charge by contacting us at 400 Hamilton Avenue, Suite 310, Palo Alto, California 94301, or by telephone by calling collect at (650) 289-3060 or on our website at www.htgc.com. The information on 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

   $                    $                

Sales load (underwriting discounts and commissions)(1)

   $                    $                

Proceeds to us (before expenses)(2)

   $                    $                

 

(1)

Reflects an underwriting discount that may vary between sales to retail investors and sales to institutional investors.

(2)

Before deducting expenses payable by us related to this offering, estimated at $        . See “Underwriting” in this prospectus supplement for complete details of underwriters’ compensation.

The underwriters may also purchase up to an additional $        total aggregate principal amount of Notes offered hereby, solely 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 $        , the total sales load (underwriting discounts and commissions) paid by us will be $        , and total proceeds, before expenses, will be $        .

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 September     , 2018.

Joint Book-Running Managers

 

Keefe, Bruyette & Woods,

A Stifel Company

  Morgan Stanley   UBS Investment Bank

Lead Manager

Janney Montgomery Scott

Co-Managers

 

BB&T Capital Markets   B. Riley FBR   Ladenburg Thalmann   Compass Point   Wedbush Securities

The date of this prospectus supplement is September     , 2018.


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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-22  

Selected Consolidated Financial Data

     S-23  

Capitalization

     S-25  

Senior Securities

     S-26  

Ratio of Earnings to Fixed Charges

     S-29  

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

     S-30  

Underwriting

     S-56  

Certain United States Federal Income Tax Considerations

     S-60  

Management

     S-65  

Legal Matters

     S-65  

Experts

     S-65  

Available Information

     S-65  

Index to Financial Statements

     S-66  

Prospectus

 

     Page  

Summary

     1  

Fees and Expenses

     10  

Selected Consolidated Financial Data

     12  

Risk Factors

     14  

Forward-Looking Statements

     63  

Use of Proceeds

     65  


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     Page  

Price Range of Common Stock and Distributions

     66  

Ratio of Earnings to Fixed Charges

     69  

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

     70  

Business

     113  

Portfolio Companies

     126  

Senior Securities

     149  

Management

     152  

Corporate Governance

     164  

Executive Compensation

     170  

Control Persons and Principal Stockholders

     192  

Certain Relationships and Related Transactions

     194  

Certain United States Federal Income Tax Considerations

     195  

Regulation

     205  

Determination of Net Asset Value

     211  

Sales of Common Stock Below Net Asset Value

     215  

Dividend Reinvestment Plan

     220  

Description of Capital Stock

     221  

Description of Our Preferred Stock

     228  

Description of Our Subscription Rights

     230  

Description of Warrants

     232  

Description of Our Debt Securities

     234  

Plan of Distribution

     247  

Brokerage Allocation and Other Practices

     249  

Custodian, Transfer and Dividend Paying Agent and Registrar

     249  

Legal Matters

     249  

Experts

     249  

Available Information

     250  

Index to Financial Statements

     F-1  


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PROSPECTUS SUPPLEMENT SUMMARY

This summary highlights some of the information in this prospectus supplement and may not contain all of the information that is important to you. For a more complete understanding of this offering, we encourage you to read this entire prospectus supplement and the accompanying prospectus and the documents that are referenced in this prospectus supplement and the accompanying prospectus, together with any accompanying supplements. In this prospectus supplement and the accompanying prospectus, unless the context otherwise requires, the “Company,” “Hercules,” “HTGC,” “we,” “us” and “our” refer to Hercules Capital, Inc. and its wholly-owned subsidiaries and its affiliated securitization trusts.

Our Company

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

As of June 30, 2018, our total assets were approximately $1.8 billion, of which our investments comprised $1.7 billion at fair value and $1.8 billion at cost. Since inception through June 30, 2018, we have made debt and equity commitments of more than $8.0 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 $115.4 million and $294.8 million in assets, respectively, and accounted for approximately 5.2% and 13.4% of our total assets, respectively, prior to consolidation at June 30, 2018. At June 30, 2018, we have issued $190.2 million in Small Business Administration, or 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 June 30, 2018, 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.



 

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Organizational Chart

The following chart summarizes our organizational structure as of September 13, 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



 

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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.

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



 

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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 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

Reduced Asset Coverage Requirements

The Small Business Credit Availability Act, or the SBCAA, which was signed into law in March 2018, decreased the minimum asset coverage ratio in Section 61(a) of the 1940 Act for business development companies 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). On September 4, 2018, our Board of Directors, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act), approved the application to us of the 150% minimum asset coverage ratio set forth in Section 61(a)(2) of the 1940 Act. As a result, the minimum asset coverage ratio applicable to us will be reduced from 200% to 150%, effective as of September 4, 2019, unless approved earlier by a vote of our stockholders, in which case the 150% minimum asset coverage ratio will be effective on the day after such approval. Our Board of Directors also authorized the submission of a proposal for stockholders to accelerate the application of the 150% minimum asset coverage ratio to us at a special meeting of stockholders. As a result of our Board of Director’s approval, effective as of September 4, 2019 (or earlier if our stockholders approve the proposal to accelerate the application of the reduced asset coverage requirements to us), we will be able to incur additional indebtedness and, therefore, your risk of an investment in us may increase. In connection with the change in minimum coverage ratio, S&P Global Ratings (“S&P”) lowered our rating to a non-investment grade rating, and we terminated our ratings agreement with S&P. On September 6, 2018, DBRS, Inc. assigned us an investment grade rating. Other 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 our 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



 

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the liquidity or market value of the Notes to decline significantly” in this prospectus supplement and “Risk Factors—Risks Related to Our Securities—A downgrade, suspension or withdrawal of the credit rating assigned by a rating agency to us or our debt securities, if any, or change in the debt markets could cause the liquidity or market value of our debt securities to decline significantly” in the accompanying prospectus.

Distribution Declaration

On July 25, 2018, our Board of Directors declared a cash distribution of $0.31 per share, which was paid on August 20, 2018 to stockholders of record as of August 13, 2018. This distribution represents our fifty-second consecutive distribution since our initial public offering, bringing the total cumulative distribution to date to $14.64 per share.

Closed and Pending Commitments

As of September 13, 2018, we have:

 

   

Closed debt and equity commitments of approximately $169.8 million to new and existing portfolio companies and funded approximately $109.5 million subsequent to June 30, 2018.

 

   

Pending commitments (signed non-binding term sheets) of approximately $82.7 million.

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

 

Closed Commitments and Pending Commitments (in millions)

  

January 1—June 30, 2018 Closed Commitments

   $ 728.7  

July 1—September 13, 2018 Closed Commitments(a)

   $ 169.8  

Pending Commitments (as of September 13, 2018)(b)

   $ 82.7  

Closed and Pending Commitments as of September 13, 2018

   $ 981.2  

 

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.

ATM Equity Program Issuances

Subsequent to June 30, 2018 and as of September 13, 2018, we sold 2.2 million shares of common stock for total accumulated net proceeds of approximately $28.6 million, including $229,000 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 September 13, 2018, approximately 5.6 million shares remain available for issuance and sale under the Equity Distribution Agreement.

Hercules Technology II Debentures Full Redemption

On July 13, 2018, we completed repayment of the $41.2 million of outstanding HT II debentures.

Amendment to Wells Facility

On July 31, 2018, we entered into a further amendment to the $120.0 million revolving senior credit facility with Wells Fargo Capital Finance, LLC (the “Wells Facility”) to extend the maturity date and fully repay the pro-rata portion of outstanding balances of Alostar Bank of Commerce and Everbank Commercial Finance Inc., thereby resigning both as lenders and terminating their commitments thereunder.



 

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Departure of Officer

On August 16, 2018, Gerard R. Waldt, Jr., Controller and Interim Chief Accounting Officer, tendered his resignation from the Company. Mr. Waldt’s resignation was not a result of any disagreement with the Company on any matter relating to the Company’s operations, policies or practices. David Lund, the Company’s current Interim Chief Financial Officer, assumed the duties of Interim Chief Accounting Officer effective as of August 23, 2018. The resignation of Mr. Waldt was effective on September 7, 2018.

Portfolio Company Developments

As of September 13, 2018, 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 initial public offerings. Both companies filed confidentially under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). There can be no assurance that companies that have yet to complete their initial public offerings will do so in a timely manner or at all. Subsequent to June 30, 2018 and as of September 13, 2018, there were two companies that announced or completed liquidity events.

 

  1.

In August 2018, our portfolio company NuGEN Technologies, Inc., a leading provider for innovative next-generation sequencing kits and genomic sample preparation solutions for the fastest growing field within the genomics area, was acquired by the Tecan Group (SIX Swiss Exchange: TECN), a leading global provider of laboratory instruments and solutions in biopharmaceuticals, forensics and clinical diagnostics. Terms of the acquisition were not disclosed.

 

  2.

In August 2018, our portfolio company Avnera Corporation, a fabless semiconductor firm making custom Analog System-on-Chip (ASoC) solutions for audio, voice, speech, sensor and artificial intelligence (AI) applications, was acquired by Skyworks Solutions, Inc. (NASDAQ: SWKS), an innovator of high-performance analog semiconductors connecting people, places and things. Skyworks paid $405.0 million in cash to Avnera equity holders at closing with up to an additional $20.0 million to be paid if certain performance targets are exceeded over a 12-month period post-closing period.

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, Reston, VA, and San Diego, CA. We maintain a website on the Internet at www.htgc.com. We make available, free of charge, on our website our proxy statement, annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Information contained on our website is not incorporated by reference into this prospectus supplement or the accompanying prospectus, and you should not consider that information to be part of this prospectus supplement or the accompanying prospectus.

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



 

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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

    % Notes due 2033

 

Aggregate principal amount being offered

$        

 

Overallotment option

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

 

Initial public offering price

    % of the aggregate principal amount.

 

Principal payable at maturity

    % 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 “HCXY.”

 

Interest rate

    % per year

 

Day count basis

360-day year of twelve 30-day months

 

Original issue date of the Notes

September     , 2018

 

Stated maturity date

October 30, 2033

 

Date interest starts accruing on the Notes

September     , 2018

 

Interest payment dates for the Notes

Each January 30, April 30, July 30 and October 30, commencing October 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.


 

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Interest periods for the Notes

The initial interest period will be the period from and including September     , 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 $83.5 million in aggregate principal amount of 6.25% notes due 2024 (the “2024 Notes”), approximately $75.0 million in aggregate principal amount of 5.25% notes due 2025 (the “2025 Notes”), and approximately $230.0 million in aggregate principal amount of 4.375% convertible notes due 2022 (the “2022 Convertible Notes”), each as of June 30, 2018.

 

   

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 Wells Facility, borrowings under the $100.0 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 $31.1 million of fixed rate asset-backed notes (the “2021 Asset-Backed Notes”), each as of June 30, 2018. Note that there were no borrowings outstanding under the Wells Facility and $58.3 million of borrowings outstanding on the Union Bank Facility as of June 30, 2018.

 

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.


 

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Optional redemption

We may redeem in whole or in part at any time, or from time to time, at our option on or after October 30, 2023 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

 

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,



 

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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% through September 4, 2019 and 150% thereafter (or earlier if our stockholders approve the proposal to accelerate the application of the reduced asset coverage requirements to us) after such borrowings. See “Risk Factors—Risks Related to our Business Structure—Recently passed legislation may allow us to incur additional leverage” in the accompanying prospectus.

 

   

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 business development company (or to us if we determine to seek such similar no-action or other relief) permitting the business development company 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 business development company’s status as a RIC 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% through September 4, 2019 and 150% thereafter (or earlier if our stockholders approve the proposal to accelerate the application of the reduced asset coverage requirements to us) 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 “Risk Factors—Risks Related to our Business Structure—Recently passed legislation may allow us to incur additional leverage” in the accompanying prospectus.

 

   

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 (“U.S. GAAP”).



 

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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 five 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 $        million aggregate principal amount of Notes in this offering will be approximately $        million after deducting the underwriting discount of approximately $        million payable by us and estimated offering expenses of approximately $        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.


 

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FORWARD-LOOKING STATEMENTS

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

 

   

our current and future management structure;

 

   

our future operating results;

 

   

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

 

   

the impact of investments that we expect to make;

 

   

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

 

   

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

 

   

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

 

   

our ability to access debt markets and equity markets;

 

   

the ability of our portfolio companies to achieve their objectives;

 

   

our expected financings and investments;

 

   

our regulatory structure and tax status;

 

   

our ability to operate as a business development company, a 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.

 

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INDUSTRY AND MARKET DATA

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

 

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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 (“NAV”) 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 June 30, 2018, we had $58.3 million of borrowings outstanding 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 June 30, 2018, 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.

 

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As of June 30, 2018, we had no outstanding borrowings under our Wells Facility, $58.3 million of borrowings outstanding 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% through September 4, 2019 and 150% thereafter (or earlier if our stockholders approve the proposal to accelerate the application of the reduced asset coverage requirements to us) 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 business development company (or to us if we determine to seek such similar no-action or other relief) permitting the business development company 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 business development company’s status as a RIC 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% through September 4, 2019 and 150% thereafter (or earlier if our stockholders approve the proposal to accelerate the application of the reduced asset coverage requirements to us) 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;

 

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make investments; or

 

   

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

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, 2025 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, 2025 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,

 

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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, 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 October 30, 2023. 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. An increase in the competitive environment, inability to cover distributions, or increase in leverage could lead to a downgrade in our credit ratings and limit our access to the debt and equity markets capability impairing our ability to grow the business. 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.

 

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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 2025 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 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, 2024 Notes, 2025 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 2025 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 2025 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 2025 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.

 

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Risks Related to our Business Structure

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 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 2025 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 June 30, 2018, we had no borrowings outstanding under the Wells Facility and $58.3 million of borrowings outstanding on the Union Bank Facility. In addition, as of June 30, 2018, 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 $83.5 million in aggregate principal amount of 2024 Notes, approximately $75.0 million in aggregate principal amount of 2025 Notes, approximately $31.1 million in aggregate principal amount of 2021 Asset-Backed Notes, 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 SBCAA, 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).

On September 4, 2018, our Board of Directors, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act), approved the application to us of the 150% minimum asset coverage ratio set

 

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forth in Section 61(a)(2) of the 1940 Act. As a result, the minimum asset coverage ratio applicable to us will be reduced from 200% to 150%, effective as of September 4, 2019, unless approved earlier by a vote of our stockholders, in which case the 150% minimum asset coverage ratio will be effective on the day after such approval. Our Board of Directors also authorized the submission of a proposal for stockholders to accelerate the application of the 150% minimum asset coverage ratio to us at a special meeting of stockholders. As a result of our Board of Director’s approval, effective as of September 4, 2019 (or earlier if our stockholders approve the proposal to accelerate the application of the reduced asset coverage requirements to us), we will be able to incur additional indebtedness and, therefore, your risk of an investment in us may increase. Rating agencies have reviewed, and may continue 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, in certain cases, downgrade such ratings. Such a downgrade in our credit ratings may adversely affect our securities. See “—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 and “Risk Factors—Risks Related to Our Securities—A downgrade, suspension or withdrawal of the credit rating assigned by a rating agency to us or our debt securities, if any, or change in the debt markets could cause the liquidity or market value of our debt securities to decline significantly” in the accompanying prospectus.

As of June 30, 2018, our asset coverage ratio under our regulatory requirements as a business development company was 252.7% 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 217.2% when including all SBA leverage.

Based on assumed leverage equal to 84.9% of our net assets as of June 30, 2018, our investment portfolio would have been required to experience an annual return of at least 2.7% 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 that we employ (1) our actual asset coverage ratio as of June 30, 2018, (2) a hypothetical asset coverage ratio of 200%, and (3) a hypothetical asset coverage ratio of 150%, each at various annual returns on our portfolio as of June 30, 2018, net of expenses. The calculations in the table below are hypothetical, and actual returns may be higher or lower than those appearing in the table below.

 

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

Corresponding return to common stockholder assuming actual asset coverage as of June 30, 2018 (252.7%)(1)

     (23.57%)        (14.27%)        (4.97%)        4.34%        13.64%  

Corresponding return to common stockholder assuming 200% asset coverage(2)

     (29.09%)        (18.05%)        (7.00%)        4.04%        15.08%  

Corresponding return to common stockholder assuming 150% asset coverage(3)

     (44.94%)        (28.90%)        (12.85%)        3.19%        19.24%  

 

(1)

Assumes $1,792 million in total assets, $818 million in debt outstanding, $963.7 million in stockholders’ equity, and an average cost of funds of 5.85%, which is the approximate average cost of borrowed funds, including our SBA debentures, 2022 Notes, 2024 Notes, 2025 Notes, 2021 Asset Backed Notes, 2022 Convertible Notes, Wells Facility, and Union Bank Facility for the period ended June 30, 2018. Actual interest payments may be different.

(2)

Assumes $2,128 million in total assets including debt issuance costs on a pro forma basis, $1,154 million in debt outstanding, $963.7 million in stockholders’ equity, and an average cost of funds of 5.85%, which is the approximate average cost of borrowed funds, including our SBA debentures, 2022 Notes, 2024 Notes, 2025 Notes, 2021 Asset-Backed Notes, 2022 Convertible Notes, and Credit Facilities for the period ended June 30, 2018, along with the hypothetical estimated incremental cost of debt that would be incurred on offering the maximum permissible debt under the 200% asset coverage. Actual interest payments may be different.

 

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(3)

Assumes $3,092 million in total assets including debt issuance costs on a pro forma basis, $2,118 million in debt outstanding, $963.7 million in stockholders’ equity, and an average cost of funds of 5.85%, which is the approximate average cost of borrowed funds, including our SBA debentures, 2022 Notes, 2024 Notes, 2025 Notes, 2021 Asset-Backed Notes, 2022 Convertible Notes, and Credit Facilities for the period ended June 30, 2018, along with the hypothetical estimated incremental cost of debt that would be incurred on offering the maximum permissible debt under the 150% asset coverage. Actual interest payments may be different.

 

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USE OF PROCEEDS

We estimate that the net proceeds we will receive from the sale of the $        million aggregate principal amount of Notes in this offering will be approximately $        million (or approximately $        million if the underwriters fully exercise their overallotment option) based on a public offering of     % of par, after deducting the underwriting discount of approximately $        million (or approximately $        million if the underwriters fully exercise their overallotment option) payable by us and estimated offering expenses of approximately $        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 June 30, 2018, the aggregate principal balance of the 2024 Notes was approximately $83.5 million. 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.

 

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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. The selected financial and other data for the six-months ended June 30, 2018 and other quarterly financial information is derived from our unaudited financial statements, but in the opinion of management, reflects all adjustments (consisting only of normal recurring adjustments) that are necessary to present fairly the results of such interim periods. Interim results as of and for the six-months ended June 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.

 

     For the Six-
Months Ended
June 30,

(unaudited)
    For the Year Ended December 31,  

(in thousands, except per share amounts)

   2018     2017     2017     2016     2015     2014     2013  

Investment income:

              

Interest

   $ 88,857     $ 83,367     $ 172,196     $ 158,727     $ 140,266     $ 126,618     $ 123,671  

Fees

     9,405       11,450       18,684       16,324       16,866       17,047       16,042  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     98,262       94,817       190,880       175,051       157,132       143,665       139,713  

Operating expenses:

              

Interest

     19,264       18,861       37,857       32,016       30,834       28,041       30,334  

Loan fees

     4,537       4,186       8,728       5,042       6,055       5,919       4,807  

General and administrative:

              

Legal expenses

     1,212       2,867       4,572       4,823       3,079       1,366       1,440  

Other expenses

     6,471       5,947       11,533       11,283       13,579       8,843       7,914  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total general and administrative

     7,683       8,814       16,105       16,106       16,658       10,209       9,354  

Employee Compensation:

              

Compensation and benefits

     12,775       11,262       24,555       22,500       20,713       16,604       16,179  

Stock-based compensation

     5,166       3,742       7,191       7,043       9,370       9,561       5,974  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total employee compensation

     17,941       15,004       31,746       29,543       30,083       26,165       22,153  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     49,425       46,865       94,436       82,707       83,630       70,334       66,648  

Other income (loss)

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

     48,837       47,952       96,444       100,344       73,501       71,750       73,065  

Net realized gain (loss) on investments

     (13,831     (2,475     (26,711     4,576       5,147       20,112       14,836  

Net change in unrealized appreciation (depreciation) on investments

     23,000       (17,916     9,265       (36,217     (35,732     (20,674     11,545  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net realized and unrealized gain (loss)

     9,169       (20,391     (17,446     (31,641     (30,585     (562     26,381  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase in net assets resulting from operations

   $ 58,006     $ 27,561     $ 78,998     $ 68,703     $ 42,916     $ 71,188     $ 99,446  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in net assets per common share (basic)

   $ 0.67     $ 0.33     $ 0.95     $ 0.91     $ 0.60     $ 1.12     $ 1.67  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Distributions declared per common share:

   $ 0.62     $ 0.62     $ 1.24     $ 1.24     $ 1.24     $ 1.24     $ 1.11  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Index to Financial Statements

(in thousands,

except per share amounts)

   For the Six-Months
Ended June 30,

(unaudited)
    For the Year Ended December 31,  
   2018     2017     2017     2016     2015     2014     2013  

Balance sheet data:

              

Investments, at value

   $ 1,701,936     $ 1,395,469     $ 1,542,214     $ 1,423,942     $ 1,200,638     $ 1,020,737     $ 910,295  

Cash and cash equivalents

     59,461       160,412       91,309       13,044       95,196       227,116       268,368  

Total assets

     1,792,597       1,588,709       1,654,715       1,464,204       1,334,761       1,299,223       1,221,715  

Total liabilities

     828,900       771,258       813,748       676,260       617,627       640,359       571,708  

Total net assets

     963,697       817,451       840,967       787,944       717,134       658,864       650,007  

Other Data:

              

Total return(3)

     1.24     (2.04 %)      1.47     26.87     (9.70 %)      (1.75 %)      58.49

Total debt investments, at value

     1,545,997       1,287,623       1,415,984       1,328,803       1,110,209       923,906       821,988  

Total warrant investments, at value

     34,430       32,530       36,869       27,485       22,987       25,098       35,637  

Total equity investments, at value

     121,509       75,316       89,361       67,654       67,442       71,733       52,670  

Unfunded Commitments(2)

     129,716       57,595       73,604       59,683       75,402       147,689       69,091  

Net asset value per share(1)

   $ 10.22     $ 9.87     $ 9.96     $ 9.90     $ 9.94     $ 10.18     $ 10.51  

 

(1)

Based on common shares outstanding at period end.

(2)

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

(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 and the quarters ending March 31, 2018 and June 30, 2018. This information was derived from our unaudited consolidated financial statements. Results for any quarter are not necessarily indicative of results for the full year or for any future quarter.

 

     Quarter Ended  

(in thousands, except per share data)

   March 31,
2018
     June 30,
2018
 

Total investment income

   $ 48,700      $ 49,562  

Net investment income

     26,063        22,774  

Net increase (decrease) in net assets resulting from operations

     5,946        52,060  

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

   $ 0.07      $ 0.59  

 

     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  

 

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CAPITALIZATION

The following table sets forth (i) our actual capitalization as of June 30, 2018, and (ii) our capitalization as adjusted to give effect to the sale of $        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 $        million payable by us and estimated offering expenses of approximately $        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 June 30, 2018  
     Actual     As
Adjusted
 
     (in thousands)  

Investments at fair value

   $ 1,701,936     $                

Cash and cash equivalents

   $ 59,461     $                 

Debt(1):

    

Accounts payable and accrued liabilities

   $ 25,115     $                

Long-term SBA debentures

     188,457    

2022 Convertible Notes

     224,269    

2021 Asset-Backed Notes

     30,698    

2022 Notes

     147,728    

2024 Notes

     81,694    

2025 Notes

     72,616    

Credit Facilities

     58,323    

Notes offered herein

     —      
  

 

 

   

 

 

 

Total debt

   $ 828,900     $                
  

 

 

   

 

 

 

Stockholders’ equity:

    

Common stock, par value $0.001 per share; 200,000,000 shares authorized; 94,259,954 shares issued and outstanding

   $ 94     $                

Capital in excess of par value

     1,026,313    

Unrealized depreciation on investments

     (56,760  

Accumulated realized gains (losses) on investments

     (34,205  

Distributions in excess of investment income

     28,255    
  

 

 

   

 

 

 

Total stockholders’ equity

   $ 963,697     $    
  

 

 

   

 

 

 

Total capitalization

   $ 1,792,597     $                
  

 

 

   

 

 

 

 

(1)

The above table reflects the principal amount of indebtedness outstanding net of the associated debt issuance costs as of June 30, 2018. As of September 13, 2018, indebtedness under the Wells Facility, the Union Bank Facility, the 2022 Notes, the 2022 Convertible Notes, the 2024 Notes, the 2025 Notes, and the 2021 Asset-Backed Notes was $39.9 million, $44.2 million, $150.0 million, $230.0 million, $83.5 million, $75.0 million, and $5.9 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.”

 

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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 “N/A” 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  

December 31, 2018 (as of June 30, 2018, unaudited)(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  

December 31, 2018 (as of June 30, 2018, unaudited)

   $ 58,322,619      $ 30,498        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  

December 31, 2018 (as of June 30, 2018, unaudited)

   $ 41,200,000      $ 43,172        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  

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  

December 31, 2018 (as of June 30, 2018, unaudited)

   $ 149,000,000      $ 11,938        N/A  

 

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Class and Year

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

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  

December 31, 2018 (as of June 30, 2018, unaudited)

   $ 83,509,600      $ 21,299      $ 1,011  

2025 Notes

        

December 31, 2018 (as of June 30, 2018, unaudited)

   $ 75,000,000      $ 23,716      $ 993  

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  

December 31, 2018 (as of June 30, 2018, unaudited)

   $ 31,087,858      $ 57,215      $ 1,000  

2022 Convertible Notes

        

December 31, 2017

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

December 31, 2018 (as of June 30, 2018, unaudited)

   $ 230,000,000      $ 7,733      $ 1,012  

2022 Notes

        

December 31, 2017

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

December 31, 2018 (as of June 30, 2018, unaudited)

   $ 150,000,000      $ 11,858      $ 999  

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  

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  

December 31, 2018 (as of June 30, 2018, unaudited)

   $ 818,120,077      $ 2,174        N/A  

 

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(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 June 30, 2018, our asset coverage ratio under our regulatory requirements as a business development company was 253.0% 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.

 

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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 six-
months ended
June 30,
2018
    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
 

Earnings to Fixed Charges(1)

    3.44       2.70       2.85       2.16       3.10       3.83  

 

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

 

(1)

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

 

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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, Reston, VA, 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. We also provide “unitranche” loans, which are loans that combine both senior and mezzanine debt, generally in a first lien position.

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 $115.4 million and $294.8 million in assets, respectively, and accounted for approximately 5.2% and 13.4% of our total assets, respectively, prior to consolidation at June 30, 2018. In aggregate, at June 30, 2018, 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 June 30, 2018, we have issued $190.2 million in SBA-guaranteed debentures in our SBIC subsidiaries. On July 13, 2018, we fully redeemed the principal outstanding on our SBA HT II debenture. See “—Subsequent Events.”

 

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We have qualified as and have elected to be treated for tax purposes as a RIC under Subchapter M of the Code. Pursuant to this election, we generally will not be subject to corporate-level taxes on any income and gains that we distribute as dividends for 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 $1.7 billion at June 30, 2018 and $1.5 billion at December 31, 2017. The fair value of our debt investment portfolio at June 30, 2018 was approximately $1.5 billion, compared to a fair value of approximately $1.4 billion December 31, 2017. The fair value of the equity portfolio at June 30, 2018 was approximately $121.5 million, compared to a fair value of approximately $89.4 million at December 31, 2017. The fair value of the warrant portfolio at June 30, 2018 was approximately $34.4 million, compared to a fair value of approximately $36.8 million at December 31, 2017.

Portfolio Activity

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

 

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

Our portfolio activity for the six months ended June 30, 2018 and the year ended December 31, 2017 was comprised of the following:

 

(in millions)    June 30, 2018      December 31, 2017  

Debt Commitments(1)

     

New portfolio company

   $ 637.1      $ 773.2  

Existing portfolio company

     59.5        98.8  
  

 

 

    

 

 

 

Total

   $ 696.6      $ 872.0  
  

 

 

    

 

 

 

Funded and Restructured Debt Investments(2)

     

New portfolio company

   $ 412.6      $ 578.9  

Existing portfolio company

     118.7        175.9  
  

 

 

    

 

 

 

Total

   $ 531.3      $ 754.8  
  

 

 

    

 

 

 

Funded Equity Investments

     

New portfolio company

   $ 27.7        7.1  

Existing portfolio company

     4.7        2.9  
  

 

 

    

 

 

 

Total

   $ 32.4      $ 10.0  
  

 

 

    

 

 

 

Unfunded Contractual Commitments(3)

     

Total

   $ 129.7      $ 73.6  
  

 

 

    

 

 

 

Non-Binding Term Sheets

     

New portfolio company

   $ 70.0      $ 122.0  

Existing portfolio company

     10.0        —    
  

 

 

    

 

 

 

Total

   $ 80.0      $ 122.0  
  

 

 

    

 

 

 

 

(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 six months ended June 30, 2018, we received approximately $404.3 million in aggregate principal repayments. Of the approximately $404.3 million of aggregate principal repayments, approximately $46.5 million were scheduled principal payments and approximately $357.8 million were early principal repayments related to 26 portfolio companies. Of the approximately $357.8 million early principal repayments, approximately $38.5 million were early repayments due to merger and acquisition transactions for three portfolio companies.

 

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Total portfolio investment activity (inclusive of unearned income and excluding activity related to taxes payable, and escrow receivables) as of and for the six months ended June 30, 2018 and the year ended December 31, 2017 was as follows:

 

(in millions)    June 30,
2018
    December 31,
2017
 

Beginning portfolio

   $ 1,542.2     $ 1,423.9  

New fundings and restructures

     563.7       764.8  

Warrants not related to current period fundings

     0.2       0.6  

Principal payments received on investments

     (46.5     (119.5

Early payoffs

     (357.8     (505.6

Accretion of loan discounts and paid-in-kind principal

     16.9       36.5  

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

     (8.1     (8.1

New loan fees

     (7.0     (9.8

Sale of investments

     (1.6     (11.0

Loss on investments due to write offs

     (22.0     (39.6

Net change in unrealized appreciation (depreciation)

     21.9       10.0  
  

 

 

   

 

 

 

Ending portfolio

   $ 1,701.9     $ 1,542.2  
  

 

 

   

 

 

 

As of June 30, 2018, 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 initial public offerings. Both companies filed confidentially under the JOBS Act. There can be no assurance that companies that have yet to complete their initial public offerings will do so in a timely manner or at all.

Changes in Portfolio

We generate revenue in the form of interest income, primarily from our investments in debt securities, and commitment and facility fees. Interest income is recognized in accordance with the contractual terms of the loan agreement to the extent that such amounts are expected to be collected. Fees generated in connection with our debt investments are recognized over the life of the loan or, in some cases, recognized as earned. In addition, we generate revenue in the form of capital gains, if any, on warrants or other equity-related securities that we acquire from our portfolio companies. Our investments generally range from $12.0 million to $40.0 million, although we may make investments in amounts above or below that range. As of June 30, 2018, our debt investments have a term of between two and seven years and typically bear interest at a rate ranging from 6.0% to 14.5%. In addition to the cash yields received on our debt investments, in some instances, our debt investments may also include any of the following: exit fees, balloon payment fees, commitment fees, success fees, payment-in-kind (“PIK”) provisions or prepayment fees which may be required to be included in income prior to receipt.

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

Loan origination and commitment fees received in full at the inception of a loan are deferred and amortized into fee income as an enhancement to the related loan’s yield over the contractual life of the loan. We recognize nonrecurring fees amortized over the remaining term of the loan commencing in the quarter relating to specific loan modifications. We had approximately $33.7 million of unamortized fees at June 30, 2018, of which approximately $27.9 million was included as an offset to the cost basis of our current debt investments and approximately $5.8 million was deferred contingent upon the occurrence of a funding or milestone. At December 31, 2017, we had approximately $33.3 million of unamortized fees, of which approximately

 

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$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.

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 June 30, 2018, we had approximately $23.8 million in exit fees receivable, of which approximately $21.6 million was included as a component of the cost basis of our current debt investments and approximately $2.2 million was a deferred receivable related to expired commitments. 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.

We have debt investments in our portfolio that contain a PIK provision. The PIK interest, computed at the contractual rate specified in each loan agreement, is recorded as interest income and added to the principal balance of the loan on specified capitalization dates. To maintain our ability to be subject to tax as a RIC, this non-cash source of income must be distributed to stockholders with other sources of income in the form of dividend distributions even though we have not yet collected the cash. Amounts necessary to pay these distributions may come from available cash or the liquidation of certain investments. We recorded approximately $2.3 million and $2.5 million in PIK income during the three months ended June 30, 2018 and 2017, respectively. We recorded approximately $4.6 million and $4.7 million in PIK income during the six months ended June 30, 2018 and 2017, respectively.

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 12.7% and 12.1% during the three months ended June 30, 2018 and 2017, 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 13.5% and 14.9% for the three months ended June 30, 2018 and 2017, respectively. The effective yield is derived by dividing total investment income by the weighted average earning investment portfolio assets outstanding during the quarter, excluding non-interest earning assets such as warrants and equity investments. Both the core yield and effective yield may be higher than what our common stockholders may realize as the core yield and effective yield do not reflect our expenses and any sales load paid by our common stockholders. The total yield on our investment portfolio was 11.8% and 12.8% during the three months ended June 30, 2018 and 2017, respectively. The total yield is derived by dividing total investment income by the weighted average investment portfolio assets outstanding during the quarter, including non-interest earning assets such as warrants and equity investments at amortized cost.

The total return for our investors was approximately 1.2% and -2.0% during the six months ended June 30, 2018 and 2017, respectively. The total return equals the change in the ending market value over the beginning of the period price per share plus dividend distributions paid per share during the period, divided by the beginning price assuming the distribution is reinvested on the date of the distribution. The total return does not reflect any sales load that must be paid by investors. See “Note 9—Financial Highlights” included in the notes to our consolidated financial statements appearing elsewhere in this prospectus supplement.

Portfolio Composition

Our portfolio companies are primarily privately held companies and public companies which are active in the software, drug discovery & development, internet consumer & business services, sustainable and renewable technology, drug delivery, healthcare services, medical devices & equipment, media/content/info, diversified financial services, information services, electronics & computer hardware, consumer & business products, surgical devices, communications & networking, biotechnology tools, semiconductors, diagnostic and specialty pharmaceuticals industry sectors. These sectors are characterized by high margins, high growth rates,

 

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consolidation and product and market extension opportunities. Value for companies in these sectors is often vested in intangible assets and intellectual property.

As of June 30, 2018, approximately 80.5% of the fair value of our portfolio was composed of investments in five industries: 26.3% investments in the drug discovery & development industry, 26.2% investments in the software industry, 15.1% investments in the internet consumer & business services industry, 7.1% investments in the sustainable and renewable technology industry, and 5.8% investments in the Medical Devices & Equipment industry.

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 six months ended June 30, 2018 and the year ended December 31, 2017, our ten largest portfolio companies represented approximately 27.4% and 34.6% of the total fair value of our investments in portfolio companies, respectively. At June 30, 2018 and December 31, 2017, we had five and seven investments, respectively, that represented 5% or more of our net assets. At June 30, 2018, we had six equity investments representing approximately 65.4% of the total fair value of our equity investments, and each represented 5% or more of the total fair value of our equity investments. At December 31, 2017, we had nine equity investments which represented approximately 67.1% of the total fair value of our equity investments, and each represented 5% or more of the total fair value of our equity investments.

As of June 30, 2018, approximately 97.2% 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.

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. As of June 30, 2018, approximately 85.9% of our debt investments were in a senior secured first lien position, with 49.2% secured by a first priority security in all of the assets of the portfolio company, including its intellectual property, 29.3% 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, 1.4% of our debt investments were senior secured by the equipment of the portfolio company, and 6.1% were in a first lien “last-out” senior secured position with security interest in all of the assets of the portfolio company, whereby the “last-out” loans will be subordinated to the “first-out” portion of the unitranche loan in a liquidation, sale or other disposition. Another 13.5% of our debt investments were secured by a second priority security interest in all of the portfolio company’s assets, and 0.6% were unsecured.

Our investments in senior secured debt with warrants have detachable equity enhancement features, typically in the form of warrants or other equity-related securities designed to provide us with an opportunity for capital appreciation. These features are treated as original issue discount 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 June 30, 2018, we held warrants in 133 portfolio companies, with a fair value of approximately $34.4 million. The fair value of our warrant portfolio decreased by approximately $2.4 million, as compared to a fair value of $36.8 million at December 31, 2017 primarily related to the slight decrease in portfolio companies and valuation of the portfolio.

Our existing warrant holdings would require us to invest approximately $79.6 million to exercise such warrants as of June 30, 2018. 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

 

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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.

Portfolio Grading

We use an investment grading system, which grades each debt investment on a scale of 1 to 5 to characterize and monitor our expected level of risk on the debt investments in our portfolio with 1 being the highest quality. The following table shows the distribution of our outstanding debt investments on the 1 to 5 investment grading scale at fair value as of June 30, 2018 and December 31, 2017, respectively:

 

(in thousands)    June 30, 2018     December 31, 2017  

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

     14      $ 247,542        16.0     12      $ 345,191        24.4

2

     43        791,931        51.2     32        583,017        41.2

3

     25        463,702        30.0     32        443,775        31.3

4

     4        41,960        2.7     4        41,744        2.9

5

     2        862        0.1     5        2,257        0.2
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 
     88      $ 1,545,997        100.0     85      $ 1,415,984        100.0
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

As of June 30, 2018, our debt investments had a weighted average investment grading of 2.21 on a cost basis, as compared to 2.17 at December 31, 2017. 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 decline in weighted average investment grading at June 30, 2018 from December 31, 2017 is primarily due to the payoff of four positions with a credit rating 1 as well as the downgrade of three positions from a credit rating 2 to a credit rating 3. In addition, one position was downgraded to a credit rating 5, while four positions that were rated 5 as of December 31, 2017 were sold or liquidated during the period.

At June 30, 2018, we had two debt investments on non-accrual with a cumulative investment cost and fair value of approximately $2.8 million and $33,000, respectively. At December 31, 2017, we had five debt investments on non-accrual with cumulative investment cost and fair value of approximately $14.8 million and $340,000, respectively. The decrease in the cumulative cost of debt investments on non-accrual between June 30, 2018 and December 31, 2017 is the result of the liquidation of two debt investments that were on non-accrual at December 31, 2017, which resulted in a realized loss of approximately $10.3 million, slightly offset by a loan repayment in full from one debt investment.

Results of Operations

Comparison of the three and six months ended June 30, 2018 and 2017

Investment Income

Interest Income

Total investment income for the three months ended June 30, 2018 was approximately $49.6 million as compared to approximately $48.5 million for the three months ended June 30, 2017. Total investment income for the six months ended June 30, 2018 was approximately $98.3 million as compared to approximately $94.8 million for the six months ended June 30, 2017.

 

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Interest income for the three months ended June 30, 2018 totaled approximately $45.9 million as compared to approximately $40.5 million for the three months ended June 30, 2017. Interest income for the six months ended June 30, 2018 totaled approximately $88.9 million as compared to approximately $83.4 million for the six months ended June 30, 2017. The increase in interest income for the three and six months ended June 30, 2018 as compared to the same periods ended June 30, 2017, is primarily attributable to an increase in recurring interest income and an increase in the weighted average principal outstanding of loans.

Of the $45.9 million in interest income for the three months ended June 30, 2018, approximately $45.0 million represents recurring income from the contractual servicing of our loan portfolio and approximately $911,000 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 $37.9 million and $2.6 million, respectively, of the $40.5 million interest income for the three months ended June 30, 2017.

Of the $88.9 million in interest income for the six months ended June 30, 2018, approximately $84.3 million represents recurring income from the contractual servicing of our loan portfolio and approximately $4.6 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 $77.9 million and $5.5 million, respectively, of the $83.4 million interest income for the six months ended June 30, 2017.

The following table shows the PIK-related activity for the six months ended June 30, 2018 and 2017, at cost:

 

     Six Months Ended
June 30,
 
(in thousands)    2018      2017  

Beginning PIK interest receivable balance

   $ 15,487      $ 9,930  

PIK interest income during the period

     4,621        4,666  

PIK accrued (capitalized) to principal

     (1,153      —    

Payments received from PIK loans

     (9,107      (2,031

Realized gain (loss)

     —          —    
  

 

 

    

 

 

 

Ending PIK interest receivable balance

   $ 9,848      $ 12,565  
  

 

 

    

 

 

 

The slight decrease in PIK interest income during the six months ended June 30, 2018 as compared to the six months ended June 30, 2017 is due to a decrease in the weighted average principal outstanding of loans which bear PIK interest. This decrease is offset by an increase in the number of PIK loans which bear interest.

Fee Income

Fee income from commitment, facility and loan related fees for the three months ended June 30, 2018 totaled approximately $3.7 million as compared to approximately $7.9 million for the three months ended June 30, 2017. Fee income from commitment, facility and loan related fees for the six months ended June 30, 2018 totaled approximately $9.4 million as compared to approximately $11.5 million for the six months ended June 30, 2017. The decrease in fee income for both three and six months ended June 30, 2018 is primarily due to a decrease in the acceleration of unamortized fees and one-time fees due to early repayments.

Of the $3.7 million in fee income for the three months ended June 30, 2018, approximately $1.8 million represents income from recurring fee amortization and approximately $1.9 million represents income related to the acceleration of unamortized fees due to early repayments, including one-time fees of $1.7 million for the period. Income from recurring fee amortization and the acceleration of unamortized fees due to early loan repayments represented $1.4 million and $6.5 million, respectively, of the $7.9 million in income for the three months ended June 30, 2017.

 

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Of the $9.4 million in fee income for the six months ended June 30, 2018, approximately $3.1 million represents income from recurring fee amortization and approximately $6.3 million represents income related to the acceleration of unamortized fees due to early repayments, including one-time fees of $4.8 million for the period. Income from recurring fee amortization and the acceleration of unamortized fees due to early loan repayments represented $3.6 million and $7.9 million, respectively, of the $11.5 million in income for the six months ended June 30, 2017.

In certain investment transactions, we may earn income from advisory services; however, we had no income from advisory services in the three and six months ended June 30, 2018 or 2017.

Operating Expenses

Our operating expenses are comprised of interest and fees on our borrowings, general and administrative expenses and employee compensation and benefits. Our operating expenses totaled approximately $26.8 million and $23.2 million during the three months ended June 30, 2018 and 2017, respectively. Our operating expenses totaled approximately $49.4 million and $46.9 million during the six months ended June 30, 2018 and 2017, respectively.

Interest and Fees on our Borrowings

Interest and fees on our borrowings totaled approximately $13.2 million and $10.6 million for the three months ended June 30, 2018 and 2017, respectively, and approximately $23.8 million and $23.0 million during the six months ended June 30, 2018 and 2017, respectively. Interest and fee expense during the three and six months ended June 30, 2018, as compared to the three and six months ended June 30, 2017, increased due to the issuance of our 2022 Notes in October 2017, 2025 Notes in April 2018 and interest related to our credit facilities, offset by the partial redemptions of our 2024 Notes and amortization of our 2021 Asset-Backed Notes.

We had a weighted average cost of debt, comprised of interest and fees, of approximately 6.4% and 5.5% for the three months ended June 30, 2018 and 2017, respectively, and a weighted average cost of debt of approximately 5.8% and 6.5% for the six months ended June 30, 2018 and 2017, respectively. The increase in the weighted average cost of debt for the three months ended June 30, 2018, as compared to the same period ended June 30, 2017 is attributable to the one-time non-cash acceleration of unamortized fees due to the partial redemption of our 2024 Notes in April 2018. The decrease in the weighted average cost of debt for the six months ended June 30, 2018 is primarily driven by a reduction in the weighted average principal outstanding on our higher yielding debt instruments compared to the prior 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 decreased to $3.7 million from $4.7 million for the three months ended June 30, 2018 and 2017. Our general and administrative expenses decreased to $7.7 million from $8.8 million for the six months ended June 30, 2018 and 2017. The decrease for both three and six months ended June 30, 2018 was primarily attributable to a reduction in corporate legal and other expenses.

Employee Compensation

Employee compensation and benefits totaled $7.0 million for the three months ended June 30, 2018 as compared to $5.9 million for the three months ended June 30, 2017, and $12.8 million for the six months ended June 30, 2018 as compared to $11.3 million for the six months ended June 30, 2017. The increase between the comparative periods was primarily due to increased salaries and changes in variable compensation expenses due to company performance objectives.

 

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Employee stock-based compensation totaled $2.9 million for the three months ended June 30, 2018 as compared to $1.9 million for the three months ended June 30, 2017, and $5.2 million for the six months ended June 30, 2018 as compared to $3.7 million for the six months ended June 30, 2017. The increase for the comparative periods was primarily related to restricted stock award vesting and retention rewards.

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

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

A summary of realized gains and losses for the three and six months ended June 30, 2018 and 2017 is as follows:

 

     Three Months Ended
June 30,
     Six Months Ended June 30,  
(in thousands)          2018                  2017                  2018                  2017        

Realized gains

   $ 6,880      $ 5,083      $ 7,988      $ 11,553  

Realized losses

     (15,791      (10,796      (21,819      (14,028
  

 

 

    

 

 

    

 

 

    

 

 

 

Net realized gains (losses)

   $ (8,911    $ (5,713    $ (13,831    $ (2,475
  

 

 

    

 

 

    

 

 

    

 

 

 

During the three and six months ended June 30, 2018 we recognized net realized losses of $8.9 million and $13.8 million, respectively. During the three months ended June 30, 2018, we recorded gross realized gains of $6.9 million primarily from the sale or acquisition of our holdings. These gains were offset by gross realized losses of $15.8 million primarily from the liquidation or write-off of our warrant and equity investments in seven portfolio companies and our debt investment in one portfolio company.

During the six months ended June 30, 2018, we recorded gross realized gains of $8.0 million primarily from the sale or acquisition of our holdings. These gains were offset by gross realized losses of $21.8 million primarily from the liquidation or write-off of our warrant and equity investments in thirteen portfolio companies and our debt investments in three portfolio companies

During the three and six months ended June 30, 2017, we recognized net realized losses of $5.7 million and $2.5 million respectively. During the three months ended June 30, 2017, we recorded gross realized gains of $5.1 million primarily from the sale of our holdings in one portfolio company. These gains were offset by gross realized losses of $10.8 million primarily from the liquidation or write-off of our warrant and equity investments in ten portfolio companies.

During the six months ended June 30, 2017, we recorded gross realized gains of $11.5 million primarily from the sale of our holdings in four portfolio companies. These gains were offset by gross realized losses of $14.0 million primarily from the liquidation or write-off of our warrant and equity investments in twelve portfolio companies and our debt investment in one portfolio company.

 

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The following table summarizes the change in net unrealized appreciation/depreciation of investments for the three and six months ended June 30, 2018 and 2017:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
(in thousands)    2018     2017     2018     2017  

Gross unrealized appreciation on portfolio investments

   $ 30,970     $ 68,389     $ 38,767     $ 87,867  

Gross unrealized depreciation on portfolio investments

     (14,819     (61,292     (44,367     (109,562

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

     20,925       6,015       27,591       3,610  
  

 

 

   

 

 

   

 

 

   

 

 

 

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

     37,076       13,112       21,991       (18,085

Other net unrealized appreciation (depreciation)

     1,121       475       1,009       169  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net unrealized appreciation (depreciation) on investments

   $ 38,197     $ 13,587     $ 23,000     $ (17,916
  

 

 

   

 

 

   

 

 

   

 

 

 

During the three months ended June 30, 2018, we recorded $38.2 million of net unrealized appreciation, of which $37.1 million was net unrealized depreciation from our debt, equity and warrant investments. We recorded $24.2 million of net unrealized appreciation on our debt investments which was attributable to $20.1 million of unrealized appreciation primarily due to the reversal of unrealized depreciation upon write-off of one portfolio company and loan repayments from three portfolio companies, along with $4.1 million of unrealized appreciation on the debt portfolio, including $1.8 million of unrealized appreciation on collateral-based impairments on one portfolio company.

We recorded $8.2 million of net unrealized appreciation on our equity investments and $4.7 million of net unrealized appreciation on our warrant investments during the three months ended June 30, 2018. This net unrealized appreciation of $12.9 million was primarily due to $12.1 million of unrealized appreciation on the equity and warrant portfolio investments.

During the six months ended June 30, 2018, we recorded $23.0 million of net unrealized appreciation, of which $22.0 million was net unrealized appreciation from our debt, equity and warrant investments. We recorded $15.9 million of net unrealized appreciation on our debt investments which was primarily related to $25.4 million of unrealized appreciation primarily due to the reversal of unrealized depreciation upon write-off of three portfolio companies and loan repayments from three portfolio companies. This unrealized appreciation was partially offset by $9.5 million of unrealized depreciation on the debt portfolio, including $8.3 million of unrealized depreciation on collateral-based impairments on four portfolio companies.

We recorded $4.1 million of net unrealized appreciation on our equity investments and $1.9 million of net unrealized appreciation on our warrant investments during the six months ended June 30, 2018. This net unrealized appreciation of $6.0 million was due to $3.9 million of unrealized appreciation on the equity and warrant portfolio and $2.1 million of unrealized appreciation primarily due to the reversal of unrealized depreciation upon being realized as a gain or loss due to the acquisition or liquidation of our equity and warrant investments.

During the three months ended June 30, 2017, we recorded $13.6 million of net unrealized appreciation, of which $13.2 million was net unrealized appreciation from our debt, equity and warrant investments. We recorded $50.9 million of net unrealized appreciation on our debt investments, which was primarily was attributed to the reversal of prior period collateral based impairments of $48.8 million unrealized depreciation for the prior period collateral-based impairments on two portfolio companies.

We recorded $42.9 million of net unrealized depreciation on our equity investments primarily due to the collateral-based impairment on one portfolio company, slightly offset by $6.8 million of unrealized appreciation

 

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for one portfolio company upon being realized as a gain. We also recorded $5.2 million of net unrealized appreciation on our warrant investments during the three months ended June 30, 2017.

During the six months ended June 30, 2017, we recorded $17.9 million of net unrealized depreciation, of which $18.0 million was net unrealized depreciation from our debt, equity and warrant investments. We recorded $19.7 million of net unrealized depreciation on our debt investments, which was primarily related to $38.5 million of unrealized depreciation for collateral-based impairments on seven portfolio companies offset by the reversal of $52.0 million unrealized depreciation for the prior period collateral-based impairments on three portfolio companies.

We recorded $45.7 million of net unrealized depreciation on our equity investments primarily due to $54.4 million of collateral based impairment on five portfolio companies and the reversal of approximately $2.1 million of unrealized appreciation for one portfolio company upon being realized as a gain. We also recorded $8.0 million of net unrealized appreciation on our warrant investments during six months ended June 30, 2017.

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 in 2018.

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

For the three months ended June 30, 2018, we had a net increase in net assets resulting from operations of approximately $52.1 million and for the three months ended June 30, 2017, we had a net increase in net assets resulting from operations of approximately $33.1 million. For the six months ended June 30, 2018, we had a net increase in net assets resulting from operations of approximately $58.0 million and for the six months ended June 30, 2017, we had a net increase in net assets resulting from operations of approximately $27.6 million.

Both the basic and fully diluted net change in net assets per common share were $0.59 per share for the three months ended June 30, 2018 and $0.67 per share for the six months ended June 30, 2018. Both the basic and fully diluted net change in net assets per common share were $0.40 per share and $0.33 per share for the three and six months ended June 30, 2017.

For the purpose of calculating diluted earnings per share for three and six months ended June 30, 2018 and 2017, the effect of the 2022 Convertible Notes, outstanding options, and restricted stock units under the treasury stock method was considered. The effect of the 2022 Convertible Notes was excluded from these calculations for the three and six months ended June 30, 2018 and 2017 as our share price was less than the conversion price in effect which results in anti-dilution.

Financial Condition, Liquidity, and Capital Resources

Our liquidity and capital resources are derived from our SBA debentures, 2022 Notes, 2024 Notes, 2025 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

 

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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 with JMP (the “Prior Equity Distribution Agreement”). 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 the Company 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 the Company’s common stock, if any, may be made in negotiated transactions or transactions that are deemed to be “at the market,” as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE or similar securities exchange or sales made to or through a market maker other than on an exchange, at prices related to the prevailing market prices or at negotiated prices.

During the six months ended June 30, 2018, we sold 2.6 million shares of common stock, which were issued under the Equity Distribution Agreement, for a total accumulated net proceeds of approximately $31.4 million, including $877,000 of offering expenses. As of June 30, 2018, approximately 7.8 million shares remain available for issuance and sale under the Equity Distribution Agreement. See “—Subsequent Events.”

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 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 LLC, as borrower, entered the Union Bank Facility. 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, N.A., 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

 

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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.

We did not sell any notes under the program during the three months ended June 30, 2018. During the year ended December 31, 2017, we sold 225,457 notes for approximately $5.6 million in aggregate principal amount. As of June 30, 2018, 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 pursuant to an indenture, dated September 7, 2017, between us and U.S. Bank, National Association, as trustee. The sale of the 2022 Notes generated net proceeds of approximately $147.4 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 $1.8 million.

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 April 2, 2018, we redeemed an additional $100.0 million of the remaining outstanding aggregate principal amount of the 2024 Notes.

On April 26, 2018, we issued $75.0 million in aggregate principal amount of the 2025 Notes pursuant to the Fifth Supplemental Indenture to the Base Indenture, dated April 26, 2018, between the Company and U.S. Bank, National Association, as trustee. The sale of the 2025 Notes generated net proceeds of approximately $72.6 million. Aggregate estimated offering expenses in connection with the transaction, including the underwriter’s discount and commissions were approximately $2.4 million.

On May 25, 2018, we entered into the Second Amendment (the “Amendment”) to the Union Bank Facility. The Amendment amends certain provisions of the Union Bank Facility to increase the commitments thereunder from $75.0 million to $100.0 million.

On June 14, 2018, we closed an underwritten public offering of 6.9 million shares of common stock, including an over-allotment option to purchase an additional 900,000 shares of common stock. The offering generated net proceeds, before expenses, of $81.3 million, including the underwriting discount and commissions of $2.6 million.

At June 30, 2018, we had $190.2 million of SBA debentures, $150.0 million of 2022 Notes, $83.5 million of 2024 Notes, $75.0 million of 2025 Notes, $31.1 million of 2021 Asset-Backed Notes, and $230.0 million of 2022 Convertible Notes payable, and $58.3 million of borrowings outstanding on the Union Bank Facility. We had no borrowings outstanding under the Wells Facility.

At June 30, 2018, we had $221.2 million in available liquidity, including $59.5 million in cash and cash equivalents. We had available borrowing capacity of $120.0 million under the Wells Facility and $41.7 million under the Union Bank Facility, both subject to existing terms and advance rates and regulatory requirements. We primarily invest cash on hand in interest bearing deposit accounts.

 

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At June 30, 2018, we had $118.5 million of capital outstanding in restricted accounts related to our SBIC that we may use to fund new investments in the SBIC. With our net investments of $44.0 million and $74.5 million in HT II and HT III, respectively, we have the combined capacity to issue a total of $190.2 million of SBA guaranteed debentures, subject to SBA approval. At June 30, 2018, we have issued $190.2 million in SBA guaranteed debentures in our SBIC subsidiaries. On July 13, 2018, we fully redeemed the principal outstanding on our SBA HT II debentures.

At June 30, 2018, we had approximately $15.9 million of restricted cash, which consists of collections of interest and principal payments on assets that are securitized. In accordance with the terms of the related securitized 2021 Asset-Backed Notes, based on current characteristics of the securitized debt investment portfolios, the restricted funds may be used to pay monthly interest and principal on the securitized debt and are not distributed to us or available for our general operations.

During the six months ended June 30, 2018, we principally funded our operations from (i) cash receipts from interest, dividend and fee income from our investment portfolio and (ii) cash proceeds from the realization of portfolio investments through the repayments of debt investments and the sale of debt and equity investments.

During the six months ended June 30, 2018, our operating activities used $93.9 million of cash and cash equivalents, compared to $67.6 million provided during the six months ended June 30, 2017. This $161.5 million increase in cash used in operating activities is primarily related to an increase in investment purchases of $223.1 million, partially offset by an increase in investment repayments of $64.8 million.

During the six months ended June 30, 2018, our investing activities used approximately $116,000 of cash, compared to $89,000 used during the six months ended June 30, 2017.

During the six months ended June 30, 2018, our financing activities provided $74.3 million of cash, compared to $88.8 million provided during the six months ended June 30, 2017. $14.4 million decrease in cash provided by financing activities was primarily due to the repayment of $100.0 million of our 2024 Notes in April 2018, an increase of $63.3 million of net credit facilities repayments, offset by the increase in issuance of our common stock of $65.7 million and the issuance of $75.0 million of our 2025 Notes in April 2018.

As of June 30, 2018, net assets totaled $963.7 million, with a NAV per share of $10.22. We intend to continue to operate in order to generate cash flows from operations, including income earned from investments in our portfolio companies. Our primary use of funds will be investments in portfolio companies and cash distributions to holders of our common stock.

As required by the 1940 Act, our asset coverage must be at least 200% through September 4, 2019 and 150% thereafter (or earlier if our stockholders approve the proposal to accelerate the application of the reduced asset coverage requirements to us) after each issuance of senior securities. As of June 30, 2018 our asset coverage ratio under our regulatory requirements as a business development company was 252.7% 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% through September 4, 2019 and 150% thereafter (or earlier if our stockholders approve the proposal to accelerate the application of the reduced asset coverage requirements to us), which while providing increased investment flexibility, also may increase our exposure to risks associated with leverage. Total asset coverage ratio when including our SBA debentures was 217.2% at June 30, 2018.

 

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Outstanding Borrowings

At June 30, 2018 and December 31, 2017, we had the following available borrowings and outstanding amounts:

 

     June 30, 2018      December 31, 2017  
(in thousands)    Total
Available
     Principal      Carrying
Value(1)
     Total
Available
     Principal      Carrying
Value(1)
 

SBA Debentures(2)

   $ 190,200      $ 190,200      $ 188,457      $ 190,200      $ 190,200      $ 188,141  

2022 Notes

     150,000        150,000        147,728        150,000        150,000        147,572  

2024 Notes

     83,510        83,510        81,694        183,510        183,510        179,001  

2025 Notes

     75,000        75,000        72,616        —          —          —    

2021 Asset-Backed Notes

     31,088        31,088        30,698        49,153        49,153        48,650  

2022 Convertible Notes

     230,000        230,000        224,269        230,000        230,000        223,488  

Wells Facility(3)

     120,000        —          —          120,000        —          —    

Union Bank Facility(3)

     100,000        58,323        58,323        75,000        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 979,798      $ 818,121      $ 803,785      $ 997,863      $ 802,863      $ 786,852  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(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 June 30, 2018 and December 31, 2017, 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)

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 June 30, 2018 and December 31, 2017 were as follows:

 

(in thousands)    June 30, 2018      December 31, 2017  

SBA Debentures

   $ 1,743      $ 2,059  

2022 Notes

     1,559        1,633  

2024 Notes

     1,871        4,591  

2025 Notes

     416        —    

2021 Asset-Backed Notes

     390        503  

2022 Convertible Notes

     3,269        3,715  

Wells Facility(1)

     188        227  

Union Bank Facility(1)

     273        379  
  

 

 

    

 

 

 

Total

   $ 9,709      $ 13,107  
  

 

 

    

 

 

 

 

(1)

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

Refer to “Note 4—Borrowings” included in the notes to our consolidated financial statements appearing elsewhere in this prospectus supplement for a discussion of the contract terms, interest expense, and fees associated with each outstanding borrowing as of and for the three and six months ended June 30, 2018.

 

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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 June 30, 2018, we had approximately $129.7 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 $80.0 million of non-binding term sheets outstanding to two new and one existing company, 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.

 

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As of June 30, 2018, 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)
 

ThumbTack, Inc.

   $ 25,000  

Tricida, Inc.

     25,000  

Contentful, Inc.

     15,000  

Impossible Foods, Inc.

     15,000  

Chemocentryx, Inc.

     10,000  

Proterra, Inc.

     10,000  

Evernote Corporation

     7,500  

Businessolver.com, Inc.

     6,375  

Achronix Semiconductor Corporation

     5,000  

Xometry, Inc.

     4,000  

Emma, Inc.

     2,963  

First Insight, Inc.

     1,500  

Lithium Technologies, Inc.

     878  

Greenphire, Inc.

     500  

Insurance Technologies Corporation

     500  

Salsa Labs, Inc.

     500  
  

 

 

 

Total

   $ 129,716  
  

 

 

 

 

(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 June 30, 2018:

 

     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)

   $ 818,121      $ 72,288      $ 97,073      $ 490,250      $ 158,510  

Operating Lease Obligations(4)

     16,655        2,352        5,614        5,868        2,821  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 834,776      $ 74,640      $ 102,687      $ 496,118      $ 161,331  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

Excludes commitments to extend credit to our portfolio companies.

(2)

Includes $190.2 million in principal outstanding under the SBA debentures, $150.0 million of the 2022 Notes, $83.5 million of the 2024 Notes, $75.0 million of the 2025 Notes, $31.1 million of the 2021 Asset-Backed Notes, $230.0 million of the 2022 Convertible Notes and $58.3 million under the Union Bank Facility as of June 30, 2018.

(3)

Amounts represent future principal repayments and not the carrying value of each liability. See Note 4 to our consolidated financial statements appearing elsewhere in this prospectus supplement.

(4)

Facility leases and licenses.

(5)

Reflects our intention to repay the remaining outstanding debentures in HT II in Q3 2018. See “—Subsequent Events.”

Certain premises are leased or licensed under agreements which expire at various dates through June 2027. Total rent expense amounted to approximately $510,000 and $961,000 during the three and six months ended June 30, 2018. Total rent expense amounted to approximately $449,000 and $893,000 during the three and six months ended June 30, 2017.

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

 

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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.

Distributions

The following table summarizes our distributions declared and paid, to be paid, or reinvested on all shares, including restricted stock, to date:

 

Date Declared

   Record Date      Payment Date      Amount Per Share  

Cumulative distributions declared and paid prior to January 1, 2016

         $ 11.23  

February 17, 2016

     March 7, 2016        March 14, 2016        0.31  

April 27, 2016

     May 16, 2016        May 23, 2016        0.31  

July 27, 2016

     August 15, 2016        August 22, 2016        0.31  

October 26, 2016

     November 14, 2016        November 21, 2016        0.31  

February 16, 2017

     March 6, 2017        March 13, 2017        0.31  

April 26, 2017

     May 15, 2017        May 22, 2017        0.31  

July 26, 2017

     August 14, 2017        August 21, 2017        0.31  

October 25, 2017

     November 13, 2017        November 20, 2017        0.31  

February 14, 2018

     March 5, 2018        March 12, 2018        0.31  

April 25, 2018

     May 14, 2018        May 21, 2018        0.31  

July 25, 2018

     August 13, 2018        August 20, 2018        0.31  
        

 

 

 
         $ 14.64  
        

 

 

 

On July 25, 2018, the Board of Directors declared a cash distribution of $0.31 per share to be paid on August 20, 2018 to stockholders of record as of August 13, 2018. This distribution represents our fifty-second consecutive distribution since our initial public offering, bringing the total cumulative distribution to date to $14.64 per share.

Our Board of Directors maintains a variable distribution policy with the objective of distributing four quarterly distributions in an amount that approximates 90—100% of our taxable quarterly income or potential annual income for a particular taxable year. In addition, at the end of our taxable year, our Board of Directors may choose to pay an additional special distribution, or fifth distribution, so that we may distribute approximately all of our annual taxable income in the taxable year in which it was earned, or may elect to maintain the option to spill over our excess taxable income into the following taxable year as part of any future distribution payments.

Distributions from our taxable income (including gains) to a stockholder generally will be treated as a dividend for U.S. federal income tax purposes to the extent of such stockholder’s allocable share of our current or accumulated earnings and profits. Distributions in excess of our current and accumulated earnings and profits would generally be treated first as a return of capital to the extent of a stockholder’s tax basis in our shares, and any remaining distributions would be treated as a capital gain. The determination of the tax attributes of our distributions is made annually as of the end of our taxable year based upon our taxable income for the full taxable year and distributions paid for the full taxable year. As a result, any determination of the tax attributes of our

 

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distributions made on a quarterly basis may not be representative of the actual tax attributes of the Company’s distributions for a full taxable year. Of the distributions declared during the year ended December 31, 2017, 100% were distributions derived from our current and accumulated earnings and profits.

During the three months ended June 30, 2018, we declared a distribution of $0.31 per share. If we had determined the tax attributes of our distributions year-to-date as of June 30, 2018, 100% would be from our current and accumulated earnings and profits. However, there can be no certainty to stockholders that this determination is representative of what the tax attributes of our 2018 distributions to stockholders will actually be.

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

Shortly after the close of each calendar year information identifying the source of the distribution (i.e., paid from ordinary income, paid from net capital gains on the sale of securities, and/or a return of paid-in-capital surplus which is a nontaxable distribution, if any) will be provided to our stockholders subject to information reporting. To the extent our taxable earnings fall below the total amount of our distributions for any taxable year, a portion of those distributions may be deemed a tax return of capital to our stockholders.

We expect to qualify to be subject to tax as a RIC under Subchapter M of the Code. In order to be subject to tax as a RIC, we are required to satisfy certain annual gross income and quarterly asset composition tests, as well as make distributions to our stockholders each taxable year treated as dividends for federal income tax purposes of an amount at least equal to 90% of the sum of our investment company taxable income, determined without regard to any deduction for dividends paid, plus our net tax-exempt income, if any. Upon being eligible to be subject to tax as a RIC, we would be entitled to deduct such distributions we pay to our stockholders in determining the overall components of our “taxable income.” Components of our taxable income include our taxable interest, dividend and fee income, reduced by certain deductions, as well as taxable net realized securities gains. Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses and generally excludes net unrealized appreciation or depreciation as such gains or losses are not included in taxable income until they are realized. In connection with maintaining our ability to be subject to tax as a RIC, among other things, we have made and intend to continue to make the requisite distributions to our stockholders each taxable year, which generally should relieve us from corporate-level U.S. federal income taxes.

As a RIC, we will be subject to a 4% nondeductible U.S. federal excise tax on certain undistributed income and gains unless we make distributions treated as dividends for U.S. federal income tax purposes in a timely manner to our stockholders in respect of each calendar year of an amount at least equal to the sum of (1) 98% of our ordinary income (taking into account certain deferrals and elections) for each calendar year, (2) 98.2% of our capital gain net income (adjusted for certain ordinary losses) for the 1-year period ending October 31 of each such calendar year and (3) any ordinary income and capital gain net income realized, but not distributed, in preceding calendar years. We will not be subject to this excise tax on any amount on which we incurred U.S. federal corporate income tax (such as the tax imposed on a RIC’s retained net capital gains).

Depending on the level of taxable income earned in a taxable year, we may choose to carry over taxable income in excess of current taxable year distributions treated as dividends for U.S. federal income tax purposes from such taxable income into the next taxable year and incur a 4% excise tax on such taxable income, as required. The maximum amount of excess taxable income that may be carried over for distribution in the next taxable year under the Code is the total amount of distributions treated as dividends for U.S. federal income tax purposes paid in the following taxable year, subject to certain declaration and payment guidelines. To the extent

 

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we choose to carry over taxable income into the next taxable year, distributions declared and paid by us in a taxable year may differ from our taxable income for that taxable year as such distributions may include the distribution of current taxable year taxable income, the distribution of prior taxable year taxable income carried over into and distributed in the current taxable year, or returns of capital.

We can offer no assurance that we will achieve results that will permit the payment of any cash distributions and, if we issue senior securities, we will be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our borrowings. Our ability to make distributions will be limited by the asset coverage requirements under the 1940 Act.

We intend to distribute 100% of our spillover earnings, which consists of ordinary income, from the year ended December 31, 2017 to our stockholders during 2018.

Critical Accounting Policies

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and revenues and expenses during the period reported. On an ongoing basis, our management evaluates its estimates and assumptions, which are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates. Changes in our estimates and assumptions could materially impact our results of operations and financial condition.

Reclassification

Certain balances from prior years have been reclassified in order to conform to the current year presentation.

Valuation of Investments

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

At June 30, 2018, approximately 94.9% of our total assets represented investments in portfolio companies whose fair value is determined in good faith by the Board of Directors. Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by the Board of Directors. Our investments are carried at fair value in accordance with the 1940 Act and ASC Topic 946 and measured in accordance with ASC Topic 820. Our debt securities are primarily invested in venture capital-backed companies in technology-related industries including technology, drug discovery and development, biotechnology, life sciences, healthcare and sustainable and renewable technology at all stages of development. Given the nature of lending to these types of businesses, substantially all of our investments in these portfolio companies are considered Level 3 assets under ASC Topic 820 because there is no known or accessible market or market indexes for these investment securities to be traded or exchanged. As such, we value substantially all of our investments at fair value as determined in good faith pursuant to a consistent valuation policy by our Board of Directors in accordance with the provisions of ASC Topic 820 and the 1940 Act. Due to the inherent uncertainty in determining the fair value of investments that do not have a readily available market value, the fair value of our investments determined in good faith by our Board of Directors may differ significantly from the value that would have been used had a readily available market existed for such investments, and the differences could be material.

 

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We may from time to time engage an independent valuation firm to provide us with valuation assistance with respect to certain of our portfolio investments. We engage independent valuation firms on a discretionary basis. Specifically, on a quarterly basis, we will identify portfolio investments with respect to which an independent valuation firm will assist in valuing. We select these portfolio investments based on a number of factors, including, but not limited to, the potential for material fluctuations in valuation results, credit quality and the time lapse since the last valuation of the portfolio investment by an independent valuation firm.

We intend to continue to engage an independent valuation firm to provide us with assistance regarding our determination of the fair value of selected portfolio investments each quarter unless directed by the Board of Directors to cancel such valuation services. The scope of the services rendered by an independent valuation firm is at the discretion of the Board of Directors. Our Board of Directors is ultimately, and solely, responsible for determining the fair value of our investments in good faith.

Refer to “Note 2—Summary of Significant Accounting Policies” included in the notes to our consolidated financial statements appearing elsewhere in this prospectus supplement for a discussion of our valuation policies for the three and six months ended June 30, 2018.

Income Recognition

See “—Changes in Portfolio” for a discussion of our income recognition policies and results during the three and six months ended June 30, 2018. See “—Results of Operations” for a comparison of investment income for the three and six months ended June 30, 2018 and 2017.

Stock Based Compensation

We have issued and may, from time to time, issue stock options and restricted stock to employees under the Hercules Capital, Inc. Amended and Restated 2018 Equity Incentive Plan and the Hercules Capital, Inc. 2018 Non-employee Director Plan. We follow the guidelines set forth under ASC Topic 718, (“Compensation—Stock Compensation”) to account for stock options granted. Under ASC Topic 718, compensation expense associated with stock-based compensation is measured at the grant date based on the fair value of the award and is recognized over the vesting period. Determining the appropriate fair value model and calculating the fair value of stock-based awards at the grant date requires judgment, including estimating stock price volatility, forfeiture rate and expected option life.

Recent Accounting Pronouncements

In January 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-01, “Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,” which, among other things, requires that (i) all equity investments, other than equity-method investments, in unconsolidated entities generally be measured at fair value through earnings and (ii) an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. Additionally, the ASU changes the disclosure requirements for financial instruments. ASU 2016-01 is effective for annual reporting periods, and the interim periods within those periods, beginning after December 15, 2017. We have adopted this standard, which did not have a material impact, on our consolidated financial statements and related disclosures for the periods presented.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” which, among other things, requires recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. Additionally, the ASU requires the classification of all cash payments on leases within operating activities in the Consolidated Statement of Cash Flows. ASU 2016-02 is effective for annual

 

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reporting periods, and the interim periods within those periods, beginning after December 15, 2018. Early adoption is permitted. We anticipate an increase in the recognition of right-of-use assets and lease liabilities, however, we do not believe that ASU 2016-02 will have a material impact on our consolidated financial statements and disclosures.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,” which addresses eight specific cash flow issues including, among other things, the classification of debt prepayment or debt extinguishment costs. ASU 2016-15 is effective for annual reporting periods, and the interim periods within those periods, beginning after December 15, 2017. We have adopted this standard, which did not have a material impact, on our consolidated financial statements and related disclosures for the periods presented.

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230),” which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new guidance is effective for interim and annual periods beginning after December 15, 2017. We have adopted this standard, which did not have a material impact, on our consolidated financial statements and related disclosures for the periods presented.

In June 2018, the FASB issued ASU 2018-07, “Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting”. This amendment expands the scope of Topic 718, Compensation—Stock Compensation (which currently only includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU 2018-07 supersedes Subtopic 505-50, Equity—Equity-Based Payments to Non-Employees and is effective for annual reporting periods, and the interim periods within those periods, beginning after December 15, 2018. We do not believe that ASU 2018-07 will have a material impact on our consolidated financial statements and disclosures.

Subsequent Events

Reduced Asset Coverage Requirements

The SBCAA, which was signed into law in March 2018, decreased the minimum asset coverage ratio in Section 61(a) of the 1940 Act for business development companies 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). On September 4, 2018, our Board of Directors, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act), approved the application to us of the 150% minimum asset coverage ratio set forth in Section 61(a)(2) of the 1940 Act. As a result, the minimum asset coverage ratio applicable to us will be reduced from 200% to 150%, effective as of September 4, 2019, unless approved earlier by a vote of our stockholders, in which case the 150% minimum asset coverage ratio will be effective on the day after such approval. Our Board of Directors also authorized the submission of a proposal for stockholders to accelerate the application of the 150% minimum asset coverage ratio to us at a special meeting of stockholders. As a result of our Board of Director’s approval, effective as of September 4, 2019 (or earlier if our stockholders approve the proposal to accelerate the application of the reduced asset coverage requirements to us), we will be able to incur additional indebtedness and, therefore, your risk of an investment in us may increase. In connection with the change in minimum coverage ratio, S&P lowered our rating to a non-investment grade rating, and we terminated our ratings agreement with S&P. On September 6, 2018, DBRS, Inc. assigned us an investment grade rating. Other 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

 

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affect our 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 and “Risk Factors—Risks Related to Our Securities—A downgrade, suspension or withdrawal of the credit rating assigned by a rating agency to us or our debt securities, if any, or change in the debt markets could cause the liquidity or market value of our debt securities to decline significantly” in the accompanying prospectus.

Distribution Declaration

On July 25, 2018, our Board of Directors declared a cash distribution of $0.31 per share, which was paid on August 20, 2018 to stockholders of record as of August 13, 2018. This distribution represents our fifty-second consecutive distribution since our initial public offering, bringing the total cumulative distribution to date to $14.64 per share.

ATM Equity Program Issuances

Subsequent to June 30, 2018 and as of September 13, 2018, we sold 2.2 million shares of common stock for total accumulated net proceeds of approximately $28.6 million, including $229,000 of offering expenses, under the Equity Distribution Agreement. As of September 13, 2018, approximately 5.6 million shares remain available for issuance and sale under the Equity Distribution Agreement.

Hercules Technology II Debentures Full Redemption

On July 13, 2018, we completed repayment of the $41.2 million of outstanding HT II debentures.

Amendment to Wells Facility

On July 31, 2018, we entered into a further amendment to the Wells Facility to extend the maturity date and fully repay the pro-rata portion of outstanding balances of Alostar Bank of Commerce and Everbank Commercial Finance Inc., thereby resigning both as lenders and terminating their commitments thereunder.

Departure of Officer

On August 16, 2018, Gerard R. Waldt, Jr., Controller and Interim Chief Accounting Officer, tendered his resignation from the Company. Mr. Waldt’s resignation was not a result of any disagreement with the Company on any matter relating to the Company’s operations, policies or practices. David Lund, the Company’s current Interim Chief Financial Officer, assumed the duties of Interim Chief Accounting Officer effective as of August 23, 2018. The resignation of Mr. Waldt was effective on September 7, 2018.

Portfolio Company Developments

As of September 13, 2018, 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 initial public offerings. Both companies filed confidentially under the JOBS Act. There can be no assurance that companies that have yet to complete their initial public offerings will do so in a timely manner or at all. Subsequent to June 30, 2018 and as of September 13, 2018, there were two companies that announced or completed liquidity events.

 

  1.

In August 2018, our portfolio company NuGEN Technologies, Inc., a leading provider for innovative next-generation sequencing kits and genomic sample preparation solutions for the fastest growing field within the genomics area, was acquired by the Tecan Group (SIX Swiss Exchange: TECN), a leading global provider of laboratory instruments and solutions in biopharmaceuticals, forensics and clinical diagnostics. Terms of the acquisition were not disclosed.

 

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  2.

In August 2018, our portfolio company Avnera Corporation, a fabless semiconductor firm making custom Analog System-on-Chip (ASoC) solutions for audio, voice, speech, sensor and artificial intelligence (AI) applications, was acquired by Skyworks Solutions, Inc. (NASDAQ: SWKS), an innovator of high-performance analog semiconductors connecting people, places and things. Skyworks paid $405.0 million in cash to Avnera equity holders at closing with up to an additional $20.0 million to be paid if certain performance targets are exceeded over a 12-month period post-closing period.

Quantitative and Qualitative Disclosures about Market Risk

We are subject to financial market risks, including changes in interest rates. Interest rate risk is defined as the sensitivity of our current and future earnings to interest rate volatility, variability of spread relationships, the difference in re-pricing intervals between our assets and liabilities and the effect that interest rates may have on our cash flows. Changes in interest rates may affect both our cost of funding and our interest income from portfolio investments, cash and cash equivalents and idle fund investments. Our investment income will be affected by changes in various interest rates, including LIBOR and Prime rates, to the extent our debt investments include variable interest rates. As of June 30, 2018, approximately 97.2% of the loans in our portfolio had variable rates based on floating Prime or LIBOR rates with a floor. Changes in interest rates can also affect, among other things, our ability to acquire and originate loans and securities and the value of our investment portfolio.

Based on our Consolidated Statement of Assets and Liabilities as of June 30, 2018, the following table shows the approximate annualized increase (decrease) in components of net assets resulting from operations of hypothetical base rate changes in interest rates, assuming no changes in our investments and borrowings.

 

(in thousands) Basis Point Change

   Interest
Income
     Interest
Expense
     Net
Income
     EPS(1)  

25

   $ 3,489      $ 36      $ 3,453      $ 0.04  

50

   $ 7,061      $ 71      $ 6,990      $ 0.08  

75

   $ 10,632      $ 107      $ 10,525      $ 0.12  

100

   $ 14,353      $ 143      $ 14,210      $ 0.16  

200

   $ 28,988      $ 286      $ 28,702      $ 0.33  

300

   $ 43,172      $ 429      $ 42,743      $ 0.49  

 

(1)

Earnings per share impact calculated based on basic weighted average shares outstanding of 87,125.

We do not currently engage in any hedging activities. However, we may, in the future, hedge against interest rate fluctuations (and foreign currency) by using standard hedging instruments such as futures, options, and forward contracts. While hedging activities may insulate us against changes in interest rates (and foreign currency), they may also limit our ability to participate in the benefits of lower interest rates with respect to our borrowed funds and higher interest rates with respect to our portfolio of investments. During the six months ended June 30, 2018 we did not engage in interest rate (or foreign currency) hedging activities.

Although we believe that the foregoing analysis is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in the credit market, credit quality, size and composition of the assets in our portfolio. It also does not adjust for other business developments, including borrowings under our SBA debentures, 2022 Notes, 2024 Notes, 2025 Notes, 2021 Asset-Backed Notes, 2022 Convertible Notes and Credit Facilities that could affect the net increase in net assets resulting from operations, or net income. It also does not assume any repayments from borrowers. Accordingly, no assurances can be given that actual results would not differ materially from the statement above.

Because we currently borrow, and plan to borrow in the future, money to make investments, our net investment income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest the funds borrowed. Accordingly, there can be no assurance that a significant change in market

 

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interest rates will not have a material adverse effect on our net investment income. In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment income if there is not a corresponding increase in interest income generated by variable rate assets in our investment portfolio.

For additional information regarding the interest rate associated with each of our SBA debentures, 2022 Notes, 2024 Notes, 2025 Notes, 2021 Asset-Backed Notes, 2022 Convertible Notes, and Credit Facilities, please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition, Liquidity and Capital Resources—Outstanding Borrowings” and “Note 4—Borrowings” included in the notes to our consolidated financial statements appearing elsewhere in this prospectus supplement.

 

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UNDERWRITING

We are offering the Notes described in this prospectus supplement and the accompanying prospectus through a number of underwriters. Keefe, Bruyette & Woods, Inc., Morgan Stanley & Co. LLC and UBS Securities LLC are acting as representatives of the underwriters. We have entered into an underwriting agreement with the underwriters. Subject to the terms and conditions of the underwriting agreement, we have agreed to sell to the underwriters, and each underwriter has severally and not jointly agreed to purchase from us, the aggregate principal amount of Notes listed next to its name in the following table:

 

Underwriter

   Principal Amount  

Keefe, Bruyette & Woods, Inc.

   $                

Morgan Stanley & Co. LLC

   $    

UBS Securities LLC

   $    

Janney Montgomery Scott LLC

   $    

BB&T Capital Markets, a division of BB&T Securities, LLC

   $    

B. Riley FBR, Inc.

   $    

Ladenburg Thalmann & Co. Inc.

   $    

Compass Point Research & Trading, LLC

   $    

Wedbush Securities Inc.

   $    
  

 

 

 

Total

   $                
  

 

 

 

Subject to the terms and conditions set forth in the underwriting agreement, the underwriters have agreed, severally and not jointly, to purchase all of the Notes sold under the underwriting agreement if any of these Notes are purchased. If an underwriter defaults, the underwriting agreement provides that the purchase commitments of the nondefaulting underwriters may be increased or the underwriting agreement may be terminated.

We have agreed to indemnify the several underwriters against certain liabilities, including liabilities under the Securities Act, or to contribute to payments the underwriters may be required to make in respect of those liabilities.

The underwriters are offering the Notes, subject to prior sale, when, as and if issued to and accepted by them, subject to approval of legal matters by their counsel, and other conditions contained in the underwriting agreement, such as the receipt by the underwriters of officer’s certificates and legal opinions. The underwriters reserve the right to withdraw, cancel or modify offers to the public and to reject orders in whole or in part.

Commissions and Discounts

An underwriting discount of     % per Note will be paid by us. An underwriting discount of     % per Note will be paid by us for any Notes purchased pursuant to the overallotment option.

The following table shows the total underwriting discounts and commissions that we are to pay to the underwriters in connection with this offering. The information assumes either no exercise or full exercise by the underwriters of their overallotment option.

 

     Per Note      Without
Option
     With
Option
 

Public offering price

   $                    $                    $            

Underwriting discount(1)

   $        $        $    

Proceeds, before expenses, to us(2)

   $        $        $                

 

(1)

Reflects an underwriting discount that may vary between sales to retail investors and sales to institutional investors.

(2)

Before deducting expenses payable by us related to this offering, estimated at $            .

 

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The underwriters propose to offer some of the Notes to the public at the public offering price set forth on the cover page of this prospectus supplement and some of the Notes to certain other Financial Industry Regulatory Authority (FINRA) members at the public offering price less a concession not in excess of $        per Note sold to retail investors and $        per Note sold to institutional investors. The underwriters may allow, and the dealers may reallow, a discount not in excess of     % of the aggregate principal amount of the Notes. After the initial offering of the Notes to the public, the public offering price and such concessions may be changed. No such change shall change the amount of proceeds to be received by us as set forth on the cover page of this prospectus supplement.

The expenses of the offering, including up to $10,000 in reimbursement of underwriters’ counsel fee, but not including the underwriting discount, are estimated at $        and are payable by us.

Overallotment Option

We have granted an option to the underwriters to purchase up to an additional $        aggregate principal amount of the Notes offered hereby at the public offering price within 30 days from the date of this prospectus supplement solely to cover any overallotments. If the underwriters exercise this option, each will be obligated, subject to conditions contained in the underwriting agreement, to purchase a number of additional Notes proportionate to that underwriter’s initial principal amount reflected in the above table.

No Sales of Similar Securities

We have agreed not to directly or indirectly sell, offer to sell, enter into any agreement to sell, or otherwise dispose of, any debt securities issued by the Company in minimum denominations of $25 for a period of 30 days after the date of this prospectus supplement without first obtaining the written consent of the representatives. This consent may be given at any time without public notice.

Listing

The Notes are a new issue of securities with no established trading market. We intend to apply to list the Notes on the NYSE. We expect trading in the Notes on the NYSE to begin within 30 days after the original issue date under the symbol “HCXY.” Currently there is no public market for the Notes.

We have been advised by certain of the underwriters that certain of the underwriters presently intend to make a market in the Notes after completion of this offering as permitted by applicable laws and regulations. Such underwriters are not obligated, however, to make a market in the Notes and any such market-making may be discontinued at any time in the sole discretion of such underwriters without any notice. Accordingly, no assurance can be given that an active and liquid public trading market for the Notes will develop or be maintained. If an active public trading market for the Notes does not develop, the market price and liquidity of the Notes may be adversely affected.

Price Stabilization, Short Positions

In connection with the offering, the underwriters may purchase and sell Notes in the open market. These transactions may include covering transactions and stabilizing transactions. Overallotment involves sales of securities in excess of the aggregate principal amount of securities to be purchased by the underwriters in the offering, which creates a short position for the underwriters. Covering transactions involve purchases of the securities in the open market after the distribution has been completed in order to cover short positions. Stabilizing transactions consist of certain bids or purchases of securities made for the purpose of preventing or retarding a decline in the market price of the securities while the offering is in progress.

 

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The underwriters also may impose a penalty bid. This occurs when a particular underwriter repays to the underwriters a portion of the underwriting discount received by it because the representatives have repurchased Notes sold by or for the account of such underwriter in stabilizing or short covering transactions.

Any of these activities may cause the price of the Notes to be higher than the price that otherwise would exist in the open market in the absence of such transactions. These transactions may be affected in the over-the-counter market or otherwise and, if commenced, may be discontinued at any time without any notice relating thereto.

Electronic Offer, Sale and Distribution of Notes

The underwriters may make prospectuses available in electronic (PDF) format. A prospectus in electronic (PDF) format may be made available on a web site maintained by the underwriters, and the underwriters may distribute such prospectuses electronically. The underwriters may allocate a limited principal amount of the Notes for sale to their online brokerage customers.

Other Relationships

The underwriters and their affiliates have provided in the past and may provide from time to time in the future in the ordinary course of their business certain commercial banking, financial advisory, investment banking and other services to Hercules or our portfolio companies for which they have received or will be entitled to receive separate fees. In particular, the underwriters or their affiliates may execute transactions with Hercules or on behalf of Hercules or any of our portfolio companies.

The underwriters or their affiliates may also trade in our securities, securities of our portfolio companies or other financial instruments related thereto for their own accounts or for the account of others and may extend loans or financing directly or through derivative transactions to us or any of our portfolio companies.

We may purchase securities of third parties from the underwriters or their affiliates after the offering. However, we have not entered into any agreement or arrangement regarding the acquisition of any such securities, and we may not purchase any such securities. We would only purchase any such securities if—among other things—we identified securities that satisfied our investment needs and completed our due diligence review of such securities.

After the date of this prospectus supplement, the underwriters and their affiliates may from time to time obtain information regarding specific portfolio companies or us that may not be available to the general public. Any such information is obtained by the underwriters and their affiliates in the ordinary course of its business and not in connection with the offering of the Notes. In addition, after the offering period for the sale of the Notes, the underwriters or their affiliates may develop analyses or opinions related to Hercules or our portfolio companies and buy or sell interests in one or more of our portfolio companies on behalf of their proprietary or client accounts and may engage in competitive activities. There is no obligation on behalf of these parties to disclose their respective analyses, opinions or purchase and sale activities regarding any portfolio company or regarding us to our noteholders or any other persons.

In the ordinary course of their various business activities, the underwriters and their respective affiliates may make or hold a broad array of investments and actively trade debt and equity securities (or related derivative securities) and financial instruments (including bank loans) for their own account and for the accounts of their customers. Such investments and securities activities may involve securities and/or instruments of ours or our affiliates. Certain of the underwriters and their affiliates that have a lending relationship with us routinely hedge their credit exposure to us consistent with their customary risk management policies. Typically, such underwriters and their affiliates would hedge such exposure by entering into transactions which consist of either the purchase of credit default swaps or the creation of short positions in our securities, including potentially the

 

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Notes offered hereby. Any such short positions could adversely affect future trading prices of the Notes offered hereby. The underwriters and their affiliates may also make investment recommendations and/or publish or express independent research views in respect of such securities or financial instruments and may hold, or recommend to clients that they acquire, long and/or short positions in such securities and instruments.

The principal business address of Keefe, Bruyette & Woods, Inc. is 787 7th Avenue, Fourth Floor, New York, New York 10019. The principal business address of Morgan Stanley & Co. LLC is 1585 Broadway, New York, New York 10036. The principal business address of UBS Securities LLC is 1285 Avenue of the Americas, New York, New York 10019.

Other Jurisdictions

Other than in the United States, no action has been taken by us or the underwriters that would permit a public offering of the Notes offered by this prospectus supplement in any jurisdiction where action for that purpose is required. The Notes offered by this prospectus supplement may not be offered or sold, directly or indirectly, nor may this prospectus supplement or any other offering material or advertisements in connection with the offer and sale of any such Notes be distributed or published in any jurisdiction, except under circumstances that will result in compliance with the applicable rules and regulations of that jurisdiction. Persons into whose possession this prospectus supplement comes are advised to inform themselves about and to observe any restriction relating to the offering and the distribution of this prospectus supplement. This prospectus supplement and the accompanying prospectus do not constitute an offer to sell or a solicitation of an offer to buy the Notes offered by this prospectus supplement and the accompanying prospectus in any jurisdiction in which such an offer or a solicitation is unlawful.

Alternative Settlement Cycle

We expect that delivery of the Notes will be made to investors on or about September     , 2018, which will be the          business day following the date hereof. Under Rule 15c6-1 under the Exchange Act, trades in the secondary market are required to settle in two business days, unless the parties to any such trade expressly agree otherwise. Accordingly, purchasers who wish to trade Notes prior to the delivery of the Notes hereunder will be required, by virtue of the fact that the Notes initially settle in T+     , to specify an alternate settlement arrangement at the time of any such trade to prevent a failed settlement. Purchasers of the Notes who wish to trade the Notes prior to their date of delivery should consult their advisors.

 

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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS

The following discussion is a general summary of the material U.S. federal income tax considerations (and, in the case of a non-U.S. holder (as defined below), the material U.S. federal estate tax consequences) applicable to an investment in the Notes. This summary deals only with Notes that are purchased for cash in this offering for a price equal to the “issue price” of the Notes (i.e., the first price at which a substantial amount of the notes is sold for money to investors, other than to bond houses, brokers, or similar persons or organizations acting in the capacity of underwriters, placement agents or wholesalers). This summary does not purport to be a complete description of the income and estate tax considerations applicable to such an investment. The discussion is based upon the Code, Treasury Regulations, and administrative and judicial interpretations, each as of the date of this prospectus supplement and all of which are subject to change, potentially with retroactive effect. No assurance can be given that the U.S. Internal Revenue Service (“IRS”) would not assert, or that a court would not sustain, a position contrary to any of the tax aspects set forth below. You should consult your own tax advisor with respect to tax considerations that pertain to your purchase of our Notes.

This discussion deals only with Notes held as capital assets within the meaning of Section 1221 of the Code (generally, property held for investment purposes) and does not purport to deal with persons in special tax situations, such as financial institutions, insurance companies, regulated investment companies, dealers in securities or currencies, traders in securities, former citizens of the United States, persons holding the Notes as a hedge against currency risks or as a position in a “straddle,” “hedge,” “constructive sale transaction” or “conversion transaction” for tax purposes, entities that are tax-exempt for U.S. federal income tax purposes, retirement plans, individual retirement accounts, tax-deferred accounts, persons subject to the alternative minimum tax, pass-through entities (including partnerships and entities and arrangements classified as partnerships for U.S. federal income tax purposes) and beneficial owners of pass-through entities, accrual method taxpayers for U.S. federal income tax purposes required to accelerate the recognition of any item of gross income with respect to the Notes as a result of such income being recognized on an applicable financial statement, or U.S. holders (as defined below) whose functional currency is not the U.S. dollar. In addition, this discussion does not deal with any tax consequences other than U.S. federal income tax consequences (and, in the case of a non-U.S. holder, U.S. federal estate tax consequences). If you are considering purchasing the Notes, you should consult your own tax advisor concerning the application of the U.S. federal income and estate tax laws to you in light of your particular situation, as well as any consequences to you of purchasing, owning and disposing of the Notes under the laws of any other taxing jurisdiction.

For purposes of this discussion, the term “U.S. holder” means a beneficial owner of a Note that is, for U.S. federal income tax purposes, (i) an individual citizen or resident of the United States, (ii) a corporation or other entity treated as a corporation for U.S. federal income tax purposes, created or organized in or under the laws of the United States or of any state thereof or the District of Columbia, (iii) a trust (a) subject to the control of one or more U.S. persons and the primary supervision of a court in the United States, or (b) that existed on August 20, 1996 and has made a valid election (under applicable Treasury Regulations) to be treated as a domestic trust, or (iv) an estate the income of which is subject to U.S. federal income taxation regardless of its source. The term “non-U.S. holder” means a beneficial owner of a Note that is neither a U.S. holder nor a partnership (including an entity or arrangement treated as a partnership for U.S. federal income tax purposes).

If a partnership (including an entity or arrangement treated as a partnership for U.S. federal income tax purposes) holds any Notes, the U.S. federal income tax treatment of a partner of the partnership generally will depend upon the status of the partner, the activities of the partnership and certain determinations made at the partner level. Partnerships holding Notes, and the persons holding interests in such partnerships, should consult their own tax advisors as to the consequences of investing in the Notes in their individual circumstances.

 

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Taxation of Note Holders

Taxation of U.S. Holders.

Payments or accruals of interest on a Note generally will be taxable to a U.S. holder as ordinary interest income at the time they are received (actually or constructively) or accrued, in accordance with the U.S. holder’s regular method of tax accounting.

Upon the sale, exchange, redemption, retirement or other taxable disposition of a Note, a U.S. holder generally will recognize capital gain or loss equal to the difference between the amount realized on the sale, exchange, redemption, retirement or other taxable disposition (excluding amounts representing accrued and unpaid interest, which are treated as ordinary income to the extent not previously included in income) and the U.S. holder’s adjusted tax basis in the Note. A U.S. holder’s adjusted tax basis in a Note generally will equal the U.S. holder’s initial investment in the Note. Capital gain or loss generally will be long-term capital gain or loss if the U.S. holder’s holding period in the Note was more than one year. Long-term capital gains generally are taxed at reduced rates for individuals and certain other non-corporate U.S. holders. The distinction between capital gain and loss and ordinary income and loss also is important for purposes of, among other things, the limitations imposed on a U.S. holder’s ability to offset capital losses against ordinary income.

Under applicable Treasury Regulations, if a U.S. holder recognizes a loss with respect to the Notes or shares of our common stock of $2 million or more for a non-corporate U.S. holder or $10 million or more for a corporate U.S. holder in any single taxable year (or a greater loss over a combination of taxable years), the U.S. holder may be required to file with the IRS a disclosure statement on IRS Form 8886. Direct U.S. holders of portfolio securities are in many cases excepted from this reporting requirement, but, under current guidance, U.S. holders of a RIC are not excepted. Future guidance may extend the current exception from this reporting requirement to U.S. holders of most or all RICs. The fact that a loss is reportable under these regulations does not affect the legal determination of whether the taxpayer’s treatment of the loss is proper. Significant monetary penalties apply to a failure to comply with this reporting requirement. States may also have a similar reporting requirement. U.S. holders of the Notes or our common stock should consult their own tax advisors to determine the applicability of these Treasury Regulations in light of their individual circumstances.

Taxation of Non-U.S. Holders. Except as provided below under “Information Reporting and Backup Withholding” and “FATCA,” a non-U.S. holder generally will not be subject to U.S. federal income or withholding taxes on payments of principal or interest on a Note provided that (i) income on the Note is not effectively connected with the conduct by the non-U.S. holder of a trade or business within the United States, (ii) the non-U.S. holder is not a controlled foreign corporation related to the Company through stock ownership, (iii) the non-U.S. holder is not a bank receiving interest described in Section 881(c)(3)(A) of the Code, (iv) the non-U.S. holder does not own (directly or indirectly, actually or constructively) 10% or more of the total combined voting power of all classes of stock of the Company, and (v) the non-U.S. holder provides a valid certification on an IRS Form W-8BEN, Form W-8BEN-E, or other applicable U.S. nonresident withholding tax certification form, certifying its non-U.S. holder status to (A) the applicable withholding agent, or (B) a securities clearing organization, bank, or other financial institution that holds customer securities in the ordinary course of its trade or business (i.e., a “financial institution”) and holds the Note on the non-U.S. holder’s behalf and certifies to the applicable withholding agent (directly or through one or more similarly situated financial institutions) that it has received the required statement from the non-U.S. holder certifying that it is a non-U.S. person and furnishes the applicable withholding agent with a copy of the statement.

A non-U.S. holder that is not exempt from tax under these rules generally will be subject to U.S. federal income tax withholding on payments of interest on the Notes at a rate of 30% unless (i) the income is effectively connected with the conduct of a U.S. trade or business, so long as the non-U.S. holder has provided the applicable withholding agent with an IRS Form W-8ECI or substantially similar substitute U.S. nonresident withholding tax certification form stating that the interest on the Notes is effectively connected with the non-U.S. holder’s conduct of a trade or business in the U.S. in which case the interest will be subject to U.S. federal

 

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income tax on a net income basis as applicable to U.S. holders generally (unless an applicable income tax treaty provides otherwise), or (ii) an applicable income tax treaty or provision in the Code provides for a lower rate of, or exemption from, withholding tax, so long as the non-U.S. holder has provided the applicable withhold agent with an IRS Form W-8BEN or Form W-8BEN-E (or other applicable U.S. nonresident withholding tax certification form) signed under penalties of perjury, claiming such lower rate of, or exemption from, withholding tax under such income tax treaty. To claim the benefit of an income tax treaty or to claim exemption from withholding because income is effectively connected with a U.S. trade or business, the non-U.S. holder must timely provide the appropriate, properly executed IRS forms. These forms may be required to be updated periodically. Additionally, a non-U.S. holder who is claiming the benefits of an income tax treaty may be required to obtain a U.S. taxpayer identification number and provide certain documentary evidence issued by a non-U.S. governmental authority in order to prove residence in a foreign country.

In the case of a non-U.S. holder that is a corporation and that receives income that is effectively connected with the conduct of a U.S. trade or business, such income may also be subject to a branch profits tax (which is generally imposed on a non-U.S. corporation on the actual or deemed repatriation from the United States of earnings and profits attributable to a U.S. trade or business) at a 30% rate. The branch profits tax may not apply (or may apply at a reduced rate) if the non-U.S. holder is a qualified resident of a country with which the United States has an income tax treaty. To claim an exemption from withholding because interest on the Notes is effectively connected with a United States trade or business, a non-U.S. holder must timely provide the appropriate, properly executed U.S. nonresident withholding tax certification form (currently on IRS Form W-8ECI) to the applicable withholding agent.

Generally, a non-U.S. holder will not be subject to U.S. federal income or withholding taxes on any amount that constitutes capital gain upon the sale, exchange, redemption, retirement or other taxable disposition of a Note, provided that the gain is not effectively connected with the conduct of a trade or business in the United States by the non-U.S. holder (and, if required by an applicable income tax treaty, is not attributable to a United States “permanent establishment” maintained by the non-U.S. holder). Non-U.S. holders should consult their own tax advisors with regard to whether taxes will be imposed on capital gain in their individual circumstances.

A Note that is held by an individual who, at the time of death, is not a citizen or resident of the United States (as specially defined for U.S. federal estate tax purposes) generally will not be subject to the U.S. federal estate tax, unless, at the time of death, (i) such individual directly or indirectly, actually or constructively, owns ten percent or more of the total combined voting power of all classes of our stock entitled to vote within the meaning of Section 871(h)(3) of the Code and the Treasury Regulations thereunder or (ii) such individual’s interest in the Notes is effectively connected with the individual’s conduct of a U.S. trade or business.

Information Reporting and Backup Withholding. A U.S. holder (other than an “exempt recipient,” including a corporation and certain other persons who, when required, demonstrate their exempt status) may be subject to backup withholding on, and to information reporting requirements with respect to, payments of principal and interest on, and proceeds from the sale, exchange, redemption or retirement of, the Notes. In general, if a non-corporate U.S. holder subject to information reporting fails to furnish a correct taxpayer identification number or otherwise fails to comply with applicable backup withholding requirements, backup withholding at the applicable rate (currently, 24%) may apply.

In addition, backup withholding tax and certain other information reporting requirements apply to payments of principal and interest on, and proceeds from the sale, exchange, redemption or retirement of, the Notes held by a non-U.S. holder, unless an exemption applies. Backup withholding and information reporting will not apply to payments we make to a non-U.S. holder if such non-U.S. holder has provided to the applicable withholding agent under penalties of perjury the required certification of their non-U.S. person status as discussed above (and the applicable withholding agent does not have actual knowledge or reason to know that they are a U.S. person) or if the non-U.S. holder is an exempt recipient.

 

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If a non-U.S. holder sells or redeems a Note through a U.S. broker or the U.S. office of a foreign broker, the proceeds from such sale or redemption will be subject to information reporting and backup withholding unless such non-U.S. holder provides a withholding certificate or other appropriate documentary evidence establishing that such non-U.S. holder is not a U.S. person to the broker and such broker does not have actual knowledge or reason to know that such non-U.S. holder is a U.S. person, or the non-U.S. holder is an exempt recipient eligible for an exemption from information reporting and backup withholding. If a non-U.S. holder sells or redeems a Note through the foreign office of a broker who is a U.S. person or has certain enumerated connections with the United States, the proceeds from such sale or redemption will be subject to information reporting unless the non-U.S. holder provides to such broker a withholding certificate or other appropriate documentary evidence establishing that the non-U.S. holder is not a U.S. person and such broker does not have actual knowledge or reason to know that such evidence is false, or the non-U.S. holder is an exempt recipient eligible for an exemption from information reporting. In circumstances where information reporting by the foreign office of such a broker is required, backup withholding will be required only if the broker has actual knowledge that the non-U.S. holder is a U.S. person.

You should consult your tax advisor regarding the qualification for an exemption from backup withholding and information reporting and the procedures for obtaining such an exemption, if applicable. Any amounts withheld under the backup withholding rules from a payment to a beneficial owner generally would be allowed as a refund or a credit against such beneficial owner’s U.S. federal income tax provided the required information is timely furnished to the IRS.

Medicare Tax on “Net Investment Income.” A tax of 3.8% will be imposed on certain “net investment income” (or “undistributed net investment income”, in the case of estates and trusts) received by U.S. holders with modified adjusted gross income above certain threshold amounts. “Net investment income” as defined for U.S. federal Medicare contribution purposes generally includes interest payments and gain recognized from the sale or other disposition of the Notes. U.S. holders should consult their own tax advisors regarding the effect, if any, of this tax on their ownership and disposition of the Notes.

FATCA. Certain provisions of the Code, known as FATCA, generally impose a withholding tax of 30% on certain payments to certain foreign entities (including financial intermediaries) unless various U.S. information reporting and diligence requirements (that are in addition to, the requirement to deliver an applicable IRS Form W-8, as discussed above) and certain other requirements have been satisfied. FATCA withholding generally applies to payments of interest and, after December 31, 2018, payments of gross proceeds (including principal payments) from the sale, redemption, retirement or other disposition of debt securities that can produce U.S. source interest (such as Notes) (collectively, “withholdable payments”) to certain non-U.S. entities (including, in some circumstances, where such an entity is acting as an intermediary) that fail to comply with certain certification, identification, withholding and information reporting requirements imposed by FATCA. FATCA withholding taxes generally apply to all withholdable payments without regard to whether the beneficial owner of the payment would otherwise be entitled to an exemption from withholding taxes pursuant to an applicable income tax treaty with the U.S. or under U.S. domestic law. If FATCA withholding taxes are imposed with respect to any payments of interest or proceeds made under the Notes, holders that are otherwise eligible for an exemption from, or reduction of, U.S. federal withholding taxes with respect to such interest or proceeds will be required to seek a credit or refund from the IRS in order to obtain the benefit of such exemption or reduction, if any. Beneficial owners of or prospective beneficial owners of the Notes may be required to provide additional information to enable the applicable withholding agent to determine whether withholding is required. Persons located in jurisdictions that have entered into an intergovernmental agreement with the U.S. to implement FATCA may be subject to different rules. Non-U.S. holders, and U.S. holders that expect to hold their Notes through non-U.S. entities should consult their own tax advisors regarding the effect, if any, of these withholding and reporting provisions.

 

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The preceding discussion of material U.S. federal income tax considerations is for general information only and is not tax advice. We urge you to consult your own tax advisor with respect to the particular tax consequences to you of an investment in the Notes, including the possible effect of any pending legislation or proposed regulations.

 

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MANAGEMENT

On August 16, 2018, Gerard R. Waldt, Jr., Controller and Interim Chief Accounting Officer, tendered his resignation from the Company. Mr. Waldt’s resignation was not a result of any disagreement with the Company on any matter relating to the Company’s operations, policies or practices. David Lund, the Company’s current Interim Chief Financial Officer, assumed the duties of Interim Chief Accounting Officer effective as of August 23, 2018. The resignation of Mr. Waldt was effective on September 7, 2018.

LEGAL MATTERS

Certain legal matters in connection with the securities offered hereby will be passed upon for us by Dechert LLP, New York, NY. Certain legal matters in connection with the securities offered hereby will be passed upon for the underwriters by Fried, Frank, Harris, Shriver & Jacobson LLP, New York, NY.

EXPERTS

The consolidated financial statements as of December 31, 2017 and 2016 and for each of the three years in the period ended December 31, 2017 and management’s assessment of the effectiveness of internal control over financial reporting (which is included in Management’s Annual Report on Internal Control over Financial Reporting) as of December 31, 2017 included in the accompanying prospectus have been so included in reliance on the report of PricewaterhouseCoopers LLP, an independent registered public accounting firm, given on the authority of said firm as experts in auditing and accounting.

AVAILABLE INFORMATION

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

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

 

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INDEX TO FINANCIAL STATEMENTS

 

UNAUDITED FINANCIAL STATEMENTS

  

Consolidated Statements of Assets and Liabilities as of June  30, 2018 and December 31, 2017 (unaudited)

     S-67  

Consolidated Statements of Operations for the three and six months ended June 30, 2018 and 2017 (unaudited)

     S-69  

Consolidated Statements of Changes in Net Assets for the six months ended June 30, 2018 and 2017 (unaudited)

     S-70  

Consolidated Statements of Cash Flows for the six months ended June 30, 2018 and 2017 (unaudited)

     S-71  

Consolidated Schedule of Investments as of June  30, 2018 (unaudited)

     S-73  

Consolidated Schedule of Investments as of December  31, 2017 (unaudited)

     S-91  

Notes to Consolidated Financial Statements (unaudited)

     S-108  

Consolidated Schedule of Investments In and Advances to Affiliates as of June 30, 2018

     S-151  

 

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HERCULES CAPITAL, INC.

CONSOLIDATED STATEMENT OF ASSETS AND LIABILITIES

(unaudited)

(dollars in thousands, except per share data)

 

     June 30, 2018     December 31, 2017  

Assets

    

Investments:

    

Non-control/Non-affiliate investments (cost of $1,614,160 and $1,506,454, respectively)

   $ 1,616,515     $ 1,491,458  

Control investments (cost of $59,337 and $25,419, respectively)

     56,716       19,461  

Affiliate investments (cost of $84,063 and $87,956, respectively)

     28,705       31,295  
  

 

 

   

 

 

 

Total investments in securities, at value (cost of $1,757,560 and $1,619,829, respectively)

     1,701,936       1,542,214  

Cash and cash equivalents

     59,461       91,309  

Restricted cash

     15,886       3,686  

Interest receivable

     14,408       12,262  

Other assets

     906       5,244  
  

 

 

   

 

 

 

Total assets

   $ 1,792,597     $ 1,654,715  
  

 

 

   

 

 

 

Liabilities

    

Accounts payable and accrued liabilities

   $ 25,115     $ 26,896  

SBA Debentures, net (principal of $190,200 and $190,200, respectively)(1)

     188,457       188,141  

2022 Notes, net (principal of $150,000 and $150,000, respectively)(1)

     147,728       147,572  

2024 Notes, net (principal of $83,510 and $183,510, respectively)(1)

     81,694       179,001  

2025 Notes, net (principal of $75,000 and $0, respectively)(1)

     72,616       —    

2021 Asset-Backed Notes, net (principal of $31,088 and $49,153, respectively)(1)

     30,698       48,650  

2022 Convertible Notes, net (principal of $230,000 and $230,000, respectively)(1)

     224,269       223,488  

Credit Facilities

     58,323       —    
  

 

 

   

 

 

 

Total liabilities

   $ 828,900     $ 813,748  

Net assets consist of:

    

Common stock, par value

     94       85  

Capital in excess of par value

     1,026,313       908,501  

Unrealized appreciation (depreciation) on investments(2)

     (56,760     (79,760

Accumulated undistributed realized gains (losses) on investments

     (34,205     (20,374

Undistributed net investment income

     28,255       32,515  
  

 

 

   

 

 

 

Total net assets

   $ 963,697     $ 840,967  
  

 

 

   

 

 

 

Total liabilities and net assets

   $ 1,792,597     $ 1,654,715  
  

 

 

   

 

 

 

Shares of common stock outstanding ($0.001 par value, 200,000,000 authorized)

     94,260       84,424  

Net asset value per share

   $ 10.22     $ 9.96  

 

(1)

The Company’s SBA Debentures, 2022 Notes, 2024 Notes, 2025 Notes, 2021 Asset-Backed Notes and 2022 Convertible Notes, as each term is defined herein, are presented net of the associated debt issuance costs for each instrument. See “Note 4—Borrowings”.

(2)

Amounts include $1.1 million and $2.1 million in net unrealized depreciation on other assets and accrued liabilities, including escrow receivables, and estimated taxes payable as of June 30, 2018 and December 31, 2017, respectively.

 

See notes to consolidated financial statements.

 

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The following table presents the assets and liabilities of our consolidated securitization trust for the 2021 Asset-Backed Notes (see Note 4), which is a variable interest entity (“VIE”). The assets of our securitization VIE can only be used to settle obligations of our consolidated securitization VIE, these liabilities are only the obligations of our consolidated securitization VIE, and the creditors (or beneficial interest holders) do not have recourse to our general credit. These assets and liabilities are included in the Consolidated Statement of Assets and Liabilities above.

 

(Dollars in thousands)

   June 30, 2018      December 31, 2017  

Assets

     

Restricted Cash

   $ 15,886      $ 3,686  

Total investments in securities, at value (cost of $98,105 and $146,208, respectively)

     97,924        144,513  
  

 

 

    

 

 

 

Total assets

   $ 113,810      $ 148,199  
  

 

 

    

 

 

 

Liabilities

     

2021 Asset-Backed Notes, net (principal of $31,088 and $49,153, respectively)(1)

   $ 30,698      $ 48,650  
  

 

 

    

 

 

 

Total liabilities

   $ 30,698      $ 48,650  
  

 

 

    

 

 

 

 

(1)

The Company’s 2021 Asset-Backed Notes are presented net of the associated debt issuance costs. See “Note 4—Borrowings”.

 

 

See notes to consolidated financial statements.

 

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HERCULES CAPITAL, INC.

CONSOLIDATED STATEMENT OF OPERATIONS

(unaudited)

(in thousands, except per share data)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
         2018             2017             2018             2017      

Investment income:

        

Interest income

        

Non-control/Non-affiliate investments

   $ 44,535     $ 39,979     $ 86,369     $ 82,324  

Control investments

     841       527       1,427       1,041  

Affiliate investments

     500       —         1,061       2  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     45,876       40,506       88,857       83,367  
  

 

 

   

 

 

   

 

 

   

 

 

 

Fee income

        

Commitment, facility and loan fee income:

        

Non-control/Non-affiliate investments

     1,930       2,440       4,370       5,374  

Control investments

     —         5       —         10  

Affiliate investments

     84       —         192       —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commitment, facility and loan fee income

     2,014       2,445       4,562       5,384  
  

 

 

   

 

 

   

 

 

   

 

 

 

One-time fee income:

        

Non-control/Non-affiliate investments

     1,672       5,501       4,843       6,066  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total one-time fee income

     1,672       5,501       4,843       6,066  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total fee income

     3,686       7,946       9,405       11,450  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

     49,562       48,452       98,262       94,817  

Operating expenses:

        

Interest

     9,878       9,254       19,264       18,861  

Loan fees

     3,362       1,348       4,537       4,186  

General and administrative

        

Legal Expenses

     637       2,141       1,212       2,867  

Other Expenses

     3,037       2,609       6,471       5,947  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total general and administrative

     3,674       4,750       7,683       8,814  
  

 

 

   

 

 

   

 

 

   

 

 

 

Employee compensation:

        

Compensation and benefits

     7,017       5,916       12,775       11,262  

Stock-based compensation

     2,857       1,909       5,166       3,742  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total employee compensation

     9,874       7,825       17,941       15,004  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     26,788       23,177       49,425       46,865  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

     22,774       25,275       48,837       47,952  

Net realized gain (loss) on investments

        

Non-control/Non-affiliate investments

     (3,953     (5,319     (7,465     (2,030

Control investments

     (2,900     (394     (4,308     (445

Affiliate investments

     (2,058     —         (2,058     —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net realized gain (loss) on investments

     (8,911     (5,713     (13,831     (2,475
  

 

 

   

 

 

   

 

 

   

 

 

 

Net change in unrealized appreciation (depreciation) on investments

        

Non-control/Non-affiliate investments

     32,700       66,255       18,360       34,100  

Control investments

     3,957       (53,349     3,337       (53,135

Affiliate investments

     1,540       681       1,303       1,119  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net unrealized appreciation (depreciation) on investments

     38,197       13,587       23,000       (17,916
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net realized and unrealized gain (loss)

     29,286       7,874       9,169       (20,391
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in net assets resulting from operations

   $ 52,060     $ 33,149     $ 58,006     $ 27,561  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income before investment gains and losses per common share:

        

Basic

   $ 0.26     $ 0.31     $ 0.57     $ 0.58  
  

 

 

   

 

 

   

 

 

   

 

 

 

Change in net assets resulting from operations per common share:

        

Basic

   $ 0.59     $ 0.40     $ 0.67     $ 0.33  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.59     $ 0.40     $ 0.67     $ 0.33  
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding

        

Basic

     87,125       82,292       85,868       81,858  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     87,199       82,395       85,939       81,953  
  

 

 

   

 

 

   

 

 

   

 

 

 

Distributions declared per common share:

        

Basic

   $ 0.31     $ 0.31     $ 0.62     $ 0.62  

See notes to consolidated financial statements.

 

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HERCULES CAPITAL, INC.

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS

(unaudited)

(dollars and shares in thousands)

 

   

 

Common Stock

    Capital in
excess

of par value
    Unrealized
Appreciation
(Depreciation)

on Investments
    Accumulated
Undistributed
Realized
Gains (Losses)

on Investments
    Undistributed
Net Investment

Income
    Net
Assets
 
    Shares     Par Value  

Balance at December 31, 2016

    79,555     $ 80     $ 839,657     $ (89,025   $ 14,314     $ 22,918     $ 787,944  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in net assets resulting from operations

    —         —         —         (17,916     (2,475     47,952       27,561  

Public offering, net of offering expenses

    3,309       3       46,908       —         —         —         46,911  

Issuance of common stock due to stock option exercises

    27       —         211       —         —         —         211  

Retired shares from net issuance

    (18     —         (170     —         —         —         (170

Issuance of common stock under restricted stock plan

    10       —         —         —         —         —         —    

Retired shares for restricted stock vesting

    (145     —         (1,988     —         —         —         (1,988

Distributions reinvested in common stock

    81       —         1,122       —         —         —         1,122  

Issuance of Convertible Notes

    —         —         3,413       —         —         —         3,413  

Distributions

    —         —         —         —         —         (51,330     (51,330

Stock-based compensation(1)

    —         —         3,777       —         —         —         3,777  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2017

    82,819     $ 83     $ 892,930     $ (106,941   $ 11,839     $ 19,540     $ 817,451  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2017

    84,424     $ 85     $ 908,501     $ (79,760   $ (20,374   $ 32,515     $ 840,967  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in net assets resulting from operations

    —         —         —         23,000       (13,831     48,837       58,006  

Public offering, net of offering expenses

    9,486       9       112,617       —         —         —         112,626  

Issuance of common stock due to stock option exercises

    38       —         433       —         —         —         433  

Retired shares from net issuance

    (36     —         (447     —         —         —         (447

Issuance of common stock under restricted stock plan

    336       —         —         —         —         —         —    

Retired shares for restricted stock vesting

    (57     —         (688     —         —         —         (688

Distributions reinvested in common stock

    69       —         854       —         —         —         854  

Distributions

    —         —         —         —         —         (53,097     (53,097

Stock-based compensation(1)

    —         —         5,043       —         —         —         5,043  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2018

    94,260     $ 94     $ 1,026,313     $ (56,760   $ (34,205   $ 28,255     $ 963,697  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Stock-based compensation includes $20 and $35 of restricted stock and option expense related to director compensation for the six months ended June 30, 2018 and 2017, respectively.

See notes to consolidated financial statements.

 

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HERCULES CAPITAL, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(unaudited)

(dollars in thousands)

 

     For the Six Months
Ended June 30,
 
     2018     2017  

Cash flows from operating activities:

    

Net increase (decrease) in net assets resulting from operations

   $ 58,006     $ 27,561  

Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by (used in) operating activities:

    

Purchase of investments

     (563,744     (340,632

Principal and fee payments received on investments

     414,347       349,519  

Proceeds from the sale of investments

     9,768       18,450  

Net unrealized depreciation (appreciation) on investments

     (23,000     17,916  

Net realized loss (gain) on investments

     13,831       2,475  

Accretion of paid-in-kind principal

     (4,696     (4,656

Accretion of loan discounts

     (1,562     (3,776

Accretion of loan discount on Convertible Notes

     336       280  

Accretion of loan exit fees

     (8,923     (10,653

Change in deferred loan origination revenue

     3,415       19  

Unearned fees related to unfunded commitments

     1,616       769  

Amortization of debt fees and issuance costs

     3,999       3,557  

Depreciation

     94       105  

Stock-based compensation and amortization of restricted stock grants(1)

     5,043       3,777  

Change in operating assets and liabilities:

    

Interest and fees receivable

     (2,146     1,410  

Prepaid expenses and other assets

     518       589  

Accounts payable

     244       —    

Accrued liabilities

     (1,016     898  
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     (93,870     67,608  

Cash flows from investing activities:

    

Purchases of capital equipment

     (116     (89
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (116     (89

Cash flows from financing activities:

    

Issuance of common stock, net

     112,626       46,911  

Retirement of employee shares

     (701     (1,947

Distributions paid

     (52,243     (50,208

Issuance of 2022 Convertible Notes

     —         230,000  

Issuance of 2024 Notes

     —         5,637  

Issuance of 2025 Notes

     75,000       —    

Repayments of 2019 Notes

     —         (110,364

Repayments of 2024 Notes

     (100,000     —    

Repayments of 2021 Asset-Backed Notes

     (18,065     (21,527

Borrowings of credit facilities

     150,700       8,497  

Repayments of credit facilities

     (92,377     (13,513

Cash paid for debt issuance costs

     (519     (4,480

Fees paid for credit facilities and debentures

     (83     (253
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     74,338       88,753  

Net increase (decrease) in cash, cash equivalents and restricted cash

     (19,648     156,272  
  

 

 

   

 

 

 

Cash, cash equivalents and restricted cash at beginning of period

     94,995       21,366  
  

 

 

   

 

 

 

Cash, cash equivalents and restricted cash at end of period

   $ 75,347     $ 177,638  
  

 

 

   

 

 

 

Supplemental non-cash investing and financing activities:

    

Distributions reinvested

     854       1,122  

 

(1)

Stock-based compensation includes $20 and $35 of restricted stock and option expense related to director compensation for the six months ended June 30, 2018 and 2017, respectively.

See notes to consolidated financial statements.

 

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The following table presents a reconciliation of cash, cash equivalents and restricted cash reported within the Consolidated Statement of Assets and Liabilities that sum to the total of the same such amounts in the Consolidated Statement of Cash Flows:

 

     For the Six Months
Ended June 30,
 

(Dollars in thousands)

   2018      2017  

Cash and cash equivalents

   $ 59,461      $ 160,412  

Restricted cash

     15,886        17,226  
  

 

 

    

 

 

 

Total cash, cash equivalents and restricted cash presented in the Consolidated Statements of Cash Flows

   $ 75,347      $ 177,638  
  

 

 

    

 

 

 

See “Note 2—Summary of Significant Accounting Policies” and “Note 11- Recent Accounting Pronouncements” for a description of restricted cash and cash equivalents.

 

 

See notes to consolidated financial statements.

 

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Index to Financial Statements

HERCULES CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

June 30, 2018

(unaudited)

(dollars in thousands)

 

Portfolio Company

 

Sub-Industry

  Type of
Investment(1)
 

Maturity
Date

 

Interest Rate and Floor(2)

  Principal
Amount
    Cost(3)     Value(4)  

Debt Investments

 

 

Biotechnology Tools

 

 

1-5 Years Maturity

 

 

Exicure, Inc.(12)

  Biotechnology Tools   Senior Secured   September 2019  

Interest rate PRIME + 6.45%

or Floor rate of 9.95%, 3.85% Exit Fee

  $ 4,999     $ 5,152     $ 5,172  
           

 

 

   

 

 

 

Subtotal: 1-5 Years Maturity

 

    5,152       5,172  
           

 

 

   

 

 

 

Subtotal: Biotechnology Tools (0.54%)*

 

    5,152       5,172  
           

 

 

   

 

 

 

Consumer & Business Products

             

Under 1 Year Maturity

             

Gadget Guard (p.k.a Antenna79)(15)

  Consumer & Business Products   Senior Secured   December 2018  

Interest rate PRIME + 1.5%

or Floor rate of 11.00%

  $ 1,000       1,000       1,000  
           

 

 

   

 

 

 

Subtotal: Under 1 Year Maturity

 

    1,000       1,000  
           

 

 

   

 

 

 

1-5 Years Maturity

 

   

Gadget Guard (p.k.a Antenna79)(15)

  Consumer & Business Products   Senior Secured   December 2019  

Interest rate PRIME + 2.95%

or Floor rate of 12.45%, 2.95% Exit Fee

  $ 16,814       17,072       17,064  

WHOOP, INC.

  Consumer & Business Products   Senior Secured   July 2021  

Interest rate PRIME + 3.75%

or Floor rate of 8.50%, 6.95% Exit Fee

  $ 6,000       5,915       5,916  
           

 

 

   

 

 

 

Subtotal: 1-5 Years Maturity

 

    22,987       22,980  
           

 

 

   

 

 

 

Subtotal: Consumer & Business Products (2.49%)*

 

    23,987       23,980  
           

 

 

   

 

 

 

Diversified Financial Services

 

   

1-5 Years Maturity

 

   

Gibraltar Business Capital, LLC.(7)

  Diversified Financial Services   Unsecured   March 2023   Interest rate FIXED 14.50%   $ 10,000       9,809       9,809  
           

 

 

   

 

 

 

Subtotal: 1-5 Years Maturity

 

    9,809       9,809  
           

 

 

   

 

 

 

Subtotal: Diversified Financial Services (1.02%)*

 

    9,809       9,809  
           

 

 

   

 

 

 

Drug Delivery

             

Under 1 Year Maturity

             

Agile Therapeutics, Inc.(11)

  Drug Delivery   Senior Secured   December 2018  

Interest rate PRIME + 4.75%

or Floor rate of 9.00%, 3.70% Exit Fee

  $ 7,625       8,160       8,160  

ZP Opco, Inc. (p.k.a. Zosano Pharma)(11)

  Drug Delivery   Senior Secured   December 2018  

Interest rate PRIME + 2.70%

or Floor rate of 7.95%, 2.87% Exit Fee

  $ 3,233       3,570       3,570  
           

 

 

   

 

 

 

Subtotal: Under 1 Year Maturity

 

    11,730       11,730  
           

 

 

   

 

 

 

1-5 Years Maturity

             

AcelRx Pharmaceuticals, Inc.(11)(15)

  Drug Delivery   Senior Secured   March 2020  

Interest rate PRIME + 6.05%

or Floor rate of 9.55%, 11.69% Exit Fee

  $ 14,891       15,567       15,486  

Antares Pharma Inc.(10)(15)

  Drug Delivery   Senior Secured   July 2022  

Interest rate PRIME + 4.50%

or Floor rate of 9.25%, 4.25% Exit Fee

  $ 25,000       25,155       25,124  
           

 

 

   

 

 

 

Subtotal: 1-5 Years Maturity

 

    40,722       40,610  
           

 

 

   

 

 

 

Subtotal: Drug Delivery (5.43%)*

 

    52,452       52,340  
           

 

 

   

 

 

 

 

See notes to consolidated financial statements.

 

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Index to Financial Statements

HERCULES CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

June 30, 2018

(unaudited)

(dollars in thousands)

 

Portfolio Company

 

Sub-Industry

  Type of
Investment(1)
 

Maturity
Date

 

Interest Rate and Floor(2)

  Principal
Amount
    Cost(3)     Value(4)  

Drug Discovery & Development

 

 

Under 1 Year Maturity

 

 

Auris Medical Holding, AG(5)(10)

  Drug Discovery & Development   Senior Secured   February 2019  

Interest rate PRIME + 6.05%

or Floor rate of 9.55%, 5.75% Exit Fee

  $ 3,067       $3,695       $3,695  

CytRx Corporation(11)(15)

  Drug Discovery & Development   Senior Secured   August 2018  

Interest rate PRIME + 6.00%

or Floor rate of 9.50%, 7.09% Exit Fee

  $ 7,884       9,576       9,576  

Epirus Biopharmaceuticals, Inc.(8)

  Drug Discovery & Development   Senior Secured   December 2018  

Interest rate PRIME + 4.70%

or Floor rate of 7.95%, 3.00% Exit Fee

  $ 2,277       2,561       33  
           

 

 

   

 

 

 

Subtotal: Under 1 Year Maturity

 

    15,832       13,304  
           

 

 

   

 

 

 

1-5 Years Maturity

 

 

Acacia Pharma Inc.

  Drug Discovery & Development   Senior Secured   January 2022  

Interest rate PRIME + 4.50%

or Floor rate of 9.25%, 3.95% Exit Fee

  $ 10,000       9,759       9,759  

Aveo Pharmaceuticals, Inc.(10)(13)

  Drug Discovery & Development   Senior Secured   July 2021  

Interest rate PRIME + 4.70%

or Floor rate of 9.45%, 5.40% Exit Fee

  $ 10,000       9,993       9,861  
  Drug Discovery & Development   Senior Secured   July 2021  

Interest rate PRIME + 4.70%

or Floor rate of 9.45%, 3.00% Exit Fee

  $ 10,000       10,066       10,011  
         

 

 

   

 

 

   

 

 

 

Total Aveo Pharmaceuticals, Inc.

  $ 20,000       20,059       19,872  

Axovant Sciences
Ltd.(5)(10)(13)(16)

  Drug Discovery & Development   Senior Secured   March 2021  

Interest rate PRIME + 6.80%

or Floor rate of 10.55%

  $ 55,000       53,942       53,958  

Brickell Biotech, Inc.(12)

  Drug Discovery & Development   Senior Secured   September 2019  

Interest rate PRIME + 5.70%

or Floor rate of 9.20%, 7.49% Exit Fee

  $ 5,581       5,960       5,967  

BridgeBio Pharma LLC

  Drug Discovery & Development   Senior Secured   January 2022  

Interest rate PRIME + 4.35%

or Floor rate of 9.35%, 6.35% Exit Fee

  $ 35,000       34,651       34,651  

Chemocentryx, Inc.(10)(15)(17)

  Drug Discovery & Development   Senior Secured   December 2021  

Interest rate PRIME + 3.30%

or Floor rate of 8.05%, 6.25% Exit Fee

  $ 15,000       14,892       14,833  

Genocea Biosciences, Inc.(11)

  Drug Discovery & Development   Senior Secured   May 2021  

Interest rate PRIME + 2.75%

or Floor rate of 7.75%, 10.12% Exit Fee

  $ 14,000       14,591       14,568  

Mesoblast(5)(10)

  Drug Discovery & Development   Senior Secured   March 2022  

Interest rate PRIME + 4.95%

or Floor rate of 9.45%, 6.95% Exit Fee

  $ 35,000       34,894       34,894  

Metuchen Pharmaceuticals LLC(12)(14)

  Drug Discovery & Development   Senior Secured   October 2020  

Interest rate PRIME + 7.25%

or Floor rate of 10.75%,

PIK Interest 1.35%, 2.25% Exit Fee

  $ 20,731