| GLADSTONE INVESTMENT CORPORATION\DE Item 1A Risk Factors An investment in our securities involves a number of significant risks and other factors relating to our structure and investment objectives |
| As a result, we cannot assure you that we will achieve our investment objectives |
| You should consider carefully the following information before making an investment in our securities |
| We are a new company with limited operating history |
| We were incorporated in Delaware on February 18, 2005 |
| We are subject to all of the business risks and uncertainties associated with any new business, including the risk that we will not achieve our investment objectives and that the value of your investment could decline substantially |
| We anticipate that it will take us up to two years to invest substantially all of the net proceeds of our initial public offering |
| During this period, we will invest in temporary investments, such as cash and cash equivalents, and then senior secured loans, all of which we expect will earn yields substantially lower than the interest income that we anticipate receiving with respect to investments in subordinated debt, mezzanine debt, preferred stock and other types of investments we may make |
| As a result, our dividends may be substantially lower than the dividends that we expect to pay when our portfolio is fully invested |
| We are dependent upon our key management personnel and the key management personnel of our Adviser for our future success, particularly David Gladstone, George Stelljes III and Terry Lee Brubaker |
| We are dependent on the diligence, skill and network of business contacts of our senior management and other management members for the final selection, structuring, closing and monitoring of our investments |
| Our future success depends to a significant extent on the continued service and coordination of our senior management team, particularly David Gladstone, our chairman and chief executive officer, George Stelljes III, our president and chief investment officer, and Terry Lee Brubaker, our vice-chairman and chief operating officer |
| The departure of any of our executive officers or key employees from us or from our adviser, GMC, could have a material adverse effect on our ability to implement our business strategy and to achieve our investment objectives |
| We are dependent on our Adviser’s continued operations and may not find a suitable replacement if our Adviser discontinues operations or terminates the investment advisory agreement |
| We have no employees |
| We expect that our chief executive officer, chief operating officer, chief investment officer and chief financial officer, and the employees of our Adviser, will not spend all of their time managing our activities and our investment portfolio |
| Our executive officers and the employees of our Adviser may allocate some, or a material portion, of their time to businesses and activities that are not related to our business |
| We have no separate facilities and are completely reliant on our Adviser, which has significant 13 ______________________________________________________________________ discretion as to the implementation and execution of our business strategies and risk management practices |
| We are subject to the risk of discontinuation of our Adviser’s operations or termination of the investment advisory agreement and the risk that, upon such event, no suitable replacement will be found |
| We believe that our success depends to a significant extent upon our Adviser and that discontinuation of its operations could have a material adverse effect on our ability to achieve our investment objectives |
| Our financial condition and results of operation will depend on our ability to manage future growth effectively |
| Our ability to achieve our investment objectives will depend on our ability to grow, which in turn will depend on GMC’s ability to identify, invest in, and monitor companies that meet our investment criteria |
| Accomplishing this result on a cost-effective basis will largely be a function of GMC’s structuring of the investment process, its ability to provide competent, attentive and efficient services to us, and our access to financing on acceptable terms |
| The executive officers of GMC will have substantial responsibilities under the investment advisory and management agreement, as well as in connection with their roles as officers of Gladstone Commercial Corporation, Gladstone Capital Corporation, GMC and other entities managed by our Adviser (“the Gladstone Companies”) |
| They may also be called upon to provide managerial assistance to our portfolio companies |
| These demands on their time may distract them or slow the rate at which they are able to invest our assets |
| In order for us to grow, GMC will need to hire, train, supervise, and manage new investment professionals and supporting employees |
| However, we can offer no assurance that GMC will be able to find and/or hire new investment professionals or supporting employees or that any such employees will contribute to the work of GMC Any failure to manage our future growth effectively could have a material adverse effect on our business, financial condition and results of operations |
| If we do not invest the proceeds of our initial offering in a timely manner, our returns to stockholders will be significantly lower |
| We have estimated that it may take us up to two years to invest all the cash proceeds from our initial offering in the types of investments we intend to make |
| We can give no assurance that we will be successful in meeting that estimate |
| To the extent that it takes us longer to invest the cash proceeds from our initial public offering, the returns to stockholders are likely to be less than if we invested the proceeds over the time period we have allotted |
| If our primary investments are deemed not to be qualifying assets, we could lose our status as a business development company or be precluded from investing according to our current business plan |
| If we are to maintain our status as a business development company, we must not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to each such acquisition, at least 70prca of our total assets are qualifying assets |
| If we acquire mezzanine loans or dividend-paying equity securities from an issuer that has outstanding marginable securities at the time we make an investment, these acquired assets cannot be treated as qualifying assets |
| See “Regulation as a Business Development Company — Qualifying Assets |
| ” This results from the definition of “eligible portfolio company” under the 1940 Act, which in part looks to whether a company has outstanding marginable securities |
| Amendments promulgated in 1998 by the Board of Governors of the Federal Reserve System to Regulation T under the Securities Exchange Act of 1934, as amended, or the Exchange Act, expanded the definition of marginable security to include any non-equity security |
| These amendments have raised questions as to whether a private company that has outstanding debt securities would qualify as an eligible portfolio company |
| We believe that the junior debt and equity instruments that we expect to make should constitute qualifying assets because the privately held companies in which we invest will generally not, at the time of our investment, have outstanding marginable securities |
| Until the questions raised by the amendments to Regulation T have been clarified through SEC rulemaking or addressed by legislative, administrative, or judicial action, we intend to treat as qualifying assets only those loans that are not investment grade, do not have a public secondary market, and are issued by a private issuer that does not have outstanding a class of margin-eligible securities at the time of our investment |
| Likewise, we will treat equity securities issued by a portfolio company as qualifying assets only if such securities are issued by a private company that has no marginable securities outstanding at the time we purchase such securities |
| To date, we do not believe that either the SEC or its staff has taken any position with respect to our analysis of the issues discussed above, and neither the SEC nor its staff has indicated that it concurs with our analysis |
| We intend to adjust our investment focus as needed to comply with and/or take advantage of any future administrative position, judicial decision or legislative action |
| The SEC has recently proposed amendments to the rules concerning business development companies that would clarify that, among other things, companies that do not have a class of securities listed on an exchange or NASDAQ would be considered eligible portfolio companies |
| 14 ______________________________________________________________________ Further, separate and similar legislation, entitled the “Increased Capital Access for Growing Businesses Act,” has been introduced in both the US House of Representatives and the US Senate |
| If passed in current form, the legislation would strike the 1940 Act language that ties the definition of eligible portfolio company to whether a company has outstanding marginable securities |
| In lieu of this language, the legislation would provide that, among other things, companies that do not have a class of securities listed on a national securities exchange would be considered eligible portfolio companies |
| The legislation introduced in the US House of Representatives, HR 436, was passed unanimously and referred to the US Senate Committee on Banking, Housing and Urban Affairs in April 2005 |
| The US Senate bill, S 1396, was introduced and referred to the US Senate Committee on Banking, Housing and Urban Affairs in July 2005 |
| There can be no guarantee that this legislation will be passed and become effective without substantial amendment, if it becomes effective at all |
| Unless and until the proposed rules or legislation described above are adopted or passed , if there were a court ruling or regulatory decision that conflicted with our interpretations, we could lose our status as a business development company or be precluded from investing in the manner described in this prospectus |
| This in turn could cause us to lose our status as a RIC Any of these results would have a material adverse effect on our ability to invest in the manner described in this prospectus, on our operating results, financial condition and ability to pay dividends, and on the value of our common stock |
| See “—Regulations governing our operation as a business development company will affect our ability to and the way in which we raise additional capital |
| ” Such a ruling or decision also may require us to dispose of investments that we made based on our interpretation of Regulation T Such dispositions could have a material adverse effect on our stockholders |
| We may need to dispose of such investments quickly, which would make it difficult to dispose of such investments on favorable terms |
| In addition, because these types of investments will generally be illiquid, we may have difficulty finding a buyer and, even if we do find a buyer, we may have to sell the investments at a substantial loss |
| See “Risk Factors—The lack of liquidity in our investments may adversely affect our business |
| ” Our Adviser’s failure to identify and invest in securities that meet our investment criteria or perform its responsibilities under the investment advisory agreement may adversely affect our ability for future growth |
| Our ability to achieve our investment objectives will depend on our ability to grow, which in turn will depend on our Adviser’s ability to identify and invest in securities that meet our investment criteria |
| Accomplishing this result on a cost-effective basis will be largely a function of our Adviser’s structuring of the investment process, its ability to provide competent and efficient services to us, and our access to financing on acceptable terms |
| The senior management team of our Adviser has substantial responsibilities under the investment advisory agreement |
| In order to grow, our Adviser will need to hire, train supervise and manage new employees successfully |
| Any failure to manage our future growth effectively could have a material adverse effect on our business, financial condition and results of operations |
| We operate in a highly competitive market for investment opportunities |
| A number of entities will compete with us for investments in small and mid-sized companies |
| We will compete with public and private buyout funds, commercial and investment banks, commercial financing companies, and, to the extent they provide an alternative form of financing, hedge funds |
| Many of our competitors are substantially larger and have considerably greater financial, technical, and marketing resources than we do |
| For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us |
| In addition, some of our competitors may have higher risk tolerances or different risk assessments, which would allow them to consider a wider variety of investments and establish more relationships than us |
| Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a business development company |
| The competitive pressures we face could have a material adverse effect on our business, financial condition, and results of operations |
| Also, as a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we can offer no assurance that we will be able to identify and make investments that are consistent with our investment objective |
| We will not seek to compete primarily based on the interest rates we will offer, and we believe that some of our competitors may make loans with interest rates that will be comparable to or lower than the rates we offer |
| We may lose investment opportunities if we do not match our competitors’ pricing, terms, and structure |
| If we match our competitors’ pricing, terms, and structure, we may experience decreased net interest income and increased risk of credit loss |
| 15 ______________________________________________________________________ Regulations governing our operation as a business development company will affect our ability to and the way in which we raise additional capital |
| We may issue debt securities or preferred stock and/or borrow money from banks or other financial institutions, which we refer to collectively as “senior securities,” up to the maximum amount permitted by the 1940 Act |
| Senior securities are defined by the 1940 Act to include bonds, debentures, notes or similar obligations or instruments that are securities and evidence indebtedness and stock of a class having priority over any other class as to distribution of assets or payment of dividends |
| Under the provisions of the 1940 Act, we will be permitted, as a business development company, to issue senior securities only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200prca after each issuance of senior securities |
| If that happens, we may be required to sell a portion of our investments and, depending on the nature of our leverage, repay a portion of our indebtedness at a time when such sales may be disadvantageous |
| We are not generally able to issue and sell our common stock at a price below net asset value per share |
| We may, however, sell our common stock or warrants, options, or rights to acquire our common stock at a price below the current net asset value of the common stock if our Board of Directors determines that such sale is in our best interests and the best interests of our stockholders, and our stockholders approve such sale |
| In any such case, the price at which our securities are to be issued and sold may not be less than a price which, in the determination of our Board of Directors, closely approximates the market value of such securities (less any distributing commission or discount) |
| In addition to issuing securities to raise capital as described above, we may in the future seek to securitize certain of our assets to generate cash for funding new investments |
| Securitization involves our creating a wholly-owned subsidiary and contributing a pool of loans to the subsidiary, which then would deposit the loans to a single purpose trust |
| The trust would then typically sell a class of investment grade interests to the public, and we would retain a residual portion of the equity in the securitized pool of loans |
| The declaration of trust for the securitization entity would typically provide for preferential distributions of interest, principal and liquidation proceeds to the holders other than the holder of the residual equity |
| Accordingly, in a securitization transaction, the residual equity that we would retain would typically bear greater risk than if we held all the loans comprising the securitized pool in their entirety |
| An inability to successfully securitize our loan portfolio could limit our ability to grow our business, fully execute our business strategy, and decrease our earnings, if any |
| Moreover, the successful securitization of our loan portfolio might expose us to losses as the residual loans in which we do not sell interests will tend to be those that are riskier and more apt to generate losses |
| If we issue senior securities, including debt, we will be exposed to additional risks, including the typical risks associated with leverage |
| We will be exposed to increased risk of loss if we incur debt to make investments |
| If we do incur debt, a decrease in the value of our investments would have a greater negative impact on the value of our common stock than if we did not use debt |
| Our ability to pay dividends would be restricted if our asset coverage ratio was not at least 200prca, and any amounts that we would use to service our indebtedness would not be available for dividends to our common stockholders |
| It is likely that any senior debt securities we issue will be governed by an indenture or other instrument containing covenants restricting our operating flexibility |
| We, and indirectly our stockholders, will bear the cost of issuing and servicing such securities |
| Any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock |
| We will be exposed to risks associated with changes in interest rates |
| General interest rate fluctuations may have a substantial negative impact on our investments and investment opportunities and, accordingly, may have a material adverse effect on investment objectives and our rate of return on invested capital |
| In addition, an increase in interest rates would make it more expensive to use debt to finance our investments |
| Many of our portfolio investments will be recorded at fair value as determined in good faith by our Board of Directors based on recommendations by Standard & Poor’s Evaluation Service, who recommends values using its own methodology; this may result in uncertainty as to the value of our portfolio investments |
| A large percentage of our portfolio investments will be in the form of securities that are not publicly traded |
| The fair value of securities and other investments that are not publicly traded may not be readily determinable |
| Our Board of Directors will determine the fair 16 ______________________________________________________________________ value of these securities quarterly, and will use the recommendations of Standard & Poor’s’ Evaluation Service (“S&P”) to determine the value of many of our debt securities |
| The types of factors that may be considered in determining the fair value of our investments include the nature and realizable value of any collateral, the portfolio company’s earnings and cash flows and its ability to make payments on its obligations, the markets in which the portfolio company does business, comparison to publicly traded companies, discounted cash flow, and other relevant factors |
| Because such valuations, particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time, and may be based on estimates, our determinations of fair value may differ materially from the values that might have resulted from a readily available market for these securities |
| Our net asset value could be adversely affected if our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the disposal of such securities |
| At this time S&P will only evaluate the debt portion of our investments, and our Board of Directors will establish the fair value of the equity securities we may hold without the evaluation of S&P Because the loans we make and equity securities we receive when we make loans are not publicly traded, there will be uncertainty regarding the value of our privately held securities that could adversely affect our determination of our net asset value |
| We expect that very few, if any, of our portfolio loans or equity securities, at least initially, will be publicly traded or have a readily determinable market value |
| We value these securities based on a determination of their fair value, based on recommendations provided by S&P and management and approved by our Board of Directors |
| Due to the uncertainty inherent in valuing these securities, our determinations of fair value may differ materially from the values that would exist if a ready market for these securities existed |
| Our net asset value could be materially affected if our determinations regarding the fair value of our investments are materially different from the values that we ultimately realize on our disposal of such securities |
| The lack of liquidity of our privately held investments may adversely affect our business |
| We will generally make investments in private companies whose securities are not traded in any public market |
| Substantially all of these securities will be subject to legal and other restrictions on resale and will otherwise be less liquid than publicly traded securities |
| The illiquidity of our investments may make it difficult for us to sell such investments if the need arises |
| In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize substantial book losses upon liquidation |
| In addition, we may face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we, GMC, or our respective officers, employees or affiliates have material non-public information regarding such portfolio company |
| We may experience fluctuations in our quarterly results |
| We could experience fluctuations in our quarterly operating results due to a number of factors, including the interest rates payable on the debt securities we acquire, the default rates on such securities, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets, and general economic conditions |
| As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods |
| There are significant potential conflicts of interest which could impact our investment returns |
| Our executive officers and directors, and the officers and directors of our investment adviser, GMC, serve or may serve as officers, directors or principals of entities that operate in the same or a related line of business as we do or of investment funds managed by our affiliates |
| Accordingly, they may have obligations to investors in those entities, the fulfillment of which might not be in the best interests of us or our stockholders |
| Gladstone, our chairman and chief executive officer, is the chairman of the board and chief executive officer of GMC, Gladstone Capital and Gladstone Commercial |
| Brubaker, our vice chairman and secretary is either the vice-chairman or president, chief operating officer and secretary of GMC, Gladstone Capital and Gladstone Commercial |
| Moreover, GMC may establish or sponsor other investment vehicles which from time to time may have potentially overlapping investment objectives with those of the Company and accordingly may invest in, whether principally or secondarily, asset classes similar to those targeted by the Company |
| While GMC generally has broad authority to make investments on behalf of the investment vehicles that it advises, GMC has adopted investment allocation procedures to address these potential conflicts and intends to direct investment opportunities to the our Gladstone affiliate with the investment strategy that most closely fits the investment opportunity |
| Nevertheless, the management of GMC may face conflicts in the allocation of investment opportunities to other entities managed by GMC As a result, it is possible that we may not be given the opportunity to participate in certain investments made by other members of the Gladstone Group or investment funds managed by investment managers affiliated with GMC 17 ______________________________________________________________________ While we will not invest in any portfolio company in which any of our affiliates currently has an investment, our affiliate, Gladstone Commercial, may purchase property from or lease property to portfolio companies that we do not control under certain circumstances |
| We may pursue such transactions only if (i) the portfolio company is not controlled by us or any of our affiliates, (ii) the portfolio company satisfies the tenant underwriting criteria or owns real estate that meets the lease underwriting criteria of Gladstone Commercial, and (iii) the transaction is approved by a majority of our independent directors and a majority of the independent directors of Gladstone Commercial |
| We expect that any such negotiations between Gladstone Commercial and our portfolio companies would result in lease terms consistent with the terms that the portfolio companies would be likely to receive were they not portfolio companies of ours |
| However, if Gladstone Commercial provides a lease to a current or prospective portfolio company of ours, it is likely that there will be a conflict of interest in connection with such a transaction |
| There is a risk that, for Gladstone Commercial to provide a lease to a portfolio company, there could be situations where we enter into a transaction that is riskier than we would customarily make in order to enable Gladstone Commercial, or another affiliate, to provide the lease portion of the financing; this carries a greater risk of default |
| If any of these risks were to materialize, it could have a material adverse effect on our ability to generate cash flow to make distributions to stockholders |
| Certain of our officers, who are also officers of GMC, may from time to time serve as directors of certain of our portfolio companies |
| If an officer serves in such capacity with one of our portfolio companies, such officer will owe fiduciary duties to all shareholders of the portfolio company, which duties may from time to time conflict with the interests of our stockholders |
| In the course of our investing activities, we will pay management and incentive fees to GMC and will reimburse Gladstone Administration for certain expenses it incurs |
| As a result, investors in our common stock will invest on a “gross” basis and receive distributions on a “net” basis after expenses, resulting in, among other things, a lower rate of return than one might achieve through our investors themselves making direct investments |
| As a result of this arrangement, there may be times when the management team of GMC has interests that differ from those of our stockholders, giving rise to a conflict |
| GMC will receive a quarterly incentive fee based, in part, on our pre-incentive fee net investment income, if any, for the immediately preceding calendar quarter |
| This income-based portion of the incentive fee is subject to a quarterly hurdle rate before providing an income incentive fee return to GMC Because the hurdle rate is fixed and is based in relation to current interest rates, which are currently relatively low on a historical basis, if interest rates rise, it would become easier for our investment income to exceed the hurdle rate and, as a result, more likely that GMC will receive an income-based incentive fee than if interest rates on our investments remained constant or decreased |
| Subject to the receipt of any requisite stockholder approval under the 1940 Act, our Board of Directors may readjust the hurdle rate by amending the investment advisory and management agreement |
| We have entered into a license agreement with GMC, pursuant to which GMC has agreed to grant us a non-exclusive license to use the name “Gladstone” and the Diamond G logo |
| Under the license agreement, we will have the right to use the “Gladstone” name and the Diamond G logo as long as GMC remains our investment adviser |
| We will typically invest in transactions involving acquisitions, buyouts and recapitalizations of companies, which will subject us to the risks associated with change in control transactions |
| Our strategy includes making debt and equity investments in companies in connection with acquisitions, buyouts and recapitalizations, which will subject us to the risks associated with change in control transactions |
| Change in control transactions often present a number of uncertainties |
| Companies undergoing change in control transactions often face challenges retaining key employees, maintaining relationships with customers and suppliers |
| While we hope to avoid many of these difficulties by participating in transactions where the management team is retained and by conducting thorough due diligence in advance of our decision to invest, if our portfolio companies experience one or more of these problems, we may not realize the value that we expect in connection with our investments which would likely harm our operating results and financial condition We may not realize gains from our equity investments |
| When we invest in mezzanine or senior secured loans, we may acquire warrants or other equity securities as well |
| In addition we may invest in preferred and common stock |
| Our goal is ultimately to dispose of such equity interests and realize gains upon our disposition of such interests |
| Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience |
| 18 ______________________________________________________________________ Our investments in prospective portfolio companies may be risky, and you could lose all or part of your investment |
| Investing in small and mid-sized companies involves a number of significant risks, including: • these companies may have limited financial resources and may be unable to meet their obligations under their debt securities that we hold, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of us collecting on any guarantees we may have obtained in connection with our investment; • these companies typically have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors’ actions and market conditions, as well as general economic downturns; • these companies are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn, on us; and • these companies generally have less predictable operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion, or maintain their competitive positions |
| In addition, our executive officers, directors, and GMC may, in the ordinary course of business, be named as defendants in litigation arising from our investments in these portfolio companies |
| Economic recessions or downturns could impair our portfolio companies and harm our operating results |
| Many of our portfolio companies may be susceptible to economic slowdowns or recessions and may be unable to make interest or principal payments on our loans during these periods |
| Therefore, our under-performing assets are likely to increase and the value of our portfolio is likely to decrease during these periods |
| Adverse economic conditions also may decrease the value of collateral securing some of our loans and the value of our equity investments |
| Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in revenues, net income and assets |
| Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us |
| These events could prevent us from increasing investments and could harm our operating results |
| A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, acceleration of the maturity of its senior and other loans and foreclosure on its assets pledged as collateral for such loans, which could trigger cross-defaults under other agreements and jeopardize our portfolio company’s ability to meet its obligations under the debt securities that we hold |
| We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company |
| In addition, if one of our portfolio companies were to be forced to seek bankruptcy protection, even though we may have structured our interest as senior debt, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might re-characterize our debt holdings and subordinate all or a portion of our claim to those of other creditors |
| An investment strategy focused primarily on privately-held companies presents certain challenges, including the lack of available information about these companies |
| We invest primarily in privately-held companies |
| Generally, little public information exists about these companies, and we will be required to rely on the ability of GMC’s investment professionals to obtain adequate information to evaluate the potential returns from investing in these companies |
| If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and we may lose money on our investments |
| Also, privately-held companies frequently have less diverse product lines and smaller market presence than larger competitors |
| These factors could affect our investment returns |
| Our portfolio companies are likely to have debt that ranks equally with, or senior to, our investments in such companies |
| We invest primarily in subordinated debt, mezzanine debt and preferred equity securities issued by our portfolio companies in connection with buyouts or recapitalizations of these companies |
| Portfolio companies undergoing these types of transactions usually will have other debt that ranks equally with, or senior to, the debt securities in which we invest |
| By their terms, such debt instruments may provide that the holders are entitled to receive payment of interest or principal on or before the dates on which we are entitled to receive payments in respect of the debt securities in which we invest |
| Also, in the event of insolvency, liquidation, dissolution, reorganization, or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution with respect to our investment |
| After repaying its senior creditors, our portfolio company may not have any remaining assets to use for repaying its obligation to us |
| In the case of debt ranking equally with debt securities in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization, or bankruptcy of the relevant portfolio company |
| In addition, we may not be in a position to control any portfolio company by investing in its debt securities |
| 19 ______________________________________________________________________ Therefore, we are subject to the risk that a portfolio company in which we invest may make business decisions with which we disagree, and the management of such company, as representatives of the holders of their equity securities, may take risks or otherwise act in ways that do not serve our interests as debt investors |
| Our incentive fee may induce GMC to make certain investments, including speculative investments |
| The incentive fee payable by us to GMC may create an incentive for GMC to make investments on our behalf that are more speculative than GMC would make in the absence of such compensation arrangement |
| The way in which the incentive fee payable to GMC is determined, which is calculated as a percentage of the return on invested capital, may encourage GMC to use leverage to increase the return on our investments |
| Under certain circumstances, the use of leverage carries with it the risk of our default on our debt obligations, which could result in premature sale or liquidation of our assets and otherwise adversely affect the holders of our common stock |
| In addition, GMC receives the incentive fee based, in part, upon net capital gains realized on our investments |
| Unlike the portion of the incentive fee based on income, there is no hurdle rate applicable to the portion of the incentive fee based on net capital gains |
| As a result, GMC may have a tendency to invest more in investments that are likely to result in capital gains as compared to income producing securities |
| Such a practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during economic downturns |
| Moreover, once an incentive fee on capital gains has been paid to GMC, it is not subject to being returned in the event we realize capital losses in the future |
| The incentive fee payable by us to GMC also may create an incentive for GMC to invest on our behalf in instruments, such as zero coupon bonds, that may be higher yielding but may have a deferred interest feature |
| Under these investments, we would accrue the interest over the life of the investment but would not receive the cash income from the investment until the end of the term |
| The income-based portion of our net investment that is used to calculate the income portion of our investment fee, however, includes accrued interest |
| For example, accrued interest, if any, on our investments in any zero coupon bonds will be included in the calculation of our incentive fee, even though we will not receive any cash interest payments in respect of payment on any such bonds until their maturity dates |
| Our investments in securities of companies with foreign operations may involve significant risks in addition to the risks inherent in investments in companies primarily based in the US Our investment strategy does not contemplate potential investments in debt or equity securities of foreign companies, however, some of our portfolio companies may have operations outside the United States |
| Investing in companies with a significant presence outside the US may expose us to additional risks not typically associated with investing in companies whose operations are primarily conducted in the US These risks include changes in exchange control regulations, political and social instability, expropriation, imposition of foreign taxes, fluctuations in foreign currency exchange rates, less liquid markets and less available information than is generally the case in the United States, higher transaction costs, less government supervision of exchanges, brokers, and issuers, less developed bankruptcy laws, difficulty in enforcing contractual obligations, lack of uniform accounting and auditing standards, and greater price volatility |
| Although most of our investments will be US dollar-denominated, we may make investments denominated in foreign currencies, most likely Canadian dollars, that would subject us to the risk that the value of the foreign currency will change in relation to the US dollar |
| Among the factors that may affect currency values are trade balances, the level of short-term interest rates, differences in relative values of similar assets in different currencies, long-term opportunities for investment and capital appreciation, and political developments |
| We may employ hedging techniques to minimize these risks, but we can offer no assurance that such strategies will be effective |
| Our hedging activities may not fully protect us from adverse changes in exchange rates or interest rates |
| If we engage in hedging transactions, we may expose ourselves to risks associated with such transactions |
| We may utilize instruments such as forward contracts, currency options and interest rate swaps, caps, collars and floors to seek to hedge against fluctuations in the relative values of our portfolio positions from changes in currency exchange rates and market interest rates |
| Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline |
| However, such hedging can establish other positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions |
| Such hedging transactions may also limit the opportunity for gain if the values of the portfolio positions should increase |
| Moreover, it may not be possible to hedge against a situation of an exchange rate or interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price |
| 20 ______________________________________________________________________ The success of our hedging transactions will depend on our ability to correctly predict movements in currency exchange and interest rates |
| Therefore, while we may enter into such transactions to seek to reduce currency exchange rate and interest rate risks, unanticipated changes in currency exchange rates or interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions |
| In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary |
| Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged |
| Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss |
| In addition, it may not be possible to hedge fully or perfectly against currency fluctuations affecting the value of securities denominated in non- US currencies because the value of those securities is likely to fluctuate as a result of factors not related to currency fluctuations |
| At March 31, 2006, we were not engaged in any hedging activities |
| We will be subject to corporate level tax if we are unable to satisfy Internal Revenue Code requirements for RIC qualification |
| To maintain our qualification as a RIC, we must meet income source, asset diversification and annual distribution requirements |
| The annual distribution requirement is satisfied if we distribute at least 90prca of our ordinary income and short-term capital gains to our stockholders on an annual basis |
| Because we use leverage, we are subject to certain asset coverage ratio requirements under the 1940 Act and could, under certain circumstances, be restricted from making distributions necessary to qualify as a RIC Warrants we receive with respect to debt investments will create “original issue discount,” which we must recognize as ordinary income, increasing the amounts we are required to distribute to maintain RIC status |
| Because such warrants will not produce distributable cash for us at the same time as we are required to make distributions in respect of the related original issue discount, we will need to use cash from other sources to satisfy such distribution requirements |
| The asset diversification requirements must be met at the end of each calendar quarter |
| If we fail to meet these tests, we may need to quickly dispose of certain investments to prevent the loss of RIC status |
| Since most of our investments will be illiquid, such dispositions, if even possible, may not be made at prices advantageous to us and, in fact, may result in substantial losses |
| If we fail to qualify as a RIC for any reason and become fully subject to corporate income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution, and the actual amount distributed |
| For additional information regarding asset coverage ratio and RIC requirements, see “Business—Leverage” and “Business—Material US Federal Tax Considerations—Regulated Investment Company Status |
| ” There is a risk that you may not receive dividends or that our dividends may not grow over time |
| Our current intention is to distribute at least 90prca of our ordinary income and short-term capital gains to our stockholders on a quarterly basis |
| We expect to retain net realized long-term capital gains to supplement our equity capital and support the growth of our portfolio, although our Board of Directors may determine in certain cases to distribute these gains |
| We cannot assure you that we will achieve investment results or maintain a tax status that will allow or require any specified level of cash distributions or year-to-year increases in cash distributions |
| The market price of our shares may fluctuate significantly |
| The market price and marketability of our shares may from time to time be significantly affected by numerous factors, including many over which we have no control and that may not be directly related to us |
| These factors include the following: • price and volume fluctuations in the stock market from time to time, which are often unrelated to the operating performance of particular companies; • significant volatility in the market price and trading volume of shares of RICs, business development companies or other companies in our sector, which is not necessarily related to the operating performance of these companies; • changes in regulatory policies or tax guidelines, particularly with respect to RICs or business development companies; • loss of BDC status; • loss of RIC status; • changes in our earnings or variations in our operating results; • changes in the value of our portfolio of investments; • any shortfall in our revenue or net income or any increase in losses from levels expected by securities analysts; • departure of key personnel; 21 ______________________________________________________________________ • operating performance of companies comparable to us; • short-selling pressure with respect to our shares or business development companies generally; • general economic trends and other external factors; and • loss of a major funding source |
| Fluctuations in the trading prices of our shares may adversely affect the liquidity of the trading market for our shares and, if we seek to raise capital through future equity financings, our ability to raise such equity capital |
| Shares of closed-end investment companies frequently trade at a discount from net asset value |
| This characteristic of shares of closed-end investment companies is separate and distinct from the risk that our net asset value per share will decline |
| Although shares of our common stock have historically traded at a premium to net asset value, there can be no guarantee that they will continue to do so |