Item 1.
Business
General
We are a specialty
finance company that lends to and invests in development-stage companies in the technology, life science, healthcare information
and services and cleantech industries (collectively, our “Target Industries”). Our investment objective is to generate
current income from the loans we make and capital appreciation from the warrants we receive when making such loans. We make secured
loans (“Venture Loans”) to companies backed by established venture capital and private equity firms in our Target
Industries (“Venture Lending”). We also selectively lend to publicly traded companies in our Target Industries. Venture
Lending is typically characterized by, (1) the making of a secured loan after a venture capital or equity investment in the
portfolio company has been made, which investment provides a source of cash to fund the portfolio company’s debt service
obligations under the Venture Loan, (2) the senior priority of the Venture Loan which requires repayment of the Venture Loan
prior to the equity investors realizing a return on their capital, (3) the relatively rapid amortization of the Venture Loan
and (4) the lender’s receipt of warrants or other success fees with the making of the Venture Loan.
We are an externally
managed, closed-end, non-diversified management investment company that has elected to be regulated as a business development
company (“BDC”) under the Investment Company Act of 1940 (the “1940 Act”). As a BDC, we are required to
comply with regulatory requirements, including limitations on our use of debt. We are permitted to, and expect to, finance our
investments through borrowings. However, as a BDC, we are only generally allowed to borrow amounts such that our asset coverage,
as defined in the 1940 Act, equals at least 200% after such borrowing. The amount of leverage that we employ depends on our assessment
of market conditions and other factors at the time of any proposed borrowing.
Our predecessor company,
Compass Horizon Finance Company LLC, A Delaware limited liability company (“Compass Horizon”), commenced operations
in March 2008. We were formed in March 2010 as a Delaware corporation for the purpose of acquiring Compass Horizon and continuing
its business as a public entity.
From our inception
and through December 31, 2012, we funded 85 portfolio companies and invested $476.9 million in loans (including 40 loans
that have been repaid). As of December 31, 2012, our total investment portfolio consisted of 45 loans which totaled $220.3 million,
and our net assets were $145.0 million. All of our existing loans are secured by all or a portion of the tangible and intangible
assets of the applicable portfolio company. The loans in our loan portfolio will generally not be rated by any rating agency.
If the individual loans in our portfolio were rated, they would be rated below “investment grade” because they are
subject to many risks, including volatility, intense competition, shortened product life cycles and periodic downturns.
For the year ended
December 31, 2012, our loan portfolio had a dollar-weighted average annualized yield of approximately 14.2% (excluding any yield
from warrants). As of December 31, 2012, our loan portfolio had a dollar-weighted average term of approximately 41 months
from inception and a dollar-weighted average remaining term of approximately 33 months. In addition, we held warrants to
purchase either common stock or preferred stock in 62 portfolio companies. As of December 31, 2012, substantially all of our loans
had an original committed principal amount of between $1 million and $15 million, repayment terms of between 20 and
48 months and bore current pay interest at annual interest rates of between 9% and 13%.
We have elected to
be treated for federal income tax purposes as a regulated investment company (“RIC”), under Subchapter M of the Internal
Revenue Code (the “Code”). As a RIC, we generally will not have to pay corporate-level federal income taxes on any
net ordinary income or capital gains that we distribute to our stockholders if we meet certain source-of-income, distribution,
asset diversification and other requirements.
We are externally
managed and advised by our Advisor. Our Advisor manages our day-to-day operations and also provides all administrative services
necessary for us to operate.
Our common stock
began trading October 29, 2010 and is currently traded on the NASDAQ Global Select Market under the symbol “HRZN”.
Information Available
Our principal executive
office is located at 312 Farmington Avenue, Farmington, Connecticut 06032, our telephone number is (860) 676-8654, and our
internet address is
horizontechnologyfinancecorp.com
. We make available, free of charge, on our website our 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 U.S. Securities and Exchange
Commission (the “SEC”). Information contained on our website is not incorporated by reference into this annual report
on Form 10-K and you should not consider information contained on our website to be part of this annual report on Form 10-K
or any other report we file with the SEC.
Our Advisor
Our investment activities
are managed by our Advisor and we expect to continue to benefit from our Advisor’s ability to identify attractive investment
opportunities, conduct diligence on and value prospective investments, negotiate investments and manage our diversified portfolio
of investments. In addition to the experience gained from the years that they have worked together both at our Advisor and prior
to the formation by our Advisor, the members of our investment team have broad lending backgrounds, with substantial experience
at a variety of commercial finance companies, technology banks and private debt funds, and have developed a broad network of contacts
within the venture capital and private equity community. This network of contacts provides a principal source of investment opportunities.
Our Advisor is a
Delaware limited liability company that is a registered investment advisor under the Investment Advisers Act of 1940 (the “Advisers
Act”). The principal executive address of our Advisor is 312 Farmington Avenue, Farmington, Connecticut 06032.
Our Advisor is led
by five senior managers, including its two co-founders, Robert D. Pomeroy, Jr., our Chief Executive Officer, and Gerald A.
Michaud, our President. The other senior managers include Christopher M. Mathieu, our Senior Vice President and Chief Financial
Officer, John C. Bombara, our Senior Vice President, General Counsel and Chief Compliance Officer and Daniel S. Devorsetz, our
Senior Vice President and Chief Credit Officer.
Our Strategy
Our investment objective
is to maximize our investment portfolio’s total return by generating current income from the loans we make and capital appreciation
from the warrants we receive when making such loans. To further implement our business strategy, we expect our Advisor to continue
to employ the following core strategies:
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Structured Investments in
the Venture Capital and Private
Equity Markets.
We
make loans to development-stage companies within our Target Industries
typically in the form of secured amortizing loans. The secured
amortizing debt structure provides a lower risk strategy, as
compared to equity investments, to participate in the emerging
technology markets because the debt structures we typically utilize
provide collateral against the downside risk of loss, provide
return of capital in a much shorter timeframe through current-pay
interest and amortization of loan principal and have a senior
position to equity in the borrower’s capital structure
in the case of insolvency, wind down or bankruptcy. Unlike venture
capital and private equity investments, our investment returns
and return of our capital do not require equity investment exits
such as mergers and acquisitions or initial public offerings.
Instead, we receive returns on our loans primarily through regularly
scheduled payments of principal and interest and, if necessary,
liquidation of the collateral supporting the loan upon a default.
Only the potential gains from warrants depend upon equity investments
exits.
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“Enterprise Value”
Lending.
We and our Advisor take an enterprise
value approach to the loan structuring and underwriting process.
We secure our senior or subordinated lien position against the
enterprise value of a portfolio company.
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Creative Products with Attractive
Risk-Adjusted
Pricing.
Each of our existing
and prospective portfolio companies has its own unique funding
needs for the capital provided from the proceeds of our Venture
Loans. These funding needs include funds for additional development
“runways”, funds to hire or retain sales staff or
funds to invest in research and development in order to reach
important technical milestones in advance of raising additional
equity. Our loans include current-pay interest, commitment fees,
end-of-term payments (“ETPs”), pre-payment fees and
non-utilization fees. We believe we have developed pricing tools,
structuring techniques and valuation metrics that satisfy our
portfolio companies’ requirements while mitigating risk
and maximizing returns on our investments.
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Opportunity for Enhanced Returns.
To
enhance our loan portfolio returns, in addition to interest and
fees, we obtain warrants to purchase the equity of our portfolio
companies, as additional consideration for making loans. The
warrants we obtain generally include a “cashless exercise”
provision to allow us to exercise these rights without requiring
us to make any additional cash investment. Obtaining warrants
in our portfolio companies has allowed us to participate in the
equity appreciation of our portfolio companies, which we expect
will enable us to generate higher returns for our investors.
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Direct Origination.
We
originate transactions directly with technology, life science,
healthcare information and services and cleantech companies.
These transactions are referred to our Advisor from a number
of sources, including referrals from, or direct solicitation
of, venture capital and private equity firms, portfolio company
management teams, legal firms, accounting firms, investment banks
and other lenders that represent companies within our Target
Industries. Our Advisor has been the sole or lead originator
in substantially all transactions in which the funds it manages
have invested.
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Disciplined and Balanced Underwriting
and Portfolio
Management.
We use a disciplined
underwriting process that includes obtaining information validation
from multiple sources, extensive knowledge of our Target Industries,
comparable industry valuation metrics and sophisticated financial
analysis related to development-stage companies. Our Advisor’s
due diligence on investment prospects includes obtaining and
evaluating information on the prospective portfolio company’s
technology, market opportunity, management team, fund raising
history, investor support, valuation considerations, financial
condition and projections. We seek to balance our investment
portfolio to reduce the risk of down market cycles associated
with any particular industry or sector, development-stage or
geographic area. Our Advisor employs a “hands on”
approach to portfolio management requiring private portfolio
companies to provide monthly financial information and to participate
in regular updates on performance and future plans.
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Use of Leverage.
We
currently use leverage to increase returns on equity through
credit facilities provided by Wells Fargo Capital Finance, LLC
(the “Wells Facility”) and Fortress Credit Co LLC
(the “Fortress Facility” and collectively with the
Wells Facility, the “Credit Facilities”) and through
our 7.375% senior notes due 2019 (the “Senior Notes”).
See “Item 7 — Management’s Discussion and Analysis
of Financial Condition and Results of Operations —
Liquidity and Capital Resources” for additional information
about the Credit Facilities and the Senior Notes. In addition,
we may issue additional debt securities or preferred stock in
one or more series in the future.
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Market Opportunity
We focus our investments
primarily in four key industries of the emerging technology market: technology, life science, healthcare information and services
and cleantech. The technology sectors we focus on include communications, networking, wireless communications, data storage, software,
cloud computing, semiconductor, internet and media, and consumer-related technologies. The life science sectors we focus on include
biotechnology, drug delivery, bioinformatics and medical devices. The healthcare information and services sectors we focus on
include diagnostics, medical record services and software and other healthcare related services and technologies that improve
efficiency and quality of administered healthcare. The cleantech sectors we focus on include alternative energy, water purification,
energy efficiency, green building materials and waste recycling.
We believe that Venture
Lending has the potential to achieve enhanced returns that are attractive notwithstanding the high degree of risk associated with
lending to development-stage companies. Potential benefits include:
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interest rates that typically
exceed rates that would be available to portfolio companies if
they could borrow in traditional commercial financing transactions;
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the loan support provided by
cash proceeds from equity capital invested by venture capital
and private equity firms;
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relatively rapid amortization
of loans;
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senior ranking to equity and
collateralization of loans to minimize potential loss of capital; and
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potential equity appreciation
through warrants.
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We believe that Venture
Lending also provides an attractive financing source for portfolio companies, their management teams and their equity capital
investors, as it:
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is typically less dilutive to
the equity holders than additional equity financing;
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extends the time period during
which a portfolio company can operate before seeking additional
equity capital or pursuing a sale transaction or other liquidity
event; and
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allows portfolio companies to
better match cash sources with uses.
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Competitive Strengths
We believe that we,
together with our Advisor, possess significant competitive strengths, including:
Consistently
Execute Commitments and Close Transactions.
Our Advisor and its senior management and investment professionals
have an extensive track record of originating, underwriting and closing Venture Loans. Our Advisor has directly originated, underwritten
and managed more than 150 Venture Loans with an aggregate original principal amount over $975 million since it commenced
operations in 2004. In our experience, prospective portfolio companies prefer lenders that have a demonstrated ability to deliver
on their commitments.
Robust
Direct Origination Capabilities.
Our Advisor’s managing directors each have significant experience originating
Venture Loans in our Target Industries. This experience has given each managing director a deep knowledge of our Target Industries
and an extensive base of transaction sources and references. Our Advisor’s brand name recognition in our market has resulted
in a steady flow of high quality investment opportunities that are consistent with the strategic vision and expectations of our
Advisor’s senior management.
Highly
Experienced and Cohesive Management Team.
Our Advisor has had the same senior management team of experienced professionals
since its inception. This consistency allows companies, their management teams and their investors to rely on consistent and predictable
service, loan products and terms and underwriting standards.
Relationships
with Venture Capital and Private Equity Investors.
Our Advisor has developed strong relationships with venture
capital and private equity firms and their partners. The strength and breadth of our Advisor’s venture capital and private
equity relationships would take other firms considerable time and expense to develop and we believe this represents a significant
barrier to entry.
Well-Known
Brand Name.
Our Advisor has originated Venture Loans to more than 150 companies in our Target Industries under
the “Horizon Technology Finance” brand. We believe that the “Horizon Technology Finance” brand as a competent,
knowledgeable and active participant in the Venture Lending marketplace will continue to result in a significant number of referrals
and prospective investment opportunities in our Target Industries.
Competition
We compete for investments
with a number of investment funds and other BDCs, as well as traditional financial services companies such as commercial banks
and other financing sources. Some of our competitors are larger and have greater financial, technical, marketing and other resources
than we have. We believe we compete effectively with these entities primarily on the basis of the experience, industry knowledge
and contacts of our Advisor’s investment professionals, its responsiveness and efficient investment analysis and decision-making
processes, its creative financing products and highly customized investment terms. We do not intend to compete primarily on the
interest rates we offer and believe that some competitors make loans with rates that are comparable to or lower than our rates.
For additional information concerning the competitive risks see “Item 1A — Risk Factors — Risks Related
to Our Business and Structure — We operate in a highly competitive market for investment opportunities, and if we are
not able to compete effectively, our business, results of operations and financial condition may be adversely affected and the
value of your investment in us could decline.”
Investment Criteria
We make investments
in companies that are diversified by their stage of development, their Target Industries and sectors of Target Industries and
their geographical location, as well as by the venture capital and private equity sponsors that support our portfolio companies.
While we invest in companies at various stages of development, we require that prospective portfolio companies be beyond the seed
stage of development and have received at least their first round of venture capital or private equity financing before we will
consider making an investment. We expect a prospective portfolio company to demonstrate its ability to advance technology and
increase its value over time.
We have identified
several criteria that we believe have proven, and will prove, important in achieving our investment objective. These criteria
provide general guidelines for our investment decisions. However, we caution you that not all of these criteria are met by each
portfolio company in which we choose to invest.
Management.
Our portfolio companies are generally led by experienced management that has in-market expertise in the Target
Industry in which the company operates, as well as extensive experience with development-stage companies. The adequacy and completeness
of the management team is assessed relative to the stage of development and the challenges facing the potential portfolio company.
Continuing
Support from One or More Venture Capital and Private Equity Investors.
We typically invest in companies in which
one or more established venture capital and private equity investors have previously invested and continue to make a contribution
to the management of the business. We believe that established venture capital and private equity investors can serve as a committed
partner and will assist their portfolio companies and their management teams in creating value. We take into consideration the
total amount raised by the company, the valuation history, investor reserves for future investment and the expected timing and
milestones to the next equity round financing.
Operating
Plan and Cash Resources.
We generally require that a prospective portfolio company, in addition to having sufficient
access to capital to support leverage, demonstrate an operating plan capable of generating cash flows or the ability to raise
the additional capital necessary to cover its operating expenses and service its debt. Our review of the operating plan will take
into consideration existing cash, cash burn, cash runway and the milestones necessary for the company to achieve cash flow positive
operations or to access additional equity from the investors.
Enterprise
and Technology Value.
We expect that the enterprise value of a prospective portfolio company should substantially
exceed the principal balance of debt borrowed by the company. Enterprise value includes the implied valuation based upon recent
equity capital invested as well as the intrinsic value of the company’s particular technology, service or customer base.
Market
Opportunity and Exit Strategy.
We seek portfolio companies that are addressing large market opportunities that
capitalize on their competitive advantages. Competitive advantages may include a unique technology, protected intellectual property,
superior clinical results or significant market traction. As part of our investment analysis, we typically also consider potential
realization of our warrants through merger, acquisition or initial public offering based upon comparable exits in the company’s
Target Industry.
Investment Process
Our
board of directors (“Board”) has delegated authority for all investment decisions to our Advisor. Our Advisor, in
turn,
has created an integrated approach to the loan origination, underwriting, approval
and documentation process that we believe effectively combines the skills of our Advisor’s professionals. This process allows
our Advisor to achieve an efficient and timely closing of an investment from the initial contact with a prospective portfolio
company through the investment decision, close of documentation and funding of the investment, while ensuring that our Advisor’s
rigorous underwriting standards are consistently maintained. We believe that the high level of involvement by our Advisor’s
staff in the various phases of the investment process allows us to minimize the credit risk while delivering superior service
to our portfolio companies.
Origination.
Our Advisor’s loan origination process begins with its industry-focused regional managing directors who
are responsible for identifying, contacting and screening prospects. These managing directors meet with key decision makers and
deal referral sources such as venture capital and private equity firms and management teams, legal firms, accounting firms, investment
banks and other lenders to source prospective portfolio companies. We believe our brand name and management team are well known
within the Venture Lending community, as well as by many repeat entrepreneurs and board members of prospective portfolio companies.
These broad relationships, which reach across the Venture Lending industry, give rise to a significant portion of our Advisor’s
deal origination.
The responsible
managing director of our Advisor obtains review materials from the prospective portfolio company and from those materials, as
well as other available information, determines whether it is appropriate for our Advisor to issue a non-binding term sheet. The
managing director bases this decision to proceed on his or her experience, the competitive environment and the prospective portfolio
company’s needs and also seeks the counsel of our Advisor’s senior management and investment team.
Term
Sheet.
If the managing director determines, after review and consultation with senior management, that the potential
transaction meets our Advisor’s initial credit standards, our Advisor will issue a non-binding term sheet to the prospective
portfolio company.
The terms
of the transaction are tailored to a prospective portfolio company’s specific funding needs while taking into consideration
market dynamics, the quality of the management team, the venture capital and private equity investors involved and applicable
credit criteria, which may include the prospective portfolio company’s existing cash resources, the development of its technology
and the anticipated timing for the next round of equity financing.
Underwriting.
Once the term sheet has been negotiated and executed and the prospective portfolio company has remitted a good
faith deposit, we request additional due diligence materials from the prospective portfolio company and arrange for a due diligence
visit.
Due
Diligence.
The due diligence process includes a formal visit to the prospective portfolio company’s location
and interviews with the prospective portfolio company’s senior management team including its Chief Executive Officer, Chief
Financial Officer, Chief Scientific or Technology Officer, principal marketing or sales professional and other key managers. The
process includes obtaining and analyzing information from independent third parties that have knowledge of the prospective portfolio
company’s business, including, to the extent available, analysts that follow the technology market, thought leaders in our
Target Industries and important customers or partners, if any. Outside sources of information are reviewed, including industry
publications, scientific and market articles, Internet publications, publicly available information on competitors or competing
technologies and information known to our Advisor’s investment team from their experience in the technology markets.
A key
element of the due diligence process is interviewing key existing investors in the prospective portfolio company, who are often
also members of the prospective portfolio company’s board of directors. While these board members and/or investors are not
independent sources of information, their support for management and willingness to support the prospective portfolio company’s
further development are critical elements of our decision making process.
Investment
Memorandum.
Upon completion of the due diligence process and review and analysis of all of the information provided
by the prospective portfolio company and obtained externally, our Advisor’s assigned credit officer prepares an investment
memorandum for review and approval. The investment memorandum is reviewed by our Advisor’s Chief Credit Officer and submitted
to our Advisor’s investment committee for approval.
Investment
Committee.
Our Board delegates authority for all investment decisions to our Advisor’s investment committee.
Our Advisor’s
investment committee is responsible for overall credit policy, portfolio management, approval of all investments, portfolio monitoring
and reporting and managing of problem accounts. The committee interacts with the entire staff of our Advisor to review potential
transactions and deal flow. This interaction of cross-functional members of our Advisor’s staff assures efficient transaction
sourcing, negotiating and underwriting throughout the transaction process. Portfolio performance and current market conditions
are reviewed and discussed by the investment committee on a regular basis to assure that transaction structures and terms are
consistent and current.
Loan
Closing and Funding.
Approved investments are documented and closed by our Advisor’s in-house legal and
loan administration staff. Loan documentation is based upon standard templates created by our Advisor and is customized for each
transaction to reflect the specific deal terms. The transaction documents typically include a loan and security agreement, warrant
agreement and applicable perfection documents, including Uniform Commercial Code financing statements and, as applicable, may
also include a landlord agreement, patent and trademark security grants, a subordination agreement and other standard agreements
for commercial loans in the Venture Lending industry. Funding requires final approval by our Advisor’s General Counsel,
Chief Executive Officer or President, Chief Financial Officer and Chief Credit Officer.
Portfolio
Management and Reporting.
Our Advisor maintains a “hands on” approach to maintain communication with
our portfolio companies. At least quarterly, our Advisor contacts our portfolio companies for operational and financial updates
by phone and performs reviews. Our Advisor may contact portfolio companies deemed to have greater credit risk on a monthly basis.
Our Advisor requires all private companies to provide financial statements. For public companies, our Advisor typically relies
on publicly reported quarterly financials. Our Advisor also typically receives copies of bank and security statements, as well
as any other information required to verify reported financial information. This allows our Advisor to identify any unexpected
developments in the financial performance or condition of a portfolio company
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Our Advisor
has developed a proprietary credit rating system to analyze the quality of our loans. Using this system, our Advisor analyzes
and then rates the credit risk within the portfolio on a monthly basis. Each portfolio company is rated on a 1 through 4 scale,
with 3 representing the rating for a standard level of risk. A rating of 4 represents an improved and better credit quality. A
rating of 2 or 1 represents a deteriorating credit quality and increasing risk. Newly funded investments are typically assigned
a rating of 3, unless extraordinary circumstances require otherwise. These investment ratings are generated internally by our
Advisor, and we cannot guarantee that others would assign the same ratings to our portfolio investments or similar portfolio investments.
Our Advisor
closely monitors portfolio companies rated a 1 or 2 for adverse developments. In addition, our Advisor maintains regular contact
with the management, board of directors and major equity holders of these portfolio companies in order to discuss strategic initiatives
to correct the deterioration of the portfolio company.
The table below describes
each rating level:
Rating
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4
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The portfolio company has performed in
excess of our expectations at the time of initial underwriting as demonstrated by exceeding revenue milestones, clinical milestones
or other operating metrics or as a result of raising capital well in excess of our underwriting assumptions. Generally the
portfolio company displays one or more of the following: its enterprise value greatly exceeds our loan balance; it has achieved
cash flow positive operations or has sufficient cash resources to cover the remaining balance of the loan; there is strong
potential for warrant gains from our warrants; and there is a high likelihood that the borrower will receive favorable future
financing to support operations. Loans rated 4 are the lowest risk profile in our portfolio and there is no expected risk
of principal loss.
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3
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The portfolio company has performed to
our expectations at the time of initial underwriting as demonstrated by hitting revenue milestones, clinical milestones or
other operating metrics. It has raised, or is expected to raise, capital consistent with our underwriting assumptions. Generally
the portfolio company displays one or more of the following: its enterprise value comfortably exceeds our loan balance; it
has sufficient cash resources to operate according to its plan; it is expected to raise additional capital as needed; and
there continues to be potential for warrant gains from our warrants. All new loans are rated 3 when approved and thereafter
3-rated loans represent a standard risk profile, with no loss currently expected.
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2
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The portfolio company has performed below
our expectations at underwriting as demonstrated by missing revenue milestones, delayed clinical progress or otherwise failing
to meet projected operating metrics. It may have raised capital in support of the poorer performance but generally on less
favorable terms than originally contemplated at the time of underwriting. Generally the portfolio company displays one or
more of the following: its enterprise value exceeds our loan balance but at a lower multiple than originally expected; it
has sufficient cash to operate according to its plan but liquidity may be tight; and it is planning to raise additional capital
but there is uncertainty and the potential for warrant gains from our warrants are possible, but unlikely. Loans rated 2 represent
an increased level of risk. While no loss is currently anticipated for a 2-rated loan, there is potential for future loss
of principal.
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1
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The portfolio company has performed well
below plan as demonstrated by materially missing revenue milestones, delayed or failed clinical progress or otherwise failing
to meet operating metrics. The portfolio company has not raised sufficient capital to operate effectively or retire its debt
obligation to us. Generally the portfolio company displays one or more of the following: its enterprise value may not exceed
our loan balance; it has insufficient cash to operate according to its plan and liquidity may be tight; and there are uncertain
plans to raise additional capital or the portfolio company is being sold under distressed conditions. There is no potential
for warrant gains from our warrants. Loans rated 1 are generally put on non-accrual status and represent a high degree of
risk of loss.
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For a discussion
of the ratings of our existing portfolio, see “Item 7 — Management’s Discussion and Analysis of Financial Condition
and Results of Operations — Loan Portfolio Asset Quality.”
Managerial Assistance
As a BDC, we offer,
through our Advisor, and must provide upon request, managerial assistance to certain of our portfolio companies. This assistance
may involve monitoring the operations of the portfolio companies, participating in board of directors and management meetings,
consulting with and advising officers of portfolio companies and providing other organizational and financial guidance.
We may receive fees
for these services, though we may reimburse our Advisor for its direct expenses related to providing such services on our behalf.
Employees
We do not have any
employees. Each of our executive officers is an employee of our Advisor. Our day-to-day investment operations are managed by our
Advisor. As of December 31, 2012, our Advisor had 19 employees, including investment and portfolio management professionals,
operations and accounting professionals, legal counsel and administrative staff. In addition, we reimburse our Advisor for our
allocable portion of expenses incurred by it in performing its obligations under the administration agreement with Horizon Technology
Finance Management LLC, as Administrator (the “Administration Agreement”), including our allocable portion of the
cost of our Chief Financial Officer and Chief Compliance Officer and their respective staffs.
Investment Management Agreement
Under the terms of
our Investment Management Agreement with our Advisor (the “Investment Management Agreement”), our Advisor:
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determines
the composition of our
portfolio, the nature
and timing of the changes
to our portfolio and
the manner of implementing
such changes;
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identifies,
evaluates and negotiates
the structure of the
investments we make (including
performing due diligence
on our prospective portfolio
companies); and
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closes,
monitors and administers
the investments we make,
including the exercise
of any voting or consent
rights.
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Our Advisor’s
services under the Investment Management Agreement are not exclusive, and it is free to furnish similar services to other entities
so long as its services to us are not impaired.
Investment Advisory Fees
Pursuant to our Investment
Management Agreement, we pay our Advisor a fee for investment advisory and management services consisting of a base management
fee and an incentive fee.
Base
Management Fee.
The base management fee is calculated at an annual rate of 2.00% of our gross assets, payable monthly
in arrears. For purposes of calculating the base management fee, the term “gross assets” includes any assets acquired
with the proceeds of leverage.
Incentive
Fee.
The incentive fee has two parts, as follows:
The first part is
calculated and payable quarterly in arrears based on our pre-incentive fee net investment income for the immediately preceding
calendar quarter. For this purpose, “pre-incentive fee net investment income” means interest income, dividend income
and any other income" (including any other fees (other than fees for providing managerial assistance), such as commitment,
origination, structuring, diligence and consulting fees or other fees that we receive from portfolio companies) accrued during
the calendar quarter, minus our operating expenses for the quarter (including the base management fee, expenses payable under
the Administration Agreement and any interest expense and any dividends paid on any issued and outstanding preferred stock, but
excluding the incentive fee). Pre-incentive fee net investment income includes, in the case of investments with a deferred interest
feature (such as original issue discount, debt instruments with payment-in-kind interest and zero coupon securities), accrued
income that we have not yet received in cash. The incentive fee with respect to our pre-incentive fee net income will be 20.00%
of the amount, if any, by which our pre-incentive fee net investment income for the immediately preceding calendar quarter exceeds
a 1.75% (which is 7.00% annualized) hurdle rate and a “catch-up” provision measured as of the end of each calendar
quarter. Under this provision, in any calendar quarter, our Advisor receives no incentive fee until our net investment income
equals the hurdle rate of 1.75%, but then receives, as a “catch-up,” 100.00% of our pre-incentive fee net investment
income with respect to that portion of such pre-incentive fee net investment income, if any, that exceeds the hurdle rate but
is less than 2.1875%. The effect of this provision is that, if pre-incentive fee net investment income exceeds 2.1875% in any
calendar quarter, our Advisor will receive 20.00% of our pre-incentive fee net investment income as if a hurdle rate did not apply.
Pre-incentive fee
net investment income does not include any realized capital gains, realized capital losses or unrealized capital appreciation
or depreciation. Because of the structure of the incentive fee, it is possible that we may pay an incentive fee in a quarter where
we incur a loss. For example, if we receive pre-incentive fee net investment income in excess of the quarterly minimum hurdle
rate, we pay the applicable incentive fee even if we have incurred a loss in that quarter due to realized and unrealized capital
losses. Our net investment income used to calculate this part of the incentive fee is also included in the amount of our gross
assets used to calculate the 2.00% base management fee. These calculations are appropriately pro-rated for any period of less
than three months and adjusted for any share issuances or repurchases during the current quarter.
The following is
a graphical representation of the calculation of the income-related portion of the incentive fee:
Quarterly Incentive Fee Based on Net
Investment Income
Pre-incentive fee net investment income
(expressed as a percentage of the value of net assets)
Percentage of pre-incentive
fee net investment income allocated to first part of
incentive fee
The second part of
the incentive fee will be determined and payable in arrears as of the end of each calendar year (or upon termination of the Investment
Management Agreement, as of the termination date), and will equal 20% of our realized capital gains, if any, on a cumulative basis
from the date of our election to be a BDC, through the end of each calendar year, computed net of all realized capital losses
and unrealized capital depreciation on a cumulative basis, less all previous amounts paid in respect of the capital gain incentive
fee.
Examples of Incentive Fee Calculation
Example 1: Income Related Portion
of Incentive Fee for Each Fiscal Quarter
Alternative 1
Assumptions
:
Investment income (including interest,
dividends, fees, etc.) = 1.25%
Hurdle rate(1) = 1.75%
Management fee(2) = 0.50%
Other expenses (legal, accounting, custodian,
transfer agent, etc.)(3) = 0.20%
Pre-Incentive Fee Net Investment Income
(investment income - (management fee +
other expenses)) = 0.55%
Pre-Incentive Fee Net Investment Income
does not exceed hurdle rate; therefore, there is no income-related incentive fee.
Alternative 2
Assumptions
:
Investment income (including interest,
dividends, fees, etc.) = 2.80%
Hurdle rate(1) = 1.75%
Management fee(2) = 0.50%
Other expenses (legal, accounting, custodian,
transfer agent, etc.)(3) = 0.20%
Pre-Incentive Fee Net Investment Income
(investment income - (management fee +
other expenses)) = 2.10%
Incentive fee = 100.00% × Pre-Incentive
Fee Net Investment Income (subject to “catch-up”)(4)
= 100.00% × (2.10% - 1.75%)
= 0.35%
Pre-Incentive Fee
Net Investment Income exceeds the hurdle rate, but does not fully satisfy the “catch-up” provision; therefore, the
income related portion of the incentive fee is 0.35%.
Alternative 3
Assumptions
:
Investment income (including interest,
dividends, fees, etc.) = 3.00%
Hurdle rate(1) = 1.75%
Management fee(2) = 0.50%
Other expenses (legal, accounting, custodian,
transfer agent, etc.)(3) = 0.20%
Pre-Incentive Fee Net Investment Income
(investment income) - (management fee
+ other expenses) = 2.30%
Incentive fee = 100.00% × Pre-Incentive
Fee Net Investment Income (subject to “catch-up”)(4)
Incentive fee = 100.00% × “catch-up”
+ (20.00% × (Pre-Incentive Fee Net Investment Income -
2.1875%))
Catch up = 2.1875% - 1.75%
= 0.4375%
Incentive fee = (100.00% × 0.4375%)
+ (20.00% × (2.30% - 2.1875%))
= 0.4375% + (20.00% × 0.1125%)
= 0.4375% + 0.0225%
= 0.46%
Pre-Incentive Fee
Net Investment Income exceeds the hurdle rate and fully satisfies the “catch-up” provision; therefore, the income
related portion of the incentive fee is 0.46%.
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(1)
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Represents 7.00% annualized hurdle rate.
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(2)
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Represents 2.00% annualized base management fee.
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(3)
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Excludes organizational and offering expenses.
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(4)
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The “catch-up” provision is intended to provide
our Advisor with an incentive fee of 20.00% on all Pre-Incentive
Fee Net Investment Income as if a hurdle rate did not apply when
our net investment income exceeds 2.1875% in any fiscal quarter.
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Example 2: Capital Gains Portion
of Incentive Fee
Alternative 1
Assumptions
:
Year 1: $20 million
investment made in Company A (“Investment A”), and $30 million investment made in Company B (“Investment
B”)
Year 2: Investment
A sold for $50 million and fair market value (“FMV”) of Investment B determined to be $32 million
Year 3: FMV of Investment
B determined to be $25 million
Year 4: Investment
B sold for $31 million
The capital gains
portion of the incentive fee, if any, would be:
Year 1: None (No
sales transaction)
Year 2: Capital gains
incentive fee of $6 million ($30 million realized capital gains on sale of Investment A multiplied by 20%)
Year 3: None; $5 million
(20% multiplied by ($30 million cumulative capital gains less $5 million cumulative capital depreciation)) less $6 million
(previous capital gains fee paid in Year 2)
Year 4: Capital gains
incentive fee of $200,000; $6.2 million ($31 million cumulative realized capital gains multiplied by 20%) less $6 million
(capital gains incentive fee taken in Year 2)
Alternative 2
Assumptions
:
Year 1: $20 million
investment made in Company A (“Investment A”), $30 million investment made in Company B (“Investment B”)
and $25 million investment made in Company C (“Investment C”)
Year 2: Investment
A sold for $50 million, FMV of Investment B determined to be $25 million and FMV of Investment C determined to be $25 million
Year 3: FMV of Investment
B determined to be $27 million and Investment C sold for $30 million
Year 4: FMV of Investment
B determined to be $35 million
Year 5: Investment
B sold for $20 million
The capital gains
incentive fee, if any, would be:
Year 1: None (no
sales transaction)
Year 2: $5 million
capital gains incentive fee (20% multiplied by $25 million ($30 million realized capital gains on Investment A less
unrealized capital depreciation on Investment B))
Year 3: $1.4 million
capital gains incentive fee(1) ($6.4 million (20% multiplied by $32 million ($35 million cumulative realized capital
gains less $3 million unrealized capital depreciation)) less $5 million capital gains incentive fee received in Year
2
Year 4: None (no
sales transaction)
Year 5: None ($5 million
(20% multiplied by $25 million (cumulative realized capital gains of $35 million less realized capital losses of $10 million))
less $6.4 million cumulative capital gains incentive fee paid in Year 2 and Year 3(2)
The hypothetical
amounts of returns shown are based on a percentage of our total net assets and assume no leverage. There is no guarantee that
positive returns will be realized and actual returns may vary from those shown in this example.
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(1)
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As illustrated in Year 3 of Alternative 1 above, if we
were to be wound up on a date other than its fiscal year end
of any year, we may have paid aggregate capital gains incentive
fees that are more than the amount of such fees that would
be payable if we had been wound up on its fiscal year end of
such year.
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(2)
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As noted above, it is possible that the cumulative aggregate
capital gains fee received by the Investment Manager ($6.4 million)
is effectively greater than $5 million (20.00% of cumulative
aggregate realized capital gains less net realized capital
losses or net unrealized depreciation ($25 million)).
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Payment of Our Expenses
All investment professionals
and staff of our Advisor, when and to the extent engaged in providing investment advisory and management services, and the compensation
and routine overhead expenses of its personnel allocable to such services, are provided and paid for by our Advisor. We bear all
other costs and expenses of our operations and transactions, including, without limitation, those relating to:
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calculating our net asset
value (including the cost and expenses of any independent
valuation firms);
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expenses, including travel
expense, incurred by our Advisor or payable to third parties
performing due diligence on prospective portfolio companies,
monitoring our investments and, if necessary, enforcing our
rights;
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interest payable on debt,
if any, incurred to finance our investments;
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the costs of all future offerings
of our common stock and other securities, if any;
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the base management fee and
any incentive management fee;
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distributions on our shares;
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administration fees payable
under the Administration Agreement;
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the allocated costs incurred
by Advisor as our Administrator in providing managerial assistance
to those portfolio companies that request it;
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amounts payable to third parties
relating to, or associated with, making investments;
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transfer agent and custodial
fees;
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fees and expenses associated
with marketing efforts;
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independent director fees
and expenses;
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costs of preparing and filing
reports or other documents with the SEC;
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the costs of any reports,
proxy statements or other notices to our stockholders, including
printing costs;
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our allocable portion of the
fidelity bond;
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directors and officers/errors
and omissions liability insurance, and any other insurance
premiums;
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indemnification payments;
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direct costs and expenses
of administration, including audit and legal costs; and
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all other expenses incurred
by us or the Administrator in connection with administering
our business, such as the allocable portion of overhead under
the Administration Agreement, including rent, the fees and
expenses associated with performing compliance functions and
our allocable portion of the costs of compensation and related
expenses of our Chief Compliance Officer and our Chief Financial
Officer and their respective staffs.
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We reimburse our
Advisor for costs and expenses incurred by our Advisor for office space rental, office equipment and utilities allocable to the
performance by our Advisor of its duties under the Investment Management Agreement, as well as any costs and expenses incurred
by our Advisor relating to any non-investment advisory, administrative or operating services provided by our Advisor to us or
in the form of managerial assistance to portfolio companies that request it.
Generally, our expenses
will be expensed as incurred in accordance with GAAP. To the extent we incur costs that should be capitalized and amortized into
expense we will also do so in accordance with GAAP, which may include amortizing such amount on a straight line basis over the
life of the asset or the life of the services or product being performed or provided.
Limitation of Liability and Indemnification
The Investment Management
Agreement provides that our Advisor and its officers, managers, partners, agents, employees, controlling persons and any other
person or entity affiliated with our Advisor are not liable to us for any act or omission by it in the supervision or management
of our investment activities or for any loss sustained by us except for acts or omissions constituting willful misfeasance, bad
faith, gross negligence or reckless disregard of its obligations under the Investment Management Agreement. The Investment Management
Agreement also provides for indemnification by us of our Advisor and its officers, managers, partners, agents, employees, controlling
persons and any other person or entity affiliated with our Advisor for liabilities incurred by them in connection with their services
to us (including any liabilities associated with an action or suit by or in the right of us or our stockholders), but excluding
liabilities for acts or omissions constituting willful misfeasance, bad faith or gross negligence or reckless disregard of their
duties under the Investment Management Agreement subject to certain conditions.
Board Approval of the Investment Management Agreement
Our Board held an
in-person meeting on August 3, 2012, in order to consider and approve our Investment Management Agreement for another twelve month
period. In its consideration of the Investment Management Agreement, the Board focused on information it had received relating
to, among other things: (a) the nature, quality and extent of the advisory and other services to be provided to us by our
Advisor; (b) comparative data with respect to advisory fees or similar expenses paid by other BDCs with similar investment
objectives; (c) our projected operating expenses and expense ratio compared to BDCs with similar investment objectives; (d) any
existing and potential sources of indirect income to our Advisor or the Administrator from their relationships with us and the
profitability of those relationships; (e) information about the services to be performed and the personnel performing such
services under the Investment Management Agreement; (f) the organizational capability and financial condition of our Advisor
and its affiliates; (g) our Advisor’s practices regarding the selection and compensation of brokers that may execute
our portfolio transactions and the brokers’ provision of brokerage and research services to our Advisor; and (h) the
possibility of obtaining similar services from other third party service providers or through an internally managed structure.
Based on the information
reviewed and the discussions, the Board, including a majority of the non-interested directors, concluded that the investment management
fee rates were reasonable in relation to the services to be provided.
Duration and Termination
The Investment Management
Agreement was approved by our Board on October 25, 2010 and was renewed on August 3, 2012. Following its initial two-year
term, unless terminated, the Investment Management Agreement will remain in effect from year to year if approved annually by either
(1) our Board, including approval by a majority of our directors who are not interested persons, or (2) the affirmative vote of
the holders of a majority of our outstanding voting securities. The Investment Management Agreement will automatically terminate
in the event of its assignment. The Investment Management Agreement may be terminated by either party without penalty by delivering
notice of termination upon not more than 60 days’ written notice to the other. See “Item 1A — Risk Factors —
Risks Related to our Business and Structure — Our Advisor can resign on 60 days’ notice, and we may not
be able to find a suitable replacement within that time, resulting in a disruption in our operations that could adversely affect
our business, results of operations or financial condition.” We are dependent upon senior management personnel of our Advisor
for our success, and if our Advisor is unable to hire and retain qualified personnel or if our Advisor loses any member of its
senior management team, our ability to achieve our investment objective could be significantly harmed.
Administration Agreement
We have entered into
an Administration Agreement with the Administrator, to provide administrative services to us. For providing these services, facilities
and personnel, we reimburse the Administrator for our allocable portion of overhead and other expenses incurred by the Administrator
in performing its obligations under the Administration Agreement, including rent, the fees and expenses associated with performing
compliance functions and our allocable portion of the costs of compensation and related expenses of our Chief Compliance Officer
and our Chief Financial Officer and their respective staffs.
License Agreement
We have entered into
a license agreement with Horizon Technology Finance, LLC pursuant to which we were granted a non-exclusive, royalty-free right
and license to use the service mark “Horizon Technology Finance.” Under this agreement, we have a right to use the
“Horizon Technology Finance” service mark for so long as the Investment Management Agreement with our Advisor is in
effect. Other than with respect to this limited license, we have no legal right to the “Horizon Technology Finance”
service mark.
Regulation
We have elected to
be regulated as a BDC under the 1940 Act and elected to be treated as a RIC under Subchapter M of the Code. As with other companies
regulated by the 1940 Act, a BDC must adhere to certain substantive regulatory requirements. The 1940 Act contains prohibitions
and restrictions relating to transactions between BDCs and their affiliates (including any investment advisers or sub-advisers),
principal underwriters and affiliates of those affiliates or underwriters. The 1940 Act also requires that a majority of the directors
of the BDC be persons other than “interested persons,” as that term is defined in the 1940 Act. In addition, the 1940
Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC unless
approved by “a majority of our outstanding voting securities” as defined in the 1940 Act. A majority of the outstanding
voting securities of a company is defined under the 1940 Act as the lesser of: (i) 67% or more of such company’s outstanding
voting securities present at a meeting if more than 50% of the outstanding voting securities of such company are present and represented
by proxy or (ii) more than 50% of the outstanding shares of such company. Our bylaws provide for the calling of a special
meeting of stockholders at which such action could be considered upon written notice of not less than ten or more than sixty days
before the date of such meeting.
We may invest up
to 100% of our assets in securities acquired directly from issuers in privately negotiated transactions. With respect to such
securities, we may, for the purpose of public resale, be deemed an “underwriter” as that term is defined in the Securities
Act of 1933, as amended (the “Securities Act”).
Our intention
is to not write (sell) or buy put or call options to manage risks associated with the publicly traded securities of our portfolio
companies, except that we may enter into hedging transactions to manage the risks associated with interest rate fluctuations to
the extent that we are permitted to engage in such hedging transactions under the 1940 Act and applicable commodities laws. We
may also purchase or otherwise receive warrants to purchase the common stock of our portfolio companies in connection with acquisition
financing or other investments. Similarly, in connection with an acquisition, we may acquire rights to require the issuers of
acquired securities or their affiliates to repurchase them under certain circumstances.
We also do not intend
to acquire securities issued by any investment company that exceed the limits imposed by the 1940 Act. Under these limits, except
for registered money market funds, we generally cannot acquire more than 3% of the voting stock of any investment company, invest
more than 5% of the value of our total assets in the securities of one investment company or invest more than 10% of the value
of our total assets in the securities of more than one investment company. With regard to that portion of our portfolio invested
in securities issued by investment companies, it should be noted that such investments might subject our stockholders to additional
expenses. None of our investment policies is fundamental and any may be changed without stockholder approval.
We may also be prohibited
under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our
Board who are not interested persons and, in some cases, prior approval by the SEC. For example, under the 1940 Act, absent receipt
of exemptive relief from the SEC, we and our affiliates may be precluded from co-investing in private placements of securities.
As a result of one or more of these situations, we may not be able to invest as much as we otherwise would in certain investments
or may not be able to liquidate a position as quickly.
We expect to be periodically
examined by the SEC for compliance with the 1940 Act.
We are required to
provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore,
as a BDC, we are prohibited from protecting any director or officer against any liability to us or our stockholders arising from
willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s
office.
We and our Advisor
have adopted and implemented written policies and procedures reasonably designed to prevent violation of the federal securities
laws and review these policies and procedures annually for their adequacy and the effectiveness of their implementation. We and
our Advisor have designated a chief compliance officer to be responsible for administering the policies and procedures.
Qualifying Assets
Under the 1940 Act,
a BDC may not acquire any asset other than assets of the type listed in section 55(a) of the 1940 Act, which are referred
to as qualifying assets, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s
total assets. The principal categories of qualifying assets relevant to our proposed business are the following:
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Securities purchased in transactions
not involving any public offering from the issuer of such securities,
which issuer (subject to certain limited exceptions) is an eligible
portfolio company, or from any person who is, or has been during
the preceding 13 months, an affiliated person of an eligible
portfolio company, or from any other person, subject to such
rules as may be prescribed by the SEC. An eligible portfolio
company is defined in the 1940 Act as any issuer which:
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is organized under the laws of,
and has its principal place of business in, the United States;
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is not an investment company
(other than a small business investment company wholly owned
by the BDC) or a company that would be an investment company
but for certain exclusions under the 1940 Act; and
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satisfies any of the following:
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has a market capitalization
of less than $250 million or does not have any class
of securities listed on a national securities exchange;
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is controlled by a BDC or
a group of companies including a BDC, the BDC actually exercises
a controlling influence over the management or policies of
the eligible portfolio company, and, as a result thereof,
the BDC has an affiliated person who is a director of the
eligible portfolio company; or
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is a small and solvent company
having total assets of not more than $4 million and capital
and surplus of not less than $2 million.
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Securities of any eligible portfolio
company which we control.
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Securities purchased in a private
transaction from a U.S. issuer that is not an investment
company or from an affiliated person of the issuer, or in transactions
incident thereto, if the issuer is in bankruptcy and subject
to reorganization or if the issuer, immediately prior to the
purchase of its securities was unable to meet its obligations
as they came due without material assistance other than conventional
lending or financing arrangements.
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Securities of an eligible portfolio
company purchased from any person in a private transaction if
there is no ready market for such securities and we already own
60% of the outstanding equity of the eligible portfolio company.
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Securities received in exchange
for or distributed on or with respect to securities described
above, or pursuant to the exercise of warrants or rights relating
to such securities.
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Cash, cash equivalents, U.S. Government
securities or high-quality debt securities maturing in one year
or less from the time of investment.
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The regulations defining
qualifying assets may change over time. We may adjust our investment focus as needed to comply with and/or take advantage of any
regulatory, legislative, administrative or judicial actions in this area.
Managerial Assistance to Portfolio Companies
A BDC must have been
organized and have its principal place of business in the United States and must be operated for the purpose of making investments
in the types of securities described in “— Qualifying assets” above. However, in order to count portfolio
securities as qualifying assets for the purpose of the 70% test, the BDC must either control the issuer of the securities or must
offer to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial
assistance. Where the BDC purchases such securities in conjunction with one or more other persons acting together, the BDC will
satisfy this test if one of the other persons in the group makes available such managerial assistance. Making available managerial
assistance means, among other things, any arrangement whereby the BDC, through its directors, officers or employees, offers to
provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business
objectives and policies of a portfolio company.
Issuance of Additional Shares
We are not generally
able to issue and sell our common stock at a price below net asset value (“NAV”) per share. We may, however, issue
and sell our common stock, at a price below the current NAV of the common stock, or issue and sell warrants, options or rights
to acquire such common stock, at a price below the current NAV of the common stock if our Board determines that such sale is in
our best interest and in the best interests of our stockholders, and our stockholders have approved our policy and practice of
making such sales within the preceding 12 months. 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, closely approximates the market value of such securities.
Temporary Investments
Pending investment
in other types of “qualifying assets,” as described above, our investments may consist of cash, cash equivalents,
U.S. Government securities or high-quality debt securities maturing in one year or less from the time of investment, which
we refer to, collectively, as temporary investments, so that 70% of our assets are qualifying assets. Typically, we invest in
money market funds, highly rated commercial paper, U.S. Government agency notes, U.S. Treasury bills or in repurchase
agreements relating to such securities that are fully collateralized by cash or securities issued by the U.S. Government
or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous
agreement by the seller to repurchase it at an agreed-upon future date and at a price which is greater than the purchase price
by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that
may be invested in such repurchase agreements. However, subject to certain exceptions, if more than 25% of our total assets constitute
repurchase agreements from a single counterparty, we would not meet the diversification tests in order to qualify as a RIC for
federal income tax purposes. Thus, we do not intend to enter into repurchase agreements with a single counterparty in excess of
this limit. Our Advisor monitors the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.
Senior Securities; Derivative Securities
We are permitted,
under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to our common stock if our
asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, while
any senior securities are outstanding, we must make provisions to prohibit any distribution to our stockholders or the repurchase
of such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase.
We may also borrow amounts up to 5% of the value of our total assets for temporary or emergency purposes without regard to asset
coverage. For a discussion of the risks associated with leverage, see “Item 1A — Risk Factors — Risks Related
to our Business and Structure — We will borrow money, which magnifies the potential for gain or loss on amounts invested
and may increase the risk of investing in us.”
The 1940 Act also
limits the amount of warrants, options and rights to common stock that we may issue and the terms of such securities.
Code of Ethics
We and our Advisor
have each adopted a code of ethics pursuant to Rule 17j-1 under the 1940 Act and Rule 204A-1 under the Advisers Act, respectively,
that establishes procedures for personal investments and restricts certain personal securities transactions. Personnel subject
to each code may invest in securities for their personal investment accounts, including securities that may be purchased or held
by us, so long as such investments are made in accordance with the code’s requirements. Each code of ethics is attached
as an exhibit to this annual report on Form 10-K, and is available on the SEC’s Internet site at
http://www.sec.gov
.
You may also obtain copies of the code of ethics, 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.
You
may read and copy the code of ethics at the SEC’s Public Reference Room in Washington, D.C. You may obtain information on
the operation of the Public Reference Room by calling the SEC at (202) 942-8090.
Proxy Voting Policies and Procedures
We have delegated
our proxy voting responsibility to our Advisor. The Proxy Voting Policies and Procedures of our Advisor are set forth below. The
guidelines are reviewed periodically by our Advisor and our independent directors and, accordingly, are subject to change.
Introduction
Our Advisor is registered
with the SEC as an investment adviser under the Advisers Act. As an investment adviser registered under the Advisers Act, our
Advisor has fiduciary duties to us. As part of this duty, our Advisor recognizes that it must vote client securities in a timely
manner free of conflicts of interest and in our best interests and the best interests of our stockholders. Our Advisor’s
Proxy Voting Policies and Procedures have been formulated to ensure decision-making is consistent with these fiduciary duties.
These policies and procedures for voting proxies are intended to comply with Section 206 of, and Rule 206(4)-6 under,
the Advisers Act.
Proxy policies
Our Advisor votes
proxies relating to our portfolio securities in what our Advisor perceives to be the best interest of our stockholders. Our Advisor
reviews on a case-by-case basis each proposal submitted to a stockholder vote to determine its effect on the portfolio securities
held by us. Although our Advisor generally votes against proposals that may have a negative effect on our portfolio securities,
our Advisor may vote for such a proposal if there exist compelling long-term reasons to do so.
Our Advisor’s
proxy voting decisions are made by those senior officers who are responsible for monitoring each of our investments. To ensure
that a vote is not the product of a conflict of interest, our Advisor requires that (1) anyone involved in the decision-making
process disclose to our Chief Compliance Officer any potential conflict that he or she is aware of and any contact that he or
she has had with any interested party regarding a proxy vote and (2) employees involved in the decision-making process or
vote administration are prohibited from revealing how we intend to vote on a proposal in order to reduce any attempted influence
from interested parties.
Proxy Voting Records
You may obtain information
about how we voted proxies by making a written request for proxy voting information to: Chief Compliance Officer, Horizon Technology
Finance Corporation, 312 Farmington Avenue, Farmington, Connecticut 06032.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley
Act of 2002 (the “Sarbanes-Oxley Act”), imposes a wide variety of regulatory requirements on publicly held companies
and their insiders. Many of these requirements affect us. For example:
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pursuant to Rule 13a-14 under
the Securities Exchange Act of 1934, as amended (the “Exchange
Act”), our principal executive officer and principal financial
officer must certify the accuracy of the financial statements
contained in our periodic reports;
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pursuant to Item 307 under Regulation
S-K, our periodic reports must disclose our conclusions about
the effectiveness of our disclosure controls and procedures;
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pursuant to Rule 13a-15 under
the Exchange Act, our management must prepare an annual report
regarding its assessment of our internal control over financial
reporting, which must be audited by our independent registered
public accounting firm; and
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pursuant to Item 308 of Regulation
S-K and Rule 13a-15 under the Exchange Act, our periodic reports
must disclose whether there were significant changes in our internal
controls over financial reporting or in other factors that could
significantly affect these controls subsequent to the date of
their evaluation, including any corrective actions with regard
to significant deficiencies and material weaknesses.
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The Sarbanes-Oxley
Act requires us to review our current policies and procedures to determine whether we comply with the Sarbanes-Oxley Act and the
regulations promulgated thereunder. We will continue to monitor our compliance with all regulations under the Sarbanes-Oxley Act
and intend to take actions necessary to ensure that we are in compliance therewith.
NASDAQ Global Select Market Corporate Governance
Regulations
The NASDAQ Global
Select Market has adopted corporate governance regulations with which listed companies must comply with. We intend to be in compliance
with these corporate governance listing standards. We intend to monitor our compliance with all future listing standards and to
take all necessary actions to ensure that we are in compliance therewith.
Privacy Principles
We are committed
to maintaining the privacy of stockholders and to safeguarding our non-public personal information. The following information
is provided to help you understand what personal information we collect, how we protect that information and why, in certain cases,
we may share information with select other parties.
Generally, we do
not receive any nonpublic personal information relating to our stockholders, although certain nonpublic personal information of
our stockholders may become available to us. We do not disclose any nonpublic personal information about our stockholders or former
stockholders, except as permitted by law or as is necessary in order to service stockholder accounts (for example, to a transfer
agent or third party administrator).
We restrict access
to nonpublic personal information about our stockholders to our Advisor’s employees with a legitimate business need for
the information. We maintain physical, electronic and procedural safeguards designed to protect the nonpublic personal information
of our stockholders.
Election to be Taxed as a RIC
We have elected to
be taxed, and intend to qualify annually to maintain our election to be taxed, as a RIC under Subchapter M of the Code. To maintain
RIC tax benefits, we must, among other requirements, meet certain source-of-income and quarterly asset diversification requirements
(as described below). We also must annually distribute dividends of at least 90% of the sum of our ordinary income and realized
net short-term capital gains (i.e. net short-term capital gains in excess of net long term losses), if any, out of the assets
legally available for distribution, which we refer to as the “Annual Distribution Requirement.” Although not required
for us to maintain our RIC tax status, in order to preclude the imposition of a 4% nondeductible federal excise tax imposed on
RICs, we may distribute during each calendar year an amount at least equal to the sum of (1) 98% of our ordinary income for
the calendar year, (2) 98.2% of our capital gain net income for the one-year period ending on October 31 of the calendar
year and (3) any ordinary income and net capital gains for preceding years that were not distributed during such years (the
“Excise Tax Avoidance Requirement”). In addition, although we may distribute realized net capital gains (i.e., net
long-term capital gains in excess of short-term capital losses), if any, at least annually out of the assets legally available
for such distributions, we may decide to retain such net capital gains or ordinary income to provide us with additional liquidity.
In order to qualify as a RIC for federal income tax purposes under Section 851(a) of the Code, we must:
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maintain an election to be treated
as a BDC under the 1940 Act at all times during each taxable year;
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meet any applicable securities
law requirements, including capital structure requirements;
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derive in each taxable year at
least 90% of our gross income from distributions, interest, payments
with respect to certain securities loans, gains from the sale
of stock or other securities, net income from certain qualified
publicly traded partnerships or other income derived with respect
to our business of investing in such stock or securities; and
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diversify our holdings so that
at the end of each quarter of the taxable year:
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at least 50% of the value of our
assets consists of cash, cash equivalents, U.S. Government
securities, securities of other RICs, and other securities if
such other securities of any one issuer neither represent more
than 5% of the value of our assets nor more than 10% of the outstanding
voting securities of the issuer; and
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no more than 25% of the value
of our assets is invested in the securities, other than U.S. Government
securities or securities of other RICs, of one issuer or of two
or more issuers that are controlled, as determined under applicable
tax rules, by us and that are engaged in the same or similar or
related trades or businesses or in certain qualified publicly
traded partnerships (the “Diversification Tests”).
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Taxation as a RIC
If we qualify as
a RIC under Section 851(a) of the Code, and satisfy the Annual Distribution Requirement, then we will not be subject to federal
income tax on the portion of our investment company taxable income and net capital gain (i.e., realized net long-term capital
gains in excess of realized net short-term capital losses) we distribute to stockholders. We will be subject to U.S. federal
income tax at the regular corporate rates on any income or capital gain not distributed (or deemed distributed) to our stockholders.
We may be required
to recognize taxable income in circumstances in which we do not receive cash. For example, if we hold debt obligations that are
treated under applicable tax rules as having original issue discount (such as debt instruments with pay in kind interest or, in
certain cases, increasing interest rates or issued with warrants), we must include in income each year a portion of the original
issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by
us in the same taxable year. Because any original issue discount accrued will be included in our investment company taxable income
for the year of accrual, we may be required to make a distribution to our stockholders in order to satisfy the Annual Distribution
Requirement, even though we will not have received any corresponding cash amount.
Gain or loss realized
by us from warrants acquired by us as well as any loss attributable to the lapse of such warrants generally will be treated as
capital gain or loss. Such gain or loss generally will be long-term or short-term, depending on how long we held a particular
warrant.
Although we do not
presently expect to do so, we are authorized to borrow funds and to sell assets in order to satisfy distribution requirements.
However, under the 1940 Act, we are not permitted to make distributions to our stockholders while our debt obligations and other
senior securities are outstanding unless certain “asset coverage” tests are met. Moreover, our ability to dispose
of assets to meet our distribution requirements may be limited by (1) the illiquid nature of our portfolio and/or (2) other
requirements relating to our status as a RIC, including the Diversification Tests. If we dispose of assets in order to meet the
Annual Distribution Requirement or the Excise Tax Avoidance Requirement, we may make such dispositions at times that, from an
investment standpoint, are not advantageous.
Failure to Qualify as a RIC
If we fail to satisfy
the Annual Distribution Requirement or fail to qualify as a RIC in any taxable year, assuming we do not qualify for or take advantage
of certain remedial provisions, we will be subject to tax in that year on all of our taxable income, regardless of whether we
make any distributions to our stockholders. In that case, all of our income will be subject to corporate-level federal income
tax, reducing the amount available to be distributed to our stockholders. In contrast, assuming we qualify as a RIC, our corporate-level
federal income tax liability should be substantially reduced or eliminated. See “Election to be Taxed as a RIC” above.
If we are unable
to maintain our status as a RIC, we would be subject to tax on all of our taxable income at regular corporate rates. We would
not be able to deduct distributions to stockholders, nor would they be required to be made. Distributions would generally be taxable
to our stockholders as ordinary distribution income eligible for the 15% or 20% maximum rate to the extent of our current and
accumulated earnings and profits. Subject to certain limitations under the Code, dividends paid by us to corporate distributees
would be eligible for the dividends received deduction. Distributions in excess of our current and accumulated earnings and profits
would be treated first as a return of capital to the extent of the stockholder’s tax basis in our common stock, and any
remaining distributions would be treated as a capital gain.
Item 1A.
Risk Factors
Investing in our
securities involves a high degree of risk. In addition to
the other information contained in this annual report on Form 10-K,
you
should consider carefully the following information before making an investment in
our securities. The risks
set out below are not the only risks we face. If any of the following events
occur, our business, financial condition and
results of operations could be
materially and adversely affected. In such case, our NAV and the trading
price of
our common stock could decline, and you may lose part or all of your
investment.
Risks Related to Our Business and Structure
We have a limited operating history
and may not be able to achieve our investment
objective or generate sufficient revenue to make or sustain distributions
to our
stockholders and your investment in us could decline substantially.
We commenced operations
in March 2008 and became a public company on October 28, 2010. As a result of our limited operating history, we are subject to
certain business risks and uncertainties associated with any recently formed business enterprise, including the risk that we will
not achieve our investment objective and that the value of your investment in us could decline substantially. As a public company,
we are subject to the regulatory requirements of the SEC, in addition to the specific regulatory requirements applicable to BDCs
under the 1940 Act and RICs under the Code. Our management and our Advisor have limited experience operating under this regulatory
framework, and we may incur substantial additional costs, and expend significant time or other resources, to do so. From time
to time our Advisor may pursue investment opportunities, like equity investments, in which our Advisor has more limited experience.
In addition, we may be unable to generate sufficient revenue from our operations to make or sustain distributions to our stockholders.
We and our Advisor have limited
experience operating under the constraints imposed on
a BDC or managing an investment company, which may affect
our ability to manage our business and impair your ability to assess our prospects.
Prior to becoming
a public company in October 2010, we did not operate as a BDC or manage an investment company under the 1940 Act. As a result,
we have limited operating results under this regulatory framework that can demonstrate to you either its effect on our business
or our ability to manage our business within this framework. The 1940 Act imposes numerous constraints on the operations of BDCs.
For example, BDCs are required to invest at least 70% of their total assets in specified types of securities, primarily securities
of “eligible portfolio companies” (as defined in the 1940 Act), cash, cash equivalents, U.S. government securities
and other high quality debt investments that mature in one year or less. See “Regulation” in Item 1 above. Our
Advisor’s lack of experience in managing a portfolio of assets under these constraints may hinder our ability to take advantage
of attractive investment opportunities and, as a result, could impair our ability to achieve our investment objective. Furthermore,
if we are unable to comply with the requirements imposed on BDCs by the 1940 Act, the SEC could bring an enforcement action against
us and/or we could be exposed to claims of private litigants. In addition, we could be regulated as a closed-end management investment
company under the 1940 Act, which could further decrease our operating flexibility and may prevent us from operating our business,
either of which could have a material adverse effect on our business, results of operations or financial condition.
We are dependent upon key personnel of our Advisor and
our Advisor’s ability to hire
and retain qualified personnel.
We depend on the
members of our Advisor’s senior management, particularly Mr. Pomeroy, our Chairman and Chief Executive Officer, and
Mr. Michaud, our President, as well as other key personnel for the identification, evaluation, final selection, structuring,
closing and monitoring of our investments. These employees have critical industry experience and relationships that we rely on
to implement our business plan to originate Venture Loans in our Target Industries. Our future success depends on the continued
service of Mr. Pomeroy and Mr. Michaud as well as the other senior members of our Advisor’s management team. If our
Advisor were to lose the services of either Mr. Pomeroy or Mr. Michaud or any of the other senior members of our Advisor’s
management team, we may not be able to operate our business as we expect, and our ability to compete could be harmed, either of
which could cause our business, results of operations or financial condition to suffer. In addition, if more than one of Mr. Pomeroy,
Mr. Michaud or Mr. Mathieu, our Chief Financial Officer, cease to be actively involved in the Company or our Advisor,
and are not replaced by individuals satisfactory to Wells Fargo Capital Finance, LLC (“Wells”) within ninety days,
Wells could, absent a waiver or cure, demand repayment of any outstanding obligations under the Wells Facility. If both Mr. Pomeroy
and Mr. Michaud cease to be employed by us, and they are not replaced by individuals satisfactory to Fortress Credit Co LLC (“Fortress”)
within ninety days, then Fortress could, absent a waiver or cure, demand repayment of any outstanding obligations under the Fortress
Facility. Our future success also depends, in part, on our Advisor’s ability to identify, attract and retain sufficient
numbers of highly skilled employees. Absent exemptive or other relief granted by the SEC and for so long as we remain externally
managed, the 1940 Act prevents us from granting options to our employees and adopting a profit sharing plan, which may make it
more difficult for us to attract and retain highly skilled employees. If we are not successful in identifying, attracting and
retaining these employees, we may not be able to operate our business as we expect. Moreover, we cannot assure you that our Advisor
will remain our investment advisor or that we will continue to have access to our Advisor’s investment professionals or
its relationships. For example, our Advisor may in the future manage investment funds with investment objectives similar to ours
thereby diverting the time and attention of its investment professionals that we rely on to implement our business plan.
We operate in a highly competitive
market for investment opportunities, and if we are
not able to compete effectively, our business, results of operations
and financial
condition may be adversely affected and the value of your investment in us could
decline.
We compete for investments
with a number of investment funds and other BDCs, as well as traditional financial services companies such as commercial banks
and other financing sources. Some of our competitors are larger and have greater financial, technical, marketing and other resources
than we have. For example, some competitors may have a lower cost of funds and access to funding sources that are not available
to us. This may enable these competitors to make commercial loans with interest rates that are comparable to, or lower than, the
rates we typically offer. We may lose prospective portfolio companies if we do not match our competitors’ pricing, terms
and structure. If we do match our competitors’ pricing, terms or structure, we may experience decreased net interest income
and increased risk of credit losses. In addition, some of our competitors may have higher risk tolerances or different risk assessments,
which could allow them to consider a wider variety of investments, establish more relationships than us and build their market
shares. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as
a BDC or that the Code imposes on us as a RIC. If we are not able to compete effectively, we may not be able to identify and take
advantage of attractive investment opportunities that we identify and may not be able to fully invest our available capital. If
this occurs, our business, financial condition and results of operations could be materially adversely affected.
We borrow money, which magnifies
the potential for gain or loss on amounts invested
and may increase the risk of investing in us.
Leverage is generally
considered a speculative investment technique, and we intend to continue to borrow money as part of our business plan. The use
of leverage magnifies the potential for gain or loss on amounts invested and, therefore, increases the risks associated with investing
in us. We borrow from and issue senior debt securities to banks and other lenders. Such senior debt securities include those under
the Credit Facilities. See “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results
of Operation – Liquidity and Capital Resources.” Lenders of senior debt securities have fixed dollar claims on our
assets that are superior to the claims of our common stockholders. If the value of our assets increases, then leveraging would
cause the NAV attributable to our common stock to increase more sharply than it would have had we not leveraged. However, any
decrease in our income would cause net income to decline more sharply than it would have had we not leveraged. This decline could
adversely affect our ability to make common stock dividend payments. In addition, because our investments may be illiquid, we
may be unable to dispose of them or unable to do so at a favorable price in the event we need to do so, if we are unable to refinance
any indebtedness upon maturity, and, as a result, we may suffer losses.
Our ability to service
any debt that we incur depends largely on our financial performance and is subject to prevailing economic conditions and competitive
pressures. Moreover, as our Advisor’s management fee is payable to our Advisor based on our gross assets, including those
assets acquired through the use of leverage, our Advisor may have a financial incentive to incur leverage which may not be consistent
with our stockholders’ interests. In addition, holders of our common stock bear the burden of any increase in our expenses,
as a result of leverage, including any increase in the management fee payable to our Advisor.
Illustration:
The following table illustrates the effect of leverage on returns from an investment in our common stock assuming various
annual returns, net of expenses. The calculations in the table below are hypothetical and actual returns may be higher or lower
than those appearing in the table below:
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Assumed Return on Our Portfolio
(Net of Expenses)
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-10%
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-5%
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0%
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5%
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10%
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Corresponding return to stockholder(1)
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-20.62
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%
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-12.34
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%
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-4.06
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%
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4.21
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%
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12.49
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(1)
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Assumes $240 million in total assets, $89 million
in outstanding debt, $145 million in net assets, and an average cost of borrowed funds of 6.62% at December 31, 2012.
Actual interest payments may be different.
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Based on our outstanding indebtedness
of $89 million as of December 31, 2012 and the average cost of borrowed funds of 6.62% as of that date, our investment portfolio
would have been required to experience an annual return of at least 2.54% to cover annual interest payments on the outstanding
debt.
If we are unable to comply with
the covenants or restrictions in our Credit Facilities, make payments when due thereunder or make payments pursuant to our Senior
Notes,
our business could be materially adversely affected.
Our Credit Facilities
are secured by a lien on the assets of our wholly owned subsidiaries, Horizon Credit II LLC (“Credit II”) and
Horizon Credit III LLC (“Credit III”), which hold substantially all of our assets. The breach of certain of the covenants
or restrictions or our failure to make payments when due under the Credit Facilities, unless cured within the applicable grace
period, would result in a default under the Credit Facilities that would permit the lenders to declare all amounts outstanding
to be due and payable. In such an event, we may not have sufficient assets to repay such indebtedness and the lenders may exercise
rights available to them, including, without limitation, to the extent permitted under applicable law, the seizure of such assets
without adjudication.
The Credit Facilities
include covenants that, among other things, restrict the ability of Credit II and Credit III to (i) make loans to, or
investments in, third parties (other than Venture Loans and warrants or other equity participation rights), (ii) pay dividends
and distributions, (iii) incur additional indebtedness, (iv) engage in mergers or consolidations, (v) create liens
on the collateral securing the Credit Facilities, (vi) permit additional negative pledges on such collateral, (vii) change
the business currently conducted by them, and (viii) have a change of control.
The Credit Facilities
also require Credit II, Credit III and our Advisor to comply with various financial covenants, including, among other
covenants, maintenance by our Advisor of a minimum tangible net worth and limitations on the value of, and modifications to, the
loan collateral that secures the Credit Facilities. Complying with these restrictions may prevent us from taking actions that
we believe would help us to grow our business or are otherwise consistent with our investment objective. These restrictions could
also limit our ability to plan for or react to market conditions, meet extraordinary capital needs or otherwise restrict corporate
activities, and could result in our failing to qualify as a RIC resulting in our becoming subject to corporate-level income tax.
See “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations —
Liquidity and Capital Resources” for additional information regarding our credit arrangements.
An event of default
or acceleration under the Credit Facilities could also cause a cross-default or cross-acceleration of another debt instrument
or contractual obligation, which would adversely impact our liquidity. We may not be granted waivers or amendments to the Credit
Facilities or Senior Notes if for any reason we are unable to comply with it, and we may not be able to refinance the Credit Facilities
on terms acceptable to us, or at all.
Our Senior Notes are unsecured and
therefore are effectively subordinated to any secured indebtedness we have currently incurred or may incur in the future.
Our
Senior Notes
are not secured by any of our assets or any of the assets of our subsidiaries. As a result, the Senior Notes
arc 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
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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 Senior Notes. As of December 31, 2012, we had $46.0 million of
outstanding borrowings under our Wells Facility, and $10.0 million of outstanding borrowings under our Fortress Facility.
Our Senior Notes are structurally
subordinated to the indebtedness and other liabilities of our subsidiaries.
Our
Senior Notes are obligations exclusively of Horizon Technology Finance Corporation, and not of any of our subsidiaries. None of
our subsidiaries is a guarantor of the Senior Notes and the Senior Notes are not required to be guaranteed by any subsidiaries
we may acquire or create in the future. The assets of such subsidiaries are not directly available to satisfy the claims of our
creditors, including holders of the Senior Notes.
Except
to the extent we are a creditor with recognized claims against our subsidiaries, all claims of creditors (including trade creditors)
and holders of preferred stock, if any, of our subsidiaries have priority over our equity interests in such subsidiaries (and
therefore the claims of our creditors, including holders of the Senior 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 are 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 Senior Notes are 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. As of December 31, 2012, we had $46.0 million of outstanding borrowings under our Wells Facility, and $10.0 million
of outstanding borrowings under our Fortress Facility.
In
addition, our subsidiaries may incur substantial additional indebtedness in the future, all of which would be structurally senior
to the Senior Notes.
The indenture under which our Senior
Notes are issued contains limited protection for holders of our Senior Notes.
The
indenture under which the Senior Notes are issued offers limited protection to holders of the Senior Notes. The terms of the indenture
and the Senior 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 a material adverse impact on investments in the Senior Notes.
In particular, the terms of the indenture and the Senior Notes do not place any restrictions on our or our subsidiaries' ability
to:
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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 Senior Notes,
(2) any indebtedness
or
other
obligations
that would be
secured
and
therefore
rank effectively
senior in
right
of
payment to the Senior
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 Senior 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 Senior 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)(l )(A) as modified
by Section 61 (a)(l)
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, in either
case, to any exemptive
relief granted to
us by the SEC (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%
after
such
borrowings);
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pay
dividends 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 Senior Notes,
including subordinated
indebtedness, in
each case other than
dividends, purchases,
redemptions or payments
that would cause
a violation of Section
18(a)( I )(13) as
modified by Section
61 (a)(l) of the
1940 Act or any successor
provisions giving
effect to any exemptive
relief granted to
us by the SEC (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
unless our asset
coverage, as defined
in the 1940 Act,
equals at least 200%
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);
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sell
assets (other than
certain limited restrictions
on our ability to
consolidate, merge
or sell all or substantially
all of our assets);
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enter
into transactions
with affiliates;
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create
liens (including
liens on the shares
of our subsidiaries)
or enter into sale
and leaseback transactions;
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create
restrictions on the
payment of dividends
or other amounts
to us from our subsidiaries.
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In
addition, the indenture does not require us to offer to purchase the Senior Notes in connection with a change of control or any
other event.
Furthermore,
the terms of the indenture and the Senior Notes do not protect holders of the Senior 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 Senior
Notes may have important consequences for holders of the Senior Notes, including making it more difficult for us to satisfy our
obligations with respect to the Senior Notes or negatively affecting the trading value of the Senior Notes.
Certain
of our current debt instruments include more protections for their holders than the indenture and the Senior Notes. In addition,
other debt we issue or incur in the future could contain more protections for its holders than the indenture and the Senior 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 Senior Notes.
An active trading market for our
Senior Notes may not exist, which could limit your ability to sell our Senior Notes or affect the market price of the Senior Note.
The
Senior Notes are listed on the NYSE under the symbol “HTF”. However, we cannot provide any assurances that an active
trading market tor the Senior Notes will exist in the future or that you will be able to sell your Senior Notes. Even if an active
trading market does exist, the Senior Notes may trade at a discount from their initial offering price depending on prevailing
interest rates, the market for similar securities, our credit ratings, if any, general economic conditions, our financial condition,
performance and prospects and other factors. To the extent an active trading market does not exist, the liquidity and trading
price for the Senior Notes may be harmed. Accordingly, you may be required to bear the financial risk of an investment in the
Senior Notes for an indefinite period of time.
If we default on our obligations
to pay our other indebtedness, we may not be able to make payments on our Senior Notes.
Any
default under the agreements governing our indebtedness, including a default under the Wells Facility, and the Fortress Facility,
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 Senior Notes and
substantially decrease the market value of the Senior 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 Fortress 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, the Fortress Facility, the Senior 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, the Fortress
Facility, the Senior 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 and our lenders or debt 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 Fortress Facility, could proceed against the collateral securing the debt. Because
the Wells Facility and the Fortress Facility have, and any future credit facilities will likely have, customary cross-default
provisions, if the indebtedness thereunder or under any future credit facility is accelerated, we may be unable to repay or finance
the amounts due.
The impact of recent financial reform
legislation on us is uncertain.
In light of current
conditions in the U.S. and global financial markets and the U.S. and global economy, legislators, the presidential administration
and regulators have increased their focus on the regulation of the financial services industry. The Dodd-Frank Wall Street Reform
and Consumer Protection Act institutes a wide range of reforms that will have an impact on all financial institutions. Many of
these provisions are subject to rule making procedures and studies that will be conducted in the future. Accordingly, we cannot
predict the effect it or its implementing regulations will have on our business, results of operations or financial condition.
Because we distribute all or substantially
all of our income and any realized
net short-term capital gains over realized net long-term capital losses to our
stockholders, we will need additional capital to finance our growth, if any. If
additional funds are unavailable
or not available on favorable terms, our ability to
grow will be impaired.
To satisfy the requirements
applicable to a RIC, to avoid payment of excise taxes and to minimize or to avoid payment of corporate-level federal income taxes,
we intend to distribute to our stockholders all or substantially all of our net ordinary income and realized net short-term capital
gains over realized net long-term capital losses except that we may retain certain net long-term capital gains, pay applicable
income taxes with respect thereto, and elect to treat such retained capital gains as deemed distributions to our stockholders.
As a BDC, we generally are required to meet a coverage ratio of total assets to total senior securities, which includes all of
our borrowings and any preferred stock we may issue in the future, of at least 200%. This requirement limits the amount that we
may borrow. Because we continue to need capital to grow our loan and investment portfolio, this limitation may prevent us from
incurring debt and require us to raise additional equity at a time when it may be disadvantageous to do so. We cannot assure you
that debt and equity financing will be available to us on favorable terms, or at all, and debt financings may be restricted by
the terms of any of our outstanding borrowings. In addition, as a BDC, we are limited in our ability to issue equity securities
priced below NAV. If additional funds are not available to us, we could be forced to curtail or cease new lending and investment
activities, and our NAV could decline.
If we are unable to obtain additional debt financing,
our business could be materially adversely affected.
We may want to obtain
additional debt financing, or need to do so upon maturity of the Credit Facilities or Senior Notes, in order to obtain funds which
may be made available for investments. We may borrow under the Wells Facility until July 14, 2014, and, after such date,
we must repay the outstanding advances under the Wells Facility in accordance with its terms and conditions. All outstanding advances
under the Wells Facility are due and payable on July 14, 2017, unless such date is extended in accordance with its terms. We may
borrow under the Fortress Facility until August 23, 2016, and, after such date, we must repay the outstanding advances under the
Fortress Facility in accordance with its terms and conditions. All outstanding advances under the Fortress Facility are due and
payable on August 23, 2017 unless such date is extended in accordance with its terms. All outstanding amounts on our Senior Notes
are due and payable on March 15, 2019 unless redeemed prior to that date. If we are unable to increase, renew or replace any such
facility and enter into a new debt financing facility on commercially reasonable terms, our liquidity may be reduced significantly.
In addition, if we are unable to repay amounts outstanding under any such facilities and are declared in default or are unable
to renew or refinance these facilities, we may not be able to make new investments or operate our business in the normal course.
These situations may arise due to circumstances that we may be unable to control, such as lack of access to the credit markets,
a severe decline in the value of the U.S. dollar, a further economic downturn or an operational problem that affects third
parties or us, and could materially damage our business. Moreover, we have withdrawn our application to the Small Business Administration
(”SBA”) for a license to operate as a small business investment company (“SBIC”), which was originally
filed on December 6, 2010, and, though we may in the future submit a new application, we have no present intention to do so and,
therefore, do not expect to be able to borrow money by issuing SBA-guaranteed debentures.
Changes in interest rates may affect our cost of capital
and net investment income.
Because we currently
incur indebtedness to fund our investments, a portion of our income depends upon the difference between the interest rate at which
we borrow funds and the interest rate at which we invest these funds. Most of our investments have fixed interest rates, while
our Credit Facilities have floating interest rates. As a result, a significant change in interest rates could have a material
adverse effect on our net investment income. In periods of rising interest rates, our cost of funds could increase, which would
reduce our net investment income. We may hedge against interest rate fluctuations by using hedging instruments such as swaps,
futures, options and forward contracts, subject to applicable legal requirements, including, without limitation, all necessary
registrations (or exemptions from registration) with the Commodity Futures Trading Commission. These activities may limit our
ability to benefit from lower interest rates with respect to the hedged portfolio. Adverse developments resulting from changes
in interest rates or hedging transactions or any adverse developments from our use of hedging instruments could have a material
adverse effect on our business, financial condition and results of operations. In addition, we may be unable to enter into appropriate
hedging transactions when desired and any hedging transactions we enter into may not be effective.
Because many of our investments
typically are not and will not be in publicly traded
securities, the value of our investments may not be readily
determinable, which could
adversely affect the determination of our NAV.
Our investments consist,
and we expect our future investments to consist, primarily of loans or securities issued by privately held companies. The fair
value of these investments that are not publicly traded may not be readily determinable. In addition, we are not permitted to
maintain a general reserve for anticipated loan losses. Instead, we are required by the 1940 Act to specifically value each investment
and record an unrealized gain or loss for any asset that we believe has increased or decreased in value. We value these investments
on a quarterly basis, or more frequently as circumstances require, in accordance with our valuation policy consistent with generally
accepted accounting principles. Our Board employs an independent third-party valuation firm to assist them in arriving at the
fair value of our investments. Our Board discusses valuations and determines the fair value in good faith based on the input of
our Advisor and the third-party valuation firm. The factors that may be considered in fair value pricing our investments include
the nature and realizable value of any collateral, the portfolio company’s earnings and its ability to make payments on
its indebtedness, the markets in which the portfolio company does business, comparisons to publicly traded companies, discounted
cash flow and other relevant factors. Because such valuations are inherently uncertain and may be based on estimates, our determinations
of fair value may differ materially from the values that would be assessed if a ready market for these securities existed. Our
NAV could be adversely affected if our determinations regarding the fair value of our investments are materially higher than the
values that we ultimately realize upon the disposal of these investments.
Disruption in the capital markets and the credit markets
could adversely affect our business.
Without sufficient
access to the capital markets or credit markets, we may be forced to curtail our business operations or we may not be able to
pursue new investment opportunities. The global capital markets are in a period of disruption and extreme volatility and, accordingly,
there has been and will continue to be uncertainty in the financial markets in general.
A
prolonged period of market illiquidity or uncertainty regarding U.S. government spending levels, including negotiation of federal
spending cuts, and implementation of global fiscal austerity measures may have an adverse effect on our business, financial condition,
results of operations and cash flows. Unfavorable economic conditions, including future recessions, also could affect our investment
valuations, increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend
credit to us or our portfolio companies. These events could limit our investment originations, limit our ability to grow and negatively
impact our operating results.
We are unable to
predict when economic and market conditions may become more favorable. Even if these conditions improve significantly over the
long term, adverse conditions in particular sectors of the financial markets could adversely impact our business.
We may not realize gains from our equity investments.
We may make non-control,
equity co-investments in companies in conjunction with private equity sponsors. The equity interests we receive may not appreciate
in value and, in fact, may decline in value. 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.
We also may be unable to realize any value if a portfolio company does not have a liquidity event, such as a sale of the business,
refinancing or public offering, which would allow us to sell the underlying equity interests. In addition, our Advisor’s
significant experience in Venture Lending may not result in returns on our equity investments.
From time to time
we may also acquire equity participation rights in connection with an investment which will allow us, at our option, to participate
in future rounds of equity financing through direct capital investments in our portfolio companies. Our Advisor determines whether
to exercise any of these rights. Accordingly, you will have no control over whether or to what extent these rights are exercised,
if at all. If we exercise these rights, we will be making an additional investment completely in the form of equity which will
subject us to significantly more risk than our Venture Loans and we may not receive the returns that are anticipated with respect
to these investments.
We may not realize expected returns on warrants received
in connection with our debt
investments.
As discussed above,
we generally receive warrants in connection with our debt investments. If we do not receive the returns that are anticipated on
the warrants, our investment returns on our portfolio companies, and the value of your investment in us, may be lower than expected.
Regulations governing our operation
as a BDC affect our
ability to, and the way in which, we raise additional capital, which may expose us to
additional risks.
Our business plans
contemplate a need for a substantial amount of capital in addition to our current amount of capital. We may obtain additional
capital through the issuance of debt securities or preferred stock, and we may borrow money from banks or other financial institutions,
which we refer to collectively as “senior securities,” up to the maximum amount permitted by the 1940 Act. If we issue
senior securities, we would be exposed to typical risks associated with leverage, including an increased risk of loss. In addition,
if we issue preferred stock, it would rank senior to common stock in our capital structure and preferred stockholders would have
separate voting rights and may have rights, preferences or privileges more favorable than those of holders of our common stock.
The 1940 Act permits
us to issue senior securities in amounts such that our asset coverage ratio, as defined in the 1940 Act, equals at least 200%
after each issuance of senior securities. If our asset coverage ratio is not at least 200%, we are not permitted to pay dividends
or issue additional senior securities. If the value of our assets declines, we may be unable to satisfy this asset coverage test.
If that happens, we may be required to liquidate a portion of our investments and repay a portion of our indebtedness at a time
when we may be unable to do so or unable to do so on favorable terms. See Note 6 to Consolidated Financial Statements for additional
information regarding borrowings.
As a BDC, we generally
are not able to issue our common stock at a price below NAV without first obtaining the approval of our stockholders and our independent
directors, and we may seek such approval to sell our common stock below NAV in the future. This requirement does not apply to
stock issued upon the exercise of options, warrants or rights that we may issue from time to time. If we raise additional funds
by issuing more common stock or senior securities convertible into, or exchangeable for, our common stock, the percentage ownership
of our stockholders at that time would decrease, and you may experience dilution.
If we are unable to satisfy the
requirements under the Code for qualification as a
RIC, we will be subject to corporate-level federal income tax.
To qualify as a RIC
under the Code, we must meet certain source-of-income, diversification and other requirements contained in Subchapter M of the
Code and maintain our election to be regulated as a BDC under the 1940 Act. We must also meet the Annual Distribution Requirement
to avoid corporate-level federal income tax in that year on all of our taxable income, regardless of whether we make any distributions
to our stockholders.
The source-of-income
requirement is satisfied if we derive in each taxable year at least 90% of our gross income from dividends, interest (including
tax-exempt interest), payments with respect to certain securities loans, gains from the sale or other disposition of stock, securities
or foreign currencies, other income (including but not limited to gain from options, futures or forward contracts) derived with
respect to our business of investing in stock, securities or currencies, or net income derived from an interest in a “qualified
publicly traded partnership.” The status of certain forms of income we receive could be subject to different interpretations
under the Code and might be characterized as non-qualifying income that could cause us to fail to qualify as a RIC, assuming we
do not qualify for or take advantage of certain remedial provisions, and, thus, may cause us to be subject to corporate-level
federal income taxes.
The Annual Distribution
Requirement for a RIC is satisfied if we distribute to our stockholders on an annual basis an amount equal to at least 90% of
our net ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any.
If we borrow money, we may be subject to certain asset coverage ratio requirements under the 1940 Act and loan covenants that
could, under certain circumstances, restrict us from making distributions necessary to qualify as a RIC. If we are unable to obtain
cash from other sources, we may fail to qualify as a RIC, assuming we do not qualify for or take advantage of certain remedial
provisions, and, thus, may be subject to corporate-level income tax.
To qualify as a RIC,
we must also meet certain asset diversification requirements at the end of each calendar quarter. Failure to meet these tests
may result in our having to (1) dispose of certain investments quickly; (2) raise additional capital to prevent the
loss of RIC status; or (3) engage in certain remedial actions that may entail the disposition of certain investments at disadvantageous
prices that could result in substantial losses, and the payment of penalties, if we qualify to take such actions. Because most
of our investments are and will be in development-stage companies within our Target Industries, any such dispositions could be
made at disadvantageous prices and may result in substantial losses. If we raise additional capital to satisfy the asset diversification
requirements, it could take a longer time to invest such capital. During this period, we will invest in temporary investments,
such as money market funds, which we expect will earn yields substantially lower than the interest income that we anticipate receiving
in respect of our investments in secured and amortizing loans.
If we were to fail
to qualify for the federal income tax benefits allowable to RICs for any reason and become subject to a corporate-level federal
income tax, the resulting taxes could substantially reduce our net assets, the amount of income available for distribution to
our stockholders, and the actual amount of our distributions. Such a failure would have a material adverse effect on us, the NAV
of our common stock and the total return, if any, obtainable from your investment in our common stock. In addition, we could be
required to recognize unrealized gains, pay substantial taxes and interest and make substantial distributions before requalifying
as a RIC. See “Regulation.”
We may have difficulty paying our required distributions
if we recognize taxable
income before or without receiving cash.
We may be required
to recognize taxable income in circumstances in which we do not receive cash. For example, if we hold debt instruments that are
treated under applicable tax rules as having original issue discount (such as debt instruments with payment-in-kind interest or,
in certain cases, increasing interest rates or issued with warrants), we must include in taxable income each year a portion of
the original issue discount that accrues over the life of the debt instrument, regardless of whether cash representing such income
is received by us in the same taxable year. We do not have a policy limiting our ability to invest in original issue discount
instruments, including payment-in-kind loans. Because in certain cases we may recognize taxable income before or without receiving
cash representing such income, we may have difficulty meeting the requirement that we distribute an amount equal to at least 90%
of our net ordinary income and realized net short-term capital gains in excess of realized long-term capital losses, if any.
Accordingly, we may
need to sell some of our assets at times that we would not consider advantageous, raise additional debt or equity capital or forego
new investment opportunities or otherwise take actions that are disadvantageous to our business (or be unable to take actions
that we believe are necessary or advantageous to our business) in order to satisfy the Annual Distribution Requirement. If we
are unable to obtain cash from other sources to satisfy the Annual Distribution Requirement, we may fail to qualify for the federal
income tax benefits allowable to RICs and, thus, become subject to a corporate-level federal income tax on all our income. The
proportion of our income, consisting of net investment income and our realized gains and losses, that resulted from the portion
of original issue discount not received in cash for the years ended December 31, 2012, 2011 and 2010 was 7.9%, 7.4% and 9.1%,
respectively.
If we do not invest a sufficient
portion of our assets in qualifying assets, we could
fail to qualify as a BDC or be precluded from investing
according to our current business strategy.
As a BDC, we are
prohibited from acquiring any assets other than qualifying assets unless, at the time of and after giving effect to such acquisition,
at least 70% of our total assets are qualifying assets. Substantially all of our assets are qualifying assets and we expect that
substantially all of our assets that we may acquire in the future will be qualifying assets, although we may decide to make other
investments that are not qualifying assets to the extent permitted by the 1940 Act. If we acquire debt or equity securities from
an issuer that has outstanding marginable securities at the time we make an investment, these acquired assets may not be treated
as qualifying assets. This result is dictated by the definition of “eligible portfolio company” under the 1940 Act,
which in part looks to whether a company has outstanding marginable securities. See Item 1 above, “Regulation —
Qualifying Assets.” If we do not invest a sufficient portion of our assets in qualifying assets, we could lose our status
as a BDC, which would have a material adverse effect on our business, financial condition and results of operations.
Changes in laws or regulations governing
our business could adversely affect our
business, results of operations and financial condition.
Changes in the laws
or regulations or the interpretations of the laws and regulations that govern BDC, RICs, or non-depository commercial lenders
could significantly affect our operations, our cost of doing business and our investment strategy. We are subject to federal,
state and local laws and regulations and judicial and administrative decisions that affect our operations, including our loan
originations, maximum interest rates, fees and other charges, disclosures to portfolio companies, the terms of secured transactions,
collection and foreclosure procedures, portfolio composition and other trade practices. If these laws, regulations or decisions
change, or if we expand our business into jurisdictions that have adopted more stringent requirements, we may incur significant
expenses to comply with these laws, regulations or decisions or we might have to restrict our operations or alter our investment
strategy. In addition, if we do not comply with applicable laws, regulations and decisions, we may lose licenses needed for the
conduct of our business and be subject to civil fines and criminal penalties, any of which could have a material adverse effect
upon our business, results of operations or financial condition.
Our Advisor has significant potential
conflicts of interest with us and our stockholders.
As a result of our
arrangements with our Advisor, there may be times when our Advisor has interests that differ from those of our stockholders, giving
rise to a potential conflict of interest. Our executive officers and directors, as well as the current and future executives and
employees of our Advisor, 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. Accordingly, they may have obligations to investors in those entities, the fulfillment of which might
not be in the best interests of our stockholders. In addition, our Advisor may manage other funds in the future that may have
investment objectives that are similar, in whole or in part, to ours. Our Advisor may determine that an investment is appropriate
for us and for one or more of those other funds. In such an event, depending on the availability of the investment and other appropriate
factors, our Advisor will endeavor to allocate investment opportunities in a fair and equitable manner and act in accordance with
its written conflicts of interest policy to address and, if necessary, resolve any conflict of interests. It is also possible
that we may not be given the opportunity to participate in these other investment opportunities.
We pay management
and incentive fees to our Advisor and reimburse our Advisor for certain expenses it incurs. As a result, investors in our common
stock invest on a “gross” basis and receive distributions on a “net” basis after expenses, resulting in
a lower rate of return than an investor might achieve through direct investments. Also, the incentive fee payable by us to our
Advisor may create an incentive for our Advisor to pursue investments on our behalf that are riskier or more speculative than
would be the case in the absence of such compensation arrangements.
We have entered into
a license agreement with Horizon Technology Finance, LLC, pursuant to which it has agreed to grant us a non-exclusive, royalty-free
right and license to use the service mark “Horizon Technology Finance.” Under this agreement, we have a right to use
the “Horizon Technology Finance” service mark for so long as the Investment Management Agreement is in effect between
us and our Advisor. In addition, we pay our Advisor, our allocable portion of overhead and other expenses incurred by our Advisor
in performing its obligations under the Administration Agreement, including rent, the fees and expenses associated with performing
compliance functions, and our allocable portion of the compensation of our Chief Financial Officer and Chief Compliance Officer
and their respective staffs. Any potential conflict of interest arising as a result of our arrangements with our Advisor could
have a material adverse effect on our business, results of operations and financial condition.
Our incentive fee may impact our
Advisor’s structuring of our investments, including
by causing our Advisor to pursue speculative investments.
The incentive fee
payable by us to our Advisor may create an incentive for our Advisor to pursue investments on our behalf that are riskier or more
speculative than would be the case in the absence of such compensation arrangement. The incentive fee payable to our Advisor is
calculated based on a percentage of our return on invested capital. This may encourage our Advisor to use leverage to increase
the return on our investments. Under certain circumstances, the use of leverage may increase the likelihood of default, which
would impair the value of our common stock. In addition, our Advisor receives the incentive fee based, in part, upon net capital
gains realized on our investments. Unlike that 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, our Advisor may have a tendency to invest more capital
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 investments than would otherwise be the case, which could result in higher investment losses,
particularly during economic downturns. In addition, the incentive fee may encourage our Advisor to pursue different types of
investments or structure investments in ways that are more likely to result in warrant gains or gains on equity investments, including
upon exercise of equity participation rights, which are inconsistent with our investment strategy and disciplined underwriting
process.
The incentive fee
payable by us to our Advisor may also induce our Advisor to pursue investments on our behalf that have a deferred interest feature,
even if such deferred payments would not provide cash necessary to enable us to pay current distributions to our stockholders.
Under these investments, we would accrue interest over the life of the investment but would not receive the cash income from the
investment until the end of the term. Our net investment income used to calculate the income portion of our investment fee, however,
includes accrued interest. Thus, a portion of this incentive fee would be based on income that we have not yet received in cash.
In addition, the “catch-up” portion of the incentive fee may encourage our Advisor to accelerate or defer interest
payable by portfolio companies from one calendar quarter to another, potentially resulting in fluctuations in the timing and amounts
of dividends. Our governing documents do not limit the number of loans we may make with deferred interest features or the proportion
of our income we derive from such loans.
Our Advisor’s liability is
limited, and we have agreed to indemnify our Advisor against certain liabilities, which may lead our Advisor to act in a riskier
manner on our behalf than it would when acting for its own account.
Under the Investment
Management Agreement, our Advisor does not assume any responsibility to us other than to render the services called for under
that agreement, and it is not responsible for any action of our Board in following or declining to follow our Advisor’s
advice or recommendations. Under the terms of the Investment Management Agreement, our Advisor, its officers, members, personnel
and any person controlling or controlled by our Advisor is not liable to us, any subsidiary of ours, our directors, our stockholders
or any subsidiary’s stockholders or partners for acts or omissions performed in accordance with and pursuant to the Investment
Management Agreement, except those resulting from acts constituting gross negligence, willful misconduct, bad faith or reckless
disregard of our Advisor’s duties under the Investment Management Agreement. In addition, we have agreed to indemnify our
Advisor and each of its officers, directors, members, managers and employees from and against any claims or liabilities, including
reasonable legal fees and other expenses reasonably incurred, arising out of or in connection with our business and operations
or any action taken or omitted on our behalf pursuant to authority granted by the Investment Management Agreement, except where
attributable to gross negligence, willful misconduct, bad faith or reckless disregard of such person’s duties under the
Investment Management Agreement. These protections may lead our Advisor to act in a riskier manner when acting on our behalf than
it would when acting for its own account.
If we are unable to manage our future
growth effectively, we may be unable to achieve our investment objective, which could adversely affect our business, results of
operations and financial condition and cause the value of your investment in us to decline.
Our ability to achieve
our investment objective depends on our ability to achieve and sustain growth, which depends, in turn, on our Advisor’s
direct origination capabilities and disciplined underwriting process in identifying, evaluating, financing, investing in and monitoring
suitable companies that meet our investment criteria. Accomplishing this result on a cost-effective basis is largely a function
of our Advisor’s marketing capabilities, management of the investment process, ability to provide efficient services and
access to financing sources on acceptable terms. In addition to monitoring the performance of our existing investments, our Advisor
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 of investment. If we fail to manage our future growth effectively, our business, results of operations and
financial condition could be materially adversely affected and the value of your investment in us could decrease.
Our Board may change our operating
policies and strategies, including our investment objective, without prior notice or stockholder approval, the effects of which
may adversely affect our business.
Our Board may modify
or waive our current operating policies and strategies, including our investment objectives, without prior notice and without
stockholder approval (provided that no such modification or waiver may change the nature of our business so as to cease to be,
or withdraw our election as a BDC as provided by the 1940 Act without stockholder approval at a special meeting called upon written
notice of not less than ten or more than sixty days before the date of such meeting). We cannot predict the effect any changes
to our current operating policies and strategies would have on our business, results of operations or financial condition or on
the value of our stock. However, the effects of any changes might adversely affect our business, any or all of which could negatively
impact our ability to pay dividends or cause you to lose all or part of your investment in us.
Our quarterly and annual operating
results may fluctuate due to the nature of our business.
We could experience
fluctuations in our quarterly and annual operating results due to a number of factors, some of which are beyond our control, including:
our ability to make investments in companies that meet our investment criteria, the interest rate payable on our loans, the default
rate on these investments, 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. For example, we
have historically experienced greater investment activity during the second and fourth quarters relative to other periods. As
a result of these factors, you should not rely on the results for any prior period as being indicative of our performance in future
periods.
Our business plan and growth strategy
depends to a significant extent upon our Advisor’s referral relationships. If our Advisor is unable to develop new or maintain
existing relationships, or if these relationships fail to generate investment opportunities, our business could be materially
adversely affected.
We have historically
depended on our Advisor’s referral relationships to generate investment opportunities. For us to achieve our future business
objectives, members of our Advisor need to maintain these relationships with venture capital and private equity firms and management
teams and legal firms, accounting firms, investment banks and other lenders, and we rely to a significant extent upon these relationships
to provide us with investment opportunities. If they fail to maintain their existing relationships or develop new relationships
with other firms or sources of investment opportunities, we may not be able to grow our investment portfolio. In addition, persons
with whom our Advisor has relationships are not obligated to provide us with investment opportunities, and, therefore, there is
no assurance that such relationships will lead to the origination of debt or other investments.
Our Advisor can resign on 60 days’
notice and we may not be able to find a suitable replacement within that time, resulting in a disruption in our operations that
could adversely affect our business, results of operations or financial condition.
Under our Investment
Management Agreement, our Advisor has the right to resign at any time, including during the first two years following the Investment
Management Agreement’s effective date, upon not more than 60 days’ written notice, whether we have found a replacement
or not. If our Advisor resigns, we may not be able to find a new investment advisor or hire internal management with similar expertise
and ability to provide the same or equivalent services on acceptable terms within 60 days, or at all. If we are unable to
do so, our operations are likely to be disrupted, our business, results of operations and financial condition and our ability
to pay distributions may be adversely affected and the market price of our shares may decline. In addition, the coordination of
our internal management and investment activities is likely to suffer if we are unable to identify and reach an agreement with
a single institution or group of executives having the expertise possessed by our Advisor and its affiliates. Even if we are able
to retain comparable management, whether internal or external, the integration of new management and their lack of familiarity
with our investment objective may result in additional costs and time delays that may adversely affect our business, results of
operations or financial condition.
Our ability to enter into transactions
with our affiliates is restricted.
As a BDC, we are
prohibited under the 1940 Act from participating in certain transactions with our affiliates without the prior approval of our
independent directors and, in some cases, the SEC. Any person that owns, directly or indirectly, 5% or more of our outstanding
voting securities is considered our affiliate for purposes of the 1940 Act. We are generally prohibited from buying or selling
any security from or to an affiliate, absent the prior approval of our independent directors. The 1940 Act also prohibits certain
“joint” transactions with an affiliate, which could include investments in the same portfolio company (whether at
the same or different times), without prior approval of our independent directors. If a person acquires more than 25% of our voting
securities, we are prohibited from buying or selling any security from or to that person or certain of that person’s affiliates,
or entering into prohibited joint transactions with those persons, absent the prior approval of the SEC. Similar restrictions
limit our ability to transact business with our officers or directors or their affiliates. These restrictions could limit or prohibit
us from making certain attractive investments that we might otherwise make absent such restrictions.
While we have no
current intention to enter into any principal transactions or joint arrangements with any affiliates, we have considered and evaluated,
and will continue to consider and evaluate, the potential advantages and disadvantages of doing so. If we decide to enter into
any such transactions in the future we will not do so until we have requested and received the requisite exemptive relief under
Section 57 of the 1940 Act, the filing of which our Board has previously authorized.
We incur significant costs as a
result of being a publicly traded company.
As a publicly traded
company, we incur legal, accounting and other expenses, including costs associated with the periodic reporting requirements applicable
to a company whose securities are registered under the Securities Exchange Act of 1934, as amended, as well as additional corporate
governance requirements, including requirements under the Sarbanes-Oxley Act, and other rules implemented by the SEC.
Efforts to comply with Section 404
of the Sarbanes-Oxley Act may involve significant expenditures, and non-compliance with Section 404 of the Sarbanes-Oxley
Act may adversely affect us and the market price of our common stock.
Under current SEC
rules, we are required to report on our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley
Act and related rules and regulations of the SEC. As a result, we incur additional expenses that may negatively impact our financial
performance and our ability to make distributions. This process also results in a diversion of management’s time and attention.
We cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same
on our operations, and we may not be able to ensure that the process is effective or that our internal control over financial
reporting is or will be effective in a timely manner. In the event that we are unable to maintain or achieve compliance with Section 404
of the Sarbanes-Oxley Act and related rules, we and the market price of our securities may be adversely affected.
Terrorist attacks and other catastrophic
events may disrupt the businesses in which we invest and harm our operations and our profitability.
Terrorist attacks
and threats, escalation of military activity or acts of war may significantly harm our results of operations and your investment.
We cannot assure you that there will not be further terrorist attacks against the United States or United States businesses. Such
attacks or armed conflicts in the United States or elsewhere may impact the businesses in which we invest directly or indirectly,
by undermining economic conditions in the United States or elsewhere. In addition, because many of our portfolio companies operate
and rely on network infrastructure and enterprise applications and internal technology systems for development, marketing, operational,
support and other business activities, a disruption or failure of any or all of these systems in the event of a major telecommunications
failure, cyber-attack, fire, earthquake, severe weather conditions or other catastrophic event could cause system interruptions,
delays in product development and loss of critical data and could otherwise disrupt their business operations. Losses resulting
from terrorist attacks are generally uninsurable.
Risks Related to Our Investments
We have not yet identified many of the potential investment
opportunities for our
portfolio.
We have not yet identified
many of the potential investment opportunities for our portfolio. Our future investments will be selected by our Advisor, subject
to the approval of its investment committee. Our stockholders do not have input into our Advisor’s investment decisions.
As a result, our stockholders are unable to evaluate any of our future portfolio company investments. These factors increase the
uncertainty, and thus the risk, of investing in our securities.
We are a non-diversified investment company within the
meaning of the 1940 Act, and therefore we generally are not limited with respect to the proportion of our assets that may be invested
in securities of a single issuer.
We are classified
as a non-diversified investment company within the meaning of the 1940 Act, which means that we are not limited by the 1940 Act
with respect to the proportion of our assets that we may invest in securities of a single issuer, excluding limitations on stake
holdings in investment companies. To the extent that we assume large positions in the securities of a small number of issuers,
our NAV may fluctuate to a greater extent than that of a diversified investment company as a result of changes in the financial
condition or the market’s assessment of the issuer. We may also be more susceptible to any single economic or regulatory
occurrence than a diversified investment company. Beyond our income tax diversification requirements, we do not have fixed guidelines
for diversification, and our investments could be concentrated in relatively few portfolio companies.
If our investments do not meet our performance expectations,
you may not receive distributions.
We intend to make
distributions of income on a monthly basis to our stockholders. We may not be able to achieve operating results that will allow
us to make distributions at a specific level or increase the amount of these distributions from time to time. In addition, due
to the asset coverage test applicable to us as a BDC, we may be limited in our ability to make distributions. Also, restrictions
and provisions in any existing or future credit facilities may limit our ability to make distributions. If we do not distribute
a certain percentage of our income annually, we will suffer adverse tax consequences, including the possible loss of the federal
income tax benefits allowable to RICs.
Most of our portfolio companies will need additional
capital, which may not be
readily available.
Our portfolio companies
typically require substantial additional financing to satisfy their continuing working capital and other capital requirements
and service the interest and principal payments on our investments. We cannot predict the circumstances or market conditions under
which our portfolio companies will seek additional capital. Each round of institutional equity financing is typically intended
to provide a company with only enough capital to reach the next stage of development. It is possible that one or more of our portfolio
companies will not be able to raise additional financing or may be able to do so only at a price or on terms that are unfavorable
to the portfolio company, either of which would negatively impact our investment returns. Some of these companies may be unable
to obtain sufficient financing from private investors, public capital markets or lenders, thereby requiring these companies to
cease or curtail business operations. Accordingly, investing in these types of companies generally entails a higher risk of loss
than investing in companies that do not have significant incremental capital raising requirements.
Economic recessions or downturns
could adversely affect our business and that of our
portfolio companies which may have an adverse effect on our
business, results of
operations and financial condition.
General economic
conditions may affect our activities and the operation and value of our portfolio companies. Economic slowdowns or recessions
may result in a decrease of institutional equity investment, which would limit our lending opportunities. Furthermore, many of
our portfolio companies may be susceptible to economic slowdowns or recessions and may be unable to repay our loans during these
periods. Therefore, our non-performing assets are likely to increase and the value of our portfolio is likely to decrease during
these periods. Adverse economic conditions may also 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 could also increase our funding costs, limit our access to the
capital markets or result in a decision by lenders not to extend credit to us.
A portfolio company’s
failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination
of its loans and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize the
portfolio company’s ability to meet its obligations under the loans that we hold. We may incur expenses to the extent necessary
to recover our investment upon default or to negotiate new terms with a defaulting portfolio company. These events could harm
our financial condition and operating results.
Our investment strategy focuses
on investments in development-stage companies in our
Target Industries, which are subject to many risks, including
volatility, intense
competition, shortened product life cycles and periodic downturns, and would be
rated
below “investment grade.”
We intend to invest,
under normal circumstances, most of the value of our total assets (including the amount of any borrowings for investment purposes)
in development-stage companies, which may have relatively limited operating histories, in our Target Industries. Many of these
companies may have narrow product lines and small market shares, compared to larger established publicly owned firms, which tend
to render them more vulnerable to competitors’ actions and market conditions, as well as general economic downturns. The
revenues, income (or losses) and valuations of development-stage companies in our Target Industries can and often do fluctuate
suddenly and dramatically. For these reasons, investments in our portfolio companies, if rated by one or more ratings agency,
would typically be rated below “investment grade,” which refers to securities rated by ratings agencies below the
four highest rating categories. These companies may also have more limited access to capital and higher funding costs. In addition,
development-stage technology markets are generally characterized by abrupt business cycles and intense competition, and the competitive
environment can change abruptly due to rapidly evolving technology. Therefore, our portfolio companies may face considerably more
risk than companies in other industry sectors. Accordingly, these factors could impair their cash flow or result in other events,
such as bankruptcy, which could limit their ability to repay their obligations to us and may materially adversely affect the return
on, or the recovery of, our investments in these businesses.
Because of rapid
technological change, the average selling prices of products and some services provided by development-stage companies in our
Target Industries have historically decreased over their productive lives. These decreases could adversely affect their operating
results and cash flow, their ability to meet obligations under their debt securities and the value of their equity securities.
This could, in turn, materially adversely affect our business, financial condition and results of operations.
Any unrealized depreciation we experience
on our loan portfolio may be an indication of future realized losses, which could reduce our income available for distribution.
As a BDC, we are
required to carry our investments at fair value which shall be the market value of our investments or, if no market value is ascertainable,
at the fair value as determined in good faith pursuant to procedures approved by our Board in accordance with our valuation policy.
We are not permitted to maintain a reserve for loan losses. Decreases in the fair values of our investments are recorded as unrealized
depreciation. Any unrealized depreciation in our loan portfolio could be an indication of a portfolio company’s inability
to meet its repayment obligations to us with respect to the affected loans. This could result in realized losses in the future
and ultimately reduces our income available for distribution in future periods.
If the assets securing the loans
we make decrease in value, we may not have
sufficient collateral to cover losses and may experience losses upon
foreclosure.
We believe our portfolio
companies generally are and will be able to repay our loans from their available capital, from future capital-raising transactions
or from cash flow from operations. However, to mitigate our credit risks, we typically take a security interest in all or a portion
of the assets of our portfolio companies, including the equity interests of their subsidiaries. There is a risk that the collateral
securing our loans may decrease in value over time, may be difficult to appraise or sell in a timely manner and may fluctuate
in value based upon the business and market conditions, including as a result of an inability of the portfolio company to raise
additional capital, and, in some circumstances, our lien could be subordinated to claims of other creditors. In addition, deterioration
of a portfolio company’s financial condition and prospects, including its inability to raise additional capital, may be
accompanied by deterioration of the value of the collateral for the loan. Consequently, although such loan is secured, we may
not receive principal and interest payments according to the loan’s terms and the value of the collateral may not be sufficient
to recover our investment should we be forced to enforce our remedies.
In addition, because
we invest in development-stage companies in our Target Industries, a substantial portion of the assets securing our investment
may be in the form of intellectual property, if any, inventory, equipment, cash and accounts receivables. Intellectual property,
if any, which secures a loan could lose value if the company’s rights to the intellectual property are challenged or if
the company’s license to the intellectual property is revoked or expires. In addition, in lieu of a security interest in
a portfolio company’s intellectual property we may sometimes obtain a security interest in all assets of the portfolio company
other than intellectual property and also obtain a commitment by the portfolio company not to grant liens to any other creditor
on the company’s intellectual property. In these cases, we may have additional difficulty recovering our principal in the
event of a foreclosure. Similarly, any equipment securing our loan may not provide us with the anticipated security if there are
changes in technology or advances in new equipment that render the particular equipment obsolete or of limited value or if the
company fails to adequately maintain or repair the equipment. Any one or more of the preceding factors could materially impair
our ability to recover principal in a foreclosure.
We may choose to waive or defer
enforcement of covenants in the debt securities held in our portfolio, which may cause us to lose all or part of our investment
in these companies.
We structure the
debt investments in our portfolio companies to include business and financial covenants placing affirmative and negative obligations
on the operation of the company’s business and its financial condition. However, from time to time we may elect to waive
breaches of these covenants, including our right to payment, or waive or defer enforcement of remedies, such as acceleration of
obligations or foreclosure on collateral, depending upon the financial condition and prospects of the particular portfolio company.
These actions may reduce the likelihood of our receiving the full amount of future payments of interest or principal and be accompanied
by a deterioration in the value of the underlying collateral as many of these companies may have limited financial resources,
may be unable to meet future obligations and may go bankrupt. These events could harm our financial condition and operating results.
The lack of liquidity in our investments
may adversely affect our business, and if we
need to sell any of our investments, we may not be able to do so at
a favorable
price. As a result, we may suffer losses.
We plan to generally
invest in loans with terms of up to four years and hold such investments until maturity, unless earlier prepaid, and we do not
expect that our related holdings of equity securities will provide us with liquidity opportunities in the near-term. We expect
to primarily invest in companies whose securities are not publicly-traded, and whose securities are subject to legal and other
restrictions on resale or are otherwise less liquid than publicly traded securities. The illiquidity of these investments may
make it difficult for us to sell these investments when desired. We may also face other restrictions on our ability to liquidate
an investment in a public portfolio company to the extent that we possess material non-public information regarding the portfolio
company. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly
less than the value at which we had previously recorded these investments. As a result, we do not expect to dispose of our investments
in the near term. However, we may be required to do so in order to maintain our qualification as a BDC and as a RIC if we do not
satisfy one or more of the applicable criteria under the respective regulatory frameworks. Because most of our investments are
illiquid, we may be unable to dispose of them, in which case we could fail to qualify as a RIC and/or BDC, or we may not be able
to dispose of them at favorable prices, and as a result, we may suffer losses.
Our portfolio companies may incur
debt that ranks equally with, or senior to, our investments in such companies.
We plan to invest
primarily in loans issued by our portfolio companies. Some of our portfolio companies are permitted to have other debt that ranks
equally with, or senior to, our loans in the portfolio company. By their terms, these debt instruments may provide that the holders
thereof 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 our loans. These debt instruments may prohibit the portfolio companies from paying interest on or repaying our investments
in the event of, and during, the continuance of a default under the debt instruments. In addition, 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 payment in respect
of our investment. After repaying senior creditors, a portfolio company may not have any remaining assets to use for repaying
its obligation to us. In the case of debt ranking equally with our loans, 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.
There may be circumstances where
our loans could be subordinated to claims of other
creditors or we could be subject to lender liability claims.
Even though certain
of our investments are structured as senior loans, if one of our portfolio companies were to go bankrupt, depending on the facts
and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy
court might recharacterize our debt investment and subordinate all or a portion of our claim to that of other creditors. We may
also be subject to lender liability claims for actions taken by us with respect to a portfolio company’s business, including
in rendering significant managerial assistance, or instances where we exercise control over the portfolio company.
An investment strategy focused primarily
on privately held companies presents certain challenges, including the lack of available information about these companies, a
dependence on the talents and efforts of only a few key portfolio company personnel and a greater vulnerability to economic downturns.
We currently invest,
and plan to invest, primarily in privately held companies. Generally, very little public information exists about these companies,
and we are required to rely on the ability of our Advisor 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 a smaller market presence than larger competitors. Thus, they are generally more vulnerable to economic downturns
and may experience substantial variations in operating results. These factors could affect our investment returns.
In addition, our
success depends, in large part, upon the abilities of the key management personnel of our portfolio companies, who are responsible
for the day-to-day operations of our portfolio companies. Competition for qualified personnel is intense at any stage of a company’s
development. The loss of one or more key managers can hinder or delay a company’s implementation of its business plan and
harm its financial condition. Our portfolio companies may not be able to attract and retain qualified managers and personnel.
Any inability to do so may negatively affect our investment returns.
Prepayments of our debt investments
by our portfolio companies could adversely impact
our results of operations and reduce our return on equity.
We are subject to
the risk that the investments we make in our portfolio companies may be repaid prior to maturity. For example, most of our debt
investments have historically been repaid prior to maturity by our portfolio companies. At the time of a liquidity event, such
as a sale of the business, refinancing or public offering, many of our portfolio companies have availed themselves of the opportunity
to repay our loans prior to maturity. Our investments generally allow for repayment at any time subject to certain penalties.
When this occurs, we generally reinvest these proceeds in temporary investments, pending their future investment in new portfolio
companies. These temporary investments have substantially lower yields than the debt being prepaid, and we could experience significant
delays in reinvesting these amounts. Any future investment in a new portfolio company may also be at lower yields than the debt
that was repaid. As a result, our results of operations could be materially adversely affected if one or more of our portfolio
companies elects to prepay amounts owed to us. Additionally, prepayments could negatively impact our return on equity, which could
result in a decline in the market price of our common stock.
Our business and growth strategy
could be adversely affected if government regulations, priorities and resources impacting the industries in which our portfolio
companies operate change.
Some of our portfolio
companies operate in industries that are highly regulated by federal, state and/or local agencies. Changes in existing laws, rules
or regulations, or judicial or administrative interpretations thereof, or new laws, rules or regulations could have an adverse
impact on the business and industries of our portfolio companies. In addition, changes in government priorities or limitations
on government resources could also adversely impact our portfolio companies. We are unable to predict whether any such changes
in laws, rules or regulations will occur and, if they do occur, the impact of these changes on our portfolio companies and our
investment returns.
Our portfolio companies operating
in the life science industry are subject to
extensive government regulation and certain other risks particular to
that industry.
As part of our investment
strategy, we have invested, and plan to invest in the future, in companies in the life science industry that are subject to extensive
regulation by the Food and Drug Administration and to a lesser extent, other federal and state agencies. If any of these portfolio
companies fail to comply with applicable regulations, they could be subject to significant penalties and claims that could materially
and adversely affect their operations. Portfolio companies that produce medical devices or drugs are subject to the expense, delay
and uncertainty of the regulatory approval process for their products and, even if approved, these products may not be accepted
in the marketplace. In addition, new laws, regulations or judicial interpretations of existing laws and regulations might adversely
affect a portfolio company in this industry. Portfolio companies in the life science industry may also have a limited number of
suppliers of necessary components or a limited number of manufacturers for their products, and therefore face a risk of disruption
to their manufacturing process if they are unable to find alternative suppliers when needed. Any of these factors could materially
and adversely affect the operations of a portfolio company in this industry and, in turn, impair our ability to timely collect
principal and interest payments owed to us.
Our investments in the clean technology
industry are subject to many risks, including volatility, intense competition, unproven technologies, periodic downturns and potential
litigation.
Our investments in
clean technology, or cleantech, companies are subject to substantial operational risks, such as underestimated cost projections,
unanticipated operation and maintenance expenses, loss of government subsidies, and inability to deliver cost-effective alternative
energy solutions compared to traditional energy products. In addition, energy companies employ a variety of means of increasing
cash flow, including increasing utilization of existing facilities, expanding operations through new construction or acquisitions,
or securing additional long-term contracts. Thus, some energy companies may be subject to construction risk, acquisition risk
or other risks arising from their specific business strategies. Furthermore, production levels for solar, wind and other renewable
energies may be dependent upon adequate sunlight, wind, or biogas production, which can vary from market to market and period
to period, resulting in volatility in production levels and profitability. In addition, our cleantech companies may have narrow
product lines and small market shares, which tend to render them more vulnerable to competitors’ actions and market conditions,
as well as to general economic downturns. The revenues, income (or losses) and valuations of clean technology companies can and
often do fluctuate suddenly and dramatically and the markets in which clean technology companies operate are generally characterized
by abrupt business cycles and intense competition. Demand for cleantech and renewable energy is also influenced by the available
supply and prices for other energy products, such as coal, oil and natural gas. A change in prices in these energy products could
reduce demand for alternative energy. Cleantech companies face potential litigation, including significant warranty and product
liability claims, as well as class action and government claims. Such litigation could adversely affect the business and results
of operations of our cleantech portfolio companies. There is also uncertainty about whether agreements or government programs
providing incentives for reductions in greenhouse gas emissions will continue and whether countries around the world will enact
or maintain legislation that provides incentives for reductions in greenhouse gas emissions, without which some investments in
clean technology dependent portfolio companies may not be economical, and financing for such projects may become unavailable.
As a result, these portfolio company investments face considerable risk, including the risk that favorable regulatory
regimes expire or are adversely modified. This could, in turn, materially adversely affect the value of the clean technology companies
in our portfolio.
Cleantech companies are subject
to extensive government regulation and certain other risks particular to the sectors in which they operate and our business and
growth strategy could be adversely affected if government regulations, priorities and resources impacting such sectors change
or if our portfolio companies fail to comply with such regulations.
As part of our investment
strategy we invest in portfolio companies in Cleantech sectors that may be subject to extensive regulation by foreign, U.S. federal,
state and/or local agencies. Changes in existing laws, rules or regulations, or judicial or administrative interpretations thereof,
or new laws, rules or regulations could have an adverse impact on the business and industries of our portfolio companies. In addition,
changes in government priorities or limitations on government resources could also adversely impact our portfolio companies. We
are unable to predict whether any such changes in laws, rules or regulations will occur and, if they do occur, the impact of these
changes on our portfolio companies and our investment returns. Furthermore, if any of our portfolio companies fail to comply with
applicable regulations, they could be subject to significant penalties and claims that could materially and adversely affect their
operations. Our portfolio companies may be subject to the expense, delay and uncertainty of the regulatory approval process for
their products and, even if approved, these products may not be accepted in the marketplace.
In addition, there
is considerable uncertainty about whether foreign, U.S., state and/or local governmental entities will enact or maintain legislation
or regulatory programs that mandate reductions in greenhouse gas emissions or provide incentives for Cleantech companies. Without
such regulatory policies, investments in Cleantech companies may not be economical and financing for Cleantech companies may become
unavailable, which could materially adversely affect the ability of our portfolio companies to repay the debt they owe to us.
Any of these factors could materially and adversely affect the operations and financial condition of a portfolio company and,
in turn, the ability of the portfolio company to repay the debt they owe to us.
If our portfolio companies are unable
to commercialize their technologies, products,
business concepts or services, the returns on our investments could
be adversely
affected.
The value of our
investments in our portfolio companies may decline if our portfolio companies are not able to commercialize their technology,
products, business concepts or services. Additionally, although some of our portfolio companies may already have a commercially
successful product or product line at the time of our investment, technology-related products and services often have a more limited
market or life span than products in other industries. Thus, the ultimate success of these companies often depends on their ability
to innovate continually in increasingly competitive markets. If they are unable to do so, our investment returns could be adversely
affected and their ability to service their debt obligations to us over the life of a loan could be impaired. Our portfolio companies
may be unable to acquire or develop successful new technologies and the intellectual property they currently hold may not remain
viable. Even if our portfolio companies are able to develop commercially viable products, the market for new products and services
is highly competitive and rapidly changing. Neither our portfolio companies nor we have any control over the pace of technology
development. Commercial success is difficult to predict, and the marketing efforts of our portfolio companies may not be successful.
If our portfolio companies are unable to protect their
intellectual property rights, our business and prospects could be harmed, and if portfolio companies are required to devote significant
resources to protecting their intellectual property rights, the value of our investment could be reduced.
Our future success
and competitive position depends in part upon the ability of our portfolio companies to obtain, maintain and protect proprietary
technology used in their products and services. The intellectual property held by our portfolio companies often represents a substantial
portion of the collateral securing our investments and/or constitutes a significant portion of the portfolio companies’
value that may be available in a downside scenario to repay our loans. Our portfolio companies rely, in part, on patent, trade
secret and trademark law to protect that technology, but competitors may misappropriate their intellectual property, and disputes
as to ownership of intellectual property may arise. Portfolio companies may, from time to time, be required to institute litigation
to enforce their patents, copyrights or other intellectual property rights, protect their trade secrets, determine the validity
and scope of the proprietary rights of others or defend against claims of infringement.
Such litigation could
result in substantial costs and diversion of resources. Similarly, if a portfolio company is found to infringe or misappropriate
a third party’s patent or other proprietary rights, it could be required to pay damages to the third party, alter its products
or processes, obtain a license from the third party and/or cease activities utilizing the proprietary rights, including making
or selling products utilizing the proprietary rights. Any of the foregoing events could negatively affect both the portfolio company’s
ability to service our debt investment and the value of any related debt and equity securities that we own, as well as the value
of any collateral securing our investment.
We do not expect to control any of our portfolio companies.
We do not control,
or expect to control in the future, any of our portfolio companies, even though our debt agreements may contain certain restrictive
covenants that limit the business and operations of our portfolio companies. We also do not maintain, or intend to maintain in
the future, a control position to the extent we own equity interests in any portfolio company. As a result, 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 common equity, may take risks or otherwise act in ways that do not serve
our interests as debt investors. Due to the lack of liquidity of the investments that we typically hold in our portfolio companies,
we may not be able to dispose of our investments in the event we disagree with the actions of a portfolio company and we may therefore,
suffer a decrease in the value of our investments.
Risks Related to Our Common Stock
There is a risk that investors in our equity securities
may not receive dividends or that our dividends may not grow over time and, a portion of distributions paid to you may be a return
of capital.
We intend to make
distributions on a monthly basis to our stockholders out of assets legally available for distribution. We cannot assure you that
we will achieve investment results that will allow us to make a specified level of cash distributions or year-to-year increases
in cash distributions. Our ability to pay dividends might be adversely affected by, among other things, the impact of one or more
risk factors described in this report. In addition, due to the asset coverage test applicable to us as a BDC, we may be limited
in our ability to make distributions. All distributions will be paid at the discretion of our Board and will depend on our earnings,
our financial condition, maintenance of our RIC status, compliance with BDC regulation and such other factors as our Board may
deem relevant from time to time. We cannot assure you that we will pay distributions to our stockholders in the future. Further,
if we invest a greater amount of assets in equity securities that do not pay current dividends, that could reduce the amount available
for distribution.
On an annual basis,
we must determine the extent to which any distributions we made were paid out of current or accumulated earnings, recognized capital
gains or capital. To the extent there is a return of capital, investors will be required to reduce their basis in our stock for
U.S. federal income tax purposes, which will result in higher tax liability when the shares are sold, even if they have not
increased in value or have lost value. In addition, any return of capital will be net of any sales load and offering expenses
associated with sales of shares of our common stock. In the future, our distributions may include a return of capital.
We cannot assure you that the market price of shares
of our common stock will not
decline.
Our common stock
is listed for trading on the NASDAQ Global Select Market. We cannot predict the prices at which our common stock will trade. Shares
of closed-end management investment companies have in the past frequently traded at discounts to their NAVs, and our common stock
has been and may continue to be discounted in the market. This characteristic of closed-end management investment companies is
separate and distinct from the risk that our NAV per share may decline. We cannot predict whether shares of our common stock will
trade above, at or below our NAV. If our common stock trades below its NAV, we will generally not be able to sell additional shares
of our common stock without first obtaining the approval of our stockholders (including our unaffiliated stockholders) and our
independent directors.
Our common stock price may be volatile and may decrease
substantially.
The trading price
of our common stock may fluctuate substantially and the liquidity of our common stock may be limited, in each case depending on
many factors, some of which are beyond our control and may not be directly related to our operating performance. These factors
include the following:
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price and volume fluctuations in the overall stock
market or in the market for BDCs from time to time;
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investor demand for our shares of common stock;
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significant volatility in the market price and trading volume
of securities of registered closed-end management investment companies, BDCs or other financial services companies;
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our inability to raise capital, borrow money or deploy or invest
our capital;
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fluctuations in interest rates;
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any shortfall in revenue or net income or any increase in losses
from levels expected by investors or securities analysts;
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operating performance of companies comparable to us;
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changes in regulatory policies or tax guidelines with respect
to RICs or BDCs;
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losing RIC status;
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actual or anticipated changes in our earnings or fluctuations
in our operating results;
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changes in the value of our portfolio of investments;
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general economic conditions, trends and other external factors;
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departures of key personnel; or
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loss of a major source of funding.
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In the past, following
periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought
against that company. Due to the potential volatility of our stock price, we may therefore be the target of securities litigation
in the future. Securities litigation could result in substantial costs and divert management’s attention and resources from
our business.
Shares of closed-end investment
companies, including BDCs, frequently trade at a discount to their NAV, and we cannot assure you that the market price of our
common stock will not decline following an offering.
We cannot predict
the price at which our common stock will trade. Shares of closed-end investment companies frequently trade at a discount to their
NAV and our stock may also be discounted in the market. This characteristic of closed-end investment companies is separate and
distinct from the risk that our NAV per share may decline. We cannot predict whether shares of our common stock will trade above,
at or below our NAV. In addition, if our common stock trades below its NAV, we will generally not be able to issue additional
shares of our common stock at its market price without first obtaining the approval of our stockholders and our independent directors.
We currently invest a portion of
our capital in high-quality short-term investments,
which generate lower rates of return than those expected from
investments made in
accordance with our investment objective.
We currently invest
a portion of the net proceeds of our capital in cash, cash equivalents, U.S. government securities, money market funds and
other high-quality short-term investments. These securities may earn yields substantially lower than the income that we anticipate
receiving once these proceeds are fully invested in accordance with our investment objective.
Investing in shares of our common stock may involve an
above average degree of risk.
The investments we
make in accordance with our investment objective may result in a higher amount of risk, volatility or loss of principal than alternative
investment options. Our investments in portfolio companies may be highly speculative and aggressive, and therefore, an investment
in our common stock may not be suitable for investors with lower risk tolerance.
Anti-takeover provisions in our
charter documents and other agreements and certain
provisions of the Delaware General Corporation Law (“DGCL”)
could deter takeover attempts and
have an adverse impact on the price of our common stock.
The DGCL, our certificate
of incorporation and our bylaws contain provisions that may have the effect of discouraging a third party from making an acquisition
proposal for us. Among other things, our certificate of incorporation and bylaws:
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provide for a classified board
of directors, which may delay the ability of our stockholders
to change the membership of a majority of our Board;
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authorize the issuance of
“blank check” preferred stock that could be issued
by our Board to thwart a takeover attempt;
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do not provide for cumulative
voting;
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provide that vacancies on
the Board, including newly created directorships, may be filled
only by a majority vote of directors then in office;
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limit the calling of special
meetings of stockholders;
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provide that our directors
may be removed only for cause;
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require supermajority voting
to effect certain amendments to our certificate of incorporation
and our bylaws; and
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require stockholders to provide
advance notice of new business proposals and director nominations
under specific procedures.
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These anti-takeover
provisions may inhibit a change in control in circumstances that could give the holders of our common stock the opportunity to
realize a premium over the market price of our common stock. It is a default under our Credit Facilities if (i) a person
or group of persons (within the meaning of the Exchange Act) acquires beneficial ownership of 20% or more of our issued and outstanding
stock or (ii) during any twelve-month period individuals who at the beginning of such period constituted our Board cease
for any reason, other than death or disability, to constitute a majority of the directors in office. If either event were to occur,
Wells or Fortress could accelerate our repayment obligations under, and/or terminate, our Credit Facilities.
If we elect to issue preferred stock,
holders of any such preferred stock will have the right to elect members of our Board and have class voting rights on certain
matters.
The 1940 Act requires
that holders of shares of preferred stock must be entitled as a class to elect two directors at all times and to elect a majority
of the directors if dividends on such preferred stock are in arrears by two years or more, until such arrearage is eliminated.
In addition, certain matters under the 1940 Act require the separate vote of the holders of any issued and outstanding preferred
stock, including changes in fundamental investment restrictions and conversion to open-end status and, accordingly, preferred
stockholders could veto any such changes. Restrictions imposed on the declarations and payment of dividends or other distributions
to the holders of our common stock and preferred stock, both by the 1940 Act and by requirements imposed by rating agencies, might
impair our ability to maintain our qualification as a RIC for U.S. federal income tax purposes.
Your interest in us may be diluted
if you do not fully exercise your subscription rights in any rights offering. In addition, if the subscription price is less than
our NAV per share, then you will experience an immediate dilution of the aggregate NAV of your shares.
In the event we issue
subscription rights, stockholders who do not fully exercise their rights should expect that they will, at the completion of a
rights offering, own a smaller proportional interest in us than would otherwise be the case if they fully exercised their rights.
Such dilution is not currently determinable because it is not known what proportion of the shares will be purchased as a result
of such rights offering. Any such dilution will disproportionately affect nonexercising stockholders. If the subscription price
per share is substantially less than the current NAV per share, this dilution could be substantial.
In addition, if the
subscription price is less than our NAV per share, our stockholders would experience an immediate dilution of the aggregate NAV
of their shares as a result of such rights offering. The amount of any decrease in NAV is not predictable because it is not known
at this time what the subscription price and NAV per share will be on the expiration date of the rights offering or what proportion
of the shares will be purchased as a result of such rights offering. Such dilution could be substantial.
Investors in offerings of our common
stock may incur immediate dilution upon the closing of such offering.
If the public offering
price for any offering of shares of our common stock is higher than the book value per share of our outstanding common stock,
investors purchasing shares of common stock in any such offering will pay a price per share that exceeds the tangible book value
per share after such offering.
If we sell common stock at a discount
to our NAV per share, stockholders who do not participate in such sale will experience immediate dilution in an amount that may
be material.
The issuance or sale
by us of shares of our common stock at a discount to NAV poses a risk of dilution to our stockholders. In particular, stockholders
who do not purchase additional shares at or below the discounted price in proportion to their current ownership will experience
an immediate decrease in NAV per share (as well as in the aggregate NAV of their shares if they do not participate at all). These
stockholders will also experience a disproportionately greater decrease in their participation in our earnings and assets and
their voting power than the increase we experience in our assets, potential earning power and voting interests from such issuance
or sale. In addition, such sales may adversely affect the price at which our common stock trades.
Stockholders will experience dilution
in their ownership percentage if they do not participate in our dividend reinvestment plan.
All dividends payable
to stockholders that are participants in our dividend reinvestment plan (“DRIP”) are automatically reinvested in shares
of our common stock. As a result, stockholders that do not participate in the dividend reinvestment plan will experience dilution
over time.
The trading market or market value
of our publicly issued debt securities that we may issue may fluctuate.
Upon issuance,
any publicly issued debt securities that we may issue will not have an established trading market. We cannot assure you that a
trading market for our publicly issued debt securities will ever develop or, if developed, will be maintained. In addition to
our creditworthiness, many factors may materially adversely affect the trading market for, and market value of, our publicly issued
debt securities. These factors include:
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the time remaining to the
maturity of these debt securities;
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the outstanding principal
amount of debt securities with terms identical to these debt
securities;
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the supply of debt securities
trading in the secondary market, if any;
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the redemption or repayment
features, if any of these debt securities;
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the level, direction and volatility
of market interest rates generally; and
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market rate of interest higher
or lower than rate borne by the debt securities.
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You should
also be aware that there may be a limited number of buyers when you decide to sell your debt securities. This too may materially
adversely affect the market value of the debt securities or the trading market for the debt securities.
Terms relating to redemption may
materially adversely affect your return on the debt securities that we may issue.
If we issue
debt securities that are redeemable at our option, we may choose to redeem the debt securities at times when prevailing interest
rates are lower than the interest rate paid on the debt securities. In addition, if such debt securities are subject to mandatory
redemption, we may be required to redeem the debt securities at times when prevailing interest rates are lower than the interest
rate paid on the debt securities. In this circumstance, you may not be able to reinvest the redemption proceeds in a comparable
security at an effective interest rate as high as your debt securities being redeemed.
Credit ratings provided by third
party credit rating agencies may not reflect all risks of an investment in debt securities that we may issue.
Credit ratings
provided by third party credit rating agencies are an assessment by third parties of our ability to pay our obligations. Consequently,
real or anticipated changes in our credit ratings will generally affect the market value of debt securities that we may issue.
Credit ratings provided by third party credit rating agencies, however, may not reflect the potential impact of risks related
to market conditions generally or other factors discussed above on the market value of or trading market for any publicly issued
debt securities that we may issue.
Subsequent sales in the public market
of substantial amounts of our common stock by the selling stockholders may have an adverse effect on the market price of our common
stock, and the registration of a substantial amount of insider shares, whether or not actually sold, may have a negative impact
on the market price of our common stock.
Sales of substantial
amounts of our common stock, or the availability of such common stock for sale, whether or not actually sold, could adversely
affect the prevailing market price of our common stock. If this occurs and continues, it could impair our ability to raise additional
capital through the sale of equity securities should we desire to do so. In addition, because shares owned by HTF-CHF Holdings
LLC, an entity that is primarily owned by certain of our officers, are being registered for resale, a negative perception could
be created in the market about the Company’s prospects by such registration.