Company Quick10K Filing
Harvest Capital Credit
10-K 2020-12-31 Filed 2021-03-12
10-Q 2020-09-30 Filed 2020-11-05
10-Q 2020-06-30 Filed 2020-08-06
10-Q 2020-03-31 Filed 2020-05-13
10-K 2019-12-31 Filed 2020-03-12
10-Q 2019-09-30 Filed 2019-11-07
10-Q 2019-06-30 Filed 2019-08-08
10-Q 2019-03-31 Filed 2019-05-14
10-K 2018-12-31 Filed 2019-03-15
10-Q 2018-09-30 Filed 2018-11-08
10-Q 2018-06-30 Filed 2018-08-09
10-Q 2018-03-31 Filed 2018-05-10
10-K 2017-12-31 Filed 2018-04-02
10-Q 2017-09-30 Filed 2017-11-07
10-Q 2017-06-30 Filed 2017-08-09
10-Q 2017-03-31 Filed 2017-05-10
10-K 2016-12-31 Filed 2017-03-15
10-Q 2016-09-30 Filed 2016-11-09
10-Q 2016-06-30 Filed 2016-08-09
10-Q 2016-03-31 Filed 2016-05-10
10-K 2015-12-31 Filed 2016-03-15
10-Q 2015-09-30 Filed 2015-11-09
10-Q 2015-06-30 Filed 2015-08-10
10-Q 2015-03-31 Filed 2015-05-07
10-K 2014-12-31 Filed 2015-03-16
10-Q 2014-09-30 Filed 2014-11-13
10-Q 2014-06-30 Filed 2014-08-13
10-Q 2014-03-31 Filed 2014-05-14
10-K 2013-12-31 Filed 2014-03-31
10-Q 2013-09-30 Filed 2013-11-12
10-Q 2013-06-30 Filed 2013-08-13
10-Q 2013-03-31 Filed 2013-06-11
8-K 2021-01-22 Enter Agreement, Off-BS Arrangement, Exhibits
8-K 2020-12-23 Enter Agreement, Regulation FD, Exhibits
8-K 2020-11-24
8-K 2020-06-10
8-K 2020-05-20
8-K 2020-04-13
8-K 2019-06-11
8-K 2019-05-10
8-K 2019-03-18
8-K 2018-11-01
8-K 2018-06-12
8-K 2018-04-29
8-K 2018-02-08

HCAP 10K Annual Report

Part I
Item 1.Business
Item 1A.Risk Factors
Item 1B. Unresolved Staff Comments
Item 2.Properties
Item 3.Legal Proceedings
Item 4. Mine Safety Disclosures
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6.Selected Financial Data
Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Consolidated Financial Statements and Supplementary Data
Note 1. Organization
Note 2. Summary of Significant Accounting Policies
Note 3. Borrowings
Note 4. Concentrations of Credit Risk
Note 5. Shareholders' Equity
Note 6. Fair Value Measurements
Note 7. Related Party Transactions
Note 8. Commitments and Contingencies
Note 9. Net Increase (Decrease) in Net Assets Resulting From Operations per Common Share
Note 10. Income Tax
Note 11. Financial Highlights
Note 12. Selected Quarterly Data (Unaudited)
Note 13. Significant Subsidiary
Note 14. Subsequent Events
Item 9. Changes in and Disagreements with Independent Registered Public Accounting Firm on Accounting and Financial Disclosure
Item 9A. Controls and Procedures.
Item 9B.Other Information.
Part III
Item 10. Directors, Executive Officers and Corporate Governance
Item 11.Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.Certain Relationships and Related Transactions, and Director Independence
Item 14.Principal Accountant Fees and Services
Part IV
Item 15.Exhibits, Financial Statement Schedules
EX-31.1 exhibit311december31202012.htm
EX-31.2 exhibit312december31202012.htm
EX-32.1 exhibit321december31202012.htm
EX-32.2 exhibit322december31202012.htm

Harvest Capital Credit Earnings 2020-12-31

Balance SheetIncome StatementCash Flow

10-K 1 hcapdecember31202012-31x20.htm 10-K Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K

þ

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2020
 OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 1-35906
HARVEST CAPITAL CREDIT CORPORATION
(Exact name of registrant as specified in its charter)  

Delaware
(State of Incorporation)
46-1396995
(I.R.S. Employer Identification Number)
767 Third Avenue, 29th Floor
New York, NY
(Address of principal executive offices)
10017
(Zip Code)
Registrant’s telephone number, including area code: (212) 906-3589
Securities registered pursuant to Section 12(b) of the Act:
Title of Each ClassTrading Symbols
Name of Each Exchange on Which Registered 
Common Stock, par value $0.001 per shareHCAPNasdaq Global Market
6.125% Notes due 2022HCAPZNasdaq Global Market
 
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes ☐    No þ.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes ☐    No þ.
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  ☐.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes ☐    No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer¨Accelerated filer                    
¨

Non-accelerated filer
þ

Smaller reporting company    ¨
Emerging growth company¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act by the registered public accounting firm that prepared or issued its audit report. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes ☐    No þ.

The aggregate market value of the Registrant’s common stock held by non-affiliates of the Registrant as of June 30, 2020, was approximately $16.7 million based upon the last sale price for the Registrant’s common stock on that date.
There were 5,968,296 shares of the Registrant’s common stock outstanding as of March 12, 2021.

Documents Incorporated by Reference
None.
1



2


HARVEST CAPITAL CREDIT CORPORATION
 
 FORM 10-K FOR THE FISCAL YEAR
ENDED DECEMBER 31, 2020
 
TABLE OF CONTENTS
 
Page
  56
  56
 56
 124
 
 
3


PART I
Item 1.Business

Company
 
Harvest Capital Credit Corporation ("we," "us," and the "Company") is an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a business development company, or "BDC", under the Investment Company Act of 1940, or the “1940 Act.” We have also elected to be treated for U.S. federal income tax purposes as a regulated investment company, or "RIC", under Subchapter M of the Internal Revenue Code of 1986, as amended, or the "Code", and we intend to satisfy the Code requirements to receive RIC tax treatment annually. We provide customized financing solutions to small to mid-sized companies. We generally target companies with annual revenues of less than $100 million and annual EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization) of less than $15 million.
 
We were formed as a Delaware corporation on November 14, 2012. We completed our initial public offering on May 7, 2013. Immediately prior to the initial public offering, we acquired Harvest Capital Credit LLC in a merger whereby the outstanding limited liability company membership interests of Harvest Capital Credit LLC were converted into shares of our common stock and we assumed and succeeded to all of Harvest Capital Credit LLC’s assets and liabilities, including its entire portfolio of investments. Harvest Capital Credit LLC, which was formed in February 2011 and commenced operations in September 2011, was founded by certain members of HCAP Advisors LLC, or “HCAP Advisors,” our investment adviser and administrator, and JMP Group, Inc. (now JMP Group LLC), or “JMP Group.” Harvest Capital Credit LLC is considered to be our predecessor for accounting purposes, and as such, its financial statements are our historical financial statements.

As used herein, the terms “we”, “us,” and the “Company” refer to Harvest Capital Credit LLC for the periods prior to our initial public offering and refer to Harvest Capital Credit Corporation for the periods after the initial public offering.

Our investment objective is to generate both current income and capital appreciation primarily by making direct investments in the form of senior debt, subordinated debt and, to a lesser extent, minority equity investments in privately-held U.S. small to mid-sized companies. The companies in which we invest are typically highly leveraged, and, in most cases, our investments in such companies are not rated by any rating agency. If such investments were rated, we believe that they would likely receive a rating below investment grade (i.e., below BBB or Baa), which is often referred to as “junk.” Indebtedness of below investment grade quality is regarded as having predominantly speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal. While our primary investment focus is on making loans to, and selected equity investments in, privately-held U.S. small to mid-sized companies, we may also invest in other investments such as loans to larger, publicly-traded companies, high-yield bonds and distressed debt securities. In addition, we may also invest in debt and equity securities issued by collateralized loan obligation funds.
 
As a BDC, we are required to comply with numerous regulatory requirements. We are permitted to, and expect to continue to, finance our investments using debt and equity. However, our ability to use debt is limited in certain significant respects. See “Regulation as a BDC.”

As a RIC, we generally will not pay corporate-level U.S. federal income taxes on any net ordinary income or capital gains that we timely distribute to our stockholders as dividends. To maintain our RIC treatment, we must meet specified source-of-income and asset diversification requirements and distribute annually to our stockholders at least 90.0% of our ordinary net income and realized net short-term capital gains in excess of realized net long-term capital losses, if any. See “-Taxation as a Regulated Investment Company.”

The Proposed Merger With Portman Ridge Finance Corporation

On December 23, 2020, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Portman Ridge Finance Corporation, a Delaware corporation (“PTMN”), Rye Acquisition Sub Inc., a Delaware corporation and a direct wholly-owned subsidiary of PTMN (“Acquisition Sub”), and Sierra Crest Investment Management LLC, a Delaware limited liability company and the external investment adviser to PTMN (“Sierra Crest”). The Merger Agreement provides that (i) Acquisition Sub will merge with and into the Company (the “First Merger”), with the Company continuing as the surviving corporation and as a wholly-owned subsidiary of PTMN, and (ii) immediately after the effectiveness of the First Merger, we will merge with and into PTMN (the “Second Merger” and, together with the First Merger, the “Mergers”), with PTMN continuing as the surviving corporation. Sierra Crest is expected to manage the combined company following the Mergers.
4


The transaction is the result of a review of strategic alternatives by our board of directors and a special committee thereof (the “HCAP Special Committee”) comprised solely of the independent directors of our board of directors. Our board of directors (other than directors affiliated with HCAP Advisors, who abstained from voting), on the unanimous recommendation of the HCAP Special Committee, has approved the Merger Agreement and the transactions contemplated thereby. The boards of directors of each of PTMN and Acquisition Sub, and the managing member of Sierra Crest, have also each unanimously approved the Merger Agreement and the transactions contemplated thereby.

Under the terms of the proposed transaction, at the closing of the First Merger (the “Closing”), PTMN will issue, in respect of all of the issued and outstanding shares of our common stock (excluding shares held by our subsidiaries or held, directly or indirectly, by PTMN or Acquisition Sub and all treasury shares (“Canceled Shares”)), in the aggregate, a number of shares of common stock, par value $0.01 per share, of PTMN (“PTMN Common Stock”) equal to 19.9% of the number of shares of PTMN Common Stock issued and outstanding immediately prior to the Closing (the “Total Stock Consideration”). In addition, subject to the terms and conditions of the Merger Agreement, at the Closing, PTMN will pay, in respect of all the issued and outstanding shares of our common stock (excluding Canceled Shares) in the aggregate, an amount of cash equal to the amount by which (i) our net asset value at Closing exceeds (ii) the product of (A) the Total Stock Consideration multiplied by (B) the quotient of (i) PTMN’s net asset value at closing divided by (ii) the number of shares of PTMN Common Stock issued and outstanding as of the determination date (the “Determination Date”) which is two days prior to the Closing (the “Aggregate Cash Consideration”). In addition, as additional consideration to the holders of shares of our common stock that are issued and outstanding immediately prior to the Closing (excluding any Canceled Shares), Sierra Crest will pay or cause to be paid to such holders an aggregate amount in cash equal to $2.15 million.

Each person who as of the effective time of the First Merger is a record holder of shares of our common stock will be entitled, with respect to all or any portion of such shares, to make an election (an “Election”) to receive payment for their shares of our common stock in cash, subject to the conditions and limitations set forth in the Merger Agreement. Any record holder of shares of our common stock at the record date who does not make an Election will be deemed to have elected to receive payment for their shares of our common stock in the form of PTMN Common Stock. Each share of our common stock (other than a Canceled Share) with respect to which an Election has been made will be converted into the right to receive an amount in cash equal to the Per Share Cash Price (as defined below), subject to adjustment under the terms of the Merger Agreement.

The “Per Share Cash Price” means the quotient of (i) the sum of (A) the product of Total Stock Consideration multiplied by the PTMN Per Share Price (as defined below) plus (B) the Aggregate Cash Consideration, divided by (ii) the number of shares of our common stock issued and outstanding immediately prior to the Closing. The “PTMN Per Share Price” is defined as the average of the volume weighted average price per share of PTMN Common Stock on Nasdaq on each of the ten consecutive trading days ending with the Determination Date.

Each share of our common stock (other than a Canceled Share) with respect to which an Election has not been made will be converted into the right to receive a number of validly issued, fully paid and non-assessable shares of PTMN Common Stock, equal to the number of shares of PTMN Common Stock with a value equal to the Per Share Cash Price based on the PTMN Per Share Price, subject to adjustment under the terms of the Merger Agreement.

While each holder of our common stock will be entitled to make an Election, the maximum aggregate number of shares of PTMN Common Stock available for all of our stockholders will be fixed to equal the Total Stock Consideration and, accordingly, the aggregate amount of cash available to our stockholders will be fixed. As a result, depending on the Elections made by other stockholders, if a holder of our common stock elects to receive cash in connection with the Mergers, such holder will likely receive a portion of its merger consideration in PTMN Common Stock, and if a holder of our common stock elects to receive PTMN Common Stock in connection with the Mergers, such holder will likely receive a portion of the merger consideration in cash.

The Merger Agreement contains customary representations, warranties and covenants, including, among others, covenants relating to the operation of each of PTMN’s and our businesses during the period prior to the Closing. We have agreed to convene and hold a stockholder meeting for the purpose of seeking the adoption of the Merger Agreement by the holders of at least a majority of the outstanding shares of our common stock entitled to vote thereon.

The Merger Agreement contains “no-shop” provisions that restrict our ability to solicit or initiate discussions or negotiations with third parties regarding other proposals to acquire the Company, and we are restricted in our ability to respond to such proposals. The Merger Agreement also contains customary termination rights. In particular, at any time prior to receipt of the requisite Company stockholder approval, we may terminate the Merger Agreement in order to substantially concurrently
5


enter into a binding definitive agreement providing for the consummation of a Superior Proposal (as defined in the Merger Agreement), subject to our compliance with notice and other specified conditions contained in the non-solicitation covenants, including giving PTMN the opportunity to propose revisions to the terms of the transactions contemplated by the Merger Agreement during a period following notice, and provided that we have not otherwise materially breached any provision of the non-solicitation covenants. If we terminate the Merger Agreement as provided in the foregoing sentence or the Merger Agreement is terminated under certain other circumstances, upon notice by PTMN, we must pay PTMN a termination fee equal to approximately $2.1 million, minus any amounts that we previously paid to PTMN in the form of expense reimbursement. Similarly, if the Merger Agreement is terminated under certain other circumstances by PTMN, upon notice by us, PTMN must pay us a termination fee equal to approximately $2.1 million.

The consummation of the Mergers is subject to the satisfaction or (to the extent permitted by law) waiver of certain customary closing conditions, including obtaining the requisite Company stockholder approval. The obligation of each party to consummate the Mergers is also conditioned upon the other party’s representations and warranties being true and correct (subject to certain materiality exceptions) and the other party having performed in all material respects its obligations under the Merger Agreement.

Concurrently with our and PTMN’s entry into the Merger Agreement, we also entered into a letter agreement with Mr. Jolson (the “Jolson Letter Agreement”). Pursuant to the Jolson Letter Agreement, Mr. Jolson has agreed (i) to elect to receive shares of PTMN Common Stock as consideration in connection with the Mergers for all of the 894,273 shares of our common stock beneficially owned directly by Mr. Jolson and indirectly by Mr. Jolson through the Joseph A. Jolson 1991 Trust (the “Jolson Shares”), (ii) to not, directly or indirectly, transfer, sell, offer, exchange, assign, pledge, convey any legal or beneficial ownership interest in or otherwise dispose of, or encumber any of the Jolson Shares or enter into any contract, option, or other agreement with respect to, or consent to, a transfer of, any of the Jolson Shares or his voting or economic interest therein other than pursuant to the Merger Agreement and in connection with the Mergers during the period commencing on the date of the Jolson Letter Agreement and ending on the closing date of the Mergers and (iii) to not transfer any shares of PTMN Common Stock received in exchange for the Jolson Shares in the First Merger (the “Locked Up Securities”) or enter into any swap or other agreement that transfers, in whole or in part, any of the economic consequences of ownership of the Locked Up Securities for 90 days following the Closing.

Sierra Crest and HCAP Advisors have engaged in discussions regarding a transition services agreement pursuant to which HCAP Advisors would provide certain consulting services to Sierra Crest relating to HCAP’s existing investment portfolio subsequent to the Closing. As of the date hereof negotiations are still ongoing.
 
Available Information

Our principal executive offices are located at 767 Third Avenue, 29th Floor, New York, New York 10017, and our telephone number is (212) 906-3589. We maintain a website at http://www.harvestcapitalcredit.com. We make available on or through our website certain reports, including any amendments to those reports, and other documents that we file with or furnish to the Securities and Exchange Commission, or the "SEC." These include our annual reports on Form 10-K, our quarterly reports on Form 10-Q, and our current reports on Form 8-K, among other filings. We make this information available on our website free of charge as soon as reasonable practicable after we electronically file the information with, or furnish it to, the SEC. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports and other public filings are also available free of charge on the EDGAR Database on the SEC's website at www.sec.gov. The information on our website is not incorporated by reference in this annual report on Form 10-K.
 
JMP Group
 
We were founded by certain members of HCAP Advisors, our investment adviser and administrator, and JMP Group, a full-service investment banking and asset management firm. JMP Group currently holds an equity interest in us and, through its subsidiaries, owns a majority equity interest in HCAP Advisors. JMP Group conducts its primary business activities through two wholly-owned subsidiaries: (i) Harvest Capital Strategies, LLC ("HCS"), an SEC-registered investment adviser that focuses on venture capital and real estate funds, middle-market lending and private equity; and (ii) JMP Securities LLC, a full-service investment bank that provides equity research, institutional brokerage and investment banking services to growth companies and their investors. The shares of common stock of JMP Group are traded on the New York Stock Exchange (NYSE: JMP). Joseph A. Jolson, our Chief Executive Officer and Chairman of our board of directors, is also the Chief Executive Officer and Chairman of the board of directors of JMP Group.

 
6


Investment Adviser
 
Our investment adviser’s investment team is led by Joseph A. Jolson (our Chief Executive officer and Chairman of our board of directors), Richard P. Buckanavage (our President and Managing Director - Head of Business Development), and James Fowler, (our Chief Investment Officer), and is supported by the investment staff at HCAP Advisors, as well as investment professionals from JMP Group. In addition, HCAP Advisors expects to draw upon JMP Group’s over 20-year history in the investment management business and to benefit from the JMP Group investment professionals’ significant capital markets, trading and research expertise developed through investments in different industries and over numerous companies in the United States.
HCAP Advisors has an investment committee (the "Investment Committee") that is responsible for approving all key investment decisions that are made by HCAP Advisors on HCAP's behalf. The members of the HCAP Investment Committee are Messrs. Joseph Jolson, Richard Buckanavage, James J. Fowler, and Bryan B. Hamm. The members of the HCAP Investment Committee have extensive investment experience and collectively currently manage or oversee an investment portfolio that includes alternative assets such as venture capital and real estate funds, middle-market lending, private equity and HCAP. All key investment decisions made by HCAP Advisors on HCAP's behalf, including screening, initial approvals, final commitment, funding, and material amendments, require approval from three of the four members of the HCAP Investment Committee and must include the approval of Mr. Jolson and Mr. Buckanavage.
 
Business Strategy
 
Our investment objective is to generate both current income and capital appreciation primarily by making direct investments in the form of senior debt, subordinated debt and, to a lesser extent, minority equity investments. We have adopted the following business strategy to achieve our investment objective:
 
Capitalize on our investment adviser’s extensive relationships with small to mid-sized companies, private equity sponsors and other intermediaries. HCAP Advisors maintains extensive relationships with financial intermediaries, entrepreneurs, financial sponsors, management teams, small and mid-sized companies, attorneys, accountants, investment bankers, commercial bankers and other non-bank providers of capital throughout the United States,, which we expect will produce attractive investment opportunities for us. HCAP Advisors has been the sole or lead originator in a majority of our completed investment transactions. HCAP Advisors will also benefit from the resources and relationships of JMP Group, which maintains offices in San Francisco, New York City, Chicago, Boston, West Palm Beach, and Minneapolis.
 
Leverage the skills of our experienced investment adviser. The principals of HCAP Advisors have experience advising, investing in and lending to small and mid-sized companies and have been active participants in the primary leveraged credit markets. Throughout their careers, they have navigated various economic cycles as well as several market disruptions. We believe this experience and understanding allows them to select and structure better investments for us and to efficiently monitor and provide managerial assistance to our portfolio companies.
 
Apply disciplined underwriting policies. Lending to small to mid-sized private companies requires in-depth due diligence and credit underwriting expertise, which the principals of our investment adviser have gained throughout their extensive careers. HCAP Advisors has implemented disciplined and consistent underwriting policies in every transaction. These policies include a thorough analysis of each potential portfolio company’s competitive position, financial performance, management team, operating discipline, growth potential and industry considerations.
 
Maintain rigorous portfolio management. The principals of HCAP Advisors have significant investing and board-level experience with small to mid-sized companies, and as a result, we expect that our investment adviser will be a value-added partner to, and remain in close contact with, our directly originated portfolio companies. After originating an investment in a company, the investment professionals of HCAP Advisors will monitor each investment closely, typically receiving monthly, quarterly and annual financial statements, meeting face-to-face with our portfolio companies, as well as frequent informal communication with portfolio companies. In addition, our portfolio company investments generally contain financial covenants, and we obtain compliance certificates relating to those covenants quarterly from our portfolio companies. We believe that HCAP Advisors' initial and ongoing portfolio review process will allow it to effectively monitor the performance and prospects of our portfolio companies.

“Enterprise value” lending. We and HCAP Advisors take an enterprise value approach to the loan structuring and underwriting process. “Enterprise value” is the value that a portfolio company’s most recent investors place on the portfolio
7


company or “enterprise.” The value of the enterprise is determined by multiplying (x) the number of shares of common stock of the portfolio company outstanding on the date of calculation, on a fully diluted basis (assuming the conversion of all outstanding convertible securities and the exercise of all outstanding options and warrants), by (y) the price per share paid by the most recent purchasers of equity securities of the portfolio company plus the value of the portfolio company's liabilities. We generally secure a subordinated lien or a senior secured lien position against the enterprise value of a portfolio company and we obtain pricing enhancements in the form of warrants and other fees that we expect will build long-term asset appreciation in our portfolio. “Enterprise value” lending requires an in-depth understanding of the companies and markets served. We believe the experience that our investment adviser possesses gives us enhanced capabilities in making these qualitative “enterprise value” evaluations, which we believe can produce a high quality loan portfolio with enhanced returns for our stockholders.

 Opportunity for enhanced returns. To enhance our loan portfolio returns, in addition to receiving interest, we may 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 allows us to participate in the equity appreciation of our portfolio companies, which we expect will enable us to generate higher returns for our investors. We may also make a direct equity investment in a portfolio company in conjunction with a debt investment, which may provide us with additional equity upside in our investment. Furthermore, we seek to enhance our loan portfolio returns by obtaining ancillary structuring and other fees related to the origination, investment, disposition or liquidation of debt and investment securities.
 
Investment Criteria
 
We use the following criteria and guidelines in evaluating investment opportunities and constructing our portfolio. However, not all of these criteria and guidelines have been, or will be, met in connection with each of our investments.
 
Value orientation / Positive cash flow. We place a premium on analysis of business fundamentals from an investor’s perspective and have a distinct value orientation. We target companies with proven business models in which we can invest at reasonable multiples of operating cash flow. We also typically invest in companies with a history of profitability. We generally do not invest in start-up companies, “turn-around” situations or companies that we believe have unproven business plans.
 
Experienced management teams with meaningful equity ownership. We target portfolio companies that have management teams with significant relevant industry experience coupled with meaningful equity ownership. We believe management teams with these attributes are more likely to manage the companies in a manner that protects our debt investment and enhances the value of our equity investment.
 
Niche market leaders with defensible market positions. We target companies that have developed defensible and/or leading positions within their respective markets or market niches and are well positioned to capitalize on growth opportunities. We favor companies that demonstrate significant competitive advantages, which we believe helps to protect their market position and profitability.
 
Diversified customer and supplier base. We prefer to invest in companies that have a diversified customer and supplier base. Companies with a diversified customer and supplier base are generally better able to endure economic downturns, industry consolidation and shifting customer preferences.
 
Limiting portfolio concentration. We seek to avoid concentrated exposure to a particular sector, which serves to diversify our portfolio and help to mitigate the risks of an economic downturn in any particular industry sector. In addition, we seek to diversify our portfolio from a geographic and a single borrower concentration perspective to mitigate the risk of an economic downturn in any particular part of the U.S. or concentration risk with respect to a particular borrower. We have adopted a guideline that we will generally refrain from investing more than 15% of our portfolio in any single industry sector.
 
Ability to exert meaningful influence. We seek to target investment opportunities in which we are the lead/sole investor in our tranche and in which we can add value through rigorous portfolio management and exercising certain rights and remedies available to us when necessary.
 
Private equity sponsorship. When feasible, we seek to invest in companies in conjunction with private equity sponsors who have proven capabilities in building value. We believe that a private equity sponsor can serve as a committed partner and advisor that will actively work with the company and its management team to meet company goals and create value. We assess
8


a private equity sponsor’s commitment to a portfolio company by, among other things, the capital contribution it has made or will make in the portfolio company.
 
Security interest. We generally seek a first or second priority security interest in all of the portfolio company’s tangible and intangible assets as collateral for our debt investment, subject in some cases to permitted exceptions. Although we do not intend to operate as an asset-based lender, the estimated liquidation value of the assets, if any, collateralizing the debt securities that we hold is evaluated as a potential source of repayment. We evaluate both tangible assets, such as accounts receivable, inventory and equipment, and intangible assets, such as intellectual property, customer lists, networks and databases.
  
Covenants. We seek to negotiate covenants in connection with our investments that afford our portfolio companies with flexibility in managing their businesses, but also act as a tool to minimize our loss of capital. Such restrictions may include affirmative and negative covenants, default penalties, lien protection, change of control provisions and board rights, including either observation or participation rights. Our investments generally have cross-default and material adverse change provisions, require the provision of periodic financial reports and operating metrics, and limit the portfolio company’s ability to incur additional debt, sell assets, engage in transactions with affiliates and consummate an extraordinary transaction, such as a merger, acquisition or recapitalization. In addition, we may require other performance or financial-based covenants, as we deem appropriate.
 
Exit strategy. We generally seek to invest in companies that we believe possess attributes that will provide us with the ability to exit our investments within a pre-established investment horizon. We expect to exit our investments typically through one of three scenarios: (i) the sale of the company resulting in repayment of all outstanding debt, (ii) the recapitalization of the company through which our loan is replaced with debt or equity from a third party or parties or (iii) the repayment of the initial or remaining principal amount of our loan then outstanding at maturity. In some investments, there may be scheduled amortization of some portion of our loan which would result in a partial exit of our investment prior to the maturity of the loan.
 
Investment Process
 
The investment professionals of HCAP Advisors have responsibility for originating investment opportunities, evaluating potential investments, transaction due diligence, preparation of a preliminary deal evaluation memorandum, negotiation of definitive terms and conditions, securing approval from the Investment Committee, negotiation of legal documentation and monitoring/management of portfolio investments. There are six key elements of our investment process:

Origination
Evaluation
Structuring/Negotiation
Due Diligence/Underwriting
Documentation/Closing
Portfolio Management/Investment Monitoring.
 
 Origination
 
HCAP Advisors develops investment opportunities through a relationship network of financial intermediaries, entrepreneurs, financial sponsors, management teams, small- and mid-sized companies, attorneys, accountants, investment bankers, commercial bankers and other non-bank providers of capital throughout the United States. This investment sourcing network has been developed by the principals of HCAP Advisors, and enabled them to originate investments in every region of the United States. We believe that the strength of this network should enable HCAP Advisors to receive the first look at many investment opportunities. We believe that directly originating our own senior debt and subordinated debt investments and equity co-investments gives us greater control over due diligence, structure, terms and ultimately results in stronger investment performance. As a lead and often sole investor in the particular tranche of the capital structure, we also expect to obtain board or observation rights, which allow us to take a more active role in monitoring our investment after we close the investment.
 
We also expect HCAP Advisors’ relationship with JMP Group, which, through HCS, also manages a family of venture capital and real estate funds, and middle-market lending and private equity funds, to generate investment opportunities for us. We may, from time to time, and subject to the conditions included in our existing SEC co-investment exemptive relief under the 1940 Act (the "Exemptive Relief"), co-invest alongside certain accounts and funds affiliated with JMP Group.
  


9


Evaluation
 
An initial review of the potential investment opportunity will be performed by one or more of HCAP Advisors’ investment professionals. During the initial review process, the investment professionals may solicit input regarding industry and market dynamics from credit analysts and/or equity research analysts within our investment adviser and JMP Group. If the investment opportunity does not meet our investment criteria, feedback will be delivered timely through our origination channels. To the extent an investment appears to meet our investment criteria, the investment professionals of HCAP Advisors will begin preliminary due diligence.
 
Structuring/Negotiation
 
When an investment professional of HCAP Advisors identifies an investment opportunity that appears to meet our investment criteria, one or more of its investment professionals will prepare a pre-screen memorandum. During the process, comprehensive and proprietary models are created to evaluate a range of outcomes based on sensitized variables including various economic environments, changes in the cost of production, and various product or service supply/demand and pricing scenarios. HCAP Advisors’ investment professionals will perform preliminary due diligence and tailor a capital structure to match the historical financial performance and growth strategy of the potential portfolio company.
 
The pre-screen memorandum will also include the following:

transaction description;
company description, including product or service analysis, market position, industry dynamics, customer and supplier analysis, and management evaluation;
quantitative and qualitative analysis of historical financial performance and preparation of 5-year financial projections;
competitive landscape;
business strengths and weaknesses;
quantitative and qualitative analysis of business owner(s) (including private equity firm);
potential investment structure, leverage multiples and expected yield calculations; and
outline of key due diligence areas.
 
The Investment Committee then reviews the pre-screen memorandum and determines whether the opportunity fits our general investment criteria and should be considered for further due diligence. If the Investment Committee makes a positive determination, HCAP Advisors’ investment professionals will then negotiate and execute a non-binding term sheet with the potential portfolio company and conduct further due diligence.
 
During the formal approval process for investments, HCAP Advisors’ investment professionals regularly communicate with at least one member of the Investment Committee throughout in order to ensure efficiency as well as clarity for our prospective portfolio companies and clients.
  
Due Diligence/Underwriting
 
Once a non-binding term sheet has been negotiated and executed with the potential portfolio company and, in limited circumstances, the prospective portfolio company has remitted a good faith deposit, we begin our formal underwriting and due diligence process by requesting additional due diligence materials from the prospective portfolio company and arranging additional on-site visits with management and relevant employees. HCAP Advisors typically requests the following information as part of the due diligence process: 

annual and interim (including monthly) financial information;
completion of a quality of earnings assessment by an accounting firm;
capitalization tables showing details of equity capital raised and ownership;
recent presentations to investors or board members covering the portfolio company’s current status and market opportunity;
detailed business plan, including an executive summary and discussion of market opportunity;
detailed background on all senior members of management, including background checks by third party;
detailed forecast for the current and subsequent five fiscal years;
information on competitors and the prospective portfolio company’s competitive advantage;
10


completion of Phase I (and, if necessary, Phase II) environmental assessment;
marketing information on the prospective portfolio company’s products, if any;
information on the prospective portfolio company’s intellectual property; and
information on the prospective portfolio company from its key customers or clients.
 
The due diligence process generally includes a formal visit to the prospective portfolio company’s location and interviews with the prospective portfolio company’s senior management team and key operational employees. Outside sources of information are reviewed, including industry publications, market articles, Internet publications, or publicly available information on competitors.
 
Documentation/Closing
 
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, the investment professionals assigned to the opportunity prepare an investment memorandum for review and approval. The Investment Committee will reconvene to evaluate the opportunity, review the investment memorandum and discuss the findings of the due diligence process. If the opportunity receives final approval, HCAP Advisors’ principals, with the assistance of outside legal counsel, will be responsible for preparing and negotiating transaction documents and ensuring that the documents accurately reflect the terms and conditions approved by the Investment Committee. Funding requires final approval by the Investment Committee.
 
Portfolio Management/Investment Monitoring
 
HCAP Advisors employs several methods of evaluating and monitoring the performance of our portfolio companies, which, depending on the particular investment, may include the following processes, procedures, and reports:

review of available monthly or quarterly financial statements compared against the prior year’s comparable period and the company’s financial projections;

review and discussion, if applicable, of the management discussion and analysis that will accompany its financial results;

review of the company’s quarterly results and overall general business performance and assessment of the company’s compliance with all covenants (financial or otherwise), including preparation of a portfolio monitoring report or “PMR” (on a quarterly basis), which will be distributed to the members of the Investment Committee;

periodic, and often, face-to-face meetings with management team and owners (including private equity firm if applicable); and

attendance at board of directors meetings at portfolio companies through formal board seat or board observation rights.
 
Once the investment adviser has had the opportunity to review all quarterly PMRs, a meeting will be held with the investment professionals to review all of the PMRs to ensure consensus on risk rating, action steps (if any), and valuation.
  
In connection with the preparation of PMRs, each investment receives a quarterly risk rating following the five-level numeric investment rating system outlined below. The investment rating system uses a five-level numeric scale. In determining an investment rating, HCAP Advisors takes into account various aspects of a company's performance during the measurement period and assigns an investment rating to each aspect, which are then averaged. Such averages may form, but do not necessarily determine, the investment rating assigned to a portfolio company. The following is a description of the conditions associated with each investment rating:

11


Investment RatingSummary Description
1Investment Rating 1 is used for investments that are performing above expectations, and whose risks remain favorable compared to the expected risk at the time of the original investment.
2Investment Rating 2 is used for investments that are performing within expectations and whose risks remain neutral compared to the expected risk at the time of the original investment. All new loans are initially rated 2.
3Investment Rating 3 is used for investments that are performing below expectations and that require closer monitoring, but where no loss of return or principal is expected. Portfolio companies with a rating of 3 may be out of compliance with financial covenants.
4Investment Rating 4 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are often in workout. Investments with a rating of 4 are those for which there is an increased possibility of loss of return, but no loss of principal is expected.
5Investment Rating 5 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are almost always in workout. Investments with a rating of 5 are those for which loss of return and principal is expected.
 
Determination of Net Asset Value and Portfolio Valuation Process
 
The net asset value per share of our common stock will be determined quarterly by dividing the value of our total assets minus liabilities by the total number of shares of common stock outstanding at the date as of which the determination is made. We will conduct the valuation of our assets, pursuant to which our net asset value will be determined, at all times consistent with U.S. generally accepted accounting principles, or “GAAP,” and the 1940 Act.
 
In calculating the fair value of our total assets, investments for which market quotations are readily available will be valued at such market quotations, which will generally be obtained from an independent pricing service or one or more broker-dealers or market makers. 
 
We expect that there will not be a readily available market value for a substantial portion of our portfolio investments, and we will value those debt and equity securities that are not publicly traded or whose market value is not ascertainable at fair value as determined in good faith by our board of directors pursuant to our valuation policy and the 1940 Act. HCAP Advisors also employs an independent third party valuation firm to assist in determining the fair value of our portfolio investments, as described below.
 
In accordance with authoritative accounting guidance, and with the assistance of any independent third-party valuation firms that we employ, we perform detailed valuations of our debt and equity investments on an individual basis, using market, income, and bond yield approaches as appropriate. In general, we utilize a bond yield method for the majority of our debt investments, as long as it is appropriate. If, in our judgment, the bond yield approach is not appropriate, we may use the market approach, or, in certain cases, an alternative methodology potentially including an asset liquidation or expected recovery model. For our equity investments, we generally utilize the market and income approaches.
 
Under the bond yield approach, we use bond yield models to determine the present value of the future cash flow streams of our debt investments. We review various sources of transactional data, including private mergers and acquisitions involving debt investments with similar characteristics, and assess the information to benchmark appropriate discount rates in the valuation process.
 
Under the market approach, we estimate the enterprise value of the portfolio companies in which we invest. There is no one methodology to estimate enterprise value, and in fact, for any one portfolio company, enterprise value is best expressed as a range of fair values, from which we derive a single estimate of enterprise value. To estimate the enterprise value of a portfolio company, we analyze various factors, including the portfolio company’s historical and projected financial results. Typically, private companies are valued based on multiples of EBITDA, cash flows, net income, revenues or, in limited cases, book value. We generally require portfolio companies to provide annual audited and quarterly and monthly unaudited financial statements, as well as annual projections for the upcoming fiscal year, though in some cases we have waived, and in the future may determine to waive, the requirement to provide audited financial statements based on facts and circumstances that make the portfolio company's audit impracticable.
 
12


Under the income approach, we generally prepare and analyze discounted cash flow models based on projections of the future free cash flows of the business. The discount rates used are determined based upon the portfolio company's weighted average cost of capital.
 
The types of factors that the board of directors may take into account in determining fair value include, among other things, comparisons of financial ratios of the portfolio companies that issued such private equity securities to peer companies that are public, the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, and other relevant factors, including in discerning whether the impact of the COVID-19 pandemic on a portfolio company and its earnings is temporary or permanent in nature and the resulting significance thereof on our valuation of our investment. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we will consider the pricing indicated by the external event to corroborate the private equity valuation.
  
The following is a description of our valuation process. Investments are measured at fair value as determined in good faith by our management team and HCAP Advisors' investment professionals, reviewed by the audit committee (which consists entirely of directors who are not "interested persons," as such term is defined in Section 2(a)(19) of the 1940 Act, of the Company) of the board of directors, and ultimately approved by our board of directors, based on, among other factors, consistently applied valuation procedures on each measurement date.

The board of directors undertakes a multi-step valuation process at each measurement date:

Our valuation process generally begins with each investment initially being valued by our management and HCAP Advisors' investment professionals, and/or, if applicable, by an independent third-party valuation firm.

Preliminary valuation conclusions are documented and discussed with our senior management.

The audit committee of our board of directors reviews and discusses the preliminary valuations and recommends valuations to our board of directors for approval.

The board of directors discusses valuations and determines the fair value of each investment in our portfolio in good faith, based upon the input of our senior management, HCAP Advisors' investment professionals, and an independent third-party valuation firm (to the extent any such firm reviewed the investment during the applicable quarter), and the recommendation of the board of directors' audit committee.

The nature of the materials and input that our board of directors receives in the valuation process varies depending on the nature of the investment and the other facts and circumstances. For example, in the case of investments that are Level 1 or 2 assets, a formal report by our management or HCAP Advisors' investment professionals, called a portfolio monitoring report, or “PMR,” is not generally prepared, and no independent third-party valuation firm is engaged due to the availability of quotes in markets for such investments or similar assets. In the case of investments that are Level 3 assets, however, our board of directors generally receives a report on material Level 3 investments on a quarterly basis (i) from our management or HCAP Advisors' investment professionals in the form of a PMR, (ii) from an independent third-party valuation firm, or (iii) in some cases, both. In the case of investments that are Level 3 assets and have an investment rating of 1 (performing above expectations), we generally engage an independent third-party valuation firm to review all such material investments at least annually. In quarters where an external valuation is not prepared for such investments, our management or HCAP Advisors’ investment professionals generally prepare a PMR. In the case of investments that are Level 3 assets and have an investment rating of 2 through 5 (with performance ranging from within expectations to substantially below expectations), we generally engage an independent third-party valuation firm to review such material investments quarterly (and may receive a PMR in addition to the review of the independent third-party valuation firm where the Level 3 assets have an investment rating of 3 through 5). However, in certain cases for Level 3 assets, we may determine that it is more appropriate for HCAP Advisors’ investment professionals to prepare a PMR instead of engaging an independent third-party valuation firm on a quarterly basis, because a third-party valuation is not cost effective or the nature of the investment does not warrant a quarterly third-party valuation. In addition, under certain unique circumstances, we may determine that a formal valuation report is not likely to be informative, and neither a third-party valuation report nor a report from management or HCAP Advisors’ investment professionals is prepared. Such circumstances might include, for example, an instance in which the investment has paid off after the period end date but before the board of directors meets to discuss the valuations. Further, Level 3 debt investments that have closed within six months of the measurement date are valued at cost unless unique circumstances dictate otherwise.

13


Due to the inherent uncertainty in determining the fair value of investments that do not have a readily observable fair value, and the subjective judgments and estimates involved in those determinations, the fair value determinations by our board of directors, even though determined in good faith, may differ materially from the values that would have been used had a readily available market value existed for such investments, and the differences could be material.
 
Derivatives 
 
We may utilize hedging techniques such as entering into interest rate swaps to mitigate potential interest rate risk on our indebtedness. Such interest rate swaps would principally be used to protect us against higher costs on our indebtedness resulting from increases in both short-term and long-term interest rates.
 
We also may use various hedging and other risk management strategies to seek to manage various risks, including changes in currency exchange rates and market interest rates. Such hedging strategies would be utilized to seek to protect the value of our portfolio investments, for example, against possible adverse changes in the market value of securities held in our portfolio.
 
Managerial Assistance
 
As a BDC, we offer, through HCAP Advisors, and must provide upon request, managerial assistance to certain of our portfolio companies. This assistance may involve, among other things, monitoring the operations of these 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 HCAP Advisors for its expenses related to providing such services on our behalf, which shall not exceed the amount we receive from such companies for providing this assistance and will not count against the $1.4 million cap on amounts payable by the Company under the administration agreement.
 
Competition
 
We compete for investments with other BDCs and investment funds, as well as traditional financial services companies such as commercial banks and other financing sources. A number 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. 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. We believe we compete effectively with these entities primarily on the basis of the experience, industry knowledge and contacts of the principals of our investment adviser, 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 or lower than our rates.

Employees
 
We do not have any employees. Our day-to-day investment operations are managed by HCAP Advisors, and each of our officers is an employee of HCAP Advisors or another affiliate. The partners and investment professionals of HCAP Advisors and the members of the Investment Committee that support us are not employed by us and receive no compensation directly from us in connection with the management of our portfolio. However, through their financial interests in and/or employment with HCAP Advisors, they are indirectly compensated by us through the investment advisory fees we pay to HCAP Advisors.

As of March 12, 2021, our investment adviser had a total of five full-time officers and employees, who expect to draw upon the resources of JMP Group, including its investment professionals as well as finance and operational professionals, in connection with our investment activities. In addition, we reimburse HCAP Advisors for the allocable portion of overhead and other expenses incurred by it in performing its obligations under the administration agreement, including rent and the allocable portion of the compensation of our executive officers and their respective staffs. For a more detailed discussion of the administration agreement with HCAP Advisors, see “Administration Agreement.”




14


  
Investment Advisory Agreement
 
HCAP Advisors serves as our investment adviser pursuant to an investment advisory and management agreement. HCAP Advisors is registered as an investment adviser under the Investment Advisers Act of 1940, or the "Advisers Act". Subject to the overall supervision of our board of directors, HCAP Advisors manages our day-to-day operations, and provides investment advisory and management services to us.
 
 Under the terms of our investment advisory and management agreement, HCAP Advisors:

determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the manner of implementing such changes;

identifies, evaluates and negotiates the structure of the investments we make;

executes, closes, services and monitors the investments we make;

perform due diligence on our prospective portfolio companies;

determine the securities and other assets that we will purchase, retain or sell; and

such other investment advisory, research and related services as we may, from time to time, reasonably require for the investment of our funds.
 
HCAP Advisors’ services under the investment advisory and 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. Under the investment advisory and management agreement, HCAP Advisors also provides on our behalf managerial assistance to those portfolio companies to which we are required to provide such assistance.
 
Management Fee
 
Pursuant to our investment advisory and management agreement, we pay HCAP Advisors a fee for investment advisory and management services consisting of a base management fee and a two-part incentive fee.
 
 Base Management Fee. The base management fee is calculated at an annual rate of (i) 2.0% of our gross assets up to and including $350 million, (ii) 1.75% of our gross assets above $350 million and up to and including $1 billion, and (iii) 1.5% of our gross assets above $1 billion, and is payable quarterly in arrears. For purposes of calculating the base management fee, the term “gross assets” includes all assets, including any assets acquired with the proceeds of leverage, but excludes cash and cash equivalents. HCAP Advisors benefits when we incur debt or use leverage. The base management fee is calculated based on the average value of our gross assets at the end of the two most recently completed calendar quarters. Base management fee for any partial quarter will be appropriately prorated.
 
Incentive Fee. The incentive fee has two parts, as follows:
 
One component of the incentive fee is calculated and payable quarterly in arrears based on our pre-incentive fee net investment income for the immediately preceding calendar quarter and is 20% of the amount, if any, by which our pre-incentive fee net investment income for the immediately preceding calendar quarter exceeds a 2.0% (which is 8.0% annualized) hurdle rate, subject to a “catch-up” provision pursuant to which HCAP Advisors receives 100% 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 2.5% (10.0% annualized). The effect of this "catch-up" provision is that, if pre-incentive fee net investment income exceeds 2.5% in any calendar quarter, HCAP Advisors will receive 20% of our pre-incentive fee net investment income as if a hurdle rate did not apply. 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 (as defined below), 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
15


investments with a deferred interest feature (such as original issue discount, or "OID", debt instruments with payment-in-kind, or "PIK", interest and zero coupon securities), accrued income that we have not yet received in cash. Since the hurdle rate is fixed, as interest rates rise, it is easier for HCAP Advisors to surpass the hurdle rate and receive an incentive fee based on net investment income. The foregoing incentive fee is subject to a total return requirement, which provides that no incentive fee in respect of our pre-incentive fee net investment income will be payable except to the extent 20% of the cumulative net increase in net assets resulting from operations over the then current and 11 preceding quarters exceeds the cumulative incentive fees accrued and/or paid for the 11 preceding quarters. In other words, any ordinary income incentive fee that is payable in a calendar quarter is limited to the lesser of (i) 20% of the amount by which our pre-incentive fee net investment income for such calendar quarter exceeds the 2.0% hurdle rate, subject to the “catch-up” provision, and (ii) (x) 20% of the cumulative net increase in net assets resulting from operations for the then current and 11 preceding calendar quarters minus (y) the cumulative incentive fees accrued and/or paid for the 11 preceding calendar quarters. For the foregoing purpose, the “cumulative net increase in net assets resulting from operations” is the amount, if positive, of the sum of pre-incentive fee net investment income, realized gains and losses and unrealized appreciation and depreciation of the Company for the then current and 11 preceding calendar quarters.
  
Pre-incentive fee net investment income, expressed as a rate of return on the value of our net assets (defined as total assets less senior securities constituting indebtedness and preferred stock) at the end of the then current quarter, 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 will 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 component of the incentive fee is also included in the amount of our gross assets used to calculate the base management fee. These calculations are 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)
 
grapha201.jpg
 
Percentage of Pre-Incentive Fee Net Investment Income Allocated to First Component of Incentive Fee
 
The second component of the incentive fee (the "capital gains incentive fee") is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment advisory and management agreement, as of the termination date) and equals 20.0% of our cumulative aggregate realized capital gains less cumulative aggregate realized capital losses and aggregate unrealized capital depreciation, in each case calculated from the commencement date. If the difference is positive, then the capital gains incentive fee for such year is 20.0% of such amount, as noted above, less the aggregate amount of capital gains incentive fee payments previously paid to HCAP Advisors in all prior years. If such amount is negative, then no capital gains incentive fee will be payable for such year. If the investment advisory and management agreement is terminated as of a date that is not a calendar year end, the termination date shall be treated as though it were a calendar year end for purposes of calculating and paying a capital gains incentive fee. 




16



Payment of Our Expenses
 
We bear all costs and expenses that are incurred in our operation and transactions and not specifically assumed by HCAP Advisors pursuant to the investment advisory and management agreement or the administration agreement. These costs and expenses include, but are not limited to, those relating to:

our organization;
calculating our net asset value (including the cost and expenses of any independent valuation firms);
expenses, including travel expense, incurred by HCAP Advisors or payable to third parties performing due diligence on prospective portfolio companies, monitoring our investments and, if necessary, enforcing our rights;
interest payable on debt, if any, incurred to finance our investments;
offerings of our securities;
investment advisory and management fees;
distributions on our shares;
administration fees payable under the administration agreement;
the allocated costs incurred by HCAP Advisors, as our administrator, in providing managerial assistance to those portfolio companies that request it;
amounts payable to third parties relating to, or associated with, making investments;
transfer agent and custodial fees;
registration fees;
listing fees;
taxes;
independent director fees and expenses;
preparing and filing reports or other documents with the SEC;
preparation of any reports, proxy statements or other notices to our stockholders, including printing costs;
our fidelity bond;
directors and officers/errors and omissions liability insurance, and any other insurance premiums;
indemnification payments;
expenses relating to the development and maintenance of our website;
direct costs and expenses of administration, including audit and legal costs; and
all other expenses reasonably incurred by us or our investment adviser in connection with administering our business, such as the allocable portion of overhead under the administration agreement, including rent and the allocable portion of the cost of our officers and their respective staffs.
 
Limitation of Liability and Indemnification
 
The investment advisory and management agreement provides that HCAP Advisors and its officers, managers, partners, controlling persons, members, directors, employees, agents and affiliates are not liable to us or any of our stockholders for any act or omission by it or its employees in the supervision or management of our investment activities or for any loss sustained by us or our stockholders, except that the foregoing exculpation does not extend to any act or omission constituting willful misfeasance, bad faith, gross negligence or reckless disregard of its obligations under the investment advisory and management agreement. The investment advisory and management agreement also provides for indemnification by us of HCAP Advisors’ members, managers, partners, directors, officers, employees, agents and control persons for liabilities incurred by it in connection with their services to us, subject to the same limitations and to certain conditions.
 
Duration and Termination
Our board of directors approved the investment advisory and management agreement at its first meeting, held on January 17, 2013. The investment advisory and management agreement was originally executed as of April 29, 2013 for an initial term of two years. Our board of directors most recently re-approved the investment advisory and management agreement on March 5, 2020 for an additional one-year term.

Unless earlier terminated as described below, including upon the completion of the Mergers, the investment advisory and management agreement provides that it will remain in effect if approved annually by our board of directors or by the affirmative vote of the holders of a majority of our outstanding voting securities, including, in either case, approval by a
17


majority of our directors who are not parties to such agreement or who are not “interested persons,” as such term is defined in Section 2(a)(19) of the 1940 Act, of any such party. The investment advisory and management agreement will automatically terminate in the event of its assignment. The investment advisory and management agreement may also be terminated by either party without penalty upon not more than 60 days’ written notice to the other party. See “Risk Factors - Our investment adviser has the right to 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 financial condition, business and results of operations.”
The investment advisory and management agreement will automatically terminate without penalty upon the completion of the Mergers. See "—The Proposed Merger With Portman Ridge Finance Corporation" above.
Board Approval of the Investment Advisory and Management Agreement
In consideration of its re-approval of the investment advisory and management agreement with HCAP Advisors during a meeting held on March 5, 2020, the board of directors focused on information it had received relating to, among other things:

the nature, extent, and quality of the advisory and other services to be provided to us by our investment adviser, including, without limitation, in relation to the origination and underwriting of investments in middle market and lower middle market private companies and information with respect to our investment adviser’s portfolio management process;

the performance of the Company and HCAP Advisors, including, without limitation, comparative data with respect to the performance of BDCs with similar investment objectives;

comparative data with respect to advisory fees or similar expenses paid by other BDCs with similar investment objectives, as well as other externally managed BDCs;

our operating expenses and expense ratio compared to BDCs with similar investment objectives, including, without limitation, consideration of administrative fees paid by other BDCs with similar investment objectives, as well as other externally managed BDCs, given HCAP Advisors’ provision of administrative services to the Company under the administration agreement and receipt of administrative fees for such services;

any existing and potential sources of indirect income to HCAP Advisors from its relationships with us and the profitability of those relationships, including, without limitation, administrative fees paid to HCAP Advisors in its capacity as the administrator under the administration agreement with the Company;

information about the services to be performed, the cost of such services, and the personnel performing such services under the investment advisory and management agreement, including, without limitation, the experience of such personnel in originating investments in the middle market and lower middle market;

the organizational capability and financial condition of HCAP Advisors;

the extent to which economies of scale would be realized if the Company grows and whether fee levels reflect these economies of scale for the benefit of the Company's stockholders, including, without limitation, consideration that the investment advisory and management agreement includes breakpoints that provide for the reduction of the base management fee as the Company’s gross assets increase above certain thresholds; and

such other matters as the board of directors determined were relevant to their consideration of the investment advisory and management agreement.

In connection with their consideration of the renewal of the investment advisory and management agreement, our board of directors gave weight to each of the factors described above, but did not identify one particular factor as controlling their decision. Based on the information reviewed and the discussions, the board of directors, including a majority of the directors who are not “interested persons” as defined in the 1940 Act, concluded that the investment management fee rates are reasonable in relation to the services to be provided and approved the renewal of the investment advisory and management agreement.
18



Organization of the Investment Adviser
 
HCAP Advisors is a Delaware limited liability company. The principal executive offices of HCAP Advisors are located at 767 Third Avenue, 29th Floor, New York, New York 10017.
 
Administration Agreement
 
HCAP Advisors also serves as our administrator pursuant to an administration agreement, which became effective on April 29, 2018. Prior to April 29, 2018, another affiliate of JMP Group, JMP Credit Advisors, served as our administrator. Pursuant to the aforementioned administration agreement, HCAP Advisors furnishes us with office facilities, equipment and clerical, bookkeeping, recordkeeping services at such office facilities and other such services as our administrator, subject to review by our board of directors, shall from time to time determine to be necessary or useful to perform its obligations under the administration agreement. Under the administration agreement, HCAP Advisors also performs, or oversees the performance of, our required administrative services, which include, among other things, being responsible for maintaining the financial and other records which we are required to maintain and preparing reports required to be filed with the SEC or any other regulatory authority. In addition, HCAP Advisors assists us in determining and publishing our net asset value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports to our stockholders, and generally oversees the payment of our expenses and the performance of administrative and professional services rendered to us by others.

In full consideration of the provision of the services of HCAP Advisors as our administrator, we reimburse HCAP Advisors for the costs and expenses incurred by it in performing its obligations and providing personnel and facilities under the administration agreement. Payments under the administration agreement are equal to an amount based upon our allocable portion of HCAP Advisors' overhead in performing its obligations under the administration agreement, including rent and our allocable portion of the cost of our executive officers and their respective staffs. In addition, if HCAP Advisors provides managerial assistance to our portfolio companies, we may receive fees from the applicable portfolio company in exchange for such services. We will generally reimburse HCAP Advisors at cost for the managerial assistance services they provide to any portfolio company, which amount will not exceed the amount that we receive from such portfolio company for providing this assistance and will not count against the $1.4 million cap on amounts payable by us under the administration agreement.

Our board of directors or a committee thereof discusses with our administrator the methodology employed in determining how the expenses are allocated to us. Our board of directors or a committee thereof also assesses the reasonableness of such reimbursements for expenses allocated to us based on the breadth, depth and quality of such services. In addition, our board of directors or a committee thereof consider other factors in assessing the reasonableness of the fee, including the amounts paid for such services by other BDCs and the costs that may be associated with obtaining similar services from other third-party service providers.

Similar to arrangements in prior years with our previous administrator, HCAP Advisors has agreed to a cap on amounts payable by us under the administration agreement. This cap set the maximum amount that would be payable by us under the administration agreement to $1.4 million for each of 2018, 2019 and 2020.

The existence of a cap, and the determination of a proper cap amount, in subsequent years will be determined by the mutual agreement of the independent members of our board of directors, on our behalf, and the administrator. The administration agreement may be terminated by either party without penalty upon 60 days’ written notice to the other.
 
The administration agreement provides that, absent willful misfeasance, bad faith or negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations, HCAP Advisors, its affiliates and their respective directors, officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated with it are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of the administrator’s services under the administration agreement or otherwise as administrator for us.

License Agreement
 
We have entered into a license agreement with an affiliate of JMP Group pursuant to which it has agreed to grant us a non-exclusive, royalty-free license to use the name “Harvest.” Under this agreement, we have a right to use the “Harvest” name
19


for so long as an affiliate of JMP Group remains our investment adviser. Other than with respect to this limited license, we have no legal right to the “Harvest” name. 

Regulation as a BDC
 
We have elected to be regulated as a BDC under the 1940 Act. 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 and requires that a majority of the directors on a BDC's board of directors 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 shares present at a meeting if more than 50% of the outstanding shares of such company are present and represented by proxy or (ii) more than 50% of the outstanding shares of such company.
 
We do not intend to acquire securities issued by any investment company (i.e., mutual fund, registered closed-end fund or BDC) that exceed the limits imposed by the 1940 Act. Under these limits, except for registered money market funds and subject to certain exceptions, we generally cannot acquire more than 3% of the voting stock of one 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 investment companies, generally. 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.
 
We are also prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our board of directors 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 are generally precluded from co-investing in private placements of securities. However, on December 10, 2015, we received the Exemptive Relief permitting us greater flexibility to negotiate the terms of co-investments with certain accounts managed or held by JMP Group and certain of its subsidiaries, in each case in a manner consistent with our investment objectives and strategies as well as regulatory requirements and other pertinent factors (including the terms and conditions of the Exemptive Relief). Under the terms of the relief, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) that the transaction is consistent with the interests of our stockholders and is consistent with our investment objectives and strategies. We intend to co-invest, subject to the conditions included in the Exemptive Relief, with certain accounts managed or held by JMP Group and certain of its subsidiaries. We believe that such co-investments may afford us additional investment opportunities.
 
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 HCAP Advisors 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 HCAP Advisors have designated a chief compliance officer to be responsible for administering these 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 business are generally the following:
20



1.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:
is organized under the laws of, and has its principal place of business in, the United States;
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
satisfies any of the following:
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;
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
has a market capitalization of less than $250 million or does not have any class of securities listed on a national securities exchange.

2. Securities of any eligible portfolio company which we control.

3. Securities purchased in a private transaction from a U.S. issuer that is not an investment company (other than a small business investment company wholly owned by us) 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.

4. 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.

5. 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.

6. Cash, cash equivalents, U.S. Government securities or high-quality debt securities maturing in one year or less from the time of investment.
 
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 (1), (2) or (3) in “— Qualifying assets” above. BDCs generally must offer to make available to the issuer of the securities significant managerial assistance, except in circumstances where either (i) the BDC controls such issuer of securities or (ii) the BDC purchases such securities in conjunction with one or more other persons acting together and 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, employees or agents, 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 of our Common Stock
 
We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, issue and sell our common stock at a price below the current net asset value of the common stock if our board of directors determines that such sale is in our best 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
21


securities are to be issued and sold may not be less than a price which, in the determination of our board of directors, closely approximates the market value of such securities.

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 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, 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 maintain our qualification 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. HCAP Advisors monitors the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.
 
Senior securities; Derivative securities
 
The Small Business Credit Availability Act (the "SBCAA"), which was signed into law in March 2018, among other things, amended Section 61(a) of the 1940 Act to add a new Section 61(a)(2) that reduces the asset coverage requirement applicable to BDCs from 200% to 150% so long as the BDC meets certain disclosure requirements and obtains certain approvals. On May 4, 2018, our board of directors unanimously approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, effective May 4, 2019, our applicable asset coverage ratio under the 1940 Act decreased to 150% from 200%. Thus, for purposes of the 1940 Act, we are permitted under specified conditions, to issue multiple classes of debt and one class of stock senior to our common stock if our asset coverage ratio, as defined in the 1940 Act, is at least equal to 150% immediately after each such issuance; provided however that we are still required to comply with the provisions of our existing $45.0 million senior secured revolving credit facility (as modified, amended and restated from time to time, the "Credit Facility") that limit our ability to incur such additional leverage. Under the Credit Facility, for example, our senior debt-to-tangible equity ratio is limited to 1.00 to 1.00 and our total debt-to-tangible equity ratio is limited to 1.40 to 1.00. We may also borrow amounts up to 5% of the value of our total assets for temporary purposes without regard to asset coverage. See "Risk Factors--Risks Relating to Our Business and Structure-- Regulations governing our operations and capital structure affect (and could limit) our ability to raise, and the way in which we may raise, additional capital."
 
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 HCAP Advisors have each adopted a code of ethics pursuant to Rule 17j-1 under the 1940 Act and a code of conduct 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 codes’ requirements. The code of ethics and code of conduct are available on the EDGAR database on the SEC’s website at http://www.sec.gov. Both documents are also available on our corporate governance webpage of http://www.harvestcapitalcredit.com/corporate-governance.
 
Proxy voting policies and procedures
 
We have delegated our proxy voting responsibility, with respect to our portfolio companies, to our investment adviser. The Proxy Voting Policies and Procedures of our investment adviser are set forth below. The guidelines are reviewed periodically by our investment adviser and our independent directors and, accordingly, are subject to change.
 




22


Introduction
 
Our investment adviser is registered with the SEC as an investment adviser under the Advisers Act. As an investment adviser registered under the Advisers Act, our investment adviser has fiduciary duties to us. As part of this duty, our investment adviser 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 investment adviser’s Proxy Voting Policies and Procedures have been formulated to ensure decision-making 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
 
HCAP Advisors votes proxies relating to our portfolio securities in what our investment adviser perceives to be the best interest of our stockholders. Our investment adviser 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 investment adviser will generally vote against proposals that may have a negative effect on our portfolio securities, our investment adviser may vote for such a proposal if there exist compelling long-term reasons to do so.
 
Our investment adviser’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 investment adviser 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. If a vote may involve a material conflict of interest, prior to approving such vote, our investment adviser must consult with our chief compliance officer to determine whether the potential conflict is material and if so, the appropriate method to resolve such conflict. If the conflict is determined not to be material, our investment adviser’s employees shall vote the proxy in accordance with our investment adviser’s proxy voting policy.
 
Proxy voting records
 
Our stockholders may obtain information about how we voted proxies by making a written request for proxy voting information to Chief Compliance Officer, Harvest Capital Credit Corporation, 767 Third Avenue, 29th Floor, New York, New York 10017.
 
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 non-public personal information relating to our stockholders, although certain non-public personal information of our stockholders may become available to us. We do not disclose any non-public personal information about our stockholders or former stockholders to anyone, 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 non-public personal information about our stockholders to our investment adviser’s and administrator’s employees with a legitimate business need for the information. We maintain physical, electronic and procedural safeguards designed to protect the non-public personal information of our stockholders. 

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002, as amended (the "Sarbanes-Oxley Act"), imposes several regulatory requirements on publicly held companies and their insiders. Many of these requirements affect us.

For example:

23


pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), our Chief Executive Officer and Chief Financial Officer must certify the accuracy of the financial statements contained in our periodic reports;

pursuant to Item 307 of Regulation S-K, our periodic reports must disclose our conclusions about the effectiveness of our disclosure controls and procedures;

pursuant to Rule 13a-15 of the Exchange Act, our management must prepare an annual report regarding its assessment of our internal control over financial reporting; and

pursuant to Item 308 of Regulation S-K and Rule 13a-15 of the Exchange Act , our periodic reports must disclose whether there were significant changes in our internal control 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.

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 there-under. We continue to monitor our compliance with all regulations that are adopted under the Sarbanes-Oxley Act and continue to take actions necessary to ensure that we are in compliance with that act.

Taxation as a Regulated Investment Company
 
We have elected to be treated as a RIC under Subchapter M of the Code. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that we timely distribute to our stockholders as dividends. To maintain our qualification as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below). In addition, to be able to deduct the amount of our distributions, we must distribute to our stockholders, for each taxable year, at least 90% of our “investment company taxable income,” which is generally our net ordinary taxable income plus the excess of our realized net short-term capital gains over our realized net long-term capital losses (the “Annual Distribution Requirement”).
  
For any taxable year in which we:
• qualify as a RIC; and
• satisfy the Annual Distribution Requirement,
we will not be subject to U.S. federal income tax on the portion of our investment company taxable income and net capital gain, defined as net long-term capital gains in excess of 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 net income or net capital gain not distributed (or deemed distributed) to our stockholders.

We will be subject to a 4% nondeductible U.S. federal excise tax on certain undistributed income unless we distribute in a timely manner an amount at least equal to the sum of (1) 98% of our net ordinary income for each calendar year, (2) 98.2% of our capital gain net income for the one-year period ending October 31 in that calendar year and (3) any income recognized, but not distributed, in preceding years and on which we paid no corporate-level U.S. federal income tax (the “Excise Tax Avoidance Requirement”). We generally will endeavor in each taxable year to make sufficient distributions to our stockholders to avoid any U.S. federal excise tax on our earnings. In this regard, the Company does not expect to incur an excise tax for the year ended December 31, 2020.

In order to maintain our qualification as a RIC for U.S. federal income tax purposes, we must, among other things:

continue to qualify as a BDC under the 1940 Act at all times during each taxable year;

derive in each taxable year at least 90% of our gross income from dividends, interest, payments with respect to loans of certain securities, 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 (the “90% Income Test”); and
24



diversify our holdings so that at the end of each quarter of the taxable year:

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 do not represent more than 5% of the value of our assets or more than 10% of the outstanding voting securities of the issuer; and

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, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships” (the “Diversification Tests”).
 
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 OID (such as debt instruments with PIK interest or, in certain cases, increasing interest rates or issued with warrants), we must include in income each year a portion of the OID that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. We may also have to include in income other amounts that we have not yet received in cash, such as PIK interest and deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation such as warrants or stock, or certain income with respect to foreign corporations. Because any OID or other amounts 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.
 
We are authorized to borrow funds and to sell assets in order to satisfy the distribution requirements. However, under the 1940 Act, we are not permitted in certain circumstances 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. If we are prohibited from making distributions or are unable to obtain cash from other sources to make the distributions, we may fail to qualify for tax treatment as a RIC, which would result in us becoming subject to corporate-level U.S. federal income tax.
  
In accordance with certain applicable Treasury regulations and a revenue procedure issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, the cash available for distribution must be allocated among each stockholder electing to receive cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than the lesser of (a) the portion of the distribution such shareholder has elected to receive in cash, or (b) an amount equal to his or her entire distribution times the percentage limitation on cash available for distribution. If these and certain other requirements are met, for U.S federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. We have no current intention of paying distributions in shares of our stock in accordance with these Treasury regulations or revenue procedure. 

The NASDAQ Stock Market Corporate Governance Regulations
 
The NASDAQ Stock Market has adopted corporate governance regulations that listed companies must comply with. We are in compliance with such corporate governance listing standards applicable to BDCs.
 
 
25


Item 1A.Risk Factors
 
 Investing in our securities involves a number of significant risks. 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. Additional risks and uncertainties not presently known to us or not presently deemed material by us might also impair our operations and performance. 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 net asset value, the trading price of our common stock and the value of any of our other securities, to the extent outstanding, including any preferred stock, subscription rights, warrants, or debt securities, may decline, and you may lose all or part of your investment.

The following is a summary of the principal risk factors associated with an investment in the Company. Further details regarding each risk included in the below summary list can be found further below.

We are dependent upon our investment adviser’s key personnel for our future success.

We provide debt and equity capital primarily to small and mid-sized companies, which may present a greater risk of loss than providing debt and equity capital to larger companies.

Because the majority of the loans we make and equity securities we receive are not publicly traded, there is uncertainty regarding the value of our privately held securities that could adversely affect our determination of our net asset value.

There are significant potential conflicts of interest which could impact our investment returns.

Regulations governing our operations and capital structure affect (and could limit) our ability to raise, and the way in which we may raise, additional capital.

Because we borrow money in connection with our investment activities, the potential for gain or loss on amounts invested in us is magnified and may increase the risk of investing in us, and our operating and investment activities may be restricted by the terms of our borrowing arrangements.

All of our assets are subject to security interests under the Credit Facility, and if we default on our obligations under the Credit Facility, we may suffer materially adverse consequences, including foreclosure on our assets.

The involvement of our investment adviser’s investment professionals in our valuation process may create conflicts of interest.

A failure on our part to maintain our qualification as a BDC would significantly reduce our operating flexibility.

We will be subject to corporate-level income tax and may default under our Credit Facility if we are unable to satisfy certain RIC qualification requirements under Subchapter M of the Code or do not satisfy the annual distribution requirement.

The pendency of the proposed Mergers could adversely affect our business, financial results and operations.

If the Mergers do not close, we will not benefit from the expenses incurred in pursuit of the Mergers and, under certain circumstances, we will be required to pay half of PTMN’s expenses incurred in connection with the Mergers, subject to a maximum reimbursement payment of $500,000.

The termination of the Merger Agreement could negatively impact us.

26


The Mergers are subject to closing conditions, including the requisite approval of our stockholders, that, if not satisfied or waived, will result in the Mergers not being completed, which may result in material adverse consequences to our business and operations.

We will be subject to operational uncertainties and contractual restrictions while the Mergers are pending, including restrictions on pursuing alternatives to the Mergers.

Events outside of our control, including public health crises, may negatively affect our portfolio companies and the results of our operations.

We are currently operating in a period of capital markets disruption and economic uncertainty, which could limit our access to capital and result in a decision by lenders, including existing lenders, not to extend credit to us or decline to renew, extend or expand existing credit facilities.

Our investments may be risky, and we could lose all or part of our principal.

Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.

Our portfolio is concentrated in a limited number of portfolio companies and industries, which will subject us to a risk of significant loss if any of these companies defaults on its obligations under any of its debt instruments or if there is a downturn in a particular industry.

Shares of closed-end investment companies, including BDCs, may trade at a discount to their net asset value.

Risks Relating to Our Business and Structure
 
We are dependent upon our investment adviser’s key personnel for our future success.
 
Our day-to-day investment operations are managed by HCAP Advisors, subject to oversight and supervision by our board of directors. As a result, we depend on the diligence, skill and network of business contacts of the principals of our investment adviser. These individuals have critical industry experience and relationships that we rely on to implement our business plan. If our investment adviser, which has a small number of investment professionals, loses the services of these individuals and cannot replace them, we may not be able to operate our business as we expect, and our ability to compete in this industry could be harmed, which could cause our operating results to suffer. In addition, we can offer no assurance that HCAP Advisors will remain our investment adviser.
 
The investment professionals of our investment adviser may in the future become affiliated with entities engaged in business activities similar to those intended to be conducted by us, and may have conflicts of interest in allocating their time. We expect that these investment professionals will continue to dedicate a significant portion of their time to our investment activities; however, they may in the future engage in other business activities which could divert their time and attention from our investment activities. For example, Joseph A. Jolson, our Chief Executive Officer and the Chairman of our board of directors, is also the Chief Executive Officer and chairman of the board of directors of JMP Group, which owns, directly or indirectly, a majority interest in HCAP Advisors (our investment adviser and administrator).
 
Our business model depends to a significant extent upon strong referral relationships of the principals of our investment adviser, and their inability to maintain or develop these relationships, as well as the failure of these relationships to generate investment opportunities, could adversely affect our business.
 
We expect that the principals of our investment adviser will maintain their relationships with financial institutions, private equity and other non-bank investors, investment bankers, commercial bankers, attorneys, accountants and consultants, and we rely to a significant extent upon these relationships to provide us with potential investment opportunities. If the principals of our investment adviser fail to maintain their existing relationships or to develop new relationships with other sponsors or sources of investment opportunities, we will not be able to grow our investment portfolio. In addition, individuals
27


with whom the principals of our investment adviser have relationships are not obligated to provide us with investment opportunities, and, therefore, there is no assurance that such relationships will generate investment opportunities for us.
  
Our financial condition and results of operations depend on our ability to manage our business and our future growth effectively.
 
Our ability to achieve our investment objective depends on our ability to manage and grow our business. This depends, in turn, on our investment adviser’s ability to identify, invest in, and monitor companies that meet our investment criteria.
 
Accomplishing this result on a cost-effective basis will be largely a function of our investment adviser’s structuring and execution of its investment process, its ability to provide competent, attentive and efficient services to us, and our access to financing on acceptable terms. The principals of our investment adviser have substantial responsibilities under the investment advisory and management agreement. Such demands on their time may distract them or slow our rate of investment. In order to grow, our investment adviser will need to hire, train, supervise and manage new employees. However, we can offer no assurance that any such employees will contribute effectively to the work of our investment adviser. Any failure to manage our future growth effectively could have a material adverse effect on our business, financial condition and results of operations.
 
We provide debt and equity capital primarily to small and mid-sized companies, which may present a greater risk of loss than providing debt and equity capital to larger companies.
 
Our portfolio consists primarily of debt and equity investments in small and mid-sized companies. Compared to larger companies, small and mid-sized companies generally have limited access to capital and higher funding costs, may be in a weaker financial position and may need more capital to expand, compete and operate their businesses. They also typically have fewer administrative resources, which can lead to greater uncertainty in their ability to generate accurate and reliable financial data, including their ability to deliver audited financial statements. In addition, many small and mid-sized companies may be unable to obtain financing from the public capital markets or other traditional sources, such as commercial banks, in part because loans made to these types of companies entail higher risks than loans made to companies that have larger businesses, greater financial resources or are otherwise able to access traditional credit sources on more attractive terms.
 
A variety of factors may affect the ability of borrowers to make scheduled payments on loans, including failure to satisfy financial targets and covenants, a downturn in a borrower’s industry or changes in the economy in general. In addition, investing in small and mid-sized companies in general involves a number of significant risks, including that small and mid-sized companies:

may have limited financial resources and may be unable to meet their obligations under their debt securities that we hold, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of us realizing any guarantees we may have obtained in connection with our investment;

typically have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render small and mid-sized companies more vulnerable to competitors’ actions and market conditions, as well as general economic downturns;

are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn, on us;

generally have less predictable operating results, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position;

may from time to time be parties to litigation, and our executive officers, directors and our investment adviser may, in the ordinary course of business, be named as defendants in litigation arising from our investments in the portfolio companies;

may have difficulty accessing the capital markets to meet future capital needs, which may limit their ability to grow or to repay their outstanding indebtedness upon maturity; and

28


may be particularly vulnerable to changes in customer preferences and market conditions, depend on a limited number of customers, and face intense competition, including from companies with greater financial, technical, managerial and marketing resources.
 
Any of these factors or changes thereto could impair a small or mid-sized company’s financial condition, results of operation, cash flow or result in other adverse events, such as bankruptcy, any of which could limit a borrower’s ability to make scheduled payments on our loans. This, in turn, could result in losses in our loan portfolio and a decrease in our net interest income and net asset value.
 
Because the majority of the loans we make and equity securities we receive are not publicly traded, there is uncertainty regarding the value of our privately held securities that could adversely affect our determination of our net asset value.
 
Substantially all of our portfolio investments are in the form of securities that are not publicly traded. The fair value of securities and other investments that are not publicly traded may not be readily determinable. We value the securities we hold for which market quotations are not available at fair value as determined in good faith by our board of directors and in accordance with generally accepted accounting principles in the United States, or “GAAP.” Our board of directors utilizes the services of an independent valuation firm to aid it in determining the fair value of these securities. The factors that may be considered in the fair value pricing of our investments include the nature and realizable value of any collateral, the portfolio company’s ability to make payments, the portfolio company's earnings, the markets in which the portfolio company does business, comparison to publicly traded companies, discounted cash flow, enterprise value and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time, and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. Our net asset value could be adversely affected if our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the disposal of such securities.
 
There are significant potential conflicts of interest which could impact our investment returns.
 
HCAP Advisors' investment professionals may serve as officers, directors, principals, portfolio managers or advisors of or to entities that operate in the same or a related line of business as we do or of investment funds, accounts or vehicles managed by our investment adviser or its affiliates. Accordingly, they have or may in the future have obligations to investors in those funds, accounts or vehicles, the fulfillment of which obligations might not be in the best interests of us or our stockholders. We also note that any investment fund, account or vehicle managed by HCAP Advisors or its affiliates in the future may have overlapping investment objectives with our own and, accordingly, may invest in asset classes similar to those targeted by us. We intend to co-invest with investment funds, accounts and vehicles managed by HCAP Advisors where doing so is consistent with our investment strategy as well as applicable law and SEC staff interpretations. Without an exemptive order from the SEC, which we have obtained (as described below), we generally will be permitted to co-invest with such investment funds, accounts and vehicles only when the only term that is negotiated is price. When we invest alongside other investment funds, accounts and vehicles managed by HCAP Advisors or an affiliate thereof, we expect HCAP Advisors to make such investments on our behalf in a fair and equitable manner consistent with our investment objective and strategies so that we are not disadvantaged in relation to any other future client of HCAP Advisors. In situations where co-investment alongside other investment funds, accounts and vehicles managed by HCAP Advisors or an affiliate thereof is not permitted or appropriate, such as when there is an opportunity to invest in different securities of the same issuer, HCAP Advisors will need to decide whether we or such other entity or entities will proceed with the investment. HCAP Advisors will make these determinations based on its policies and procedures, which generally require that such opportunities be offered to eligible accounts on a basis that will be fair and equitable over time. Although HCAP Advisors will endeavor to allocate investment opportunities in a fair and equitable manner in such event, it is possible that we may not be given the opportunity to participate in certain investments made by such other funds that are consistent with our investment objective.
 
In addition, on December 10, 2015, we received the Exemptive Relief permitting us greater flexibility to negotiate the terms of co-investments with certain accounts managed or held by JMP Group and certain of its subsidiaries, in each case in a manner consistent with our investment objectives and strategies as well as regulatory requirements and other pertinent factors (including the terms and conditions of the Exemptive Relief). Under the terms of the relief, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including (1) the terms of the proposed transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching in respect of us or our stockholders on the part of any person concerned and (2) the proposed transaction is consistent with the interests of our stockholders and is consistent with our
29


investment objectives and strategies. We intend to co-invest, subject to the conditions included in the Exemptive Relief, with certain accounts managed or held by JMP Group and certain of its subsidiaries. We believe that such co-investments may afford us additional investment opportunities.

Our incentive fee may induce our investment adviser to pursue speculative investments.
 
The incentive fee payable by us to our investment adviser may create an incentive for our investment adviser to pursue investments on our behalf that are risky or more speculative than would be the case in the absence of such compensation arrangement. Our investment adviser will receive 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, the investment adviser 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 lead us to invest in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during economic downturns.
 
The incentive fee payable by us to our investment adviser also may induce it to invest on our behalf in instruments that have a deferred interest feature, such as PIK interest. Under these investments, we would accrue the interest over the life of the investment but would not receive the cash income from the investment until the end of the investment’s term, if at all. Our net investment income used to calculate the income portion of our incentive fee, however, includes accrued interest. Thus, a portion of the incentive fee would be based on income that we have not yet received in cash and may never receive in cash if the portfolio company is unable to satisfy such interest payment obligation to us. While we may make incentive fee payments on income accruals that we may not collect in the future and with respect to which we do not have a formal “claw back” right against our investment adviser per se, the amount of accrued income written off in any period will reduce the income in the period in which such write-off was taken and thereby reduce or have the effect of eliminating such period’s incentive fee payment. However, in light of the 2% quarterly hurdle rate relating to the income incentive fee payable to our investment adviser, the reduction in such period’s income incentive fee may not correlate perfectly with the benefit, if any, previously received by the investment adviser with respect to the income incentive fee at the time of the accrual of such income.
 
Finally, the fact that the incentive fee payable to our investment adviser is calculated based on a percentage of our return on invested capital may encourage our investment adviser to use leverage to increase the return on our investments. Under certain circumstances, the use of leverage may increase the likelihood of default, which could impair the value of our securities, particularly our common stock.
 
Our base management fee may induce our investment adviser to incur leverage.
 
The fact that our base management fee is payable based upon our gross assets, which would include any borrowings for investment purposes, may encourage our investment adviser to use leverage to make additional investments. Under certain circumstances, the use of increased leverage may increase the likelihood of default, which could impair the value of our securities, particularly our common stock. Given the subjective nature of the investment decisions made by our investment adviser on our behalf, we may not be able to monitor this potential conflict of interest.
 
PIK interest earned increases our assets under management and, as a result, will increase the amount of base management fees and potential incentive fees payable by us to HCAP Advisors.
 
Certain of our debt investments may contain provisions providing for the payment of PIK interest. Because PIK interest results in an increase in the size of the loan balance of the underlying loan, the receipt by us of PIK interest will have the effect of increasing our assets under management. As a result, because the base management fee that we pay to HCAP Advisors is based on the value of our gross assets, the receipt by us of PIK interest will result in an increase in the amount of the base management fee payable by us. In addition, because the incentive fee that we pay to HCAP Advisors is based on a hurdle rate, the receipt of PIK interest by us will have the effect of increasing our pre-incentive fee net investment income during the quarter, and if that return is above the hurdle rate, may cause us to pay an incentive fee to HCAP Advisors.
 
We cannot predict how any tax reform legislation will affect us, our investments, or our stockholders, and any such legislation could adversely affect our business.
New tax reform legislation and any U.S. Treasury regulations, administrative interpretations or court decisions interpreting such legislation could significantly and negatively affect our ability to maintain our tax treatment as a RIC or the
30


U.S. federal income tax consequences to us and our stockholders of such qualification, or could have other adverse consequences. Stockholders are urged to consult with their tax advisors regarding tax legislative, regulatory, or administrative developments and proposals and their potential effect on an investment in our securities.
 
Legislation permits us to incur additional leverage.
BDCs are generally able to issue senior securities such that their asset coverage, as defined in the 1940 Act, equals at least 200% of gross assets less all liabilities and indebtedness not represented by senior securities, after each issuance of senior securities. In March 2018, the SBCAA amended Section 61(a) of the 1940 Act to add a new Section 61(a)(2) that reduces the asset coverage requirement applicable to BDCs from 200% to 150% so long as the BDC meets certain disclosure requirements and obtains certain approvals. On May 4, 2018, our board of directors unanimously approved the application of the reduced asset coverage requirements in Section 61(a)(2) to us, effective May 4, 2019. As a result of the board approval, effective May 4, 2019, the asset coverage ratio under the 1940 Act applicable to us decreased to 150% from 200%. In other words, under the 1940 Act, we are now able to borrow $2 for investment purposes for every $1 of investor equity, as opposed to borrowing $1 for investment purposes for every $1 of investor equity. As a result, we are able to incur additional indebtedness, subject to applicable provisions under our $45.0 million Credit Facility (as discussed below) and any other credit facility to which we may become subject in the future, and our investors may face increased investment risk. In addition, our management fee is based on our gross assets, which includes leverage and, as a result, if we were to incur additional leverage, management fees paid to our investment adviser would increase.

Regulations governing our operations and capital structure affect (and could limit) our ability to raise, and the way in which we may raise, additional capital.
 
Our business requires a substantial amount of capital. However, we may not be able to raise additional capital in the future on favorable terms or at all. We may issue debt securities, other evidences of indebtedness or preferred stock, and we may borrow money from banks or other financial institutions, which we collectively refer to as “senior securities,” up to the maximum amount permitted by the 1940 Act and as permitted by our borrowing arrangements, including under the Credit Facility.

In accordance with approval from our board of directors in May 2018, Section 61(a) of the 1940 Act generally prohibits us from incurring indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 150% (i.e., the amount of debt may not exceed 67% of the value of our assets). However, in the event that we incur additional indebtedness, we would still be required to comply with or amend any then-existing provisions of our Credit Facility that limit our ability to incur such additional leverage. Under our existing Credit Facility, for example, our senior debt-to-tangible equity ratio is limited to 1.00 to 1.00, and our total debt-to-tangible equity ratio is limited to 1.40 to 1.00.

Leverage increases the risks associated with an investment in us. Leverage magnifies the potential for loss on investments in our indebtedness and on invested equity capital. As we use leverage to partially finance our investments, you will experience increased risks of investing in our securities. Increasing our leverage, for example, makes our net asset value more sensitive to decreases and increases in our total assets and subject to greater variation. If the value of our assets increases, then the additional leverage would cause the net asset value attributable to our common stock to increase more sharply than it would have had we not increased our leverage. Conversely, if the value of our assets decreases, the additional leverage would cause net asset value to decline more sharply than it otherwise would have had we not increased our leverage. Similarly, any increase in our income in excess of interest payable on the borrowed funds would cause our net investment income to increase more than it would without the additional leverage, while any decrease in our income would cause net investment income to decline more sharply than it would have had we not increased our leverage. Such a decline could negatively affect our ability to pay common stock dividends, scheduled debt payments or other payments related to our securities. Leverage is generally considered a speculative investment technique. As a result of issuing senior securities, we will also be exposed to typical risks associated with leverage, including an increased risk of loss.

If we issue preferred stock, it will rank “senior” to common stock in our capital structure, and will have priority over our common stock as to the distribution of assets and payments of dividends. Preferred stockholders will also have separate voting rights and may have rights, preferences or privileges more favorable than those of holders of our common stock. The issuance of preferred stock could have the effect of delaying, deferring or preventing a transaction or a change of control that might involve a premium price for holders of our common stock or otherwise be in the best interest of the holders of our common stock.
 
31


To the extent that we are constrained in our ability to issue debt or other senior securities, we will depend on issuances of common stock to finance our operations. As a BDC, we generally are not able to issue our common stock at a price below net asset value without first obtaining required approvals of our stockholders and independent directors. This requirement may limit our ability to issue additional stock to finance our operations, since our common stock for the last year has traded at a discount to our net asset value and will likely continue to do so. In addition, 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, which may subject them to dilution. If we cannot raise additional capital, we may be significantly constrained in our ability to make new investments and grow our business.
 
Because we borrow money in connection with our investment activities, the potential for gain or loss on amounts invested in us is magnified and may increase the risk of investing in us, and our operating and investment activities may be restricted by the terms of our borrowing arrangements.
 
Borrowings, also known as leverage, magnify the potential for gain or loss on invested equity capital. As we use leverage to partially finance our investments, you will experience increased risks associated with investing in our common stock. If the value of our assets increases, then leveraging would cause the net asset value attributable to our common stock to increase more sharply than it would have had we not utilized leverage. Conversely, if the value of our assets decreases, leveraging would cause net asset value to decline more sharply than it otherwise would have had we not utilized leverage. Similarly, any increase in our income in excess of interest payable on the borrowed funds would cause our net investment income to increase more than it would without the leverage, while any decrease in our income would cause our net investment income to decline more sharply than it would have had we not borrowed. Such a decline could negatively affect our ability to make distributions to our stockholders.

At December 31, 2020, we had $64.3 million of outstanding indebtedness with an annualized cost of $3.8 million related to interest and unused line fees, which assumes a weighted average cost of debt capital of 5.9% (which includes the unused fee) at December 31, 2020. In order for us to cover these annualized interest payments on indebtedness, we must achieve annual returns on our investments of at least 4.2%. As of December 31, 2020, our asset coverage for borrowed amounts was 197%.
 
Advances under our Credit Facility bear interest at a rate per annum equal to the lesser of (i) applicable LIBOR plus 4.50% (with a 1.00% LIBOR floor) and (ii) the maximum rate permitted under applicable law. In addition, the Credit Facility requires payment of a monthly fee of 0.50% per annum for unused amounts during the revolving period, which is calculated based on the difference between (a) the maximum loan amount and (b) the average daily principal balance of the obligations outstanding during the prior calendar month. The Credit Facility is secured by all of our assets. If we are unable to meet the financial obligations under the Credit Facility, and an event of default occurs and is not cured, the lenders under the Credit Facility could exercise their remedies against the Company’s assets and would have a superior claim to such assets over our stockholders. In addition, our operating and investment activities may be restricted by the terms of our borrowing arrangements and compliance with affirmative and negative covenants thereunder, including with respect to the Credit Facility, which could have a material adverse effect on our financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition, Liquidity and Capital Resources - Credit Facility" included in Part II, Item 7 in this Annual Report on Form 10-K for more information regarding the terms and conditions of the Credit Facility.

Our $28.8 million in aggregate principal amount of unsecured notes due 2022, or the "2022 Notes", have a fixed annual interest rate of 6.125% and require quarterly interest payments until the notes mature in September 2022.
  
Illustration. The following table illustrates the effect of leverage on returns from an investment in our common stock as of December 31, 2020 assuming various annual returns, net of expenses, but before operating expenses. The calculations in the table below are hypothetical and actual returns may be higher or lower than those appearing below.
 
Assumed Return on Our Portfolio
(net of expenses)
-10%-5%0%5%10%
Corresponding return to stockholder (26.5)%(16.3)%(6.1)%4.1%14.3%
 
Assumes (i) $89.6 million in portfolio investments (at fair value) at December 31, 2020, (ii) $64.3 million in outstanding indebtedness at December 31, 2020, (iii) $62.2 million in net assets at December 31, 2020 and (iv) average cost of funds of 5.9%, which is the estimated weighted average borrowing cost under our Credit Facility (including our unused fee of 0.50%)
32


and 2022 Notes as of December 31, 2020. The corresponding returns to stockholders are net of interest expense, but excludes other operating expenses. Based on the above assumptions, our investment portfolio at fair value would have had to produce an annual return of at least 4.2% to cover annual interest payments on our outstanding debt.
 
All of our assets are subject to security interests under the Credit Facility, and if we default on our obligations under the Credit Facility, we may suffer materially adverse consequences, including foreclosure on our assets.
 
As of December 31, 2020, all of our assets were pledged as collateral under our Credit Facility. If we default on our obligations under the Credit Facility, the lenders have the right to foreclose upon and sell, or otherwise transfer, the collateral subject to their security interests. If the lenders exercise their right to sell the assets pledged under the Credit Facility, such sales may be completed at distressed sale prices, thereby diminishing or potentially eliminating the amount of cash available to us after repayment of the amounts outstanding under the Credit Facility. Such deleveraging of our company could significantly impair our ability to effectively operate our business and otherwise have a material adverse effect on our financial condition, results of operations and cash flows. Further, in such a circumstance, we could be forced to curtail or cease new investment activities and lower or eliminate the distributions that we have historically paid to our stockholders.
 
Changes in interest rates may affect our cost of capital and net investment income.
 
We leverage our investments with borrowed money and plan to continue doing so to the extent that we make new investments. As a result, our net investment income depends, in part, upon the difference between the rate at which we borrow funds and the rate at which we invest those funds. While we have a significant percentage of floating rate assets to match our floating rate liabilities, we can offer no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income in the event we use debt to finance our investments.

Changes relating to the LIBOR calculation process may adversely affect the value of the LIBOR-indexed, floating rate debt securities in our portfolio and adversely affect our debt financing, which could have an adverse effect on our business, financial condition and results of operations.

In July 2017, the U.K. Financial Conduct Authority announced that it intends to phase out the use of LIBOR by the end of 2021. On November 30, 2020, the ICE Benchmark Administration Limited, or the "IBA," the administrator of LIBOR, announced that it would consult in early December 2020 to consider extending the LIBOR transition deadline to the end of June 2023. Following consultations in December 2020 and January 2021, the IBA announced that (i) it intends to cease publication of 1-week and 2-month U.S. dollar LIBOR at the end of 2021 and (ii) subject to compliance with applicable regulations, it intends to continue publication of the remaining U.S. dollar LIBOR tenors until June 30, 2023, effectively extending the LIBOR transition period to June 30, 2023. There is currently no definitive information regarding the future utilization of LIBOR or of any particular replacement rate. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, has identified the Secured Overnight Financing Rate, or "SOFR," as its preferred alternative rate for LIBOR. SOFR is a new index calculated by short term repurchase agreements, backed by Treasury securities and is based on directly observable U.S. Treasury-backed repurchase transactions. Other jurisdictions have also proposed their own alternative to LIBOR, including the Sterling Overnight Index Average for Sterling markets, the EURO Short Term Rate for Euros and Tokyo Overnight Average Rate for Japanese Yens. Although SOFR appears to be the preferred replacement rate for U.S. dollar LIBOR, at this time, it is not possible to predict whether or not SOFR will attain market traction as a LIBOR replacement or the effect of any such changes as the establishment of alternative reference rates or other reforms to LIBOR may be enacted in the United States, United Kingdom or elsewhere. As such, the potential effect of SOFR and LIBOR on our net investment income cannot yet be determined, and the future of LIBOR at this time is uncertain.

The expected discontinuation of LIBOR could have a significant impact on our business. We typically use LIBOR as a reference rate in loans we extend to portfolio companies such that the interest due to us pursuant to a loan extended to a portfolio company is calculated using LIBOR. As of December 31, 2020, we had a total of $30.7 million principal balance, or 36.6% of the principal balance of our debt investment portfolio, in such LIBOR-linked debt investments whose maturity dates extend past December 31, 2021. If LIBOR ceases to exist, we may need to renegotiate these debt investments extending beyond 2021 to replace LIBOR with the new standard that is established in its place or another pricing method, which could have an adverse effect on our ability to receive attractive returns. To date, certain of the loan agreements with our portfolio companies have already been amended to include fallback language providing a mechanism for the parties to negotiate a new reference interest rate in the event that LIBOR ceases to exist. In addition, borrowings under our Credit Facility, which is currently set to mature on October 30, 2021, bear interest at LIBOR plus a margin rate. As a result, if we are able to extend our Credit Facility
33


beyond 2021, we may need to renegotiate the interest-rate provisions in the Credit Facility to replace LIBOR with the new standard that is established in its place or another pricing method.

Alteration of the terms of a debt instrument or a modification of the terms of other types of contracts to replace an interbank offered rate with a new reference rate could result in a taxable exchange and the realization of income and gain/loss for U.S. federal income tax purposes. The IRS has issued proposed regulations regarding the tax consequences of the transition from interbank offered rates to new reference rates in debt instruments and non-debt contracts. Under the proposed regulations, to avoid such alteration or modifications of the terms of a debt instrument being treated as a taxable exchange, among other requirements, the fair market value of the modified instrument or contract must be substantially equivalent to its fair market value before the qualifying change was made. The IRS may withdraw, amend or finalize, in whole or part, these proposed regulations and/or provide additional guidance, with potential retroactive effect. Beyond these challenges, we anticipate there may be additional risks to our current processes and information systems that will need to be identified and evaluated by us.

Given the current uncertainties over LIBOR’s discontinuation and the replacement alternatives, it is not possible at this time to predict the effect of any such changes, any establishment of alternative reference rates, or any other reforms to LIBOR that may be enacted in the United Kingdom or elsewhere, including any impact on our LIBOR-linked debt investments that mature after December 31, 2021. In addition, any further changes or reforms to the determination or supervision of LIBOR may result in a sudden or prolonged increase or decrease in reported LIBOR, which could have an adverse impact on the market value for or value of any LIBOR-linked securities, loans, and other financial obligations or extensions of credit held by or due to us and could have a material adverse effect on our business, financial condition and results of operations.

Provisions of the Delaware General Corporation Law and our certificate of incorporation and bylaws could deter takeover attempts and have an adverse impact on the price of our common stock.
 
The Delaware General Corporation Law (the "DGCL") and our certificate of incorporation and bylaws contain provisions that may have the effect of discouraging, delaying or making difficult a change in control of our company or the removal of our incumbent directors. The existence of these provisions, among others, may have a negative impact on the price of our common stock and may discourage third-party bids for ownership of our company. These provisions may prevent any premiums being offered to holders of our common stock.

We are subject to Section 203 of the DGCL, the application of which is subject to any applicable requirements of the 1940 Act. This section generally prohibits us from engaging in mergers and other business combinations with stockholders that beneficially own 15% or more of our voting stock, or with their affiliates, unless our directors or stockholders approve the business combination in the prescribed manner. If our board of directors does not approve a business combination, Section 203 of the DGCL may discourage third parties from trying to acquire control of us and increase the difficulty of consummating such an offer.

We have also adopted measures that may make it difficult for a third party to obtain control of us, including provisions of our certificate of incorporation classifying our board of directors in three classes serving staggered three-year terms, and provisions of our certificate of incorporation authorizing our board of directors to classify or reclassify shares of our preferred stock in one or more classes or series, and to cause the issuance of additional shares of our stock. These provisions, as well as other provisions of our certificate of incorporation and bylaws, may delay, defer or prevent a transaction or a change in control that might otherwise be in the best interests of our security holders.
 
The investment advisory and management agreement and the administration agreement with our investment adviser were not negotiated on an arm’s length basis and may not be as favorable to us as if they had been negotiated with an unaffiliated third party.
 
The investment advisory and management agreement with our investment adviser and the administration agreement with our administrator were negotiated between related parties. Joseph A. Jolson, our Chief Executive Officer and the Chairman of our board of directors, is also the Chief Executive Officer and chairman of the board of directors of JMP Group, which owns, directly or indirectly, a majority interest in HCAP Advisors (both the Company's investment adviser and administrator). Consequently, the terms of these agreements, including fees payable to our investment adviser, may not be as favorable to us as if they had been negotiated with an unaffiliated third party. In addition, we may choose not to enforce, or to enforce less vigorously, our rights and remedies under these agreements because of our desire to maintain our ongoing relationship with JMP Group and its respective affiliates.
34


 Our board of directors may change our investment objective, operating policies and strategies without prior notice or stockholder approval.
 
Our board of directors has the authority, except as provided otherwise under the 1940 Act, to modify or waive certain of our operating policies and strategies without prior notice and without stockholder approval. However, absent stockholder approval, we may not change the nature of our business so as to cease to be, or withdraw our election as, a BDC. Under Delaware law, we also cannot be dissolved without prior stockholder approval. We cannot predict the effect any changes to our current operating policies and strategies would have on our business, operating results and value of our securities. Nevertheless, the changes may adversely affect our business and affect our ability to make distributions.
 
The involvement of our investment adviser’s investment professionals in our valuation process may create conflicts of interest.
 
Our portfolio investments are generally not in publicly traded securities. As a result, the values of these securities are not readily available, and we value these securities at fair value as determined in good faith by our board of directors. In connection with that determination, and in addition to valuations prepared by the independent third party valuation firm that we employ, investment professionals from our investment adviser prepare portfolio company valuations based upon the most recent portfolio company financial statements available and projected financial results of each portfolio company. The participation of our investment adviser’s investment professionals in our valuation process could result in a conflict of interest as our investment adviser’s management fee is based on our gross assets.
 
Our investment adviser has the right to 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 financial condition, business and results of operations.
 
HCAP Advisors has the right, under the investment advisory and management agreement, to resign at any time upon not less than 60 days’ written notice, whether we have found a replacement or not. If our investment adviser resigns, we may not be able to find a new investment adviser 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 quickly, our operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions are likely to 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 investment adviser and its affiliates. Even if we are able to retain comparable management, whether internal or external, the integration of such management and their lack of familiarity with our investment objective may result in additional costs and time delays that may adversely affect our financial condition, business and results of operations.

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.
 
We may not acquire 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. See “Business--Regulation as a BDC.”
 
We believe that most of the senior debt and subordinated debt investments that we intend to target should constitute qualifying assets. However, we may be precluded from investing in what we believe are attractive investments if such investments are not qualifying assets for purposes of the 1940 Act. Similarly, these rules could prevent us from making follow-on investments in existing portfolio companies (which could result in the dilution of our position).
 
A failure on our part to maintain our qualification as a BDC would significantly reduce our operating flexibility.
 
If we fail to continuously qualify as a BDC, we might be subject to regulation as a registered closed-end investment company under the 1940 Act, which would significantly decrease our operating flexibility. In addition, failure to comply with the requirements imposed on BDCs by the 1940 Act could cause the SEC to bring an enforcement action against us. For additional information on the qualification requirements of a BDC, see the disclosure under the caption “Business--Regulation as a BDC.”
 

35


We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income.
 
As a RIC, we will be required to distribute annually at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses to maintain our eligibility for RIC tax treatment. For U.S. federal income tax purposes, we will include in taxable income certain amounts that we have not yet received in cash, such as contracted PIK interest, which represents contractual interest added to the loan balance and due at the end of the loan term. The increases in loan balances as a result of contracted PIK arrangements will be included in income in advance of receiving cash payment, and will be separately identified on our consolidated statements of cash flows. We also may be required to include in income certain other amounts that we will not receive in cash.
 
Any warrants that we receive in connection with our debt investments will generally be valued as part of the negotiation process with the particular portfolio company. As a result, a portion of the aggregate purchase price for the debt investments and warrants will be allocated to the warrants that we receive. This will generally result in our debt instruments having OID for tax purposes, which we must recognize as ordinary income as such OID accrues regardless of whether we have received any corresponding payment of such interest. Other features of debt instruments that we hold may also cause such instruments to generate OID.
 
Since in certain cases we may recognize income before or without receiving cash representing such income, we may have difficulty meeting the requirement to distribute at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses to maintain our eligibility for RIC tax treatment. Accordingly, we may have to sell some of our assets, raise additional debt or equity capital, incur additional indebtedness or reduce new investment originations to meet these distribution requirements. If we are unable to obtain cash from other sources to satisfy such distribution requirements, we may fail to qualify for RIC tax treatment and thus may become subject to corporate-level income tax.
 
We will be subject to corporate-level income tax and may default under our Credit Facility if we are unable to satisfy certain RIC qualification requirements under Subchapter M of the Code or do not satisfy the annual distribution requirement.
 
In order to satisfy the requirements for RIC tax treatment, we must meet the following annual distribution, income source and asset diversification requirements to be relieved of federal taxes on income and gains distributed to our stockholders.

The Annual Distribution Requirement for a RIC will be satisfied if we distribute to our stockholders on an annual basis 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. Because we use debt financing, we are, and may in the future be, subject to certain financial covenants under our debt arrangements and the 1940 Act that could, under certain circumstances, restrict us from making distributions necessary to satisfy the Annual Distribution Requirement. If we are unable to obtain cash from other sources, we could fail to qualify for RIC tax treatment and thus could become subject to corporate-level income tax.

The income source requirement will be satisfied if we obtain at least 90% of our income for each year from dividends, interest, gains from the sale of stock or securities or similar sources.

The asset diversification requirement will be satisfied if we meet certain asset diversification requirements at the end of each quarter of our taxable year. To satisfy this requirement, at least 50% of the value of our assets must consist of cash, cash equivalents, U.S. government securities, securities of other RICs, and other acceptable securities; and no more than 25% of the value of our assets can be invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships.” Failure to meet these requirements may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because most of our investments will be in private companies, and therefore will be relatively illiquid, any such dispositions could be made at disadvantageous prices and could result in substantial losses.
 
If we fail to satisfy certain RIC qualification requirements under Subchapter M of the Code or to meet the Annual Distribution Requirement for any reason and are subject to corporate income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution and the amount of our distributions.
36


Furthermore, if we fail to maintain our qualification as a RIC, we may be in default under the terms of the Credit Facility. Such a failure would have a material adverse effect on us and our stockholders.
HCAP Equity Holdings, LLC, one of our wholly-owned taxable subsidiaries, has elected to be taxed as a C-Corporation, and future wholly-owned tax subsidiaries may elect to be taxed as C-Corporations, and may incur federal income tax expense.

One of our wholly-owned taxable subsidiaries, HCAP Equity Holdings, LLC, holds certain portfolio investments that are listed on our Consolidated Schedule of Investments. HCAP Equity Holdings, LLC is consolidated for financial reporting purposes. The purpose of HCAP Equity Holdings, LLC is to permit us to hold certain portfolio companies that are organized as limited liability companies, or “LLCs” (or other forms of pass-through entities), and still satisfy the RIC tax requirement that at least 90% of the RIC's gross revenue for income tax purposes must consist of qualifying investment income. Absent such a taxable subsidiary, a proportionate amount of any gross income of an LLC (or other pass-through entity) portfolio investment would flow through directly to the Company. To the extent that such income did not consist of qualifying investment income, it could jeopardize our ability to qualify as a RIC and therefore cause us to incur significant amounts of federal income taxes. When LLCs (or other pass-through entities) are owned by a taxable subsidiary, their income is taxed to the taxable subsidiary and does not flow through to the RIC, thereby helping us preserve our RIC status and resultant tax advantages. However, HCAP Equity Holdings, LLC is not consolidated for income tax purposes and may generate tax expense as a result of any ownership of portfolio companies. We intend to implement tax strategies to minimize the risk of HCAP Equity Holdings, LLC from incurring corporate-level U.S. federal income taxes; however there can be no such guarantee that we will be successful in implementing such strategies.

We will continue to need additional capital to finance our growth because we intend to distribute substantially all of our income to our stockholders to maintain our qualification as a RIC. If additional funds are unavailable or are not available on favorable terms, our ability to grow will be impaired.
 
In order to satisfy the requirements applicable to a RIC, we intend to distribute to our stockholders at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses. As a BDC, we are generally required to meet a coverage ratio of total assets to total senior securities, which include all of our borrowings and any preferred stock that we may issue in the future. Currently the asset coverage ratio applicable to us under the 1940 Act is 150%. This requirement will limit the amount that we may borrow. 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. In addition, as a BDC, we generally are not permitted to issue common stock priced below net asset value without stockholder and independent director approval. However, if we were to obtain the necessary approvals to issue securities at prices below net asset value, our stockholders’ investments would experience dilution as a result of such issuance. If additional funds are not available to us, we could be forced to curtail or cease our lending and investment activities, and our net asset value could decrease.

Our operations and infrastructure are dependent on information systems, and systems failures could significantly disrupt our business, which may, in turn, negatively affect our liquidity, financial condition or results of operations.

Our business is dependent on our and third parties' communications and information systems. Any failure or interruption of those systems, including as a result of the termination of an agreement with any third-party service providers, could cause delays or other problems in our activities. Our financial, accounting, data processing, backup or other operating systems and facilities may fail to operate properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control and adversely affect our business. There could be:

sudden electrical or telecommunications outages;
natural disasters such as earthquakes, tornadoes and hurricanes;
disease pandemics;
events arising from local or larger scale political or social matters, including terrorist acts; and
cyber-attacks.

These events, in turn, could have a material adverse effect on our operating results and negatively affect the market price of our common stock and our ability to pay dividends to our stockholders.

We have outsourced our technology, administrative and operational infrastructure, including data centers, disaster recovery systems and wide area networks to our investment adviser and third party-service providers. We are dependent on our service providers to manage and monitor those functions. A disruption of any of the outsourced services would be out of our
37


control and could negatively impact our business. We have yet to experience any form of disruption. However, there can be no guarantee that future disruptions will not occur, and any that may occur could be severe in nature.
Our operations also rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Although cybersecurity incidents among financial services firms are on the rise, to date, we have not experienced any material losses relating to cyber-attacks or other information security breaches; however, there can be no assurance that we will not suffer such losses in the future. Notwithstanding that we take protective measures and endeavor to modify them as circumstances warrant, our computer systems, software and networks may be vulnerable to human error, natural disasters, power loss, spam attacks, unauthorized access, distributed denial of service attacks, computer viruses and other malicious code, and other events that could have a security impact. Breaches of our network security systems could involve attacks that are intended to obtain unauthorized access to our proprietary information, destroy data or disable, degrade or sabotage our systems, often through the introduction of computer viruses and other means, and could originate from a wide variety of sources, including unknown third parties outside the firm. Although we take various measures to ensure the integrity of our systems, there can be no assurance that these measures will provide protection. A cybersecurity incident affecting our computer systems, software and networks, or that of third-party vendors and clients, could subject us to significant liability and harm our reputation. If one or more of such events occur, this could jeopardize our or our portfolio companies' or counterparties’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks or otherwise cause interruptions or malfunctions in our, our portfolio companies', our counterparties’ or third parties’ operations. We may be required to expend significant additional resources to modify our protective measures, to investigate and remediate vulnerabilities or other exposures, or to make required notifications, and we may be subject to litigation and financial losses that are either not insured or not fully covered through any insurance we maintain. A technological breakdown could also interfere with our ability to comply with financial reporting and other regulatory requirements, exposing us to potential disciplinary action by regulators. If our systems are compromised, do not operate properly or are disabled, we could suffer a disruption of our business, financial losses, liability to clients, regulatory sanctions and damage to our reputation.

We may expose ourselves to risks if we engage in hedging transactions.
 
If we engage in hedging transactions, we may expose ourselves to risks associated with such transactions. We may utilize instruments such as forward contracts, currency options and interest rate swaps, caps, collars and floors to seek to hedge against fluctuations in the relative values of our portfolio positions from changes in currency exchange rates and market interest rates. Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. However, such hedging can establish other positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the underlying portfolio positions should increase. Moreover, it may not be possible to hedge against an exchange rate or interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price.
 
The success of our hedging transactions will depend on our ability to correctly predict movements in currencies and interest rates. Therefore, while we may enter into such transactions to seek to reduce currency exchange rate and interest rate risks, unanticipated changes in currency exchange rates or interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss. In addition, it may not be possible to hedge fully or perfectly against currency fluctuations affecting the value of securities denominated in non-U.S. currencies because the value of those securities is likely to fluctuate as a result of factors not related to currency fluctuations.
  
Risks Relating to the Mergers

The pendency of the proposed Mergers could adversely affect our business, financial results and operations.

The pendency of the proposed Mergers could cause disruptions in and create uncertainty surrounding our business, including affecting our relationships with our existing and future borrowers and lenders, which could have a significant negative impact on our future revenues and results of operations, regardless of whether the Mergers are completed. In particular, HCAP Advisors or its affiliates could potentially lose important personnel as a result of the departure of employees who decide to pursue other opportunities in light of the proposed transaction, existing borrowers may elect to refinance their loans from us and our affiliates with other lenders, and existing and potential future lenders may be unable or unwilling to fund their commitments to us or otherwise extend credit to us. In addition, we have diverted, and will continue to divert, significant
38


management resources towards the completion of the Mergers, which could have a significant negative impact on our future revenues and results of operations.

We are also subject to restrictions on the conduct of our business prior to the completion of the Mergers as provided in the Merger Agreement, generally requiring us to conduct our business only in the ordinary course and subject to specific limitations, including, among other things, certain restrictions on our ability to make certain investments and acquisitions, sell, transfer or dispose of our assets, amend our organizational documents and enter into or modify certain material contracts. These restrictions could prevent us from pursuing otherwise attractive business opportunities, industry developments and future opportunities and may otherwise have a significant negative impact on our future investment income and results of operations.

Our stockholders will experience a reduction in percentage ownership and voting power in the combined company as a result of the Mergers.

Our stockholders will experience a substantial reduction in their percentage ownership interests and effective voting power in respect of the combined company relative to their percentage ownership interests in the Company prior to the Mergers. Consequently, our stockholders should expect to exercise less influence over the management and policies of the combined company following the Mergers than they currently exercise over the management and policies of the Company.

If the Mergers do not close, we will not benefit from the expenses incurred in pursuit of the Mergers and, under certain circumstances, we will be required to pay half of PTMN’s expenses incurred in connection with the Mergers, subject to a maximum reimbursement payment of $500,000.

The Mergers may not be completed. If the Mergers are not completed, we will have incurred substantial expenses for which no ultimate benefit will have been received. We have incurred out-of-pocket expenses in connection with the Mergers for investment banking, legal and accounting fees and financial printing and other related charges, much of which will be incurred even if the Mergers are not completed. In addition, under certain circumstances, we will be required to pay half of PTMN’s expenses incurred in connection with the Mergers, subject to a maximum reimbursement payment of $500,000.

The termination of the Merger Agreement could negatively impact us.

If the Merger Agreement is terminated, there may be various consequences, including:

our business may have been adversely impacted by the failure to pursue other beneficial opportunities due to the focus of management on the Mergers, without realizing any of the anticipated benefits of completing the Mergers;

we may have difficulty maintaining our RIC tax status if we do not find a replacement financing source for the Credit Facility given our current need to make quarterly borrowings under the Credit Facility to satisfy our RIC diversification requirements;

the market prices of our common stock might decline to the extent that the market price prior to termination reflects a market assumption that the Mergers will be completed;

we may not be able to find a party willing to pay an equivalent or more attractive price than the price PTMN agreed to pay in the Mergers; and

the payment of a $2.1 million termination fee or the reimbursement of up to $500,000 of PTMN's expenses, as required by the Merger Agreement and if required under the circumstances, could adversely affect our financial condition and liquidity.

The Mergers are subject to closing conditions, including the requisite approval of our stockholders, that, if not satisfied or waived, will result in the Mergers not being completed, which may result in material adverse consequences to our business and operations.

The Mergers are subject to closing conditions, including the requisite approval of our stockholders, that, if not satisfied, will prevent the Mergers from being completed. The closing condition that our stockholders approve the Mergers and the Merger Agreement may not be waived and must be satisfied for the Mergers to be completed. If our stockholders do not approve the Mergers and the Merger Agreement and the Mergers are not completed, the resulting failure to complete the Mergers could have a material adverse impact on our business and operations.
39


We will be subject to operational uncertainties and contractual restrictions while the Mergers are pending, including restrictions on pursuing alternatives to the Mergers.

Uncertainty about the effect of the Mergers may have an adverse effect on us and, consequently, on the combined company following completion of the Mergers. These uncertainties may impair HCAP Advisors’ abilities to motivate key personnel until the Mergers are consummated and could cause those who deal with the Company to seek to change their existing business relationships with us. In addition, the Merger Agreement restricts us from taking actions that we might otherwise consider to be in the best interests of the Company and our stockholders. These restrictions may prevent us from pursuing certain business opportunities that may arise prior to the completion of the Mergers, including restrictions on them pursuing alternatives to the Mergers.

The Merger Agreement contains provisions that could discourage or make it difficult for a third party to acquire us prior to the completion of the proposed Mergers.

The Merger Agreement prohibits us from soliciting alternatives to the Mergers and imposes limitations on our ability to respond to and negotiate unsolicited proposals received from third parties. The Merger Agreement contains customary non-solicitation and other provisions that, subject to limited exceptions, limit our ability to discuss, facilitate or commit to competing third-party proposals to acquire all or a significant part of the Company. We can consider and participate in discussions and negotiations with respect to an alternative proposal only in limited circumstances so long as certain notice and other procedural requirements are satisfied. In addition, subject to certain procedural requirements (including the ability of PTMN to revise its offer) and the payment of an approximately $2.1 million termination fee, we may terminate the Merger Agreement and enter into an agreement with a third party that makes a superior proposal. These provisions may discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of the Company from considering or proposing that acquisition even if it were prepared to pay consideration with a higher per share market price than that proposed in connection with the Mergers.

If the Mergers are not completed or we are not otherwise acquired, we may consider other strategic alternatives, which are subject to risks and uncertainties.

If the Mergers are not completed, the HCAP Special Committee and the Board may review and consider various alternatives available to us, including, among others, continuing as a standalone public company with no material changes to our business, seeking an alternate transaction or the liquidation and dissolution of the Company. These strategic or other alternatives available to us may involve various additional risks to our business, including, among others, distraction of our management team and associated expenses as described above in connection with the proposed Mergers, and risks and uncertainties related to our ability to complete any such alternatives and other variables which may adversely affect our operations.

Risks Relating to Economic Conditions
 
The capital markets may experience periods of disruption and instability or an economic recession. Such market conditions have historically affected and could again materially and adversely affect debt and equity capital markets in the United States and around the world, which could impair our portfolio companies and have a materially negative impact on our business, financial condition and results of operations.
The U.S. and global capital markets have, from time to time, experienced periods of disruption characterized by the freezing of available credit, a lack of liquidity in the debt capital markets, significant losses in the principal value of investments, the re-pricing of credit risk in the broadly syndicated credit market, the failure of major financial institutions and general volatility in the financial markets. During these periods of disruption, general economic conditions deteriorated with material adverse consequences for the broader financial and credit markets, and the availability of debt and equity capital for the market as a whole, and financial services firms in particular, was reduced significantly. These conditions may reoccur for a prolonged period of time or materially worsen in the future as a result of various events, including but not limited to potential trade wars between sovereign nations, the impact of public health pandemics, and the effect of geopolitical events such as the United Kingdom's withdrawal from the European Union. We may in the future have difficulty accessing debt and equity capital markets, and a severe disruption in the global financial markets and other global economic conditions could have a material adverse effect on our business, financial condition and results of operations.

Market conditions may in the future make it difficult to extend the maturity of or refinance our existing indebtedness and any failure to do so could have a material adverse effect on our business. The illiquidity of our investments may make it
40


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

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

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

Events outside of our control, including public health crises, may negatively affect our portfolio companies and the results of our operations.

Periods of market volatility have occurred and could continue to occur in response to pandemics or other events outside of our control. These types of events have adversely affected, and could continue to adversely affect, operating results for us and for our portfolio companies. For example, the COVID-19 pandemic has led to, and for an unknown period of time will continue to lead to, disruptions in local, regional, national and global markets and economies affected thereby, including the United States. With respect to U.S. and global credit markets and the economy in general, this outbreak has resulted in, and until fully resolved is likely to continue to result in, the following (among other things): (i) restrictions on travel and the temporary closure of many corporate offices, retail stores, and manufacturing facilities and factories, resulting in significant disruption to the business of many companies, including supply chains and demand, as well as layoffs of employees; (ii) increased draws by borrowers on revolving lines of credit; (iii) increased requests by borrowers for amendments or waivers of their credit agreements to avoid default, increased defaults by borrowers and/or increased difficulty in obtaining refinancing; (iv) volatility in credit markets, including greater volatility in pricing and spreads; and (v) rapidly evolving proposals and actions by state and federal governments to address the problems being experienced by markets, businesses and the economy in general, which may not adequately address the problems being faced. The pandemic is having, and any future continuation of the pandemic could have, an adverse impact on the markets and the economy in general. While certain state and local governments across the United States have taken steps to re-open their economies by lifting "stay at home" orders and re-opening businesses, a number of states and local governments have needed to pause or slow the re-opening or impose new shutdown orders due to a resurgence of COVID-19 cases and the emergence of more contagious strains of the virus. Even as the world begins to recover from the COVID-19 pandemic, many major economies, including the U.S. economy, may continue to experience a period of recession.

Although it is impossible to predict the precise nature and consequences of these events, or of any political or policy decisions and regulatory changes occasioned by emerging events or uncertainty on applicable laws or regulations that impact us and our portfolio companies and investments, it is clear that these types of events are impacting and will, for at least some time, continue to impact us and our portfolio companies; in certain instances the impact will be adverse. Any potential impact to our results of operations will depend to a large extent on future developments and new information that could emerge regarding the duration and severity of the COVID-19 pandemic and the actions taken by authorities and other entities to contain the spread or treat its impact, all of which are beyond our control. These potential impacts, while uncertain, could adversely affect our and our portfolio companies’ operating results and financial condition.

41


We are currently operating in a period of capital markets disruption and economic uncertainty, which could limit our access to capital and result in a decision by lenders, including existing lenders, not to extend credit to us or decline to renew, extend or expand existing credit facilities.

The U.S. capital markets have experienced extreme volatility and disruption following the global outbreak of COVID-19 that began in December 2019. Some economists and major investment banks have expressed concern that the continued spread of the virus globally could lead to a world-wide economic downturn. Disruptions in the capital markets have increased the spread between the yields realized on risk-free and higher risk securities, resulting in illiquidity in parts of the capital markets. These and future market disruptions and/or illiquidity would be expected to have an adverse effect on our business, financial condition, results of operations and cash flows. Unfavorable economic conditions also would be expected to increase our funding costs and may limit our access to the capital markets or result in a decision by lenders, including existing lenders, not to extend credit to us or decline to renew, extend or expand existing credit facilities. These events have limited and could continue to limit our investment originations, limit our ability to grow and have a material negative impact on our operating results, financial condition and the fair values of our investments.

If the current period of capital markets disruption and instability continues for an extended period of time, there is a risk that investors in our equity securities may not receive distributions consistent with historical levels or at all or that our distributions may not grow over time and a portion of our distributions may be a return of capital.

Although we have historically paid distributions on a monthly basis to our stockholders, 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 going forward. Our ability to pay distributions has been, and may continue to be, adversely affected by the impact of one or more of the risk factors described in this annual report on Form 10-K, including the COVID-19 pandemic described above and contractual obligations under our borrowing arrangements, including under the Credit Facility.

If we are unable to satisfy the asset coverage test applicable to us under the 1940 Act as a BDC or if we violate certain covenants under our existing or future credit facilities or other borrowing arrangements, we may be limited in our ability to make distributions in the future. If we declare a distribution and if more stockholders opt to receive cash distributions rather than participate in our dividend reinvestment plan, we may be forced to sell some of our investments in order to make cash distribution payments. To the extent we make distributions to stockholders that include a return of capital, such portion of the distribution essentially constitutes a return of the stockholder’s investment. Although such return of capital may not be taxable, such distributions would generally decrease a stockholder’s basis in our common stock and may therefore increase such stockholder’s tax liability for capital gains upon the future sale of such stock. A return of capital distribution may cause a stockholder to recognize a capital gain from the sale of our common stock even if the stockholder sells its shares for less than the original purchase price.

Risks Relating to Our Investments
 
We operate in a highly competitive market for investment opportunities.
 
We face competition from entities that also make the types of investments that we plan to make. We compete with public and private funds (including other BDCs), commercial and investment banks, commercial financing companies and, to the extent they provide an alternative form of financing, private equity funds. Many of our potential competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments than we do, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us. We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we can offer no assurance that we will be able to continue to identify and make investments that are consistent with our investment objective.
 
We do not seek to compete primarily based on the interest rates we offer, and we believe that some of our competitors may make loans with interest rates that are comparable to or lower than the rates we offer. We may lose investment opportunities if we do not match our competitors’ pricing, terms and structure. However, if we match our competitors’ pricing, terms and structure, we may experience decreased net interest income and increased risk of credit loss.
 
42


Our investments may be risky, and we could lose all or part of our principal.
 
Our portfolio consists primarily of directly originated investments in senior debt and subordinated debt of small to mid-size companies. In addition, we may make non-control, equity co-investments in these companies in conjunction with our debt investments.
 
Senior debt investments. We generally invest in senior debt of small and mid-sized companies. Senior debt investments are typically secured by the assets of the portfolio company, including a pledge of the capital stock of the portfolio company’s subsidiaries, and are senior to all other junior capital in terms of payment priority. There is, however, a risk that the collateral securing these loans may decrease in value over time, may be difficult to sell in a timely manner, may be difficult to appraise and may fluctuate in value based upon the success of the portfolio company and market conditions, including as a result of the 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 in a portfolio company’s financial condition and prospects, including its inability to raise additional capital, may be accompanied by deterioration in the value of the collateral for the loan. Consequently, the fact that a loan is secured does not guarantee that we will receive principal and interest payments according to the loan’s terms, or at all, or that we will be able to collect on the loan should we be forced to enforce our remedies.

Subordinated debt investments. We also structure our debt investments as subordinated debt with a security interest that ranks junior to a company’s secured debt in priority of payment, but senior to a company’s preferred or common stock. As such, other creditors will rank senior to us in the event of insolvency, which may result in an above average amount of risk and loss of principal.
 
Equity investments. When we invest in senior debt or subordinated debt, we may acquire equity securities as well. In addition, we may invest directly in the equity securities of portfolio companies. Our goal is ultimately to dispose of such equity interests and realize gains upon our disposition of such interests. Accordingly, we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not be sufficient to offset any other losses we experience, or opportunity costs had we instead invested in income-producing securities.

The lack of liquidity in our investments may adversely affect our business.

We generally make investments in private companies. Substantially all of these securities are subject to legal and other restrictions on resale or are otherwise less liquid than publicly traded securities. The illiquidity of our investments may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded our investments. In addition, we may face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we or our investment adviser has material non-public information regarding such portfolio company.
 
Our failure to make follow-on investments in our portfolio companies could impair our investment in a portfolio company.
 
Following an initial investment in a portfolio company, we may make additional investments in that portfolio company as “follow-on” investments, in order to:

increase or maintain in whole or in part our equity ownership percentage in a portfolio company;
exercise warrants, options or convertible securities that were acquired in the original or subsequent financing; or
attempt to preserve or enhance the value of our investment.

We may elect not to make follow-on investments, be prohibited from making any such follow-on investment due to contractual obligations under our borrowing arrangements, or otherwise lack sufficient funds to make those investments. We will have the discretion to make any follow-on investments, subject to any applicable legal requirements, including the RIC diversification requirements, and the availability of capital resources. The failure to make follow-on investments may, in some circumstances, jeopardize the continued viability of a portfolio company and our initial investment, or may result in a missed opportunity for us to increase our participation in a successful operation. Even if we have sufficient capital to make a desired follow-on investment, we may elect not to make a follow-on investment because we may not want to increase our concentration or level of risk, either because we prefer other opportunities or because we are inhibited by compliance with BDC requirements or the desire to maintain our RIC tax status.
  
43


Because we generally do not hold controlling equity interests in our portfolio companies, we may not be in a position to exercise control over our portfolio companies or to prevent decisions by the management of our portfolio companies that could decrease the value of our investments.
 
Although we may do so in the future, we generally do not take controlling equity positions in our portfolio companies. As a result, we will be subject to the risk that a portfolio company may make business decisions with which we disagree, and that the management and/or stockholders of a portfolio company may take risks or otherwise act in ways that are adverse to our interests. Due to the lack of liquidity of the debt and equity investments that we will 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 may therefore suffer a decrease in the value of our investments.
 
Prepayments of our debt investments by our portfolio companies could adversely impact our results of operations and ability to make stockholder distributions and result in a decline in the market price of our shares.
 
We are subject to the risk that the debt investments we make in our portfolio companies may be repaid prior to maturity. We expect that our investments will generally allow for repayment at any time subject to certain penalties. When this occurs, we may reinvest these proceeds in temporary investments, pending their future investment in accordance with our investment strategy. These temporary investments will typically have substantially lower yields than the debt being prepaid, and we could experience significant delays in reinvesting these amounts. Any future investment 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 ability to make, or the amount of, stockholder distributions with respect to our common stock, which could result in a decline in the market price of our shares.
 
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 invest primarily in privately held companies. Generally, little public information exists about these companies, and we will be required to rely on the ability of our investment adviser’s investment professionals to obtain adequate information to evaluate the potential returns from investing in these companies. If we are unable to uncover all material information about these companies, we may not make a fully informed investment decision, and we may lose money on our investments. Also, privately held companies frequently have less diverse product lines and smaller market presence than larger competitors. These factors could adversely affect our investment returns as compared to companies investing primarily in the securities of public companies.
 
Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such companies.
 
We invest primarily in senior debt, subordinated debt and equity securities issued by our portfolio companies. Some of our portfolio companies have, or may be permitted to incur, other debt that ranks equally with, or senior to, the debt securities in which we invest. By their terms, such debt instruments may provide that the holders are entitled to receive payment of interest or principal on or before the dates on which we are entitled to receive payments. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying such senior creditors, such portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with debt securities in which we invest, we would have to share on an equal basis any distributions with other creditors holding such debt in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.
 
There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to lender liability claims.
 
Even though we may have structured certain of our investments as senior debt, if one of our portfolio companies were to go bankrupt, depending on the facts and circumstances and based upon principles of equitable subordination as defined by existing case law, a bankruptcy court could subordinate all or a portion of our claim to that of other creditors and transfer any lien securing such subordinated claim to the bankruptcy estate. The principles of equitable subordination defined by case law have generally indicated that a claim may be subordinated only if its holder is guilty of misconduct or where the senior loan is
44


re-characterized as an equity investment and the senior lender has actually provided significant managerial assistance to the bankrupt debtor. We may also be subject to lender liability claims for actions taken by us with respect to a borrower’s business or instances where we exercise control over the borrower. It is possible that we could become subject to a lender's liability claim, including as a result of actions taken in rendering significant managerial assistance or actions to compel and collect payments from the borrower outside the ordinary course of business.
 
Second priority liens on collateral securing loans that we make to our portfolio companies may be subject to control by senior creditors with first priority liens. If there is a default, the value of the collateral may not be sufficient to repay in full both the first priority creditors and us.
 
Certain loans that we make to portfolio companies will be secured on a second priority basis by the same collateral securing senior secured debt of such companies. The first priority liens on the collateral will secure the portfolio company’s obligations under any outstanding senior debt and may secure certain other future debt that may be permitted to be incurred by the company under the agreements governing the loans. The holders of obligations secured by the first priority liens on the collateral will generally control the liquidation of and be entitled to receive proceeds from any realization of the collateral to repay their obligations in full before us. In addition, the value of the collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from the sale or sales of all of the collateral would be sufficient to satisfy the loan obligations secured by the second priority liens after payment in full of all obligations secured by the first priority liens on the collateral. If such proceeds are not sufficient to repay amounts outstanding under the loan obligations secured by the second priority liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, will only have an unsecured claim against the company’s remaining assets, if any.
  
The rights we may have with respect to the collateral securing the loans we make to our portfolio companies with senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of senior debt. Under such an intercreditor agreement, at any time that obligations that have the benefit of the first priority liens are outstanding, any of the following actions that may be taken in respect of the collateral will be at the direction of the holders of the obligations secured by the first priority liens: the ability to cause the commencement of enforcement proceedings against the collateral; the ability to control the conduct of such proceedings; the approval of amendments to collateral documents; releases of liens on the collateral; and waivers of past defaults under collateral documents. We may not have the ability to control or direct such actions, even if our rights are adversely affected.

Our portfolio is concentrated in a limited number of portfolio companies and industries, which will subject us to a risk of significant loss if any of these companies defaults on its obligations under any of its debt instruments or if there is a downturn in a particular industry.

Our portfolio is concentrated in a limited number of portfolio companies and industries. Although we will be subject to the asset diversification requirements associated with our qualification as a RIC under the Code and have adopted a guideline that we will generally refrain from investing more than 15% of our portfolio in any single industry sector (however, at times we may exceed this threshold due to the timing of exits of investments in our portfolio and the amount of the time it takes for us to reinvest the proceeds), our portfolio may be subject to concentration risk due to our investment in a limited number of portfolio companies. As a result, the aggregate returns we realize may be significantly adversely affected if a small number of investments perform poorly or if we need to write down the value of any one investment. Additionally, a downturn in any particular industry in which we are invested could also significantly impact the aggregate returns we realize. As of December 31, 2020, we had two portfolio companies on non-accrual status. These portfolio companies comprised approximately 12.9% of our debt portfolio at cost, which may be a higher percentage of the portfolio at cost than the BDC industry average. The continued failure by borrowers under these loans to pay interest and repay principal, and the failure by other borrowers to make such payments, could have a material adverse effect on our financial condition and results of operation and, consequently, our ability to meet our payment obligations under the Credit Facility and our 2022 Notes.

Any unrealized depreciation we experience on our investment 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 market value or, if no market value is ascertainable, at fair value as determined in good faith by or under the direction of our board of directors. We will record decreases in the market values or fair values of our investments as unrealized depreciation. Since our inception, we have, at times, incurred a cumulative net
45


unrealized depreciation of our portfolio. Any unrealized depreciation in our investment portfolio could result in realized losses in the future and ultimately in reductions of our income available for distribution to stockholders in future periods.

We may be subject to risks associated with "covenant-lite" loans.

Our investments in debt instruments may include “covenant-lite” loans. Covenants are contractual restrictions that lenders place on companies to limit the corporate actions a company may pursue. Generally, the loans in which we expect to invest will have financial maintenance covenants, which are used to proactively address materially adverse changes in a portfolio company’s financial performance. However, to a lesser extent, we may hold investments in “covenant-lite” loans. We use the term “covenant-lite” to refer generally to loans that do not have a complete set of financial maintenance covenants. Generally, “covenant-lite” loans provide borrower companies more freedom to negatively impact lenders because their covenants are incurrence-based, which means they are only tested and can only be breached following an affirmative action of the borrower, rather than by a deterioration in the borrower’s financial condition. Accordingly, to the extent that we invest in “covenant-lite” loans, we may have fewer rights against a borrower and may have a greater risk of loss on such investments as compared to investments in or exposure to loans with financial maintenance covenants.

Risks Relating to Our Securities and an Offering of Our Securities
 
We may be unable to invest a significant portion of the net proceeds from an offering of our securities, or from repayments by portfolio companies, on acceptable terms within an attractive time frame.
 
Delays in investing the net proceeds raised in an offering of our securities, or because of repayments, may cause our performance to be worse than that of other fully invested BDCs or other lenders or investors pursuing comparable investment strategies. We cannot assure you that we will be able to identify any investments that meet our investment objective or that any investment that we make will produce a positive return. We may be unable to invest the net proceeds of any offering, or proceeds from repayments, on acceptable terms within the time period that we anticipate or at all, which could harm our financial condition and operating results.
 
We anticipate that, depending on market conditions, it may take us a substantial period of time to invest substantially all of the net proceeds of any offering, or repayment, in securities meeting our investment objective. During this period, we will invest the net proceeds of an offering, or repayment, primarily in cash, cash equivalents, U.S. government and agency securities, repurchase agreements relating to such securities, and high-quality debt instruments maturing in one year or less from the time of investment, which may produce returns that are significantly lower than the returns which we expect to achieve when our portfolio is fully invested in securities meeting our investment objective. As a result, any distributions that we pay during this period may be substantially lower than the distributions that we may be able to pay when our portfolio is fully invested in securities meeting our investment objective. In addition, until such time as the net proceeds of an offering are invested in securities meeting our investment objective, the market price for our common stock may decline. Thus, the return on an investment in us may be lower than when, if ever, our portfolio is fully invested in securities meeting our investment objective.
 
We may allocate the net proceeds from an offering and other cash on hand in ways with which you may not agree.
 
We will have significant flexibility in investing the net proceeds of an offering and other cash on hand and may use such funds in ways with which you may not agree or for purposes other than those contemplated at the time of the offering. In addition, we can provide you with no assurance that by increasing the size of our available equity capital our expense ratio or debt ratio will be lowered.
 
Shares of closed-end investment companies, including BDCs, may trade at a discount to their net asset value.
 
Shares of closed-end investment companies, including BDCs, may trade at a discount to net asset value. This characteristic of closed-end investment companies and BDCs is separate and distinct from the risk that our net asset value per share may decline. We cannot predict whether our common stock will trade at, above or below net asset value. In addition, during times at which our common stock trades below net asset value, we will generally not be able to sell additional shares of our common stock to the public at its market price without first obtaining the approval of a majority of our stockholders (including a majority of our unaffiliated stockholders) and our independent directors for such issuance.
 

46


If our investments do not meet our performance expectations, our stockholders may not receive distributions or a portion of our distributions may be a return of capital.
 
Prior to 2020, we historically made distributions on a monthly basis to our stockholders; however, our board of directors previously determined to defer the record dates and payments of our March 2020 and April 2020 monthly dividends and suspend the declaration of any future dividends until such later time as the board of directors determines is prudent in light of our capital needs and contractual obligations, and in our stockholders' best interests. We ultimately paid the previously declared but deferred March 2020 and April 2020 monthly dividends in a single distribution of $0.16 per share on December 29, 2020, but did not declare or pay any other monthly dividends in 2020 after the declaration and payment of the March 2020 and April 2020 monthly dividends.

We may not be able to achieve operating results that will allow us to continue to make distributions at a specific level or to increase the amount of these distributions from time to time. Also, restrictions and provisions in our Credit Facility, any future credit facilities, and the indenture governing our 2022 Notes, as well as under the Merger Agreement, may limit our ability to make distributions in certain circumstances. If we do not distribute annually at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term losses, we will be subject to U.S. corporate-level federal income tax, which may reduce the amounts available for distribution. We cannot assure you that you will receive distributions at a particular level or at all.
  
When we make distributions, we will be required to determine the extent to which such distributions are paid out of current or accumulated earnings and profits. Distributions in excess of current and accumulated earnings and profits will be treated as a non-taxable return of capital to the extent of an investor’s basis in our stock and, assuming that an investor holds our stock as a capital asset, thereafter as a capital gain.
 
The market price of our common stock may fluctuate significantly.
 
The market price and liquidity of the market for our securities may be significantly affected by numerous factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include, but are not limited to, the following:

significant volatility in the market price and trading volume of securities of BDCs or other companies in our sector, which is not necessarily related to the operating performance of these companies;

changes in regulatory policies or tax guidelines, particularly with respect to RICs or BDCs;

failure to qualify or loss of our qualification, as applicable, as a RIC or BDC;

changes in earnings or variations in operating results;

changes in the value of our portfolio of investments;

changes in accounting guidelines governing valuation of our investments;

any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts;

departures of our investment adviser's key personnel;

potential actions of activist stockholders and responses from our board of directors and management;

loss of a major funding source;

operating performance of companies comparable to us;

litigation and/or governmental investigations; and

economic and political conditions or events.
47



Any fluctuations in the market price and demand for our common stock may limit or prevent investors from readily selling their common stock and may otherwise negatively affect the liquidity of our common stock. 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 become 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.
 
Sales of substantial amounts of our common stock in the public market may have an adverse effect 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, could adversely affect the prevailing market prices for our common stock. If this occurs and continues, it could impair our ability to raise additional capital through the sale of securities should we desire to do so.
  
Stockholders may experience dilution in their ownership percentage if they do not participate in our dividend reinvestment plan.
 
All distributions declared in cash payable to stockholders that are participants in our dividend reinvestment plan are generally automatically reinvested in shares of our common stock. As a result, stockholders that do not participate in the dividend reinvestment plan may experience dilution over time. Stockholders who receive distributions in shares of common stock may experience accretion to the net asset value of their shares if our shares are trading at a premium and dilution if our shares are trading at a discount. The level of accretion or discount would depend on various factors, including the proportion of our stockholders who participate in the plan, the level of premium or discount at which our shares are trading and the amount of the distribution payable to a stockholder.

You may receive shares of our common stock through the Company's dividend reinvestment plan, and we may otherwise choose to pay dividends in our common stock, in which case you may be required to pay tax in excess of the cash you receive.
 
Our cash distributions to stockholders will be automatically reinvested in additional shares of our common stock unless such stockholder has specifically "opted out" of our dividend reinvestment plan so as to receive cash distributions. In addition, we may in the future distribute taxable dividends that are payable in part in shares of our common stock. In accordance with certain applicable U.S. Treasury regulations and published guidance issued by the Internal Revenue Service ("IRS"), a RIC may treat a distribution of its own common stock as fulfilling the RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or common stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive cash, the cash available for distribution must be allocated among the stockholders electing to receive cash (with the balance of the distribution paid in stock). In no event will any stockholder electing to receive cash, receive less than the lesser of (a) the portion of the distribution such stockholder has elected to receive in cash or (b) an amount equal to his or her entire distribution times the percentage limitation on cash available for distribution. If these and certain other requirements are met, for U.S. federal income tax purposes, the amount of the dividend paid in common stock will be equal to the amount of cash that could have been received instead of common stock. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend as ordinary income (or as long-term capital gain to the extent such distribution is properly reported as a capital gain dividend) to the extent of our current and accumulated earnings and profits for U.S. federal income tax purposes. As a result, a U.S. stockholder may be required to pay tax with respect to such dividends in excess of any cash received. If a U.S. stockholder sells the stock it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our common stock at the time of the sale. Furthermore, with respect to Non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such dividends including in respect of all or a portion of such dividend that is payable in common stock. In addition, if a significant number of our stockholders determine to sell shares of our common stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our common stock.
 
Investing in our securities 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, and higher volatility or loss of principal, than alternative investment options. Our investments in portfolio companies may be speculative and, therefore, an investment in our securities may not be suitable for someone with lower risk tolerance.
48


 
If we issue preferred stock and/or debt securities, the net asset value and market value of our common stock may become more volatile or otherwise adversely affected.
 
We cannot assure you that the issuance of preferred stock and/or debt securities would result in a higher yield or return to the holders of our common stock. The issuance of preferred stock and/or debt securities would likely cause the net asset value and market value of our common stock to become more volatile. If the distribution rate on the preferred stock, or the interest rate on the debt securities, were to approach the net rate of return on our investment portfolio, the benefit of leverage to the holders of our common stock would be reduced. If the distribution rate on the preferred stock, or the interest rate on the debt securities, were to exceed the net rate of return on our portfolio, the use of leverage would result in a lower rate of return to the holders of common stock than if we had not issued the preferred stock and/or debt securities. Any decline in the net asset value of our investment would be borne entirely by the holders of our common stock. Therefore, if the market value of our portfolio were to decline, the leverage would result in a greater decrease in net asset value to the holders of our common stock than if we were not leveraged through the issuance of preferred stock and/or debt securities. This decline in net asset value would also tend to cause a greater decline in the market price for our common stock.

The issuance of shares of preferred stock with dividend or conversion rights, liquidation preferences or other economic terms favorable to the holders of preferred stock could also adversely affect the market price for our common stock by making an investment in our common stock less attractive. In addition, except in limited circumstances, the 1940 Act imposes certain features onto any preferred stock we issue that may make an investment in our common stock less attractive or otherwise limit our operational flexibility, including:

preferred stock constitutes a “senior security” for purposes of the asset coverage test;

dividends on any preferred stock we issue generally must be cumulative;

payments of dividends on and repayments of the liquidation preference of preferred stock must take preference over any dividends or other payments to our common stockholders;

the holders of shares of preferred stock, if any are issued, must be entitled as a class to elect two directors at all times and to elect a majority of the directors if and for so long as dividends on the preferred stock are in arrears by two years or more; and

under the terms of such securities, we may not be permitted to declare a cash distribution on our common stock or purchase our common stock unless our preferred stock (together with all of our other senior securities) has at the time of the declaration of any such distribution or at the time of any such purchase an asset coverage ratio of at least 150% (after deducting the amount of such dividend, distribution or purchase price, as the case may be).

There is also a risk that, in the event of a sharp decline in the value of our net assets, we would be in danger of failing to maintain required asset coverage ratios which may be required by the preferred stock and/or debt securities or of a downgrade in the ratings of the preferred stock and/or debt securities or our current investment income might not be sufficient to meet the distribution requirements on the preferred stock or the interest payments on the debt securities.

In order to counteract such an event, we might need to liquidate investments in order to fund redemption of some or all of the preferred stock and/or debt securities. In addition, we would pay (and the holders of our common stock would bear) all costs and expenses relating to the issuance and ongoing maintenance of the preferred stock and/or debt securities. Holders of preferred stock and/or debt securities may have different interests than holders of common stock and may at times have disproportionate influence over our affairs.
 
The trading market or market value of our debt securities or any convertible debt securities, if issued to the public, may be volatile.
 
Any debt securities or any convertible debt securities that we issue to the public in the future may or may not have an established trading market. We cannot assure investors that a trading market for our debt securities or any convertible debt securities, if issued to the public, would develop or be maintained if developed. In addition to our creditworthiness, many factors may materially adversely affect the trading market for, and market value of, our publicly issued debt securities or any convertible debt securities. These factors include, but are not limited to, the following:
49



the time remaining to the maturity of these debt securities;

the outstanding principal amount of debt securities with terms identical to these debt securities;

the general economic environment;

the supply of debt securities trading in the secondary market, if any;

the redemption, repayment or convertible features, if any, of these debt securities;

the level, direction and volatility of market interest rates generally; and

market rates of interest higher or lower than rates borne by the debt securities.

There also may be a limited number of buyers for our debt securities. This too may materially adversely affect the market value of the debt securities or the trading market for the debt securities. Our debt securities may include convertible features that cause them to more closely bear risks associated with an investment in our common stock.

Terms relating to redemption may materially adversely affect the return on any debt securities.
 
If we issue any debt securities or any convertible 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 the 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, a holder of our debt securities may not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as the debt securities being redeemed.
 
The issuance of subscription rights, warrants or convertible debt that are exchangeable for our common stock, may cause your interest in us to be diluted as a result of any such rights, warrants or convertible debt offering.
 
Stockholders who do not fully exercise rights, warrants or convertible debt issued to them in any offering of subscription rights, warrants or convertible debt to purchase our common stock should expect that they will, at the completion of the offering, own a smaller proportional interest in us than would otherwise be the case if they fully exercised their rights, warrants or convertible debt. We cannot state precisely the amount of any such dilution in share ownership because we do not know what proportion of the common stock would be purchased as a result of any such offering.
 
In addition, if the subscription price, warrant price or convertible debt price is less than our net asset value per share of common stock at the time of such offering, then our stockholders would experience an immediate dilution of the aggregate net asset value of their shares as a result of the offering. The amount of any such decrease in net asset value is not predictable because it is not known at this time what the subscription price, warrant price, convertible debt price or net asset value per share will be on the expiration date of such offering or what proportion of our common stock will be purchased as a result of any such offering. The risk of dilution is greater if there are multiple rights offerings. However, our board of directors will make a good faith determination that any offering of subscription rights, warrants or convertible debt would result in a net benefit to existing stockholders.
 
Future offerings of debt securities, which would be senior to our common stock upon liquidation, or equity securities, which could dilute our existing stockholders and may be senior to our common stock for the purposes of distributions, may harm the value of our common stock.
 
In the future, we may attempt to increase our capital resources by making offerings of debt or equity securities, including commercial paper, medium-term notes, senior or subordinated notes and classes of preferred stock or common stock, subject to the restrictions of the 1940 Act. Upon a liquidation of our company, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings would receive a distribution of our available assets prior to the holders of our common stock. Additional equity offerings by us may dilute the holdings of our existing stockholders or reduce the value of our common stock, or both. Any preferred stock we may issue would have a preference on distributions that could limit our ability to make distributions to the holders of our common stock. Because our decision to issue securities in any future
50


offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings in us. In addition, proceeds from a sale of common stock will likely be used to increase our total assets or to pay down our borrowings, among other uses. This would increase our asset coverage ratio and permit us to incur additional leverage under rules pertaining to BDCs by increasing our borrowings or issuing senior securities such as preferred stock or additional debt securities.

We have unsecured 2022 Notes that are effectively subordinated to any secured indebtedness we have incurred or may incur in the future.

Our 2022 Notes are not secured by any of our assets or the assets of any of our subsidiaries. As a result, the 2022 Notes are effectively subordinated to any secured indebtedness we, or any existing or future subsidiary may, have outstanding or that we or they may incur in the future (or any indebtedness that is initially unsecured to which we subsequently grant security) to the extent of the value of the assets securing such indebtedness. In any liquidation, dissolution, bankruptcy, or other similar proceeding, the holders of any of our existing or future secured indebtedness and the secured indebtedness of any existing and future subsidiary 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 2022 Notes. As of December 31, 2020, we had $35.6 million in outstanding indebtedness under our Credit Facility. This indebtedness is secured by all of our assets and therefore is effectively senior to the 2022 Notes to the extent of the value of such assets.

The 2022 Notes are structurally subordinated to the indebtedness and other liabilities of our existing and future subsidiaries.

The 2022 Notes are obligations exclusively of Harvest Capital Credit Corporation and not of any subsidiaries that we have or may have in the future. None of our existing or future subsidiaries, if any, will be a guarantor of the 2022 Notes, and the 2022 Notes are not required to be guaranteed by any subsidiaries we may have. Currently, our only existing subsidiaries are HCAP Equity Holdings, LLC and HCAP ICC, LLC, the Company's taxable blocker subsidiaries.

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, if any, will have priority over our claims (and therefore the claims of our creditors, including holders of the 2022 Notes) with respect to the assets of such subsidiaries. Even if we were recognized as a creditor of one or more of our existing or future subsidiaries, if any, our claims would still be effectively subordinated to any security interests in the assets of any such existing or future subsidiary and to any indebtedness or other liabilities of any such subsidiary senior to our claims. Consequently, the 2022 Notes will be subordinated structurally to all indebtedness and other liabilities, including trade payables, of any subsidiaries that we have or may in the future acquire or establish as financing vehicles or otherwise. All of the existing indebtedness of our existing and future subsidiaries would be structurally senior to the 2022 Notes.

The indenture under which the 2022 Notes were issued contains limited protection for holders of the 2022 Notes.

The indenture under which the 2022 Notes were issued offers limited protection to holders of the 2022 Notes. The terms of the indenture and the 2022 Notes do not restrict our or any of our existing or future subsidiaries’ ability to engage in, or otherwise be a party to, a variety of corporate transactions, circumstances or events that could have an adverse impact on an investment in the 2022 Notes. In particular, the terms of the indenture and the 2022 Notes do not place any restrictions on our or our subsidiaries’ ability to:

issue securities or otherwise incur additional indebtedness or other obligations, including (1) any indebtedness or other obligations that would be equal in right of payment to the 2022 Notes, (2) any indebtedness or other obligations that would be secured and therefore rank effectively senior in right of payment to the 2022 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 2022 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 2022 Notes with respect to the assets of our subsidiaries, in each case other than an incurrence of indebtedness or other obligation that would cause a violation of Section 18(a)(1)(A) as modified by Section 61(a) 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 each case, to any exemptive relief granted to us by the SEC. Currently, these provisions generally prohibit us from incurring additional borrowings, including through the issuance of additional debt securities, unless our asset coverage, as defined in the 1940 Act, equals at least 150% after such borrowings. See "--Risks Relating to
51


Our Business and Structure--Regulations governing our operations and capital structure affect (and could limit) our ability to raise, and the way in which we may raise, additional capital.";

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 2022 Notes, except that we have agreed that, for the period of time during which the 2022 Notes are outstanding, we will not violate Section 18(a)(1)(B) as modified by (i) Section 61(a) of the 1940 Act or any successor provisions and after giving effect to any exemptive relief granted to us by the SEC and (ii) the following two exceptions: (A) we will be permitted to declare a cash dividend or distribution notwithstanding the prohibition contained in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act, but only up to such amount as is necessary for us to maintain our status as a RIC under Subchapter M of the Internal Revenue Code of 1986; and (B) this restriction will not be triggered unless and until such time as our asset coverage has not been in compliance with the minimum asset coverage required by Section 18(a)(1)(B) as modified by Section 61(a) of the 1940 Act (after giving effect to any exemptive relief granted to us by the SEC) for more than six consecutive months. If Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act were applicable to us, these provisions would generally prohibit us from declaring any cash dividend or distribution upon any class of our capital stock, or purchasing any such capital stock if our asset coverage, as defined in the 1940 Act, were below 150% at the time of the declaration of the dividend or distribution or the purchase and after deducting the amount of such dividend, distribution or purchase. See "--Risks Relating to Our Business and Structure--Regulations governing our operations and capital structure affect (and could limit) our ability to raise, and the way in which we may raise, additional capital.";

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

enter into transactions with affiliates;

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

make investments; or

create restrictions on the payment of dividends or other amounts to us from any of our future subsidiaries.

Additionally, the indenture governing the 2022 Notes does not require us to make an offer to purchase the 2022 Notes in connection with a change of control or any other event.

Furthermore, the terms of the indenture and the 2022 Notes do not protect holders of the 2022 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 any of 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 2022 Notes may have important consequences for holders of the 2022 Notes, including making it more difficult for us to satisfy our obligations with respect to the 2022 Notes or negatively affecting the trading value of the 2022 Notes.

Other debt we issue or incur in the future could contain more protections for its holders than the indenture and the 2022 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 2022 Notes.

An active trading market for the 2022 Notes may not exist, which could limit the market price of the 2022 Notes or a holder's ability to sell them.

The 2022 Notes are an issue of debt securities listed on the Nasdaq Global Market ("Nasdaq") under the symbol “HCAPZ.” Although the 2022 Notes are listed on Nasdaq, we cannot provide any assurances that an active trading market will exist or be maintained in the future for the 2022 Notes or that holders will be able to sell their 2022 Notes. Even if an active trading market does exist or is maintained, the 2022 Notes may trade at a discount from their initial offering price depending on prevailing interest rates, the market for similar securities, our credit ratings, general economic conditions, our financial condition, performance and prospects, and other factors. To the extent an active trading market does not exist or is not
52


maintained, the liquidity and trading price for the 2022 Notes may be harmed and holders of the 2022 Notes may be required to bear the financial risk of an investment in the 2022 Notes for an indefinite period of time.

We may choose to redeem the 2022 Notes when prevailing interest rates are relatively low.

We may choose to redeem the 2022 Notes from time to time, especially when prevailing interest rates are lower than the rate borne by the 2022 Notes. If prevailing rates are lower at the time of redemption, and we were to redeem the 2022 Notes, a holder of the 2022 Notes would not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as the interest rate on the 2022 Notes being redeemed. Our redemption right also may adversely impact a holder's ability to sell the 2022 Notes.

If we default on our obligations to pay our other indebtedness, we may not be able to make payments on the 2022 Notes.

Any default under the agreements governing our indebtedness, including a default under the Credit Facility or other indebtedness to which we may be a party, that is not waived by the required lenders, and the remedies sought by such lenders, could make us unable to pay principal, premium, if any, and interest on the 2022 Notes and substantially decrease the market value of the 2022 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 (including the Credit Facility), 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 Credit 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. Our ability to generate sufficient cash flow in the future is, to some extent, subject to general economic, financial, competitive, legislative and regulatory factors as well as other factors that are beyond our control. We cannot assure you that our business will generate cash flow from operations, or that future borrowings will be available to us under the Credit Facility or otherwise, in an amount sufficient to enable us to meet our payment obligations under the 2022 Notes and our other debt and to fund other liquidity needs.

If our operating performance declines and we are not able to generate sufficient cash flow to service our debt obligations, we may in the future need to refinance or restructure our debt, including the 2022 Notes, sell assets, reduce or delay capital investments, seek to raise additional capital or seek to obtain waivers from the required lenders under the Credit Facility or other debt that we may incur in the future to avoid being in default. If we are unable to implement one or more of these alternatives, we may not be able to meet our payment obligations under the 2022 Notes and our other debt. If we breach our covenants under the Credit Facility or other debt and seek a waiver, we may not be able to obtain a waiver from the required lenders. If this occurs, we would be in default under the Credit Facility or other debt, the lenders 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 could proceed against the collateral securing the debt. Because the Credit Facility has, and any future credit facilities will likely have, customary cross-default provisions, if the indebtedness under the 2022 Notes, the Credit Facility or under any future credit facility is accelerated, we may be unable to repay or finance the amounts due.

General Risk Factors

We may experience fluctuations in our quarterly operating results.

We could experience fluctuations in our quarterly operating results due to a number of factors, including the interest rate payable on borrowings, the interest rate payable on the debt securities we acquire, the default rate on such securities, the number and size of investments we originate or acquire, 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. In light of these factors, results for any period should not be relied upon as being indicative of our performance in future periods.

Changes in laws or regulations governing our operations may adversely affect our business or cause us to alter our business strategy.

We and our portfolio companies are subject to regulation at the local, state and federal level. New legislation may be enacted or new interpretations, rulings or regulations could be adopted, including those governing the types of investments we are permitted to make or that impose limits on our ability to pledge a significant amount of our assets to secure loans or that
53


restrict the operations of a portfolio company, any of which could harm us and our stockholders and the value of our investments, potentially with retroactive effect. For example, certain provisions of the Dodd-Frank Act, which influences many aspects of the financial services industry, have been amended or repealed and the Code has been substantially amended and reformed. Any amendment or repeal of legislation, or changes in laws, regulations or regulatory interpretations thereof, could create uncertainty in the near term, which could have a material adverse impact on our business, financial condition and results of operations.

Additionally, any changes to the laws and regulations governing our operations relating to permitted investments may cause us to alter our investment strategy in order to avail ourselves of new or different opportunities. Such changes could result in material differences to the strategies and plans set forth herein and may result in our investment focus shifting from the areas of expertise of our investment adviser to other types of investments in which our investment adviser may have less expertise or little or no experience. Thus, any such changes, if they occur, could have a material adverse effect on our results of operations and the value of your investment.

Changes to U.S. tariff and import/export regulations may have a negative effect on our portfolio companies and, in turn, harm us.

The previous presidential administration implemented new tariffs against and trade policies with a number of countries, impacting a variety of goods and services. Additional tariffs and changes to trade policies could be implemented in the near future. From time to time, there is significant uncertainty about the future relationship between the United States and other countries with respect to the trade policies, treaties and tariffs. These developments, or the mere perception that any of them could occur, may have a material adverse effect on global economic conditions and the stability of global financial markets, and may significantly reduce global trade and, in particular, trade between the impacted nations and the United States. Any of these factors could depress economic activity and restrict our portfolio companies' access to suppliers or customers and have a material adverse effect on their business, financial condition and results of operations, which in turn would negatively impact us.

Our compliance with Section 404 of the Sarbanes-Oxley Act involves significant expenditures, and non-compliance with Section 404 of the Sarbanes-Oxley Act would adversely affect us and the market price of our common stock.

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 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 ensure that our evaluation, testing and remediation process is effective or that our internal control over financial reporting will continue to be effective. In the event that we are unable to maintain compliance with Section 404 of the Sarbanes-Oxley Act and related rules, we and the market price of our securities would be adversely affected.

If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud. As a result, stockholders could lose confidence in our financial and other public reporting, which would harm our business and the trading price of our common stock.

Effective internal control over financial reporting are necessary for us to provide reliable financial reports and, together with adequate disclosure controls and procedures, are designed to prevent fraud. Any failure to implement required new or improved controls, or difficulties encountered in their implementation could cause us to fail to meet our reporting obligations. In addition, any testing by us or the subsequent testing by our independent registered public accounting firm (when undertaken, as noted below), may reveal deficiencies in our internal control over financial reporting that are deemed to be material weaknesses or that may require prospective or retroactive changes to our financial statements or identify other areas for further attention or improvement. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.

We are required to disclose changes made in our internal control on financial reporting on a quarterly basis and our management is required to assess the effectiveness of these controls annually. We continued to be a non-accelerated filer as of December 31, 2020. Accordingly, we are not required to provide an independent registered public accounting firm's attestation report on our internal control over financial reporting as of December 31, 2020. An independent assessment of the effectiveness of our internal controls could detect problems that our management’s assessment might not. Undetected material weaknesses in our internal controls could lead to financial statement restatements and require us to incur the expense of remediation.

54


Our business and operation could be negatively affected if we become subject to shareholder activism, which could cause us to incur significant expense, hinder execution of investment strategy and impact our stock price.

Shareholder activism, which could take many forms or arise in a variety of situations, has been increasing in publicly traded companies and in the BDC space recently. Shareholder activism, including potential proxy contests, could result in substantial costs and divert management’s and our board of directors’ attention and resources from our business. Additionally, such shareholder activism could give rise to perceived uncertainties as to our future, adversely affect our relationships with service providers and make it more difficult to attract and retain qualified personnel. Also, we may be required to incur significant legal fees and other expenses related to activist shareholder matters. Further, our stock price could be subject to significant fluctuation or otherwise be adversely affected by the events, risks and uncertainties of any shareholder activism.

Economic recessions or downturns could impair our portfolio companies and harm our operating results.

Many of our portfolio companies are susceptible to economic slowdowns or recessions and may be unable to repay our loans during such periods. Therefore, our non-performing assets will likely increase and the value of our portfolio will likely decrease during these economic conditions. Adverse economic conditions also may decrease the value of collateral securing some of our loans and the value of our equity investments. Further, economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing investments and harm our operating results.

A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of its loans and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize such portfolio company’s ability to meet its obligations under debt securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company. In addition, if one of our portfolio companies were to go bankrupt, even if we had structured our interest as senior debt, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might re-characterize our debt holding and subordinate all or a portion of our claim to that of other creditors.

Portfolio company litigation or other litigation or claims against us or our personnel could result in additional costs and the diversion of our management’s time and resources.

In the course of investing in and providing significant managerial assistance to certain of our portfolio companies, certain persons employed by our investment adviser may serve as directors on boards of such companies. To the extent that litigation arises out of our investments in these companies or otherwise, even if without merit, we or such employees may be named as defendants in such litigation, which could result in additional costs, including defense costs, and the diversion of management time and resources. Additionally, other litigation or claims against us or our personnel could result in additional costs, including defense costs, and the diversion of our management’s time and resources. We may be unable to accurately estimate our exposure to litigation risk if we record balance sheet reserves for probable loss contingencies. As a result, any reserves we may establish to cover any settlements or judgments may not be sufficient to cover our actual financial exposure, which may have a material impact on our results of operations, financial condition, or cash flows.

While we believe we would have valid defenses to potential claims brought due to our investment in any portfolio company, and will defend any such claims vigorously, we may nevertheless expend significant amounts of money in defense costs and expenses. Further, if we enter into settlements or suffer an adverse outcome in any litigation, we could be required to pay significant amounts. In addition, if any of our portfolio companies become subject to direct or indirect claims or other obligations, such as defense costs or damages in litigation and settlement, our investment in such companies could diminish in value and we could suffer indirect losses. Further, these matters could cause us to expend significant management time and effort in connection with assessment and defense of any claims.

Item 1B. Unresolved Staff Comments

Not applicable.


 
 
55


Item 2.Properties
 
We do not own any real estate or other physical properties materially important to our operation. Our principal executive offices are located at 767 Third Avenue, 29th Floor, New York, NY 10017.
 
Item 3.Legal Proceedings
 
We, HCAP Advisors, and our subsidiaries may from time to time be involved in litigation arising out of our operations in the normal course of business or otherwise, including the enforcement of our rights under the contracts with our portfolio companies. Third parties may also seek to impose liability on us in connection with the activities of our portfolio companies. While we cannot predict the outcome of these legal proceedings with certainty, we do not expect that the above-described proceedings will have a material adverse effect on our consolidated financial statements. Except as discussed below, neither we, HCAP Advisors nor our subsidiaries are currently subject to any material pending legal proceedings, other than ordinary routine litigation incidental to our business.

We and certain of our officer and directors as well as JMP Group have been named as defendants in two putative stockholder class action lawsuits, both filed in the Court of Chancery in the State of Delaware, captioned Stewart Thompson v. Joseph Jolson, et al., Case No. 2021-0164 and Ronald Tornese v. Joseph Jolson, et al., Case No. 2021-0167 (the "Delaware Actions"). In addition, we and certain of our officer and directors, among others, have been named as defendants in a stockholder action, filed in the Supreme Court of the State of New York, captioned Greg Ramanauskas v. Harvest Capital Credit Corp, et al. (collectively with the Delaware Actions, the “Litigations”).

On February 25, 2021, two putative stockholders, each purporting to act on behalf of himself and our common stockholders, filed substantially identical verified class action complaints in the Court of Chancery in the State of Delaware. The complaints in the Delaware Actions allege certain breaches of fiduciary duties against the defendants as well as aiding and abetting claims against JMP Group and our Chief Executive Officer concerning our proposed merger with PTMN and Acquisition Sub. On March 5, 2021, a putative stockholder filed a similar complaint in the Supreme Court of the State of New York, alleging certain breaches of fiduciary duties against the individual defendants and aiding and abetting claims against us, PTMN, Acquisition Sub, and Sierra Crest. The complaints generally allege that the defendants breached their fiduciary duties in connection with the proposed merger and caused to be filed with the SEC an allegedly materially incomplete and misleading registration statement on Form N-14 relating to the proposed merger. The plaintiffs in the Litigations ask the court to enjoin the proposed merger, and award attorneys’ fees and costs, among other relief. Further, the plaintiffs in the Delaware Actions ask the court to direct the defendants to account to plaintiffs and the putative class for all damages suffered as a result of the alleged wrongdoing. The Litigations remain at an early stage.

We intend to defend ourselves vigorously against the allegations in the aforementioned actions. Neither the outcome of the lawsuits nor an estimate of any reasonably possible losses is determinable at this time. An adverse judgment for monetary damages could have a material adverse effect on our operations and liquidity or that of any combined company. There can be no assurances that additional complaints or demands will not be filed or made with respect to the proposed Mergers. If additional similar complaints or demands are filed or made, absent new or different allegations that are material, we may not necessarily announce them.
 
Item 4. Mine Safety Disclosures

Not applicable.
 
 
56


PART II
 
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Common Stock
 
Our common stock is traded on the Nasdaq Global Market under the symbol “HCAP.”

As of March 8, 2021, we had 15 shareholders of record of our common stock, which does not include stockholders who are beneficial owners but whose shares are held in "nominee" or "street name" by brokers and other nominees.
 
 
Distribution Policy
 
Our distributions, if any, are determined by our board of directors. We have elected to be treated for federal income tax purposes as a RIC under Subchapter M of the Code. If we maintain our qualification as a RIC, we will not be taxed on our investment company taxable income or realized net capital gains, to the extent that such taxable income or gains are distributed, or deemed to be distributed, to stockholders on a timely basis.
 
To receive RIC tax treatment, we must, among other things, distribute annually 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. Depending on the level of taxable income earned in a tax year, we may choose to carry forward taxable income in excess of current year distributions into the next tax year and pay a 4% excise tax on such income. Any such carryover taxable income must be distributed through a dividend declared prior to the later of the 15th day of the ninth month after the year which generated such taxable income or the extended due date of the tax return related to that year. We may, in the future, make deemed distributions to our stockholders of our net capital gains. We can offer no assurance that we will achieve results that will permit the payment of any cash distributions and, if we issue senior securities, we may be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our borrowings.
  
We have adopted an “opt out” dividend reinvestment plan, or “DRIP,” for our common stockholders. As a result, if we make cash distributions, then stockholders’ cash distributions will be automatically reinvested in additional shares of our common stock, unless they specifically “opt out” of the dividend reinvestment plan so as to receive cash distributions.
 
Prior to 2020, we historically made distributions on a monthly basis to our stockholders; however, our board of directors previously determined to defer the record dates and payments of our March 2020 and April 2020 monthly dividends and suspend the declaration of any future dividends until such later time as the board of directors determines is prudent in light of our capital needs and contractual obligations, and in our stockholders' best interests. We may not be able to achieve operating results that will allow us to continue to make distributions at a specific level or to 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 our Credit Facility, any future credit facilities, and the indenture governing our 2022 Notes, as well as under the Merger Agreement, may limit our ability to make distributions in certain circumstances. If we do not distribute annually at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term losses, we will fail to maintain our qualification for RIC tax treatment and will be subject to U.S. federal corporate-level federal income tax, which may reduce the amounts available for distribution. We cannot assure you that you will receive distributions at a particular level or at all. We ultimately paid the previously declared but deferred March 2020 and April 2020 monthly dividends in a single distribution of $0.16 per share on December 29, 2020, but did not declare or pay any other monthly dividends in 2020 after the declaration and payment of the March 2020 and April 2020 monthly dividends.

Tax characteristics of all distributions paid by us (or the applicable withholding agent) are reported to stockholders on Form 1099-DIV after the end of the calendar year. For the years ended December 31, 2019 and December 31, 2018, we made return of capital distributions totaling $0.23 and $0.16 per share, respectively. For the year ended December 31, 2020, we estimate that $0.21 per share of the distributions paid represented a return of capital. Our future distributions, and the rate of those distributions, if any, will be determined by our board of directors.


57


Sales of Unregistered Securities
 
During the year ended December 31, 2020, we issued a total of 22,442 shares of our common stock under our DRIP. The aggregate value of the shares of our common stock issued under the DRIP during the year ended December 31, 2020 was approximately $0.2 million.


Purchases of Equity Securities
 
During the three months ended December 31, 2020, the Company did not make any repurchases of its common stock.

Stock Performance Graph
 
The following graph compares the cumulative total return on our common stock with the cumulative total return of the Russell 2000 Financial Services Index and NASDAQ Financial 100 Index, for the five-year period ended December 31, 2020. The graph assumes that, on December 31, 2015, a person invested $100 in each of our common stock, at the closing price of our common stock on that date, the Russell 2000 Financial Services Index and the NASDAQ Financial 100 Index. The graph measures cumulative stockholder returns, which takes into account both changes in stock price and distributions. It assumes reinvestment of all cash dividends prior to any tax effect. The stock price performance shown on the graph below is not necessarily indicative of future price performance.
chart-7ea4bfe58c03484388d1.jpg

58


Item 6.Selected Financial Data
 
The following selected financial and other data as of and for the years ended December 31, 2020, 2019, 2018, 2017, and 2016, is derived from our audited consolidated financial statements. The data below should be read in conjunction with our financial statements and related notes thereto, "Risk Factors" included in Part I, Item 1A in this Annual Report on Form 10-K, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Part II, Item 7 in this Annual Report on Form 10-K. "Other Data" in the table below has not been audited.
As of and for the
Year Ended December 31,
20202019201820172016
Statement of Operations Data:
Interest income$11,190,499 $12,335,573 $15,525,664 $18,468,062 $20,738,511 
Other income357,317 334,811 658,257 236,198 154,963 
Operating expenses9,883,637 8,841,598 10,201,522 10,467,406 10,841,052 
Net investment income, after taxes1,664,179 3,828,786 5,982,399 8,236,854 10,052,422 
Net change in unrealized appreciation (depreciation) on investments2,160,547 (2,671,388)(428,921)1,458,173 (3,528,349)
Provision for taxes on unrealized gains on investments(1,236,329)— — — — 
Net realized losses on investments(4,923,171)(2,363,853)(486,680)(8,062,441)(517,586)
Net increase (decrease) in net assets resulting from operations(2,334,774)(1,206,455)5,066,798 1,632,586 6,006,487 
Other Data:
Dollar-weighted average annualized yield on debt and other income-producing investments (1)11.9 %14.0 %14.8 %15.3 %15.4 %
Dollar-weighted average annualized yield on total investments (1)9.1 %11.3 %12.7 %13.7 %14.4 %
Number of portfolio companies at year-end21 25 24 31 31 
Per Share Data (2):
Net increase (decrease) in net assets resulting from operations per share$(0.39)$(0.20)$0.79 $0.25 $0.96 
Net investment income per share$0.28 $0.63 $0.93 $1.28 $1.60 
Distributions declared per common share$0.40 $0.98 $1.16 $1.45 $1.35 
Net asset value per share$10.42 $11.23 $12.30 $12.66 $13.86 
Statement of Asset and Liabilities Data:
Gross investments$89,554,573 $116,809,390 $94,913,862 $115,600,678 $134,101,534 
Cash and restricted cash39,383,960 21,847,282 28,775,548 11,464,437 7,556,978 
Total assets129,944,513 140,059,736 125,319,701 128,152,840 142,989,647 
Borrowings64,341,406 72,450,000 45,750,000 45,471,853 54,446,613 
Total liabilities67,727,992 73,278,254 46,923,737 46,371,411 55,867,351 
Net assets62,216,521 66,781,482 78,395,964 81,781,429 87,122,296 

(1)The dollar-weighted average annualized effective yield on debt and other income-producing investments is computed using the effective interest rates for our debt investments and other income-producing investments, including cash and PIK interest as well as the accretion of deferred fees. The individual investment yields are then weighted by the respective fair values of the investments (as of the date presented) in calculating the weighted average effective yield as a percentage of our debt and other income-producing investments. The dollar-weighted average annualized yield on total investments takes the same yields but weights them to determine the weighted average effective yield as a percentage of the Company's total investments. The dollar-weighted average annualized yield on the Company’s investments for a given period will generally be higher than what investors in our common stock would realize in a return over the same period because the dollar-weighted average annualized yield does not reflect the Company’s expenses or any sales load that may be paid by investors. ProAir Holdings Corporation and GK Holdings, Inc. were excluded from this calculation as of December 31, 2020, Infinite Care, LLC was excluded from this calculation as of December 31, 2019, December 31, 2018, and December 31, 2017, and CP Holdings Co, Inc. (Choice Pet) was excluded from the calculation as of December 31, 2019 because they were on non-accrual status on such dates.
(2)All per share amounts are basic and diluted.
 

59


Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations 
Forward-Looking Statements
 
Some of the statements in this annual report on Form 10-K constitute forward-looking statements, which relate to future events or our future performance or financial condition. The forward-looking statements contained in this annual report on Form 10-K involve risks and uncertainties, including statements as to:

our future operating results, including the performance of our existing investments;

the introduction, withdrawal, success and timing of business initiatives and strategies;

changes in political, economic or industry conditions, the interest rate environment or conditions affecting the financial and capital markets, including with respect to changes from the impact of the Coronavirus ("COVID-19") pandemic;

the length and duration of the COVID-19 outbreak in the United States as well as worldwide and the magnitude of the economic impact of that outbreak;

the effect of the disruptions caused by the COVID-19 pandemic on our ability to continue to effectively manage our business and on the availability of equity and debt capital and our use of borrowed money to finance a portion of our investments;

the relative and absolute investment performance and operations of our investment adviser;

the impact of increased competition;

the impact of investments we intend to make and future acquisitions and divestitures;

our ability to turn potential investment opportunities into transactions and thereafter into completed and successful investments;

the unfavorable resolution of any existing or future legal proceedings;

the effect of the COVID-19 pandemic on our business prospects and the prospects of our portfolio companies, including our and their ability to achieve our respective objectives;

our regulatory structure and tax status;

the adequacy of our cash resources and working capital;

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

the impact of interest rate volatility on our results, particularly because we use leverage as part of our investment strategy;

the impact of legislative and regulatory actions and reforms, including in response to the COVID-19 pandemic; and regulatory, supervisory or enforcement actions of government agencies relating to us or our investment adviser;

our contractual arrangements and relationships with third parties, including but not limited to lenders and investors, including other investors in our portfolio companies;

our ability to access capital and any future financings by us;

the ability of our investment adviser to attract and retain highly talented professionals;

the impact of changes to tax legislation and, generally, our tax position;
60


the ability of the parties to consummate the Mergers on the expected timeline, or at all;

the ability to realize the anticipated benefits of the proposed Mergers;

the effects of disruption on our business from the proposed Mergers;

the combined company’s plans, expectations, objectives and intentions, as a result of the Mergers;

the effect that the pendency of the Mergers or consummation of the Mergers may have on the trading price of our common stock or PTMN Common Stock; and

any potential termination of the Merger Agreement or action of our stockholders or PTMN’s stockholders with respect to any proposed transaction.
 
Such forward-looking statements may include statements preceded by, followed by or that otherwise include the words “may,” “might,” “will,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “estimate,” “anticipate,” “predict,” “potential,” “plan” or similar words.
 
We have based the forward-looking statements included in this annual report on Form 10-K on information available to us on the date of this annual report on Form 10-K, and we assume no obligation to update any such forward-looking statements. Actual results could differ materially from those anticipated in our forward-looking statements, and future results could differ materially from historical performance. We undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law or SEC rule or regulation. You are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
 
The following analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes thereto contained elsewhere in this annual report on Form 10-K.
 
Overview
 
We were formed as a Delaware corporation on November 14, 2012 and completed our initial public offering on May 7, 2013. Immediately prior to the initial public offering, we acquired Harvest Capital Credit LLC in a merger whereby the outstanding limited liability company membership interests of Harvest Capital Credit LLC were converted into shares of our common stock and we assumed and succeeded to all of Harvest Capital Credit LLC’s assets and liabilities, including its entire portfolio of investments.
  
Our investment objective is to generate both current income and capital appreciation primarily by making direct investments in the form of senior debt, subordinated debt and, to a lesser extent, minority equity investments. We seek to accomplish our investment objective by targeting investments in small to mid-sized U.S. private companies with annual revenues of less than $100 million and annual EBITDA (earnings before interest, taxes, depreciation and amortization) of less than $15 million. We believe that transactions involving companies of this size offer higher yielding investment opportunities, lower leverage levels and other terms more favorable than transactions involving larger companies.
 
We are an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a BDC under the 1940 Act.
 
We have also elected to be treated for U.S. federal income tax purposes as a RIC under Subchapter M of the Code, and we intend to continue to qualify annually for tax treatment as a RIC.

Our investment adviser, HCAP Advisors, which is registered as an investment adviser under the Advisers Act, manages our day-to-day operations and provides investment advisory and management services to us, subject to the overall supervision of our board of directors and pursuant to an investment advisory and management agreement. HCAP Advisors also serves as our administrator pursuant to an administration agreement, through which it furnishes us with office facilities, equipment and clerical, bookkeeping and recordkeeping services and performs, or oversees the performance of, our required administrative services.
61


 
Proposed Merger With Portman Ridge Finance Corporation

On December 23, 2020, we entered into the Merger Agreement with PTMN, Acquisition Sub and Sierra Crest. The Merger Agreement provides that (i) Acquisition Sub will merge with and into the Company in the First Merger, with us continuing as the surviving corporation and as a wholly-owned subsidiary of PTMN, and (ii) immediately after the effectiveness of the First Merger, we will merge with and into PTMN in the Second Merger, with PTMN continuing as the surviving corporation. Sierra Crest is expected to manage the combined company following the Mergers.

The consummation of the Mergers is subject to the satisfaction or (to the extent permitted by law) waiver of certain customary closing conditions, including obtaining the requisite approval of our stockholders. For further information, see “Note 1. Organization—The Proposed Merger with Portman Ridge Finance Corporation” to our consolidated financial statements included in this Annual Report on Form 10-K.

COVID-19 Update

The COVID-19 pandemic, and the related effects on the U.S. and global economies, has had adverse consequences for the business operations of certain of our portfolio companies and has adversely affected, and threatens to continue to adversely affect, our operations and the operations of HCAP Advisors.

We are continuing to monitor the COVID-19 pandemic and its impact on our business and the business of our portfolio companies, and we have continued to fund existing unfunded revolving lines of credit when requests have been made from our portfolio companies and intend to continue to do so. We may also participate in follow-on investments with respect to existing portfolio companies. Due to the adverse effects of the COVID-19 pandemic on our operations and our liquidity, and in light of our contractual obligations, we have decided to temporarily cease to make and originate new investments. We will decide to resume to make and originate new investments when we believe it is prudent in light of our capital needs and contractual obligations, and in the best interests of us and our stockholders.

Neither our management nor our board of directors can predict the full impact of the COVID-19 pandemic, including its duration and the magnitude of its economic impact, and we cannot predict the extent and duration of various travel restrictions, business closures and other quarantine measures imposed, or may in the future be imposed, by various local, state, and federal governmental authorities, as well as non-U.S. governmental authorities. As such, we are unable to accurately predict the extent to which COVID-19 will negatively affect our portfolio companies’ operating results or the impact that such disruptions may have on our results of operations and financial condition.

Depending on the duration and extent of the disruption to the operations of our portfolio companies, we expect that certain of our portfolio companies will, and will continue to, experience financial distress and possibly default on their financial obligations to us and their other capital providers. This risk is amplified with respect to portfolio companies operating in certain industries, such as aerospace and defense, beverage, food and tobacco, construction and building, consumer goods, retail, business services, energy services and others. For example, in June 2020, one of our portfolio companies, General Nutrition Centers, Inc. ("GNC"), filed for bankruptcy. In October 2020, GNC was restructured upon the finalization of its plan of reorganization, in connection with which we received approximately $1.9 million, representing a full payoff at par of each of our New Money DIP Term Loan and Roll-up DIP Term Loan. We also received an additional $1.2 million in cash, in connection with the finalization of its plan of reorganization, representing a discounted payoff of our $3.0 million original tranche B-2 Term Loan and received our pro rata share of a new Second Lien Term Loan with a par value of $1.8 million in GNC Holdings, LLC.

Some of our portfolio companies have taken steps to reduce operating expenses, such as significantly curtailing business operations, reducing headcounts and/or deferring capital expenditures, and we expect that additional portfolio companies may take similar steps if subjected to prolonged and severe financial distress, which may impair their business on a permanent basis. These developments would likely result in a decrease in the value of our investment in any such portfolio company, which decrease could be material. To mitigate these risks, a majority of our portfolio companies received approval for loans under the U.S. Small Business Administration's ("SBA") Paycheck Protection Program ("PPP Loan") created as part of the Coronavirus Aid, Relief, and Economic Security Act. Assuming that the PPP Loan proceeds are used to cover certain costs and expenses (e.g. documented payroll, mortgage interest, rent, and utility costs) and certain conditions are met, these PPP Loans could be completely forgiven by the U.S. federal government. Through the date of this filing, fourteen of our portfolio companies had received approval of PPP Loans totaling $30.3 million and certain portfolio companies are in the application process to receive
62


approval for additional PPP Loans. As of December 31, 2020, we had two portfolio companies, with a combined fair value of $5.6 million, on non-accrual status. The effects of the COVID-19 pandemic discussed above increase the risk that we will place additional portfolio investments on non-accrual status in the future.

The COVID-19 pandemic and its effects on our portfolio companies have already had adverse material effects on our investment income, particularly our interest income, received from our investments, and we expect that such adverse effects will continue for the duration of the pandemic and potentially for some time thereafter. During the year ended December 31, 2020 we added three portfolio companies, ProAir Holdings Corporation, GK Holdings, Inc., and GNC, to our non-accrual assets. GNC was subsequently removed from our non-accrual assets after it was restructured. We may need to restructure our investments in some of our portfolio companies as a result of the adverse effects of the COVID-19 pandemic, which could result in reduced interest payments, an increase in the amount of “paid-in-kind” or “PIK” interest we receive, and the placement of any such investment on non-accrual status. Certain restructurings of our portfolio investments included in the borrowing base for our Credit Facility or any future credit facility could result in a reduction in any such borrowing base, which may have a material adverse effect on our results of operations, financial condition and available liquidity going forward. In addition, any decreases in our net investment income would increase the portion of our cash flows dedicated to servicing borrowings, including existing borrowings and required amortization payments under the Credit Facility and existing borrowings under the 2022 Notes, and any distribution payments to stockholders. As discussed below, under “Financial Condition, Liquidity and Capital Resources,” our board of directors previously took action to defer the record dates and payments of our March 2020 and April 2020 monthly dividends and determined to suspend the declaration of any future dividends until further notice. We ultimately paid the previously declared but deferred March 2020 and April 2020 monthly dividends in a single distribution of $0.16 per share on December 29, 2020 to shareholders of record at the close of business on December 15, 2020. Depending on the duration of the COVID-19 pandemic and the extent of its effects on our portfolio companies’ operations and our net investment income, any future distributions to our stockholders may be for amounts less than our historical distributions, may be made less frequently than historical practices, and may be made in part cash and part stock (as per each stockholder's election), subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least 20% of the aggregate declared distribution.

Primarily as a result of the COVID-19 pandemic, we have had a significant reduction in our net asset value as of December 31, 2020, as compared to our net asset value as of December 31, 2019. The decrease in net asset value as of December 31, 2020 primarily resulted from realized losses on certain portfolio company investments we exited during the year as well as due to decreases in the fair value of some of our portfolio company investments, which are primarily the result of the adverse economic effects of the COVID-19 pandemic and the continuing uncertainty surrounding its long-term impact.

As of December 31, 2020, we are permitted under the 1940 Act, as a BDC, to borrow amounts such that our asset coverage, as defined in the 1940 Act, equals at least 150% after such borrowing. In addition, the Credit Facility contains events of default and cross-default provisions relating to other indebtedness, as well as affirmative and negative covenants, including, among other things: (i) a limit on our senior debt-to-tangible equity ratio of 1.00 to 1.00 at any time; (ii) a limit on our total debt-to-tangible equity ratio of 1.40 to 1.00 at any time; (iii) a limit on our debt service coverage ratio of 1.25 to 1.00 as of the end of any quarter in the period beginning as of August 1, 2020 (which ratio was 1.40 to 1.00 as of the end of any quarter prior to August 1, 2020); (iv) a requirement that our tangible net worth not be less than $58.0 million; (v) minimum liquidity; and (vi) maintenance of RIC and BDC status. The indenture governing the 2022 Notes (the "2022 Notes Indenture") also contains certain covenants, including covenants (i) prohibiting our issuance of any senior securities unless, immediately after such issuance, we are in compliance with the 1940 Act asset coverage requirements (after giving effect to any exemptive relief granted to us by the SEC), and, (ii) if our asset coverage has been below the 1940 Act minimum asset coverage requirements (after giving effect to any exemptive relief granted to us by the SEC) for more than six consecutive months, prohibiting the declaration of any cash dividend or distribution on our common stock (except to the extent necessary for us to maintain our treatment as a RIC under Subchapter M of the Code), or purchasing any of our common stock, unless, 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, we are in compliance with the 1940 Act asset coverage requirements (after giving effect to any exemptive relief granted to us by the SEC).

As of December 31, 2020, we were in compliance with our asset coverage requirements under the 1940 Act and with the covenants under the terms of the Credit Facility and under the 2022 Notes Indenture. However, any continued increase in net unrealized depreciation on our investment portfolio or further significant reductions in our net asset value as a result of the effects of the COVID-19 pandemic or otherwise increases the risk of (i) triggering the 1940 Act asset coverage covenants under the 2022 Notes Indenture, which would limit our ability to raise debt capital, pay distributions to our stockholders, and repurchase shares of our common stock, (ii) reducing our borrowing base under the Credit Facility or any future credit facility
63


going forward, and (iii) breaching certain covenants under the Credit Facility, including but not limited to those relating to tangible net worth and debt service coverage ratio. In the event that unrealized depreciation in the fair value of portfolio investments included in the borrowing base of the Credit Facility or any future credit facility or other factors cause our aggregate outstanding borrowings under the Credit Facility or such other credit facility to exceed the applicable borrowing base, we would be required to immediately prepay the lenders an amount equal to such excess amount. If we are unable to remit such payment or we otherwise breach a covenant under the Credit Facility, or are unable to cure any event of default or obtain a waiver from the lenders, the lenders may choose to foreclose upon and sell, or otherwise transfer, the collateral subject to their security interests, which comprises all of our assets as of December 31, 2020, and accelerate our repayment obligations under the Credit Facility. Any such event would have a material adverse effect on our business, liquidity, financial condition, results of operations and ability to pay distributions to our stockholders. In addition, if the lenders exercise their right to sell the assets pledged under the Credit Facility, such sales may be completed at distressed sale prices, thereby diminishing or potentially eliminating the amount of cash available to us after repayment of the amounts outstanding under the Credit Facility. See "Risk Factors" included in Part I, Item 1A in this Annual Report on Form 10-K.

We are also subject to financial risks, including changes in market interest rates. As of December 31, 2020, 48.4% of our debt investments bore interest based on floating rates (some of which were subject to interest rate floors), which generally are LIBOR-based. In addition, the Credit Facility has floating rate interest provisions. In connection with the COVID-19 pandemic, the U.S. Federal Reserve and other central banks have reduced certain interest rates and LIBOR has decreased. A prolonged reduction in interest rates will reduce our gross investment income and could result in a decrease in our net investment income if such decreases in LIBOR are not offset by a corresponding increase in the spread over LIBOR that we earn on any portfolio investments, a decrease in our operating expenses, or a decrease in the interest rate of our floating interest rate liabilities tied to LIBOR. See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” for an analysis of the impact of hypothetical base rate changes in interest rates.

We will continue to monitor the rapidly evolving situation relating to the COVID-19 pandemic and related guidance from U.S. and international authorities, including federal, state and local public health authorities. Given the dynamic nature of this situation and the fact that there may be developments outside of our control that require us or our portfolio companies to adjust plans of operation, we cannot reasonably estimate the full impact of COVID-19 on our financial condition, results of operations or cash flows in the future. However, we do expect that it could have a material adverse impact on our future net investment income, the fair value of our portfolio investments, and the results of operations and financial condition of us and our portfolio companies.

Portfolio
 
Portfolio Composition
 
As of December 31, 2020, we had $89.6 million (at fair value) invested in 21 companies. As of December 31, 2020, our portfolio, at fair value, was comprised of approximately 71.1% senior secured term loans, 10.5% junior secured term loans and 18.4% equity and equity-like investments.

As of December 31, 2019, we had $116.8 million (at fair value) invested in 25 companies. As of December 31, 2019, our portfolio, at fair value, was comprised of approximately 73.6% senior secured term loans, 16.0% junior secured term loans and 10.4% equity and equity-like investments.
  
We originate and invest primarily in privately-held middle-market companies (typically those with less than $15.0 million of annual EBITDA) through first lien and second lien debt, sometimes with a corresponding equity investment component. The composition of our investments as of December 31, 2020 and December 31, 2019 was as follows:
 
December 31, 2020December 31, 2019
CostFair ValueCostFair Value
Senior Secured $66,041,926 $64,629,875 $87,032,136 $85,954,384 
Junior Secured 14,329,126 9,417,801 20,413,183 18,757,348 
Equity and Equity Related 13,663,289 15,506,897 16,004,386 12,097,658 
Total Investments $94,034,341 $89,554,573 $123,449,705 $116,809,390 
64


  
At December 31, 2020, our average portfolio company debt investment at amortized cost and fair value was approximately $4.2 million and $3.9 million, respectively, and our largest portfolio company debt investment by amortized cost and fair value was approximately $13.7 million and $10.8 million, respectively. At December 31, 2019, our average portfolio company debt investment at amortized cost and fair value was approximately $4.5 million and $4.2 million, respectively, and our largest portfolio company debt investment by amortized cost and fair value was approximately $13.1 million and $11.6 million, respectively.
 
At December 31, 2020, 48.4% of our debt investments bore interest based on floating rates (some of which were subject to interest rate floors), such as LIBOR, and 51.6% bore interest at fixed rates. At December 31, 2019, 53.0% of our debt investments bore interest based on floating rates (some of which were subject to interest rate floors), such as LIBOR, and 47.0% bore interest at fixed rates.
 
The weighted average effective yield of our debt and other income-producing investments, as of December 31, 2020 and December 31, 2019, was approximately 11.9% and 14.0%, respectively. The weighted average effective yield on the entire portfolio, as of December 31, 2020 and December 31, 2019, was 9.1% and 11.3%, respectively. The weighted average annualized effective yield on debt and other income-producing investments is computed using the effective interest rates for our debt and other income-producing investments, including cash and PIK interest as well as the accretion of deferred fees. The individual investment yields are then weighted by the respective fair values of the investments (as of the date presented) in calculating the weighted average effective yield as a percentage of our debt and other income-producing investments. ProAir Holdings Corporation and GK Holdings, Inc. were excluded from the calculation as of December 31, 2020 because they were on non-accrual status on that date. Infinite Care, LLC and CP Holding Co., Inc. (Choice Pet) were excluded from the calculation as of December 31, 2019 because they were on non-accrual status on that date. Equity components of the investment portfolio were also excluded from these calculations either because they do not have stated interest rates or are non-income-producing. The weighted average annualized yield on total investments takes the same yields but weights them to determine the weighted average effective yield as a percentage of our total investments. The dollar-weighted average annualized yield on our investments for a given period will generally be higher than what investors in our common stock would realize in a return over the same period because the dollar-weighted average annualized yield does not reflect our expenses or any sales load that may be paid by investors.
For investments that have a PIK interest component, PIK interest is accrued each period but generally not collected until the debt investment is sold or paid off. A roll forward of PIK interest for the years ended December 31, 2020 and December 31, 2019 is summarized in the tables below.

2020
Q1Q2Q3Q4FY
PIK, beginning of period$3,855,222 $4,102,226 $3,505,245 $3,694,494 $3,855,222 
Accrual264,962 255,109 292,631 486,522 1,299,224 
Payments(17,958)(24,588)(103,382)(122,512)(268,440)
  PIK, end of period$4,102,226 $3,505,245 $3,694,494 $4,046,725 $4,046,725 

2019
Q1Q2Q3Q4FY
PIK, beginning of period$3,123,501 $3,287,499 $3,449,314 $3,617,999 $3,123,501 
Accrual206,634 206,245 205,805 243,149 861,833 
Payments(42,636)(44,430)(37,120)(5,926)(130,112)
  PIK, end of period$3,287,499 $3,449,314 $3,617,999 $3,855,222 $3,855,222 

Investment Activity
 
65


During the year ended December 31, 2020, we closed $2.2 million of debt investment commitments in 3 existing portfolio companies and made $0.4 million of equity investments in 3 existing portfolio companies. We did not originate or fund investments in any new portfolio companies during the year ended December 31, 2020. See "COVID-19 Update" above. During the year ended December 31, 2019, we closed $55.3 million of debt investment commitments in nine new and seven existing portfolio companies. We also made $3.7 million of equity investments in three new and three existing portfolio companies.
 
During the year ended December 31, 2020, we exited $25.3 million of debt investment commitments from 6 portfolio companies. We also exited $0.3 million of equity investments from 2 portfolio companies. During the year ended December 31, 2019, we exited $21.4 million of debt investment commitments from eight portfolio companies. We also exited $0.2 million of equity investments from two portfolio companies.
 
Our level of investment activity can vary substantially from period to period depending on many factors, including the level of merger and acquisition activity in our target market, the general economic environment and the competitive environment for the types of investments we make.
 
Asset Quality
 
In addition to various risk management and monitoring tools, we use an investment rating system to characterize and monitor the credit profile and expected level of returns on each investment in our portfolio. This investment rating system uses a five-level numeric scale. The following is a description of the conditions associated with each investment rating:
Investment Rating 1 is used for investments that are performing above expectations, and whose risks remain favorable compared to the expected risk at the time of the original investment.

Investment Rating 2 is used for investments that are performing within expectations and whose risks remain neutral compared to the expected risk at the time of the original investment. All new loans are initially rated 2.

Investment Rating 3 is used for investments that are performing below expectations and that require closer monitoring, but where no loss of return or principal is expected. Portfolio companies with a rating of 3 may be out of compliance with financial covenants.

Investment Rating 4 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are often in workout. Investments with a rating of 4 are those for which there is an increased possibility of loss of return, but no loss of principal is expected.

Investment Rating 5 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are almost always in workout. Investments with a rating of 5 are those for which loss of return and principal is expected.
  


The following table shows the investment rankings of our debt investments at fair value (in millions):

66


As of December 31, 2020As of December 31, 2019
Investment RatingFair Value (in millions)% of Total
Portfolio
Number of
Portfolio Companies
Fair Value (in millions)% of Total
Portfolio
Number of
Portfolio Companies
1$16.0 21.9 %$14.6 13.9 %
220.1 27.5 %66.1 63.1 %13 
313.0 17.8 %2.2 2.2 %
424.0 32.8 %13.8 13.2 %
5— — %— 8.0 7.6 %
$73.1 100.0 %14 $104.7 100.0 %20 


Loans and Debt Securities on Non-Accrual Status
 
We do not accrue interest income on loans and debt securities if we doubt our ability to collect such interest. Generally, when an interest payment default occurs on a loan in the portfolio, when interest has not been paid for greater than 90 days, or when management otherwise believes that the issuer of the loan will not be able to service the loan and other obligations, we will place the loan on non-accrual status and will cease accruing interest income on that loan until all principal and interest is current through payment or until a restructuring occurs, such that the interest income is deemed collectible. However, we remain contractually entitled to this interest, and any collections actually received on these non-accrual loans may be recognized as interest income on a cash basis or applied to the principal depending on management's judgment regarding collectability. As of December 31, 2020, we had investments in two portfolio companies on non-accrual status (our junior secured debt investment in ProAir Holdings Corporation and our junior secured debt investment in GK Holdings, Inc.), which totaled $5.6 million at fair value and $10.4 million at cost and comprised an aggregate of 12.9% of our debt investments at cost. As of December 31, 2019, we had investments in two portfolio companies on non-accrual status (our senior secured debt investment in Infinite Care, LLC and our junior secured debt investment in CP Holding Co., Inc. (Choice Pet)), which totaled $10.6 million at fair value and $10.7 million at cost and comprised an aggregate of 10.0% of our debt investments at cost. The failure by a borrower or borrowers to pay interest and repay principal could have a material adverse effect on our financial condition and results of operation.
 
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Set forth below is a comparison of the results of operations and changes in financial condition for the years ended December 31, 2020 and 2019. The comparison of, and changes between, the fiscal years ended December 31, 2019 and December 31, 2018 can be found within "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Part II of our annual report on Form 10-K for the fiscal year ended December 31, 2019, which is incorporated herein by reference.

Results of Operations

An important measure of our financial performance is the net increase or decrease in net assets resulting from operations, which includes net investment income, net change in realized gain or loss and net change in unrealized appreciation or depreciation. Net investment income is the difference between our income from interest, distributions, fees and other investment income and our operating expenses, including interest on borrowed funds. Net realized gain or loss on investments is generally the difference between the proceeds received from dispositions of portfolio investments and their amortized cost. Net change in unrealized appreciation or depreciation on investments is the net unrealized change in the fair value of our investment portfolio.
 
Revenues
 
We generate revenue primarily in the form of interest income on debt investments and, to a lesser extent, capital gains on equity investments we make in portfolio companies. Our debt investments typically have terms of five to seven years and bear interest at a fixed or floating rate. Interest on our debt investments is payable at least quarterly. Payments of principal on our debt investments may be amortized over the stated term of the investment, deferred for several years or due entirely at maturity. In some cases, our debt investments may pay interest in kind, or PIK. Any outstanding principal amount of our debt
67


investments and any accrued but unpaid interest will generally become due at the maturity date. The level of interest income we receive is directly related to the balance of interest-bearing investments multiplied by the weighted average yield of our investments. We expect that the dollar amount of interest and any dividend income that we earn to increase as the size of our investment portfolio increases and to decrease as the size of our investment portfolio decreases. In addition, we may generate revenue in the form of prepayment, commitment, loan origination, structuring or due diligence fees and consulting fees, which may be non-recurring in nature.

Investment income for the year ended December 31, 2020 totaled $11.5 million, compared to investment income of $12.7 million for the year ended December 31, 2019. Investment income for the year ended December 31, 2020 was comprised of $8.8 million in cash interest, $1.3 million in PIK interest, $1.1 million in fees earned on the investment portfolio, and $0.4 million in other income. Investment income for the year ended December 31, 2019 was comprised of $10.7 million in cash interest, $0.9 million in PIK interest, $0.8 million in fees earned on the investment portfolio and $0.3 million in other income.

The $1.1 million decrease in investment income in the year ended December 31, 2020 is primarily attributable to a lower weighted average effective yield on our portfolio, a decrease in the size of our interest-earning portfolio, and lower prepayment fees compared to the year ended December 31, 2019 as well as to the addition of Pro Air Holdings Corporation, GK Holdings, Inc., and GNC (which was subsequently removed after it was restructured) to our non-accrual assets during the year ended December 31, 2020, offset by the removal of Infinite Care, LLC from our non-accrual assets during the year.
Expenses
 
Our primary operating expenses include the payment of fees to HCAP Advisors under the investment advisory and management agreement, our allocable portion of overhead expenses and other administrative expenses under the administration agreement with HCAP Advisors, including the allocated costs incurred by HCAP Advisors in providing managerial assistance to those portfolio companies that request it, and other operating costs described below. We bear all other out-of-pocket costs and expenses of our operations and transactions, which include:

interest expense and unused line fees;

the cost of calculating our net asset value, including the cost of any third-party valuation services;

the cost of effecting sales and repurchases of shares of our common stock and other securities;

fees payable to third parties relating to making investments, including out-of-pocket fees and expenses associated with performing due diligence and reviews of prospective investments;

transfer agent and custodial fees;

out-of-pocket fees and expenses associated with marketing efforts;

federal and state registration fees and any stock exchange listing fees;

U.S. federal, state and local taxes;

independent directors’ fees and expenses;

brokerage commissions;

fidelity bond, directors’ and officers’ liability insurance and other insurance premiums;

direct costs, such as printing, mailing, long distance telephone and staff;

fees and expenses associated with independent audits and outside legal costs, and

costs associated with our reporting and compliance obligations under applicable U.S. federal and state securities laws.

68


Operating expenses totaled $9.9 million for the year ended December 31, 2020, compared to $8.8 million for the year ended December 31, 2019. Interest expense increased by $0.4 million to $3.6 million at December 31, 2020, primarily due to an increase in our average daily borrowings to finance our portfolio and operations and a higher weighted-average interest rate on borrowings under our Credit Facility during the year ended December 31, 2020. In addition, during the year ended December 31, 2020, we accelerated approximately $0.1 million of deferred financing costs in accordance with ASC 470 Debt, due to the reduction in our borrowing capacity under our Credit Facility. Professional fees increased to $1.6 million for the year ended December 31, 2020 from $1.1 million for the year ended December 31, 2019. General and administrative expenses increased to $1.1 million for the year ended December 31, 2020 from $1.0 million for the year ended December 31, 2019. Professional fees increased primarily due to the increased professional fees we incurred during the fourth quarter relating to the proposed Mergers. General and administrative increased slightly primarily due to one-time additional director fee compensation of $0.2 million paid to the independent members of our board of directors to compensate them for the additional services they provided to us relating to the proposed Mergers. These expenses were partially offset by a decrease in non-Mergers related expenses, as we reviewed all of our service providers in 2019 and changed certain service providers to more cost-effective solutions, which led to decreases in certain operating expenses during the year ended December 31, 2020. During the year ended December 31, 2020, we incurred approximately $1.0 million in expenses relating to the proposed Mergers.
 
Base management fees for the year ended December 31, 2020 were $2.1 million, compared to $2.2 million for the year ended December 31, 2019. The slight decrease in base management fees is attributable to a smaller average outstanding investment portfolio in 2020 as compared to 2019.

We did not incur any incentive management fees for each of the years ended December 31, 2020 or December 31, 2019. We did not incur an incentive management fees as a result of our pre-incentive fee net investment income not exceeding the hurdle rate in both 2020 and 2019. We only incur an income incentive management fee if our pre-incentive fee net investment income return exceeds a 2.0% (8.0% annualized) hurdle rate. Our pre-incentive fee net investment income did not meet the hurdle for each of the three months ended March 31, 2020, June 30, 2020, September 30, 2020, December 31, 2020, March 31, 2019, June 30, 2019, September, 30, 2019, and December 31, 2019. The incentive fees paid or owed to HCAP Advisors are also subject to a three-year total return requirement, such that no incentive fee, in respect of pre-incentive fee net investment income, will be payable except to the extent 20.0% of the cumulative net increase in net assets resulting from operations over the calendar quarter for which such fees are being calculated and the 11 preceding quarters exceeds the cumulative incentive fees paid or accrued over the 11 preceding quarters. The total return requirement did not impact the income incentive fee calculation for the year ended December 31, 2020 or December 31, 2019.

 Administrative services expense was $1.4 million for each of the years ended December 31, 2020 and 2019. HCAP Advisors agreed to a $1.4 million cap on amounts payable by us under the administration agreement for both 2020 and 2019. The cap included limits such that amounts payable would not exceed $1.4 million for the year. We hit the $1.4 million cap for both fiscal years 2020 and 2019. The actual administrative services expense that would have been payable to HCAP Advisors for the years ended December 31, 2020 and December 31, 2019 exceeded the cap by approximately $0.1 million and $0.5 million, respectively.
 
Net Investment Income
 
For the year ended December 31, 2020, net investment income was $1.7 million, compared to $3.8 million for the year ended December 31, 2019. For the year ended December 31, 2020, net investment income per share was $0.28, compared to $0.63 for the year ended December 31, 2019.
 
Net Realized Gains and Losses
 
Realized gains and losses on investments are calculated using the specific identification method. We measure realized gains or losses on equity investments as the difference between the net proceeds from the sale and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized. We measure realized gains or losses on debt investments as the difference between the net proceeds from the repayment or sale and the contractual amount owed to us on the investment, without regard to unrealized appreciation or depreciation previously recognized or unamortized deferred fees. Upon prepayment of debt investments, we recognize the acceleration of unamortized deferred fees as interest income and we recognize the collection of prepayment and other fees as other income.
 
69


We recognized $4.9 million and $2.4 million in net realized losses on our investments for the years ended December 31, 2020 and December 31, 2019, respectively. A summary of realized gains and losses for the years ended December 31, 2020 and December 31, 2019 is as follows:
 
Year Ended December 31,
20202019
CP Holding Co., Inc. (Junior Secured Term Loan)$(2,038,300)$— 
Dell International L.L.C. (Senior Secured Term Loan)— 6,151 
Deluxe Entertainment Services Group, Inc. (Senior Secured Term Loan)— (2,404,987)
Deluxe Entertainment Services Group, Inc. (Junior Secured Term Loan)(522,921)— 
Deluxe Entertainment Services Group, Inc. (Common Equity)(2,056,418)— 
Flight Lease VII, LLC (Common Equity Interest)(112,500)(271,811)
Flight Lease XII, LLC (Common Equity Interest)(231,411)— 
Flight Lease XIII, LLC (Common Equity Interest)— (23,680)
Fox Rent A Car, Inc. (Common Equity Warrants)15,994 239,743 
General Nutrition Centers, Inc. (Senior Secured Term Loan)(263,836)— 
Kleen-Tech Acquisition, LLC (Common Equity Warrants)440,117 — 
Mercury Network, LLC (Common Equity Units)— 69,981 
Northeast Metal Works LLC (Preferred Equity Interest)— 20,750 
Regional Engine Leasing, LLC (Residual Value)(102,421)— 
Surge Busy Bee Holdings, LLC (Class B Equity Warrants)(51,475)— 
     Net realized losses$(4,923,171)$(2,363,853)

Net Change in Unrealized Appreciation of Investments
 
Net change in unrealized appreciation or depreciation primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded appreciation or depreciation when gains or losses are realized.
 
Net change in unrealized appreciation on investments totaled $2.2 million for the year ended December 31, 2020 and net change in unrealized depreciation totaled $2.7 million for the year ended December 31, 2019. The change between years is primarily the result of exiting investments at losses during the year ended December 31, 2020.
 
Net Increase (Decrease) in Net Assets Resulting from Operations
 
The net decrease in net assets resulting from operations was $2.3 million for the year ended December 31, 2020 compared to a $1.2 million net decrease in net assets resulting from operations for the year ended December 31, 2019. The $1.1 million decrease between periods was a result of the factors discussed above. 
 
Financial Condition, Liquidity and Capital Resources
 
Cash Flows from Operating and Financing Activities
 
Our operating activities provided cash of $28.0 million for the year ended December 31, 2020 and used cash $23.2 million for the year ended December 31, 2019, primarily in connection with the payoffs and fundings of investments and receipt of interest payments from our portfolio companies. Our financing activities used cash of $10.4 million for the year ended December 31, 2020 and provided cash of $16.3 million for the year ended December 31, 2019, primarily in connection with borrowings and repayments on our Credit Facility, distributions paid to shareholders, and repurchases of our common stock.
 
Our liquidity and capital resources are derived from our Credit Facility, proceeds received from the offerings of our securities, such as the 2022 Notes in August 2017, cash flows from operations, including investment sales and repayments, and cash income earned. Our primary use of funds from operations includes investments in portfolio companies and other operating expenses we incur, as well as the payment of distributions to the holders of our common stock. We used, and expect to continue to use, these capital resources as well as proceeds from public and private offerings of securities to finance our investment
70


activities. To the extent the proposed Mergers do not close, we may amend or refinance our leverage facilities and borrowings, in order to, among other things, modify covenants or the interest rates payable and extend the reinvestment period or maturity date.
 
Although we have no current plans to raise capital, we may need to raise capital in the future and cannot assure you that we will be successful if we need to do so. In this regard, for so long as our common stock trades at a price below our net asset value per share, we will likely be limited in our ability to raise equity capital given that we cannot sell our common stock at a price below net asset value per share unless our stockholders approve such a sale and our board of directors makes certain determinations in connection therewith. For all of 2020 and 2019, our common stock traded at a discount to our then-current net asset value. If our common stock continues to trade at a discount to net asset value, we will be limited in our ability to raise equity capital unless we obtain the approval described above, which we have not previously requested from stockholders.
 
BDCs are generally required, upon issuing any senior securities, to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities, to total senior securities, which include all of the BDC's borrowings and any outstanding preferred stock, of at least 200%. However, the SBCAA, which was signed into law, in March 2018, among other things, amended Section 61(a) of the 1940 Act to add a new Section 61(a)(2) that reduces the asset coverage requirement applicable to BDCs from 200% to 150% so long as the BDC meets certain disclosure requirements and obtains certain approvals. On May 4, 2018, our board of directors unanimously approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, effective May 4, 2019, our applicable asset coverage ratio under the 1940 Act decreased to 150% from 200%. See "Risk Factors--Risks Relating to Our Business and Structure--Regulations governing our operations and capital structure affect (and could limit) our ability to raise, and the way in which we may raise, additional capital."

As of December 31, 2020, our aggregate indebtedness, including outstanding borrowings under our Credit Facility and the aggregate principal amount outstanding on our 2022 Notes, was $64.3 million, and our asset coverage, as defined in the 1940 Act, was 197%. As of December 31, 2019, our aggregate indebtedness, including outstanding borrowings under our Credit Facility and the aggregate principal amount outstanding on our 2022 Notes, was $72.5 million, and our asset coverage, as defined in the 1940 Act, was 192%. The amount of leverage that we employ as a BDC will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing.

As of December 31, 2020 and December 31, 2019, we had cash and restricted cash of $39.4 million and $21.8 million, respectively.
 
Credit Facility
 
On October 29, 2013, we entered into a Loan and Security Agreement (as amended, restated and modified from time to time, the "Loan and Security Agreement") with CapitalSource Bank (now Pacific Western Bank, following a merger), as agent and a lender, and each of the lenders from time to time party thereto, including City National Bank, to provide us with our $45.0 million Credit Facility. The Credit Facility is secured by all of our assets, including our equity interest in HCAP Equity Holdings, LLC and HCAP ICC, LLC.

As of December 31, 2020, advances under the Credit Facility bear interest at a rate per annum equal to the lesser of (i) the applicable LIBOR plus 4.50% (with a 1.00% LIBOR floor) and (ii) the maximum rate permitted under applicable law. During the revolving period, availability under the Credit Facility is determined by advance rates against eligible loans in the borrowing base up to a maximum aggregate availability of $44.3 million. Advance rates against individual investments range from 40% to 65% depending on the seniority of the investment in the borrowing base.
In addition, as of December 31, 2020, the Credit Facility included the following terms, among other things: (i) a revolving period scheduled to expire on January 31, 2021 (please see "Recent Developments" below for information regarding the extension of the revolving period to June 30, 2021); (ii) provides for a senior leverage ratio (the ratio of total borrowed money other than subordinated debt and unsecured longer-term indebtedness to equity) of 1-to-1; (iii) provides for a total leverage ratio (the ratio of total debt to equity) of 1.4-to-1 and a limit on our debt service coverage ratio of 1.25-to-1.00 as of the end of any quarter in the period beginning as of August 1, 2020 (which ratio was 1.40-to-1.00 as of the end of any quarter prior to August 1, 2020); (iv) additional advances requested under the Credit Facility will be made only at the discretion of the
71


lenders; (v) aggregate commitments under the Loan and Security Agreement are $45.0 million; (vi) a tangible net worth covenant that reflects a minimum amount equal to $58.0 million; (vii) an effective limitation on the aggregate value of eligible loans in the borrowing base to maximum of approximately $44.3 million; (viii) requires us to pay a monthly fee of 0.50% per annum for unused amounts during the revolving period, calculated based on the difference between (a) the maximum loan amount under the Loan and Security Agreement and (b) the average daily principal balance of the obligations outstanding during the prior calendar month; (iv) prohibits us from repurchasing shares of our common stock and declaring and paying any distribution or dividend until the termination of the Loan and Security Agreement, except, in the case of distributions and dividends, to the extent necessary for us to maintain our eligibility to qualify as a RIC under Subchapter M of the Code; (x) includes a minimum liquidity covenant threshold of least $2.2 million through termination of the Loan and Security Agreement; and (xi) permits the use of an Alternative Rate (as defined in the Loan and Security Agreement) in place of LIBOR if certain conditions are satisfied.
Beginning as of August 1, 2020, during the amortization period, we are required to pay down the principal amount outstanding under the Credit Facility on a monthly basis in equal installments during the relevant calendar quarter so that such outstanding amounts will be reduced by an amount equal to or greater than (i) $2.2 million for each of the first two full calendar quarters following July 31, 2020, (ii) $3.3 million for each of the succeeding two full calendar quarters and (iii) $4.3 million for each succeeding calendar quarter until termination of the Credit Facility, which is scheduled to mature on October 30, 2021. During the amortization period, 90% of all principal collections we receive from our portfolio companies must generally be paid to the lenders to pay down our obligations and other amounts outstanding under the Credit Facility. In addition, any proceeds we receive from the sale or issuance of our equity or debt securities during the amortization period must generally be applied to the prepayment of our obligations under the Credit Facility.
The Credit Facility contains additional customary terms and conditions, including, without limitation, affirmative and negative covenants, including, without limitation, information reporting requirements, a minimum debt-service coverage ratio, and maintenance of RIC and BDC status. The Credit Facility also contains customary events of default, including, without limitation, nonpayment, misrepresentation of representations and warranties in a material respect, breach of covenant, cross-default to other indebtedness, bankruptcy, change of control, and the occurrence of a material adverse effect. In addition, the Credit Facility provides that, upon the occurrence and during the continuation of any event of default, our administration agreement could be terminated and a backup administrator could be substituted by the agent.
The maturity date under the Credit Facility is the earlier of (x) October 30, 2021, or (y) the date that is six months prior to the maturity of any of our outstanding unsecured long-term indebtedness. Based on our outstanding 2022 Notes that mature on September 15, 2022, the maturity date under the Credit Facility is October 30, 2021. HCAP Equity Holdings, LLC became a co-borrower under the Credit Facility in August 2016, and HCAP ICC, LLC, became a borrower under the Credit Facility in November 2017.
As of December 31, 2020 and December 31, 2019, the outstanding balance on the $45.0 million Credit Facility was $35.6 million and $43.7 million, respectively.
2022 Notes