10-K 1 mcgc2014123110-k.htm 10-K MCGC 2014.12.31 10-K


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-K
(Mark One)
x    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2014
OR
¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
___________________
Commission file number 0-33377
MCG CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
 
54-1889518
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
1001 19th Street North, 10th Floor, Arlington, VA
 
22209
(Address of principal executive offices)
 
(Zip Code)
(703) 247-7500
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $0.01 per share
 
The NASDAQ Global Select 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  x
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  x
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  x   No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
o
Accelerated filer
x
Non-accelerated filer
o
Smaller reporting company
o
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x
The aggregate market value of the Registrant’s voting shares of common stock held by non-affiliates of the Registrant on June 30, 2014, was $208,493,565, based on $3.92 per share, the last reported sale price of the shares of common stock on the NASDAQ Global Select Market. For purposes of this computation, shares held by certain stockholders and by directors and executive officers of the Registrant have been excluded. Such exclusion of shares held by such persons is not intended, nor shall it be deemed, to be an admission that such persons are affiliates of the Registrant. There were 37,074,635 shares of the Registrant’s common stock outstanding as of February 23, 2014.
Documents Incorporated by Reference
Portions of the Registrant’s definitive Proxy Statement relating to its 2015 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission, are incorporated by reference into Part III of this Annual Report on Form 10-K as indicated herein.




TABLE OF CONTENTS
 
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 Consolidated 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.
Financial Statements and Supplementary Data
Item 9.
Changes in and Disagreements with Accountants 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 and Financial Statement Schedules
SIGNATURES




PART I
ITEM 1.
BUSINESS
General
We are a solutions-focused commercial finance company that provides capital and advisory services to lower middle-market companies throughout the United States. Generally, our portfolio companies use our capital investment to finance acquisitions, recapitalizations, buyouts, organic growth, working capital and other general corporate purposes.
We are an internally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. As a BDC we must meet various regulatory tests, which include investing at least 70% of our total assets in private or thinly traded public U.S.-based companies and limitations on our ability to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt generally may not exceed 50% of the value of our assets).
In addition, we have elected to be treated for federal income tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code. In order to continue to qualify as a RIC for federal income tax purposes and obtain favorable RIC tax treatment, we must meet certain requirements, including certain minimum distribution requirements. If we satisfy these requirements, we generally will not have to pay corporate-level taxes on any income we distribute to our stockholders as distributions, allowing us to substantially reduce or eliminate our corporate-level tax liability. From time to time, our wholly owned subsidiaries may execute transactions that trigger corporate-level tax liabilities. In such cases, we recognize a tax provision in the period when it becomes more likely than not that the taxable event will occur.
Corporate Structure
We make certain of our investments through wholly owned subsidiaries, all of which are structured as Delaware corporations and limited liability companies, to hold the assets of one or more of our portfolio companies. Some of these subsidiaries in turn have wholly owned subsidiaries, all of which are Delaware corporations that hold the assets of certain of our portfolio companies.
Company Background
We were incorporated in Delaware in 1998. On March 18, 1998, we changed our name from MCG, Inc. to MCG Credit Corporation and, on June 14, 2001, to MCG Capital Corporation. Our principal executive offices are located at 1001 19th Street North, 10th Floor, Arlington, VA 22209 and our telephone number is (703) 247-7500.
In this Annual Report on Form 10-K, the terms “Company,” “MCG,” “we,” “us” and “our” refer to MCG Capital Corporation and its wholly owned subsidiaries unless the context otherwise requires.
We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and, accordingly, file reports, proxy statements and other information with the Securities Exchange Commission, or the SEC. Such reports, proxy statements and other information can be read and copied at the public reference facilities maintained by the SEC at the Public Reference Room, 100 F Street, N.E., Washington, D.C. 20549. Information regarding the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a web site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC.
Our Internet address is www.mcgcapital.com. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available free of charge on our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
Our logo, trademarks and service marks are the property of MCG. Other trademarks or service marks appearing in this Annual Report on Form 10-K are the property of their respective holders.

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Significant Developments in 2014
Originations and Advances — For the three and twelve month periods ended December 31, 2014, we made $0.1 million and $10.0 million, respectively, in originations and advances to existing portfolio companies.
Loan Monetizations — For the three and twelve month periods ended December 31, 2014, we received $15.6 million and $265.4 million, respectively, in loan payoffs and amortization payments.
Equity Monetizations and Realizations — For the three and twelve month periods ended December 31, 2014, we received $5.7 million and $16.7 million, respectively, in proceeds from the sale of equity investments, principally the sale of securities in each of Accurate Group Holdings, Inc., C7 Data Centers, Inc., G&L Investment Holdings, LLC, Golden Knight II CLO, Ltd. and IDOC, LLC. With the exception of the publicly listed minority equity investment in Broadview Networks Holdings, Inc., in which we have a built-in capital tax loss of approximately $93 million, and the pending sale of our last control equity investment in RadioPharmacy Investors, LLC that we expect to close in March 2015, during the year ended December 31, 2014 we exited all of our equity positions.
Loans on Non-Accrual — As of December 31, 2014, we had no loans on non-accrual, at cost or fair value.
Reduced Leverage — As of December 31, 2014, we had no borrowings. During the twelve month period ended December 31, 2014, we (i) terminated our MCG Commercial Loan Trust 2006-1, or 2006-1 Trust; (ii) terminated our unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million, or the Bank of America Unsecured Revolver; (iii) prepaid in full the $150 million of small business investment company, or SBIC, debentures owed to the United States Small Business Administration, or SBA, by Solutions Capital I, L.P., or Solutions Capital and (iv) sold the remaining participating interest in our secured financing.
Open-Market Purchases of Our Stock — For the three and twelve month periods ended December 31, 2014, we repurchased 7,827,960 and 32,186,556 shares of our common stock at weighted average purchase prices of $3.74 and $3.73, respectively, including 4,859,744 shares purchased on December 10, 2014 in a modified "Dutch Auction" tender offer at $3.75 per share. In January 2015, we repurchased 1,061,075 shares of our common stock at a weighted average purchase price of $3.93, which we believe will contribute two cents per share in accretion to our net asset value in the first quarter of 2015. We acquired these shares from sellers in open market transactions or the modified "Dutch Auction" tender offer. We retired these shares upon settlement, thereby reducing the number of shares issued and outstanding.
Dividends — For the year ended December 31, 2014, we declared and paid $0.25 per share in dividends.
Operating Costs — For the three and twelve month periods ended December 31, 2014, our total operating costs were $3.0 million and $23.7 million, respectively. During the three month period ended December 31, 2014, we incurred $0.6 million in severance costs and $0.7 million in professional fees associated with the lawsuit against various defendants involved in our subordinated loan transaction with Color Star Growers of Colorado, Inc., or Color Star Litigation, all of which we included in general and administrative costs. During the twelve month period ended December 31, 2014, we incurred $1.3 million in salaries and benefits related to successful Solutions Capital investment exits and $1.1 million in amortization of employee restricted stock awards that accelerated upon termination of former employees, all of which we included in employee compensation. In addition, during the twelve month period ended December 31, 2014, we incurred $3.4 million in severance payments, $2.3 million in Color Star Litigation costs and $0.3 million in contractual payments due our former CEO tied to successful Solutions Capital investment exits, all of which we included in general and administrative costs.
Outlook
We continue to believe that current market conditions in our primary lending markets are consistent with a peak of a credit cycle. We believe that we have successfully monetized investments, some of which were challenging, into a very liquid market, improving the quality of our assets and our cash position and resulting in a stronger balance sheet. We also elected to use excess cash to repay all of our outstanding debt and to repurchase our stock in the open market, including a modified "Dutch Auction" tender offer in December 2014. As a result of these capital allocation decisions, we have meaningfully reduced the size of our balance sheet and our net earning assets.
In January 2015, we entered into a merger agreement to sell our largest equity investment, Pharmalogic Holdings Corp., a subsidiary of RadioPharmacy Investors, LLC. The merger agreement contains customary representations

2



and warranties of Pharmalogic Holdings Corp. and RadioPharmacy Investors, LLC as well as covenants of Pharmalogic Holdings Corp. to conduct its business in a commercially reasonable manner consistent with past practices. The transaction is subject to customary closing conditions including receipt of certain regulatory approvals. In connection with the sale transaction, we committed to amend and restate our existing senior debt to provide $17.5 million of first lien financing at 8.5% to support the sale transaction. We expect this transaction to close by March 31, 2015. Upon consummation of the transaction, we will have exited all of our control investments. See Note 13—Significant Subsidiary in Item 8. Financial Statements and Supplementary Data.
Though we continue to take steps to rationalize our cost infrastructure and to strengthen our balance sheet, our primary asset is unencumbered cash and we do not have sufficient net earning assets to generate positive net operating income at this time.
Based on a thorough business review, on February 9, 2015, our board of directors announced its intention to explore strategic alternatives for the Company to maximize value for stockholders, including a possible sale of the Company. We may receive offers or engage in a transaction in the ordinary course which may ultimately result in a sale of any or all of our assets, above or below the fair value on our balance sheet at that time. We may also consider a variety of extraordinary transactions, such as a sale of the Company, a restructuring, a recapitalization, a merger, a consolidation, a business combination, a special dividend to stockholders, a liquidation or other transaction or series of transactions. No timetable has been set for the Company's process and we do not expect to comment further or update the market with any additional information on the process unless and until the board of directors approves a specific transaction or otherwise deems disclosure appropriate or necessary.
There can be no assurance that this strategic alternatives review will result in the Company changing its current business plan, pursuing a particular transaction, completing any such transaction, or that any transaction we might enter will prove to be beneficial to our stockholders. Further, it is not certain what impact any potential strategic alternatives, or a decision not to pursue any potential strategic alternatives, may have on the Company's stock price, operating results, business or financial condition, liquidity, or business prospects.
MCG’s Investment Portfolio
As of December 31, 2014, the majority of our investment portfolio consists of loans to lower middle-market companies that generate annual revenue of less than $200 million and earnings before interest, taxes, depreciation and amortization, or EBITDA, in the range of $3-$15 million. Generally, our portfolio companies use our capital investments to finance acquisitions, recapitalizations and buyouts, as well as for organic growth and working capital. We identify and source new portfolio companies through multiple channels, including private equity sponsors, investment bankers, brokers, fund-less sponsors, institutional syndication partners, owner operators, and other club lenders that facilitate peer-to-peer loans. We generally invest in some combination of senior debt, second-lien debt, secured and unsecured subordinated debt and equity.

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As of December 31, 2014, we had debt and equity investments in seven portfolio companies with a combined fair value of $75.3 million. The following table summarizes the fair value and revenue contributions of our current investments.
(dollars in thousands)
 
 
Interest Rate
As of December 31, 2014
Year ended December 31, 2014
Portfolio Company
Industry
Investment
Current
PIK
Total
Fair Value
% of
Portfolio
Revenues
% of Total
Revenues
 
 
 
 
 
 
 
 
 
 
RadioPharmacy
Investors, LLC
Healthcare
Senior Debt
9.5
%

9.5
%
$
17,192

22.8
%
$
2,100

7.8
%
 
Preferred LLC Interest






12,044

16.0
%

%
 
 
 
 
 
 
29,236

38.8
%
2,100

7.8
%
C7 Data Centers, Inc.
Business Services
Senior Debt
9.5
%

9.5
%
14,172

18.8
%
2,024

7.6
%
GMC Television Broadcasting, LLC
Broadcasting
Senior Debt
4.3
%

4.3
%
9,198

12.2
%
574

2.1
%
South Bay Mental Health Center, Inc.
Healthcare
Subordinated Debt
12.0
%
2.5
%
14.5
%
8,926

11.8
%
1,643

6.1
%
Industrial Safety Technologies, LLC
Manufacturing
Subordinated Debt
9.5
%
2.0
%
11.5
%
7,130

9.5
%
1,164

4.3
%
Intrafusion Holding Corp.
Healthcare
Subordinated Debt
13.6
%

13.6
%
6,404

8.5
%
1,401

5.2
%
Broadview Networks Holdings, Inc.
Communications
Common Stock






266

0.4
%

%
 
Warrants







%

%
 
 
 
 
 
 
266

0.4
%

%
Total
 
 
 
 
 
$
75,332

100.0
%
$
8,906

33.1
%
In addition to our portfolio investments, as of December 31, 2014, we had cash and cash equivalents of $105.8 million, or 57.6% of our total assets.
The following table summarizes the composition of our investment portfolio as of December 31, 2014 and 2013 at fair value:
 
December 31, 2014
December 31, 2013
(dollars in thousands)
Investments at
Fair Value
Percent of
Total Portfolio
Investments at
Fair Value
Percent of
Total Portfolio
Debt investments
 
 
 
 
Senior secured debt
$
40,562

53.8
%
$
185,524

50.3
%
Subordinated debt
 
 
 
 
Secured
22,460

29.8

108,338

29.4

Unsecured


42,452

11.5

Total debt investments
63,022

83.6

336,314

91.2

Equity investments
 
 
 
 
Preferred equity
12,044

16.0

28,390

7.7

Common/common equivalents equity
266

0.4

4,169

1.1

Total equity investments
12,310

16.4

32,559

8.8

Total investments
$
75,332

100.0
%
$
368,873

100.0
%
Our debt instruments bear contractual interest rates ranging from 4.3% to 14.5%, a portion of which may be deferred. As of December 31, 2014, approximately 85.8% of the fair value of our loan portfolio had variable interest rates, based on either the London Interbank Offer Rate, or LIBOR, or the prime rate, and 14.2% of the fair value of our loan portfolio had fixed interest rates. As of December 31, 2014, approximately 59.9% of the fair value of our loan portfolio had LIBOR floors between 1.5% and 2.0% on a LIBOR-based index or prime floors between 2.75% and 4.50%. At origination, our loans generally have four- to six-year stated maturities. Borrowers typically pay an origination fee based on a percent of the total commitment and a fee on undrawn commitments.
From time to time, we make equity investments in companies in which we have also made debt investments. Our equity investments include preferred stock, common stock and warrants and, in many cases, board observation rights. We may invest across the capital structure of our portfolio companies using a combination of debt and equity investments to meet our portfolio companies’ needs and achieve favorable risk-adjusted returns.
As of December 31, 2014, our control companies comprised 38.8% of the fair value of our portfolio and contributed 9.5% of our total revenues during 2014. In January 2015, we entered into a merger agreement to sell our largest equity investment, Pharmalogic Holdings Corp., a subsidiary of RadioPharmacy Investors, LLC. We expect this

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transaction to close by March 31, 2015. Upon consummation of this transaction, we will have exited all of our control investments.
Competition
We compete with many types of investors for the portfolio companies in which we invest, including 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 or hedge funds. As a result of these entrants, competition for investment opportunities has intensified in recent years and may intensify further in the future. A majority of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. Some may also have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments that may lead to additional market share and a competitive advantage over us. Unlike many of our competitors, we are also subject to regulatory restrictions and valuation requirements the 1940 Act imposes on us as a BDC.
The myriad competitive pressures we face require our management team to develop and maintain strong relationships with intermediaries, financial institutions, investment bankers, commercial bankers, financial advisors, attorneys, accountants, consultants and other individuals within our network in order to keep apprised of potential investment opportunities. We have experienced significant executive turnover and staff reductions while we monetized a majority our investments and repurchased our stock in the open market, which we believe has negatively impacted our ability to remain active investors with current or prospective clients. If our management team fails to maintain its existing relationships or develop new ones with important sources of investment opportunities, we may fail to remain competitive for new business or to generate positive net operating income and our investment portfolio may languish as a result. Regardless of the strength of relationships, no one is obligated to provide us with investment opportunities, and there is no assurance that such relationships will generate investment opportunities for us.
While we do not seek to compete primarily based on the interest rates we offer, we may lose investment opportunities if we do not match our competitors' pricing, terms and structure. If we do match our competitors' pricing, terms and structure to win business, we may then experience a decrease in investment income resulting from lower net earning assets. We may be precluded from taking advantage of attractive investment opportunities from time to time as a result of an inability to meet market terms, and we can offer no assurance that we will be able to identify and successfully make investments that are consistent with our investment objective. Failure to compete effectively for, and establish strong relationships that could lead to, new business would have a material adverse effect on our business, financial condition and results of operations.
Life Cycle of Debt and Equity Originations
The key aspects of our portfolio origination, servicing and monitoring process are set forth below. For each investment, we continue to evaluate investment risks and exposure relative to the amount of our total assets and net asset value, or NAV, and make adjustments as we deem prudent. Generally, we intend to keep the amount of our investment in any one company at or below $15 million, which we may accomplish by selling a portion of our initial investment to another investor post-close. We generally make loans with four- to six-year stated maturities. We believe the market-average hold period of a loan is approximately three years, although that figure has declined. Our equity investments generally do not have maturity dates.
INVESTMENT OBJECTIVE AND STRATEGIES
Our investment objective is to achieve attractive returns by generating current income and capital gains on our investments. We seek to increase our earnings and NAV by investing principally in debt or equity securities of lower middle-market companies or syndicated loans. We intend to earn interest, dividends and fees on our investments and we may report unrealized appreciation and depreciation as the fair value of our investments periodically increases or decreases. We realize capital gains or losses when the investment is eventually monetized.
The cost basis of our investments include unamortized original issue discount, premiums and fees, as well as payment-in-kind, or PIK, interest and dividends that are generally due at maturity or upon our exit from the investment.

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When we originate debt and equity investments, we strive to achieve favorable risk-adjusted rates of return in the form of current income and capital gains, while maintaining credit and investment quality in our portfolio. Before making investments, we apply well established credit processes to assess investment risk and we structure and price our investments accordingly. We have developed proprietary analytics, data and knowledge to support our business activities. We designed our investment process to achieve the following strategic objectives:
generate favorable risk-adjusted rates of return by delivering capital and strategic insight to increase our portfolio companies’ enterprise value;
maintain sound credit and investment discipline and pricing practices, regardless of market conditions, to avoid adverse investment selection; and
manage risk by utilizing an integrated team approach to business development, underwriting and investment management.
We maintain a flexible approach to funding that permits us to adjust price, maturity and other transaction terms to accommodate the needs of our portfolio companies.
ORGANIZATION OF MCG’S INVESTMENT PROFESSIONALS
Our organization includes experienced professionals who originate, underwrite, finance, syndicate, monitor and monetize investments. Our professional staff also provides accounting, finance, human resources, investor relations, legal, compliance and corporate governance functions critical to our business. As of December 31, 2014, we have six full time employees serving cross-functional roles in support of our business. The following bullets describe the key functional teams that are responsible for our investment processes:
Investment ManagementOur investment professionals are responsible for identifying and performing a financial and risk analysis of potential investment opportunities. They also underwrite and manage our investment portfolio and lead any work-out or restructuring that may occur from time to time. After an investment is approved and funded, a cross-functional team manages and monitors the performance of our investments.
Credit Committee—Prospective investments are presented to MCG's credit committee for review and approval prior to issuing a term sheet. Final approval by the credit committee generally occurs after the deal team has substantially completed the underwriting process. The credit committee includes our Chief Executive Officer and General Counsel. Our board of directors has delegated authority to the credit committee to (i) originate, underwrite and fund any non-control, non-distressed investment of $15 million or less provided that the equity component does not exceed $3 million, (ii) originate any distressed investment of $5 million or less and (iii) increase any existing investment previously approved by the Company's investment and valuation committee up to a certain over-line or established amount. As a matter of practice, our board of directors is invited to participate at every credit committee meeting and in the review and approval of all investments, irrespective of investment size.
Investment and Valuation Committee of the Board of DirectorsThe investment and valuation committee reviews and approves all investments over $15 million and has the discretion to review and approve other investments. Subsequent to the review and funding of an investment, the investment and valuation committee makes recommendations that are used by our board of directors for its quarterly determination of the fair value of our investment portfolio.
BUSINESS DEVELOPMENT
MCG and its predecessors have been active investors in lower middle-market companies since 1990. We believe our experience in lower middle-market investing is a meaningful competitive advantage that we use to operate our business. Our senior investment professionals and members of our credit committee have extensive experience investing in lower middle-market companies and in industries that we target, such as healthcare, business services, technology, software, information services and consumer directed businesses.
Our investment professionals identify and source new investments through multiple channels, including private equity sponsors, investment bankers, brokers, fund-less sponsors, institutional syndication partners, other club lenders and owner-operators. Our investment professionals also market to prospective portfolio companies identified through past relationships with executives, information gathered through proprietary and public research and relationships with accountants, lawyers and other professionals.

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Once we identify a prospective portfolio company, we review its financial reports, business plan, corporate activities and other relevant information gathered from third-party databases, industry reports and publications. We focus on a company’s fundamental performance against industry conditions and operational benchmarks, and evaluate acceptable risks and returns. We work with our current and prospective portfolio companies to understand their business, as well as the costs and benefits of their corporate development initiatives, opportunities and competition. Our detailed analysis allows us to support our portfolio companies’ corporate development decisions, even in some cases where short-term financial ratios or other metrics may decline temporarily.
RISK ANALYSIS
After identifying a prospective investment, we review the company’s operating history, executive leadership team, opportunities and the market for the company's products and services during the life of our investment, as well as the potential risks and threats to the business or the markets in which it competes. As early as possible in the process, we generally conduct on-site meetings with key executives to learn more about the investment directly from the company's leadership team and tour the company's key facilities or operating locations.
To assess the validity and stability of the company's historical and projected financial performance we often, either ourselves or through a third-party firm, perform a review of quality of earnings. For select transactions, we may engage or rely on the research of industry specific due diligence firms that provide market research or insights that we judge as prudent or helpful in in the underwriting process.
Based on our experience, we also look at the company's capitalization, proposed sources and uses of proceeds, structural considerations of various securities in the capital structure, leverage, expected cash generation, affirmative and negative covenants, methods for repayment or exit from the investment and other important considerations specific to the investment.
In particular, we analyze certain key risks in light of our underwriting criteria, including financial characteristics and portfolio-specific risk that might arise from the new investment, including, but not limited to, the following:
Industry Risks—maturity, cyclicality and seasonality associated with the industries in which we invest, as well as the proportion of our portfolio that is invested in specific industries and individual portfolio companies;
Competitive Risksstrengths and weaknesses of the prospective portfolio company relative to their competitors’ pricing, product quality, customer loyalty, substitution and switching costs, brand positioning and capitalization. We also assess the defensibility of a prospect’s market position and its opportunity for increasing market share;
Management Riskstrack records, industry experience, turnover in leadership, concentration of knowledge, the prospective portfolio company’s business plan and management incentives;
Regulatory Risks—industry specific regulation and regulation reform (e.g., healthcare reform, increased regulatory oversight, government reimbursement of for-profit schools, etc.), and economic or macro issues that may affect an investment (e.g., cost of utilities or access to power at historical rates in certain regions, access to nuclear materials for medical imaging, etc.), as well as regulations that may change the incentives of partners or investors in the investment (e.g., tax reform that may impact private equity funds or hedge funds, regulations of commercial banks, and potential reforms of BDCs);
Customer Concentration and Market Riskssustainability, stability and opportunities for the growth of the prospective portfolio company's customer base, including the number and size of its customers, attrition rates and dependence on one or a limited number of customers; and
Technology Risksimpact of technological advances in the industries and portfolio companies in which we may invest.
In addition, we evaluate industry-specific comparisons, such as cash flow margins, product and cash flow diversification, revenue growth rates, cost structure and other operating benchmarks that are derived from historical and projected financial statements. Qualitative attributes we evaluate may include management skill and depth, industry risk, substitution risk, sensitivity to economic cycles, cyclicality, geographic diversification, facilities infrastructure, administration requirements and product quality and ranking.
We have developed a series of valuation techniques to assist us in determining the risk of a potential investment and quantifying its underlying value. Analyses of comparative public and private market transactions and other data form the basis of our enterprise valuations, along with current and projected market conditions. We also look to comparable public companies to benchmark the value of the proposed investment using public market data. Using these methods

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provides multiple views of the value of the enterprise allowing us to calculate certain metrics used in both risk assessment and product pricing, such as loan-to-value ratios for our debt investments.
UNDERWRITING AND RISK MANAGEMENT
We initiate our underwriting process in tandem with the business development process, focusing on investment risk analysis. We perform standard due diligence on a prospective portfolio company’s financial performance, as well as customized analyses of its operations, systems, accounting policies, human resources and competitive, legal and regulatory environments.
In addition to gaining an in-depth understanding of a prospective portfolio company, our research and due diligence process evaluates industry-wide operational, strategic and valuation issues. We also examine emerging trends and competitive threats to the portfolio company, as well as the industry in which it operates. Portfolio companies may later draw on our valuable knowledge and insight obtained through our research to refine their strategic plans, identify acquisition opportunities and set appropriate financial and operational goals.
When presenting a prospective investment to our credit committee for approval, our investment professionals deliver a detailed investment memorandum. Should the dollar amount of the proposed investment exceed certain pre-defined thresholds, or include a significant investment in equity, the investment memorandum is also submitted to the investment and valuation committee of our board of directors for review and approval. The investment memorandum generally consists of the following:
a transaction overview, including a description of the business and the investment opportunity;
transaction rationale, underwriting considerations and an assessment of risks and mitigants;
historical financial analyses, projections and scenario modeling;
a service or product overview, customer and industry analyses, operational and regulatory analyses;
an assessment of the company's enterprise valuation relative to comparable public and private companies;
a description of the capital structure and the investment risk and return characteristics; and
a review of insights or reports obtained from third-party experts or due diligence firms.
INVESTMENT STRUCTURE
We evaluate our portfolio companies’ needs to develop investment structures that meet their capital requirements and business plans while protecting our own capital, with an expectation toward generating risk-adjusted returns through current income on our loans and capital gains on our equity investments. We structure our debt investments to mitigate risk by requiring appropriate financial and collateral coverage thresholds. To create the most effective and responsive deal structures, we consider payment priority, collateral or asset value, and financial support from guarantors and other credit enhancements. Since our investments typically include cash-flow loans, rather than asset-backed loans, we factor the enterprise value of the prospective portfolio company’s assets into our credit decisions. For loans classified as senior secured, second-lien and subordinated secured, we receive a security interest in all or a portion of the portfolio companies’ tangible and intangible assets, entitling us to a preferred position relative to both unsecured creditors and more junior lenders on the proceeds of those assets in the event of liquidation. In addition, our loan documents generally include affirmative covenants that require our portfolio companies to provide periodic financial information, notification of material events and compliance with laws, as well as restrictive covenants that prevent the portfolio company from taking a range of significant actions, such as incurring additional indebtedness or making acquisitions. Financial covenants require the portfolio companies to maintain or achieve specified financial ratios, such as cash flow leverage, interest charge coverage, total charge coverage, and, in certain cases, meet specific operational benchmarks.
Our business strategy dictates that we generally invest in some combination of the following securities:
Senior Secured Debt—We provide cash flow based senior secured debt in the form of revolving credit facilities as well as amortizing term loans, bullet maturity term loans and uni-tranche loans that blend characteristics of both senior and subordinated financing. Senior secured debt ranks senior in priority of payment to other debt and equity, and benefits from a first priority security interest in the assets of the borrower that serve as collateral for the loan(s). As such, virtually all other creditors rank junior to senior secured debt in the event of insolvency. Some of our borrowers grant a first lien on working capital collateral (i.e., receivables) to asset-based lenders that is outside of our collateral pool. Assuming we have a first lien on all other collateral, in such cases we would still classify our security as senior secured. Due to its lower risk profile and often more restrictive covenants as compared to other debt, senior secured debt generally earns a lower return.

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Second-Lien Debt—We provide second-lien term loans on a sole-source or participant basis where assets or enterprise-value based borrowing capacity is not readily available within typical senior debt leverage constraints. Second-lien debt ranks senior in priority of payment to subordinated debt, unsecured debt, select junior securities, and equity. While second lien debt benefits from a collateral interest in the assets of the borrower, its liens are subordinated to those of senior secured debt in a liquidation. As such, senior secured creditors rank ahead of second lien creditors in the event of insolvency with respect to pursuing remedies against the collateral of a portfolio company, and receiving the proceeds thereof. Due to its higher risk profile and often less restrictive covenants as compared to senior debt, second-lien debt generally earns a higher return than senior debt. We classify second-lien term loans as "Subordinated Secured" debt in our consolidated financial statements.
Secured and Unsecured Subordinated Debt—We invest in secured and unsecured subordinated debt, which may be structured with a combination of current interest, deferred interest and equity-linked components. Payment of all subordinated debt, whether secured or unsecured, ranks behind payment of senior secured and second-lien debt. While the security interest of subordinated secured debt ranks behind that of the senior secured and second-lien debt, subordinated unsecured debt enjoys no security interest in the borrower's assets. In the event of insolvency, senior secured and second-lien creditors will be paid in full before the subordinated secured and subordinated unsecured creditors. Due to its higher risk profile and often less restrictive covenants as compared to other types of loans, subordinated debt generally earns a higher return than other debt.
Equity—We principally invest in equity securities of private companies or collateralized loan structures. From time to time we may invest in equity securities of public companies. In addition, we may receive warrants to purchase preferred or common stock of a portfolio company that are related to our debt investments in such portfolio company. Preferred stock ranks senior to common stock, and often carries the right to receive a preferential return upon the sale of the company.
To protect our investments and maximize our returns, we negotiate carefully the structure of each debt and equity security in our investment portfolio, and may require board observation rights as part of our initial investment to keep abreast of company matters. Our loan and equity documentation generally includes terms governing interest rate, amortization, prepayment premiums, financial covenants, operating covenants, ownership and corporate governance parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. In some cases, our loan agreements also allow for interest rate increases and decreases to the extent the portfolio company's financial or operational performance varies materially from the portfolio company's business plan.
In addition to capital, we also offer managerial assistance to our portfolio companies. Typically, this assistance involves strategic advice, evaluation of business plans, financial modeling assistance and industry research and expertise. Providing assistance to our portfolio companies enables us to maximize our value proposition for our portfolio companies, which, in turn, helps maximize our investment returns.
INVESTMENT APPROVAL PROCESS
Our investment approval process begins with an initial screening of a business plan or financing solicitation by one of our investment professionals to assess eligibility, sector, risk profile, investment fit and expected returns. Our investment professionals meet regularly with the members of our credit committee to discuss new opportunities. Simultaneously, a non-binding indication of interest may also be executed in support of a private equity firm issuing a bid for the transaction. Deals are judged by, among other things, a prospect's revenue run rate, continuity of solid cash flow, percentage of recurring revenue, gross profit margin, bad debt as a percentage of revenue, customer renewal rate, the prospect's marketing niche, level of competition, customer base quality and concentration and strength of the management team.
The credit committee determines whether the investment should be pursued, giving consideration to the risk return profile, industry concentrations and general economic outlook for the sector in which the business operates. In these meetings the credit committee also offers insight into key issues that must be resolved before a potential investment is funded. If the credit committee agrees to move forward with an investment, the terms are documented initially by a signed term sheet or letter of intent, as applicable, consistent with the pipeline report and committee clearance, and the deal proceeds to the documentation stage. The term sheet establishes the terms and conditions under which we propose to enter into a credit or investment relationship.
Generally, our underwriting process begins after our investment professionals receive a signed term sheet or letter of intent. The assigned investment professional is responsible for oversight and completion of comprehensive due diligence, and is expected to investigate and report on all critical aspects of the proposed investment. Our due diligence

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often includes review of financial statements, discussion with key members of management, review of material contracts, background checks, reviews of customer and vendor relationships, confirmation of historical results and assumptions underlying forecasted results. When necessary or advisable based on industry or the history of the prospect itself, third party diligence is conducted. The underwriting process includes legal and business due diligence and typically an on-site visit with the prospect company, including its management team and any other key employees.
Once the underwriting process is complete, the investment professional responsible for the deal presents a credit approval memorandum, including detailed findings of the foregoing underwriting process, to the credit committee and, if required, the investment and valuation committee. If approved, the deal proceeds to final documentation and closure. All of our investments are approved by our credit committee. In addition, investments of over $15 million must also be approved by the investment and valuation committee of our board of directors.
INVESTMENT FUNDING
We fund our investments using cash from our balance sheet. As a BDC, we are subject to certain restrictions on incurring debt. For example, we are not permitted to incur indebtedness unless immediately after such borrowing we meet a coverage ratio of total assets to total senior securities (which include all of our borrowings and any preferred stock we have then issued) of at least 200%.
INVESTMENT MONITORING AND RESTRUCTURING
We monitor the status and financial performance of each company in our portfolio in order to evaluate overall portfolio quality and to facilitate quarterly valuations, which are approved by our board of directors. We are proactive in advising and communicating with companies that are underperforming and, in many instances, have added stricter covenant protection and rights over time. During the process of monitoring a loan in default, if required or necessary to protect our security interest, we will send a notice of non-compliance outlining the specific defaults that have occurred and preserving our contractual rights and remedies, followed by a review of the collateral, if any.
When our attempts to collect past due principal and/or interest on a loan are unsuccessful, we analyze the appropriate course of action. In some cases, we may consider restructuring the investment to better reflect the current financial performance of the portfolio company. We may need to extend liquidity to companies from time to time as part of a restructuring. Such a restructuring may, among other things, involve deferring principal and interest payments, adjusting interest rates or warrant positions, imposing additional fees, amending financial or operating covenants or converting debt to equity. In connection with a restructuring, we generally receive compensation from the portfolio company. When a restructuring is not an appropriate course of additional action, we generally pursue remedies available to us to minimize potential losses, including initiating foreclosure, liquidation proceedings or selling the loan.
When one of our loans becomes more than 90 days past due, or if we otherwise do not expect the portfolio company to be able to service its debt and other obligations, we will, as a general matter, place all or a portion of the loan on non-accrual status and cease recognizing interest income on that loan until all principal and interest has been brought current through payment or restructuring such that the interest income is deemed to be collectible. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. If the fair value of a loan is below cost, we may cease recognizing PIK interest and/or the accretion of a discount on the debt investment until such time that the fair value equals or exceeds cost.
INVESTMENT POLICIES
Our investment policies provide that we will not:
act as an underwriter of securities of other issuers, except to the extent that we may be deemed an “underwriter” of securities (i) purchased by us that must be registered under the Securities Act of 1933, as amended, before they may be offered or sold to the public, or (ii) in connection with offerings of securities by our portfolio companies;
sell securities short in an uncovered position;
write or buy uncovered put or call options, except to the extent of options, warrants or conversion privileges in connection with our loans or other investments, and rights to require the issuers of such investments or their affiliates to repurchase them under certain circumstances;
engage in the purchase or sale of commodities or commodity contracts, including futures contracts, except for the purpose of hedging in the ordinary course of business or where necessary in working out distressed loan or investment situations; or

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acquire more than 3% of the voting stock of, or invest more than 5% of our total assets in any securities issued by, any other investment company, except if we acquire them as part of a merger, consolidation or acquisition of assets or if they result from a sale of a portfolio company, or otherwise as permitted under the 1940 Act.
All of the above policies and the investment and lending guidelines set by our board of directors or any committees, including our investment objective to achieve current income and capital gains, are not “fundamental” as defined under the 1940 Act. Therefore, our board may change them without notice to, or approval by, our stockholders.
Other than the restrictions pertaining to the issuance of senior securities under the 1940 Act, the percentage restrictions on investments generally apply on the effective date of the transaction. A subsequent change in a percentage resulting from market fluctuations or any cause other than an action by us will not require us to dispose of portfolio securities or to take other action to satisfy the percentage restriction.
We intend to conduct our business so as to retain our status as a BDC. As such, we may not acquire any assets, other than non-investment assets necessary and appropriate to our operations as a BDC, if after giving effect to such acquisition the value of our “qualifying assets” is less than 70% of the value of our total assets.
Investment Adviser
We have no investment adviser and are internally managed by our executive officers under the supervision of the board of directors. Our investment decisions are made by our officers, directors and senior investment professionals who serve on our credit and investment and valuation committees. None of our executive officers or other employees has the unilateral authority to approve any investment.
Regulation
INVESTMENT COMPANY ACT OF 1940
As a BDC, we are regulated under the 1940 Act. The BDC structure provides stockholders the ability to retain the liquidity of a publicly traded stock, while sharing in the possible benefits, if any, of investing in primarily privately owned companies.
In part, the 1940 Act requires us to be organized in the United States for the purpose of investing in, or lending to, primarily private companies and making managerial assistance available to them. As a BDC we may use capital provided by public stockholders and from other sources to invest in long-term, private investments in businesses.
We may not, however, change the nature of our business so as to cease to be, or withdraw our election as, a BDC unless authorized by vote of a majority of our outstanding voting securities. The 1940 Act defines a majority of the outstanding voting securities 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 or represented by proxy; or
ii.
more than 50% of the outstanding shares of such company.
We currently do not anticipate any substantial change in the nature of our business.
Qualifying Assets
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) below. Thus, under the 1940 Act, we may not acquire any asset other than those 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 the following:
1.
Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions):
a.
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 that:
i.
is organized under the laws of, and has its principal place of business in, the United States;

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ii.
is not an investment company (other than a small business investment company wholly owned by us) or a company that would be an investment company but for certain exclusions under the 1940 Act; and
iii.
does not have any class of securities listed on a national securities exchange;
b.
is a company that meets the requirements of (a)(i) and (ii) above, but is not an eligible portfolio company because it has issued a class of securities on a national securities exchange, if:
i.
at the time of the purchase, we own at least 50% of the (x) greatest number of equity securities of such issuer and securities convertible into or exchangeable for such securities; and (y) the greatest amount of debt securities of such issuer, held by us at any point in time during the period when such issuer was an eligible portfolio company; and
ii.
we are one of the 20 largest holders of record of such issuer’s outstanding voting securities; or
c.
is a company that meets the requirements of (a)(i) and (ii) above, but is not an eligible portfolio company because it has issued a class of securities on a national securities exchange, if the aggregate market value of such company’s outstanding voting and non-voting common equity is less than $250.0 million.
2.
Securities of any eligible portfolio company that we control.
3.
Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident thereto, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.
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 in (1) through (4) above, or pursuant to the exercise of warrants or rights relating to such securities.
6.
Cash, cash items, U.S. Government securities or high-quality debt securities maturing in one year or less from the time of investment.
Control, as defined by the 1940 Act, is presumed to exist where a BDC beneficially owns more than 25% of the outstanding voting securities of the portfolio company. For the foreseeable future, we do not expect to add new control positions to our portfolio.
Significant Managerial Assistance
In order to count portfolio securities as qualifying assets for the purpose of the 70% test discussed above, we must either control the issuer of the securities or offer to make available significant managerial assistance; except that, where we act together to purchase such securities in conjunction with one or more other persons, one of the other persons in the group may make available such managerial assistance. Making available significant managerial assistance means, among other things, to offer to provide and, if accepted, provide significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company through monitoring of its operations, selective participation in board and management meetings, consulting with and advising its officers and directors or other organizational or financial guidance.
Warrants and Options
Under the 1940 Act, we are subject to restrictions on the amount of warrants, options, restricted stock or rights to purchase shares of capital stock that we may have outstanding at any time. In particular, the amount of capital stock that would result from the conversion or exercise of all outstanding warrants, options or rights to purchase capital stock cannot exceed 25% of our total outstanding shares of capital stock. This amount is reduced to 20% of our total outstanding shares of capital stock if the amount of warrants, options or rights issued pursuant to an executive compensation plan would exceed 15% of our total outstanding shares of capital stock. We have received exemptive relief from the SEC permitting us to issue restricted stock to our employees and directors subject to the above conditions, among others. See Regulation—Exemptive and Other Relief.

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Indebtedness and Senior Securities
We will be permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, we may not be permitted to declare any cash dividend or other distribution on our outstanding common shares, or purchase any such shares, unless, at the time of such declaration or purchase, we have asset coverage of at least 200% after deducting the amount of such dividend, distribution, or purchase price. We may also borrow amounts up to 5% of the value of our total assets for temporary or emergency purposes.
Capital Structure
As a BDC, we generally cannot issue and sell our common stock at a price below the current NAV per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the current NAV of our common stock in a rights offering to our stockholders if: 1) our board of directors determines that such sale is in the best interests of the Company and our stockholders; 2) our stockholders approve the sale of our common stock at a price that is less than the current NAV; and 3) the price at which our common stock is to be issued and sold is not less than a price that, in the determination of our board of directors, closely approximates the market value of such securities (less any sales load).
We may also be prohibited under the 1940 Act from participating in certain transactions with our affiliates without the prior approval of our directors who are not interested persons and, in some cases, prior approval by the SEC.
We do not intend to acquire securities issued by any investment company that exceed the limits imposed by the 1940 Act. Under these limits, we generally cannot acquire more than 3% of the voting stock of any registered investment company (as defined in the 1940 Act), invest more than 5% of the value of our total assets in the securities of one such investment company or invest more than 10% of the value of our total assets in the securities of such investment companies in the aggregate.
1940 Act Code of Ethics
We have adopted and will maintain a code of ethics that establishes procedures for personal investments and restricts certain personal securities transactions by our officers and directors. Personnel subject to the code may invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with the code’s requirements. Our Amended and Restated Code of Ethics, or 1940 Act Code of Ethics, will generally not permit investments by our employees in securities that may be purchased or held by us. We may be prohibited under the 1940 Act from conducting certain transactions with our affiliates without the prior approval of our directors who are not interested persons and, in some cases, the prior approval of the SEC.
A copy of our 1940 Act Code of Ethics is available on our website at www.mcgcapital.com. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Form 10-K. In addition, you may read and copy the 1940 Act Code of Ethics at the SEC’s Public Reference Room in Washington, D.C. You may obtain information on the operation of the Public Reference Room by calling the SEC at (202) 551-8090. In addition, the 1940 Act Code of Ethics attached as an exhibit to our registration statement and is available on the EDGAR Database on the SEC’s Internet site at http://www.sec.gov. You may also obtain copies of the 1940 Act Code of Ethics, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the SEC’s Public Reference Section, 100 F Street, N.E., Washington, D.C. 20549.
PRIVACY PRINCIPLES
We are committed to maintaining the privacy of our stockholders and safeguarding their 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, except as permitted by law or as is necessary in order to service stockholder accounts (for example, to a transfer agent).
We restrict access to non-public personal information about our stockholders to our employees with a legitimate business need for the information. We maintain physical, electronic and procedural safeguards designed to protect the security of the non-public personal information of our stockholders.

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PROXY VOTING POLICIES AND PROCEDURES
We vote proxies relating to our portfolio securities in the best interest of our stockholders. We review on a case-by-case basis each proposal submitted to a stockholder vote to determine its impact on the portfolio securities held by us. Although we generally vote against proposals that may have a negative impact on our portfolio securities, we may vote for such a proposal if there are compelling long-term reasons to do so.
Our proxy voting decisions are discussed with the committee that is responsible for monitoring each of our investments. To ensure that our vote is not the product of a conflict of interest, we require that: (i) anyone involved in the decision-making process disclose to our General Counsel and 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 (ii) 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.
EXEMPTIVE AND OTHER RELIEF
We have received an exemptive order from the SEC to permit us to issue restricted shares of our common stock as part of the compensation packages for certain of our employees and directors. We believe that the particular characteristics of our business, the dependence we have on key personnel to conduct our business effectively and the highly competitive environment in which we operate require the use of equity-based compensation for our personnel in the form of restricted stock. The issuance of restricted shares of our common stock requires the approval of our stockholders. In June 2006, our stockholders approved our Amended and Restated 2006 Employee Restricted Stock Plan, or the 2006 Plan, and our Amended and Restated 2006 Non-Employee Director Restricted Stock Plan.
Awards under the 2006 Plan must comply with all aspects of the SEC's order, including the following:
no one person may be granted awards totaling more than 25% of the shares available;
in any fiscal year, no person may be granted awards in excess of 500,000 shares of our common stock; and
the total number of shares that may be outstanding as restricted shares under all of our compensation plans may not exceed 10% of the total number of our shares of common stock authorized and outstanding at any time.
We requested the assurance of the staff of the Division of Investment Management that it would not recommend enforcement action to the SEC under the 1940 Act or Rule 17d-1 thereunder if we engaged in a stock repurchase program and did not rescind awards of restricted stock previously awarded in compliance with the terms and conditions of the exemptive order of the SEC so long as we agreed not to issue additional restricted stock under any compensation plan unless such issuance, together with all restricted stock outstanding under all compensation plans, does not exceed 10% of our outstanding common stock at the time of such issuance less the total number of shares previously issued, in the aggregate, pursuant to all compensatory plans. On September 27, 2013, the no-action letter was issued by the SEC.
OTHER
We will be examined periodically by the SEC for compliance with the Exchange Act and the 1940 Act.
As with other companies regulated by the 1940 Act, we must adhere to certain substantive regulatory requirements. A majority of our directors must be persons who are not interested persons, as that term is defined in the 1940 Act. We must provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a BDC, we cannot protect any director or officer against any liability to 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 are required to adopt and implement written policies and procedures reasonably designed to prevent violation of the federal securities laws, and to review these policies and procedures annually for their adequacy and the effectiveness of their implementation. Mr. Tod K. Reichert, our General Counsel and Chief Compliance Officer, is responsible for administering these policies and procedures.

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COMPLIANCE WITH THE SARBANES-OXLEY ACT OF 2002 AND THE NASDAQ GLOBAL SELECT MARKET CORPORATE GOVERNANCE REGULATIONS
The Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley Act, imposes a wide variety of regulatory requirements on publicly held companies and their insiders. The Sarbanes-Oxley Act requires us to review our policies and procedures to determine whether we comply with it and the regulations promulgated thereunder.
The NASDAQ Global Select Market has also adopted various corporate governance requirements as part of its listing standards. We believe we are in compliance with such corporate governance listing standards.
CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS
Effective as of January 1, 2002, we elected to be treated as a RIC, under Subchapter M of the Internal Revenue Code, or the Code. As a RIC, we generally do not have to pay corporate taxes on any income we distribute to our stockholders as dividends, which allows us to reduce or eliminate our corporate-level tax liability. To continue to qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as defined below). In addition, to qualify for RIC tax treatment we must distribute to our stockholders, for each taxable year, at least 90% of our “investment company taxable income,” which is generally our ordinary income plus the excess of our realized net short-term capital gains over our realized net long-term capital losses, collectively referred to as the 90% Distribution Requirement.
TAXATION AS A REGULATED INVESTMENT COMPANY
If we:
continue to qualify as a RIC, and
distribute each year to stockholders at least 90% of our investment company taxable income, which is defined in the Internal Revenue Code generally as ordinary income plus realized net short-term capital gains in excess of realized net long-term capital losses,
we will be entitled to deduct and, therefore, will not be subject to U.S. federal income tax on, the portion of our income we distribute or are deemed to distribute to stockholders. We will be subject to U.S. federal income tax at the regular corporate rate on any income not distributed (or deemed distributed) to our stockholders. We will be subject to a 4% nondeductible U.S. federal excise tax, or 4% excise tax, to the extent we do not make specified levels of distributions (actually or on a deemed basis) in a timely manner. We are subject as a RIC to the 4% excise tax to the extent that we do not distribute (on either an actual or deemed basis): 98% of our ordinary income for each calendar year; 98.2% of our capital gain net income for each calendar year; and any income realized, but not distributed, in prior calendar years.
To qualify as a RIC for federal income tax purposes, we must, among other things:
1.
continue to qualify as a BDC under the 1940 Act at all times during each taxable year;
2.
derive in each taxable year at least 90% of our gross income from (1) dividends, interest, payments with respect to certain securities, loans, gains from the sale of stock or other securities, or other income derived with respect to our business of investing in such stock or securities and (2) net income derived from an interest in a “qualified publicly traded partnership;” and
3.
diversify our holdings so that at the end of each quarter of the taxable year:
a.
at least 50% of the value of our assets consist of cash, cash items, 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
b.
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 (i) one issuer, (ii) two or more issuers that are controlled, as determined under applicable Internal Revenue Code rules, by us and are engaged in the same or similar or related trades or businesses or (iii) one or more “qualified publicly traded partnerships,” known as the Diversification Tests.
We may be required to recognize taxable income even when we do not receive cash. For example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount, we must include in taxable income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. We also may have to include in taxable income other amounts that we have not yet received in cash, such as PIK interest and deferred loan origination

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fees that are paid after origination of the loan or are paid in non-cash compensation such as warrants or stock. Because any original issue discount 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 cash distribution to our stockholders in the amount of that non-cash income in order to satisfy the 90% Distribution Requirement, even though we will not have received any cash representing such income.
If we fail to satisfy the 90% Distribution Requirement or fail to qualify as a RIC in any taxable year, we would be subject to tax in that year on all of our taxable income at regular corporate rates, regardless of whether we make any distributions to our stockholders. Distributions would not be required, and any distributions made in taxable years beginning on or after January 1, 2013 would be taxable to our stockholders as ordinary dividend income that, subject to certain limitations, may be eligible for the 15% or 20% maximum tax rate (depending on income thresholds) to the extent of our current and accumulated earnings and profits. Subject to certain limitations under the Code, corporate distributees would be eligible for the dividends-received deduction. Distributions in excess of our current and accumulated earnings and profits would be treated first as a return of capital to the extent of the stockholder’s tax basis, and any remaining distributions would be treated as a capital gain.
EMPLOYEES
We believe our success will depend greatly on our ability to identify, attract and retain capable employees. As of December 31, 2014, we employed six full-time employees, including investment, portfolio and operations professionals, in-house counsel and administrative staff. All of these employees are located in our corporate headquarters in Arlington, Virginia. Our employees are not represented by any collective bargaining unit and we believe our relations with our employees are good.

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ITEM 1A.
RISK FACTORS. 
Investing in our common stock may be speculative and involves a high degree of risk. You should consider carefully the risks described below and all other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and the related notes and the schedules and exhibits to this Annual Report on Form 10-K. The risks set forth below are not the only risks we face. If any of the following risks occur, our business, financial condition and results of operations could be materially adversely affected. In such case, our net asset value and the trading price of our common stock could decline, and you may lose all or part of your investment.
We are exploring and evaluating strategic alternatives for the Company and there can be no assurance that we will be successful in identifying a strategic alternative, that such strategic alternative will yield additional value for our stockholders or that the process will not have an adverse impact on our business.
On February 9, 2015, we announced that we had retained a financial advisor to assist us in exploring a full range of strategic alternatives for the Company to enhance value for our stockholders. The process could result in, among other things, a sale of the Company, a restructuring, a recapitalization, merger, consolidation, business combination or returning capital to investors. We cannot provide any assurance that the exploration of strategic alternatives will result in the identification or consummation of any transaction. Similarly, any strategic decision will involve risks and uncertainties, and we cannot provide any assurance that any strategic alternative, if identified, evaluated and consummated, will provide the anticipated benefits or otherwise enhance stockholder value. The process is ongoing and our Board of Directors has not set a timetable for completion of the evaluation.
We expect to incur substantial costs associated with identifying and evaluating potential strategic alternatives. Any potential transaction would be dependent upon a number of factors that may be beyond our control, including, among other factors, market conditions, industry trends, the interest of third parties in our business, stockholder approval and the availability of financing to potential buyers or the Company on reasonable terms. The process of exploring strategic alternatives may be time consuming and disruptive to our business operations. We are also subject to other risks in connection with the uncertainty created by the strategic review process, including stock price volatility and the ability to retain qualified employees. We do not currently intend to disclose further developments with respect to this process, unless and until our Board of Directors approves a specific transaction or otherwise concludes the review of strategic alternatives.
If we are unable to effectively manage the strategic review process, our business, financial condition, liquidity and results of operations could be adversely affected.
Investing in lower middle-market companies is inherently risky. Our financial results may be affected adversely if one or more of our portfolio investments defaults on its loans or fails to perform.
Our portfolio consists primarily of debt and equity investments in privately owned lower middle-market companies. Investing in lower middle-market companies involves a number of significant risks. The debt in which we invest is typically not rated. When rated by one or more rating agencies, a majority of our investments are rated below investment grade and have the highest risk of default among corporate bonds, typically referred to as junk bonds. Compared to larger publicly traded companies with greater financial, technical and marketing resources, lower middle-market companies typically have fewer resources and may experience wider variations in their operating results, making them more vulnerable to economic downturns. Lower middle-market companies experience limited access to capital and the cost of capital is usually higher than for their larger competitors. Many lower middle-market companies are unable to obtain financing from public capital markets or from traditional credit sources, such as commercial banks, often because they are perceived to pose a higher default risk. The success of lower middle-market companies often depends heavily on the managerial talents and efforts of an individual or a small group of persons. Therefore, the loss of any key employee could harm both its financial condition and its ability to compete effectively. Further, some lower middle-market companies conduct business in regulated industries. Changes in the regulatory environment impacting lower middle-market companies could result in significant expenditures and impair cash flow by making it difficult for them to conduct business in a cost effective manner, and have more dire effects, including bankruptcy. Even minor events may adversely affect the value of a loan's collateral and a company's ability to repay its obligations, which in turn may adversely affect the return on, or the recovery of, our investment in these businesses.
When evaluating a potential investment, we must rely on our employees' diligence to obtain information necessary to make well informed investment decisions. If we fail to uncover material information about our portfolio companies, either prior to or after our investment, we may lose money. A portfolio company's failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults under our loan documents and trigger cross-defaults

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under other agreements. Should other lenders choose to accelerate their loans and/or foreclose on the company's secured assets, it could jeopardize our portfolio company's ability to meet its obligations under the debt securities that we hold. We may also incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company.
Very few of our portfolio investments are publicly traded and, as a result, their value is uncertain. If our determinations regarding the fair value of our investments is higher than that which we ultimately realize upon disposition, our NAV could be affected adversely.
Typically, there is no public market for the securities of the privately held companies in which we have invested, and in which we generally expect to continue to invest. In accordance with the 1940 Act and accounting principles generally accepted in the United States, we carry substantially all of our portfolio investments at fair value as determined in good faith by our board of directors.
Whenever possible, our board of directors values our securities at market value; however, since very few of our investments are traded publicly the board considers various factors to assist it in determining fair value during the valuation process. For example, depending on the nature of the investment, the board may examine public and private mergers and acquisitions transactions, comparisons to publicly traded comparable companies, third-party assessments of valuation, discounted cash flow analyses, the nature and realizable value of any collateral, the portfolio company's earnings and its ability to make payments, the markets in which the portfolio company does business, market-based pricing, bond-yield analysis and other relevant factors. We also obtain financial and other information from portfolio companies, which may include unaudited, projected or pro forma financial information. Our board of directors also engages independent valuation firms to assist in determining the fair value of our investments. Because valuations, particularly those of private securities and private companies, are inherently uncertain, they may fluctuate over short periods of time and are often based on estimates. Our determinations of fair value may differ materially from the values that would have been used if a readily available market for these investments existed and from the amounts we may realize on any disposition of such investments. If our determinations regarding the fair value of our investments are materially higher than the values that we ultimately realize upon the disposition of such investments, our NAV could be affected adversely.
The general volatility of the financial markets and the economy could impair our portfolio companies' financial positions and operating results, which, in turn, could harm our operating results.
The future of the United States economy, sub-sectors of the broader economy and state and local economies in which we invest, is unclear. If economic performance in these markets declines in the future, the financial results of our lower middle-market portfolio companies may experience deterioration or limited growth. Prolonged, unfavorable or uncertain economic and market conditions may impact the ability of our portfolio companies to service their debt or engage in a liquidity event, such as a sale, merger, recapitalization or initial public offering.
Should this happen, we may experience a loss of value in our portfolio and decreases in our revenues, net income and net assets. Adverse economic conditions also may impair the value of collateral securing some of our loans and the value of our equity investments.
We operate in a highly competitive market for investment opportunities, and the success of our business model necessitates that we develop and maintain strong referral relationships. Failure to do so, or to offer desirable investment terms, may preclude us from winning new business and adversely affect our financial conditions and results of operations.
We compete with many types of investors for the portfolio companies in which we invest, including 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 or hedge funds. As a result of these entrants, competition for investment opportunities has intensified in recent years and may intensify further in the future. A majority of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. Some may also have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments that may lead to additional market share and a competitive advantage over us. Unlike many of our competitors, we are also subject to regulatory restrictions and valuation requirements the 1940 Act imposes on us as a BDC.
The myriad competitive pressures we face require our management team to develop and maintain strong relationships with intermediaries, financial institutions, investment bankers, commercial bankers, financial advisors, attorneys,

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accountants, consultants and other individuals within our network in order to keep apprised of potential investment opportunities. We have experienced significant executive turnover and staff reductions while we monetized a majority of our investments and repurchased our stock in the open market, which we believe has negatively impacted our ability to remain active investors with current or prospective clients. If our management team fails to maintain its existing relationships or develop new ones with important sources of investment opportunities, we may fail to remain competitive for new business or to generate positive net operating income and our investment portfolio may languish as a result. Regardless of the strength of relationships, no one is obligated to provide us with investment opportunities, and there is no assurance that such relationships will generate investment opportunities for us.
While we do not seek to compete primarily based on the interest rates we offer, we may lose investment opportunities if we do not match our competitors' pricing, terms and structure. If we do match our competitors' pricing, terms and structure to win business, we may then experience a decrease in investment income resulting from lower net earning assets. We may be precluded from taking advantage of attractive investment opportunities from time to time as a result of an inability to meet market terms, and we can offer no assurance that we will be able to identify and successfully make investments that are consistent with our investment objective. Failure to compete effectively for, and establish strong relationships that could lead to, new business would have a material adverse effect on our business, financial condition and results of operations.
Our portfolio is concentrated in certain industries, which increases our risk of significant loss if any one of these companies fails to service our debt because of industry downturns.
From time to time, we target specific industries in which to invest on a recurring basis, which may result in significant concentrations in our portfolio. As a consequence, the aggregate returns we realize may be substantially adversely affected by the unfavorable performance of a small number of such investments or a substantial write-down of any one investment. Beyond regulatory and income tax diversification requirements, we do not have fixed guidelines for industry concentration. In addition, while we generally decline to make investments in a particular industry or group of industries that would exceed 15.0% of our total assets at the time of closing, it is possible that as the values of our portfolio companies change, one industry or a group of industries may come to exceed such level. As a result, a downturn in an industry in which we have invested a significant portion of our total investments could have a materially adverse effect on us. As of December 31, 2014, due to the number of recent monetizations and loan repayments, 59.2%, 18.8% and 12.2% of our total investments at fair value were invested in healthcare, business services and broadcasting industries, respectively. Therefore, we are susceptible to the economic circumstances in these industries, and a downturn in any one of these industries could have a material adverse effect on our results of operations and financial condition.
Changes, enforcement or interpretation of healthcare or other laws and regulations applicable to some of our portfolio companies' businesses may constrain their ability to offer their products and services.
Changes, enforcement or interpretation of healthcare or other laws and regulations applicable to the businesses of some of our portfolio companies may increase their compliance and other costs of doing business, require significant systems enhancements, or render their products or services less profitable or obsolete, any of which could have a material adverse effect on their results of operations. There has also been an increased political and regulatory focus on healthcare laws in recent years, and new legislation, regulation, enforcement or interpretation may have a material effect on the business and operations of some of our portfolio companies.
We must effectively manage and deploy capital to ensure our financial condition and results of operations. If we fail to do so, we could experience a decline in our business prospects and the loss of key employees, both of which could negatively affect our operating results.
Equity capital is, and may continue to be, difficult to raise because we generally are not able to issue and sell our common stock at a price below NAV per share without stockholder approval. In addition, available debt capital may be costly and/or carry less favorable terms and conditions. Therefore, our ability to maximize our portfolio's total return depends on the ability to successfully manage and deploy capital effectively. Our debt investments generate capital from current income, and our equity and equity-related investments generally provide capital appreciation, enhancing our overall operating results. Our ability to identify and evaluate, and ultimately to finance and invest in, companies that will produce the desired financial gains rests squarely in the hands of our investment team. Accomplishing our investment objectives on a cost-effective basis is largely a function of our investment team's handling of the investment process, its ability to provide competent, attentive and efficient services and our access to investments offering acceptable terms. In addition to monitoring the performance of our existing investments, members of our investment

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team are also called upon, from time to time, to provide managerial assistance to some of our portfolio companies. These demands on their time may distract them or slow the rate of investment capital.
Our results of our operations will depend on many factors, including the availability of opportunities for investment, and economic conditions. Furthermore, if we cannot successfully operate our business or implement our investment policies and strategies it could negatively impact our ability to pay dividends. The prolonged inability to effectively deploy capital could negatively impact our business prospects, cause the departure of key employees and have an adverse impact on our operating results.
Our ability to raise additional capital is limited by the market price of our common stock and by regulations governing our operations as a BDC.
Although shares of closed-end investment companies frequently trade at a market price that is less than the NAV attributable to those shares, this characteristic has no correlation with the risk of decline to our own NAV. It is not possible to predict whether our common stock will trade at, above, or below NAV. In the recent past, the stocks of BDCs as an industry, including shares of our common stock, have traded below NAV as a result of concerns over market conditions, credit concerns, liquidity, dividend coverage, leverage restrictions, distribution requirements and various other reasons. When our common stock trades below its NAV per share, the 1940 Act prohibits us from selling shares of our common stock at a price below the current NAV unless our stockholders approve such a sale and our board of directors makes certain determinations.
We have issued debt securities and may in the future incur additional debt, issue preferred stock, and/or borrow money from banks or other financial institutions, which we refer to collectively as senior securities”. Under the provisions of the 1940 Act, as a BDC we are permitted to issue senior securities only in amounts such that our BDC asset coverage, as defined in the 1940 Act, equals at least 200% after each issuance of senior securities. If the value of our assets declines we may be unable to satisfy this test, precluding us from issuing senior securities and paying dividends. We may also be required to sell a portion of our investments and, depending on the nature of our leverage, repay a portion of our indebtedness at a time when such sales may be disadvantageous.
Failure to maintain our qualification as a BDC would significantly reduce our operating flexibility.
If we were to continuously fail to qualify as a BDC, we might become 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 Item 1. Business-Regulation.
If we fail to invest a sufficient portion of our assets in qualifying assets, we could lose our BDC status.
As a BDC, 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 within the meaning of the 1940 Act. Our failure to meet the 70% threshold could cause us to lose our status as a BDC, resulting in a material adverse effect on our business, financial condition and results of operations. In addition, the 70% requirement may preclude us from investing in potentially attractive investments, as well as prevent us from making additional investments in our existing portfolio companies, thus diluting our position, to the extent they do not meet the standard for qualifying assets under the 1940 Act. Finally, we may need to sell certain of our investments to comply with the 1940 Act, which could cause us to realize significantly less than the current value of such investments.
If we fail to qualify as a RIC, we will have to pay corporate-level taxes on our income and our income available for distribution would be reduced significantly or eliminated.
We have elected to be taxed for federal income tax purposes as a RIC, under Subchapter M of the Internal Revenue Code. To qualify as a RIC under the Internal Revenue Code, we must meet certain source-of-income, asset diversification and annual distribution requirements and maintain our status as a BDC, including:
Sources of Income. We must obtain at least 90% of our income each year from dividends, interest, gains from the sale of stock or securities or similar sources.
Asset Diversification. At the end of each taxable year, 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. No more than 25% of the value of our assets may be invested in the securities, other than U.S. government securities or securities of other RICs, (i) of one issuer, or (ii) of two or more issuers that are controlled, as

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determined under applicable Internal Revenue 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.”
Income Distribution. We must 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, if any, on an annual basis. Because we are subject to an asset coverage ratio requirement under the 1940 Act, and may also be subject to certain financial covenants under any debt financings we may incur, we could, under certain circumstances, be restricted from making the distributions necessary to satisfy the IRS requirement.
As our total assets continue to decline associated with our stock repurchase program and tender offer, dividend distributions to stockholders and other transactions that reduce our total assets, there is an increased risk of non-qualification as a RIC due to the 50% or 25% asset diversification test as outlined in Internal Revenue Code Section 851(b)(3). The 50% diversification test requires at least 50% of the value of a RIC’s total assets be invested in cash, cash items (including receivables), government securities (as defined under the 1940 Act), securities of other RIC’s, or investments in other securities that, with respect to any one issuer, do not represent more than 5 percent of the RIC’s assets or more than 10 percent of the issuer’s voting securities.
The 25% diversification test requires that not more than 25% of the value of the company’s total assets are invested in the securities (other than government securities or the securities of other RIC’s) of any one issuer, or of two or more issuers which the taxpayer controls and which are determined to be engaged in the same or similar trades or businesses. The term “controls” means the ownership of 20% or more of the total combined voting power of all classes of voting stock in a corporation.
The 50% and 25% diversification test must be satisfied at the end of each quarter of a RIC’s taxable year.
Failure to meet the foregoing 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 losses. If we fail to qualify as a RIC for any reason we would become subject to corporate-level income tax, substantially reducing our net assets, the amount of income available for distribution, if any, and the amount of our distributions. Such a failure would have a material adverse effect on our stockholders and us.
Our future success depends on our investment team. If we lose one or more of these or other key employees, our operating results may suffer from our inability to make future investments.
We depend on the members of our investment team for the identification, review, final selection, structuring, closing and monitoring of our investments. Their significant investment expertise and relationships are vital to the implementation of our business plan and we have no guarantee that they or any other employees will remain with the company. If we lose the services of one or more of these individuals, our operating results could suffer if we are unable to make future investments as we expect.
If we fail to establish new credit facilities on favorable terms, our business could be harmed materially.
We cannot be certain that we will be able to establish new borrowing facilities to provide working and investment capital, including for new originations. If we are unable to establish new facilities of a reasonable size, our liquidity will be reduced significantly. Even if we are able to consummate new borrowing facilities, we may not be able to do so on favorable terms.
We may be unable to obtain debt capital on favorable terms or at all, in which case we would not be able to use leverage to increase the return on our investments.
If we are unable to obtain debt capital, then our equity investors will not benefit from the potential for increased returns on equity resulting from leverage to the extent that our investment strategy is successful and we may be limited in our ability to make new commitments or fundings to our portfolio companies.
Prepayments of our debt investments by our portfolio companies could adversely impact our results of operations and reduce our return on equity.
We are subject to the risk that the investments we make in our portfolio companies may be repaid prior to maturity. When this occurs, we could experience significant delays in reinvesting these amounts. Any future investment in a new portfolio company may also be at lower yields than the debt that was repaid. As a result, our results of operations could be materially adversely affected if one or more of our portfolio companies elect to prepay amounts owed to us. Additionally, prepayments could negatively impact our return on equity, which could result in a decline in the market price of our common stock.

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In situations where we hold junior priority liens, our ability to control decisions with respect to our portfolio companies may be limited by lenders holding superior liens. In a default scenario, the value of collateral may be insufficient to repay us after the senior priority lenders are paid in full.
We make certain loans to portfolio companies that are secured by a junior priority security interest in the same collateral pledged to secure debt owed to lenders with liens senior to ours. Often the senior lender has procured covenants from the portfolio company prohibiting the incurrence of additional secured debt without the senior lender's consent. As a condition of permitting the portfolio company to incur junior secured indebtedness, the senior lender will require that we as junior lender enter into an intercreditor agreement that, among other things, will establish the senior lender's right to control the disposition of any collateral in the event of an insolvency proceeding or other default situation. In addition, intercreditor agreements generally will expressly subordinate junior liens to senior liens as well as the repayment of junior debt to senior debt.
Because of the control we may cede to senior lenders under intercreditor agreements, we may be unable to control the manner or timing of collateral disposition. In addition, the value of collateral securing our debt investment will ultimately depend on market and economic conditions at the time of disposal, the availability of buyers and other factors. Therefore, 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 our liens. There is also a risk that such collateral securing our investments will be difficult to sell in a timely manner or to appraise. If the proceeds of the collateral are insufficient to repay our loans, then we will have an unsecured claim to the extent of the deficiency against any of the company's remaining assets, which claim will likely be shared with many other unsecured creditors.
As a debt or minority equity investor in a portfolio company, we may have little direct influence over the entity. The stockholders and management of the portfolio company may make decisions that could decrease the value of our portfolio holdings.
We make both debt and minority equity investments. Should a portfolio company make business decisions with which we disagree, or the stockholders and management of that company take risks or otherwise act in ways that do not serve our interests, the value of our portfolio holdings could decrease and have an adverse effect on our financial position and results of operations.
If we need to sell any of our investments, we may not be able to do so at a favorable price and, as a result, we may suffer losses.
Our investments usually are subject to contractual or legal restrictions on resale or are otherwise illiquid because there is usually no established trading market. The illiquidity of most of our investments may make it difficult for us to dispose of them at a favorable price. As a result, we may suffer losses. In addition, if we were forced to liquidate some or all of the investments in our portfolio on an expedited basis, the proceeds of such liquidation could be significantly less than the current fair value of such investments. We may be required to liquidate some or all of our portfolio to meet our debt service obligations or to maintain our qualification as a BDC and as a RIC to the extent we fail to satisfy the applicable regulatory criteria.
The disposition of our investments may result in contingent liabilities.
Most of our investments involve private securities. In connection with the disposition of an investment in private securities, we may be required to make representations about the business and financial affairs of the portfolio company typical of those made in connection with the sale of a business. We may also be required to indemnify the purchasers of such investment with respect to certain potential liabilities or to the extent that any of our representations turn out to be inaccurate. These arrangements may result in contingent liabilities that ultimately yield funding obligations that must be satisfied through our return of certain distributions previously made to us.
Portfolio company litigation could result in additional costs, the diversion of management time and resources and have an adverse impact on the fair value of our investment.
In the course of providing significant managerial assistance to certain of our portfolio companies, we may serve as directors on the boards of such companies. In addition, in the course of making portfolio company investments, we may elect to take an equity position in any given company. To the extent that litigation arises out of our investments, we may be named as a defendant, which could result in additional costs and the diversion of management time and resources. In addition, litigation involving a portfolio company may be costly and affect the operations of the business, which could in turn have an adverse impact on the fair value of our investment.

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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.
If one of our portfolio companies were to go bankrupt, depending on the facts and circumstances, including the extent to which we provided managerial assistance to that portfolio company, a bankruptcy court could elect to subordinate all or a portion of our claims to those of other creditors regardless of the seniority of our original investment. In such instances, the court may deem our actions to be more like that of an equityholder than a debt holder. Were that to occur, the claims we carried as senior in right of payment on our books might instead be recharacterized by the court as junior, and therefore come much lower in the priority of payments. To the extent that there are insufficient funds remaining to pay us once other debtholders are paid in full, we may lose all or a portion of our investment.
The actions we take with respect to a portfolio company's business, including providing managerial assistance, or the exercise of control over a portfolio company could also give rise to lender liability claims. Should our actions be viewed as more akin to those of an equityholder than a debtholder because of our involvement in the operations of the portfolio company, a presumption could arise that we have a fiduciary duty to the portfolio company. A third party could then sue us, for example, in an attempt to make us liable for any negative performance by such portfolio company.
We may choose to waive or defer enforcement of covenants in the debt securities held in our portfolio, which may cause us to lose all or part of our investment in these companies.
We structure the debt investments in our portfolio companies to include business and financial covenants placing affirmative and negative obligations on the operation of the company’s business and its financial condition. However, from time to time we may elect to waive breaches of these covenants, including our right to payment, or waive or defer enforcement of remedies, such as acceleration of obligations or foreclosure on collateral, depending upon the financial condition and prospects of the particular portfolio company. These actions may reduce the likelihood of our receiving the full amount of future payments of interest or principal and be accompanied by a deterioration in the value of the underlying collateral as many of these companies may have limited financial resources, may be unable to meet future obligations and may go bankrupt. This could negatively impact our ability to pay dividends, could adversely affect our results of operation and financial condition and cause the loss of all or part of your investment.
Any unrealized losses we experience on our investment portfolio may be an indication of future realized losses, which could reduce our income available for distribution and could impair our ability to service our borrowings, if any.
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 our board of directors. Decreases in the market values or fair values of our investments will be recorded as unrealized depreciation. Any unrealized depreciation in our investment portfolio could be an indication of a portfolio company’s inability to meet its repayment obligations to us with respect to the affected investments. This could result in realized losses in the future and ultimately in reductions of our income available for distribution in future periods and could materially adversely affect our ability to service our outstanding borrowings, if any.
Our stock price has been, and continues to be, volatile and purchasers of our common stock could incur substantial losses.
The stock market in general, and the market prices for securities of financial services companies in particular, have experienced extreme volatility that often has been unrelated or disproportionate to the operating performance of these companies. If current levels of market volatility continue or worsen, we may continue to experience an adverse effect, possibly material, on our ability to access capital and on our business, financial condition and results of operations.
The market price and the liquidity of the market for our shares may from time to time be affected by a number of factors, which include, but are not limited to, the following:
our quarterly results of operations;
our origination activity, including the pace of, and competition for, new investment opportunities;
price and volume fluctuations in the overall stock market from time to time;
investors' general perception of our company, the economy and general market conditions;
actual or anticipated changes in our earnings or fluctuations in our operating results or changes in the expectations of securities analysts;
the financial performance of the specific industries in which we invest on a recurring basis, including without limitation, our investments in the healthcare, business services and education industries;

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significant transactions or capital commitments by us or our competitors;
significant volatility in the market price and trading volume of securities of BDCs or other financial services companies;
volatility resulting from trading in derivative securities related to our common stock including puts, calls or short trading positions;
potential future sales of debt securities convertible into or exchangeable or exercisable for our common stock or the conversion of such securities;
the average trading volume and the ability of investors to obtain liquidity in our shares in the open market, which may be negatively impacted by the number of shares the Company repurchases in the open market;
changes in laws or regulatory policies or tax guidelines with respect to BDCs or RICs;
loss of RIC status;
the inability to secure additional debt or equity capital;
announcements of strategic developments, acquisitions and other material events by us or our competitors;
litigation or regulatory actions affecting us or our portfolio companies; and
departures of key personnel.
If any of these factors causes an adverse effect on our business, our results of operations or our financial condition, the price of our common stock could fall and investors may not be able to sell their common stock at or above their respective purchase prices.
You may not receive future distributions.
In the event that the asset coverage ratio applicable to us as a BDC falls below 200%, we will be unable to make distributions until the ratio again meets or exceeds the threshold. If we do not distribute at least 90% of our investment company taxable income annually, we will suffer adverse tax consequences, including the possible loss of our status as a RIC for the applicable period. From December 2001 through December 31, 2014, we declared distributions totaling $14.13 per common share. Due to the market dislocation, we suspended our distributions from the third quarter of 2008 through the first quarter of 2010. We reinstated our distribution on April 29, 2010, and until the third quarter of 2014 continued to declare a quarterly dividend. There can be no assurance that distributions will resume in the future.
We will make future decisions with respect to the actual level of distributions after taking into account the minimum statutorily required level of distributions, gains and losses recognized for tax purposes, portfolio transactional events, our liquidity, cash earnings and our BDC asset coverage ratio at the time of such decision. Regulatory constraints, our inability to achieve operating results or a decline in the performance of our business could restrict our ability to make any future distributions. In addition, we may not be able to make distributions at a specific level or to increase the amount of these distributions from time to time.
We may have difficulty paying our required distributions if we recognize income before, or without, receiving cash representing such income.
In accordance with applicable tax laws and regulations, we include in taxable income certain amounts that we have not yet received in cash from our portfolio companies, such as contractual PIK interest, interest on loans that are on non-accrual status and original issue discount. PIK interest represents contractual interest added to the loan balance and due at the end of the loan term. Loans that are on non-accrual status reflect an inability of a portfolio company to make payments to us when due. Original issue discount may arise if we receive warrants in connection with the issuance of a debt instrument or in other circumstances. We are required to include in income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. Other situations may also arise where we are required to include amounts in taxable income for which we have not yet received payment in cash.
We must distribute at least 90% of our investment company taxable income to maintain the tax benefits we enjoy as a RIC. This obligation applies whether or not that income was actually received in cash. Since we may recognize income before, or without, receiving cash representing such income, we may have difficulty meeting the requirement. To raise funds to make the required distributions, we may have to raise additional debt or equity capital at unattractive rates or on unfavorable conditions. We might also need to sell some of our investments at unfavorable prices, or repurpose the cash we had reserved for new investment originations. If we cannot obtain cash from these or other sources, we may fail to qualify as a RIC and, thus, be subject to corporate-level income tax.

24



Any change in the regulation of our business could have a significant adverse effect on the profitability of our operations and our cost of doing business.
Changes in the laws, regulations or interpretations of the laws and regulations that govern BDCs, RICs or non-depository commercial lenders could have a significant adverse effect on our operations and our cost of doing business. We are subject to federal, state and local laws and regulations and also to judicial and administrative decisions that affect our operations. If these laws, regulations or decisions change, or if we expand our business into jurisdictions that have adopted requirements that are more stringent than those in which we currently conduct business, we may have to incur significant expenses in order to comply or we may have to restrict our operations.
We may in the future decide to issue preferred stock, which would magnify the risks of investing in us, as well as the potential for loss.
Because preferred stock is another form of borrowing and the dividends on any preferred stock we might issue would be cumulative, preferred stock has the same risks to our common stockholders as debt. We are obligated to pay the cumulative dividends and any liquidation preference attached to such preferred stock before we make any payments to our common stockholders. While the value of preferred stock is unaffected by our expenses or losses, preferred stockholders do not participate in any income or appreciation in excess of their stated preference. Holders of any preferred stock we might issue would have the right to elect members of the board of directors as well as class voting rights on certain matters, including changes in fundamental investment restrictions and conversion to open-end status. Accordingly, preferred stockholders could veto changes to the detriment of the company and its common stockholders. We currently have no plans to issue preferred stock.
Investments in equity securities involve a substantial degree of risk.
We have purchased, and may purchase in the future, common stock and other equity securities, including warrants, in various portfolio companies. Although equity securities historically have generated higher average total returns than debt securities over the long term, equity securities may experience more volatility in those returns than debt securities. The equity securities we acquire may fail to appreciate, decline in value or lose all value, and our ability to recover our investment will depend on our portfolio company's success. Investments in equity securities involve a number of significant risks, including the risk of further dilution in the event the portfolio company issues additional securities. Investments in preferred securities involve special risks, such as the risk of deferred distributions, illiquidity and limited voting rights.
Fluctuations in interest rates could affect our income adversely.
Because we sometimes borrow to make investments, our net income depends, in part, on the difference between the interest rate at which we borrow funds and the interest rate at which we invest these funds. Because a significant portion of our assets and liabilities may be priced using various short-term rate indices, including one-month to six-month LIBOR, commercial paper rates and the prime rate, the timing of changes in market interest rates or in the relationship between interest rate indices could affect the interest rates earned on our interest-earning assets differently than the interest rates we pay on interest-bearing liabilities. As a result, significant changes in market interest rates could have a material adverse effect on our net income.
A significant portion of our variable rate loans have interest rate floors based on the LIBOR or prime rate. These floors minimize our exposure to significant decreases in interest rates. A significant increase in market interest rates could harm our ability to attract new portfolio companies and originate new loans and investments. In addition, our non-performing assets could increase and the value of our portfolio decrease because our floating-rate loan portfolio companies may be unable to meet higher payment obligations.
Uncertainty relating to the LIBOR calculation process may adversely affect the value of our portfolio of the LIBOR-indexed, floating-rate debt securities.
Concerns have been publicized that some of the member banks surveyed by the British Bankers’ Association, or BBA, in connection with the calculation of LIBOR across a range of maturities and currencies may have been under-reporting or otherwise manipulating the inter-bank lending rate applicable to them in order to profit on their derivatives positions or to avoid an appearance of capital insufficiency or adverse reputational or other consequences that may have resulted from reporting inter-bank lending rates higher than those they actually submitted. A number of BBA member banks have entered into settlements with their regulators and law enforcement agencies with respect to alleged manipulation of LIBOR, and investigations by regulators and governmental authorities in various jurisdictions are ongoing.

25



Actions by the BBA, regulators or law enforcement agencies may result in changes to the manner in which LIBOR is determined. Uncertainty as to the nature of such potential changes may adversely affect the market for LIBOR-based securities, including our portfolio of LIBOR-indexed, floating-rate debt securities. 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 for LIBOR-based securities or the value of our portfolio of LIBOR-indexed, floating-rate debt securities.
Our business is subject to increasingly complex corporate governance, public disclosure and accounting requirements that could adversely affect our business and financial results.
We are subject to changing rules and regulations of federal and state government as well as the stock exchange on which our common stock is listed. These entities, including the Public Company Accounting Oversight Board, the SEC and the NASDAQ Stock Market have issued a significant number of new and increasingly complex requirements and regulations over the course of the last several years and continue to develop additional regulations and requirements in response to laws enacted by Congress. On July 21, 2010, the Dodd-Frank Wall Street Reform and Protection Act, or the Dodd-Frank Act, was enacted. There are significant corporate governance and executive compensation-related provisions in the Dodd-Frank Act, and the SEC has adopted, and will continue to adopt, additional rules and regulations that may impact us. Our efforts to comply with these requirements have resulted in, and are likely to continue to result in, an increase in expenses and a diversion of management’s time from other business activities.
Certain provisions of the Delaware General Corporation Law, our certificate of incorporation and our bylaws could deter takeover attempts and have an adverse impact on the price of our common stock.
The Delaware General Corporation Law, our certificate of incorporation and our bylaws contain provisions that may discourage a third party from making a proposal to acquire us. We have also adopted measures that may make it difficult for a third party to obtain control of our board or our company, including provisions in our certificate of incorporation dividing our board of directors into three classes with the term of one class expiring at each annual meeting of stockholders. These anti-takeover provisions may inhibit a change in control in circumstances that could give the holders of our common stock the opportunity to realize a premium over the market price of our common stock.
The failure in cyber security systems, as well as the occurrence of events unanticipated in our disaster recovery systems and management continuity planning could impair our ability to conduct business effectively.
The occurrence of a disaster such as a cyber attack, a natural catastrophe, an industrial accident, a terrorist attack or war, events unanticipated in our disaster recovery systems, or a support failure from external providers, could have an adverse effect on our ability to conduct business and on our results of operations and financial condition, particularly if those events affect our computer-based data processing, transmission, storage, and retrieval systems or destroy data. If a significant number of our managers were unavailable in the event of a disaster, our ability to effectively conduct our business could be severely compromised.
We depend heavily upon computer systems to perform necessary business functions. Despite our implementation of a variety of security measures, our computer systems could be subject to cyber attacks and unauthorized access, such as physical and electronic break-ins or unauthorized tampering. Like other companies, we may experience threats to our data and systems, including malware and computer virus attacks, unauthorized access, system failures and disruptions. If one or more of these events occurs, it could potentially jeopardize the confidential, proprietary and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations, which could result in damage to our reputation, financial losses, litigation, increased costs, regulatory penalties and/or customer dissatisfaction or loss.
ITEM 1B.
UNRESOLVED STAFF COMMENTS. 
None.
ITEM 2.
PROPERTIES. 
Neither we nor any of our consolidated subsidiaries own any facilities or real estate.  However, during 2014 we leased 13,684 square feet of office space for our corporate headquarters located at 1001 19th Street North, Arlington, VA 22209. Our lease expires December 31, 2015.

26



ITEM 3.
LEGAL PROCEEDINGS. 
From time to time, we are a party to certain legal proceedings incidental to the normal course of our business including the enforcement of our rights under contracts with our portfolio companies. Furthermore, third parties may try to 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 these proceedings will have a material effect upon our financial condition or results of operations.
ITEM 4.
MINE SAFETY DISCLOSURES
None.

27



PART II
ITEM 5.
MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. 
Market Information
Our common stock is traded on the NASDAQ Global Select Market under the symbol “MCGC.” The following table sets forth the high and low last sales prices of our common stock for the periods indicated, as reported on the NASDAQ Global Select Market:
 
Years ended December 31,
 
2014
2013
Quarter Ended
High
Low
High
Low
March 31
$
4.75

$
3.59

$
5.00

$
4.47

June 30
$
3.92

$
3.24

$
5.32

$
4.57

September 30
$
4.08

$
3.52

$
5.49

$
4.89

December 31
$
3.95

$
3.03

$
5.32

$
4.40

Holders
On February 23, 2015 we had approximately 91 holders of record and approximately 13,119 beneficial holders of our common stock.
Recent Sales of Unregistered Securities and Purchases of Equity Securities
STOCK REPURCHASE PROGRAM
On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million, which was terminated after we effected repurchases totaling approximately $29.4 million. On October 25, 2013, our board of directors authorized a second stock repurchase program of up to $25.0 million. On February 28, 2014, our board of directors increased the second stock repurchase program to $35.0 million. On April 25, 2014, our board of directors terminated the second stock repurchase program effective as of May 2, 2014 and authorized a third stock repurchase program of up to $50.0 million effective as of May 5, 2014. On August 5, 2014, our board of directors terminated the third stock repurchase program and authorized a fourth stock repurchase program of up to $50.0 million effective as of August 12, 2014. On October 17, 2014, our board of directors suspended the fourth stock repurchase program. On December 18, 2014, the fourth stock repurchase program, which had been suspended during our modified "Dutch Auction" tender offer, was reinstated. In January 2015, the fourth stock repurchase program was discontinued. We have provided our stockholders with notice of our intention to repurchase shares of our common stock in accordance with 1940 Act requirements. We retired all shares of common stock that we purchased in connection with the stock repurchase program.
TENDER OFFER
On November 3, 2014, we commenced a modified “Dutch Auction” tender offer pursuant to an offer to purchase dated November 3, 2014 and a related letter of transmittal, under which we offered to purchase up to $75.0 million of our common stock at a price per share not less than $3.25 and not greater than $3.75. The tender offer expired on December 3, 2014, and we accepted for payment an aggregate of 4,859,744 shares of our common stock at a purchase price of $3.75 per share for an aggregate purchase price of $18.2 million. These shares represented approximately 11.2% of our shares issued and outstanding as of the date of commencement of the tender offer. We incurred costs of $0.4 million associated with the tender offer resulting in a total cost of $18.6 million, or $3.83 per share, for the shares repurchased.
NET ISSUANCE OF RESTRICTED STOCK
For certain employees, we may be deemed to have purchased through the net issuance of shares, a portion of the shares of restricted stock previously issued under the 2006 Plan for which the forfeiture provisions have lapsed to satisfy the applicable employee’s income tax withholding obligations. We retire immediately all such shares of common stock that we purchase in connection with such net issuance to employees.

28



DIVIDEND REINVESTMENT PLAN
As part of our dividend reinvestment plan for our common stockholders, we may direct the plan administrator to purchase shares of our common stock on the open market to satisfy dividend reinvestment requests related to dividends that we pay on outstanding shares of our common stock.
The following table summarizes the shares of our common stock that we have purchased during the three months ended December 31, 2014:
Period/Purpose
Total number
of shares
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs
October 1 – 31, 2014
 
 
 
 
 
Stock repurchase program(a)
2,458,300

$
3.52

 
2,458,300

$
28,842,975

November 1 – 30, 2014
 
 
 
 
 
Restricted stock vesting(b)
220

$
3.65

(c) 
n/a

n/a

December 1 – 31, 2014
 
 
 
 
 
Tender Offer(d)
4,859,744

$
3.83

(e) 
4,859,744

$

Stock repurchase program(a)
509,916

$
3.93

 
509,916

$
26,837,074

Restricted stock vesting(b)
1,031

$
3.82

(c) 
n/a

n/a

Total December 1 – 31, 2014
5,370,691

$
3.84

 
5,369,660

$
26,837,074

Total
7,829,211

$
3.74

 
7,827,960

$
26,837,074

    
(a) 
On August 5, 2014, our board of directors authorized a stock repurchase program of up to $50.0 million effective as of August 12, 2014.
(b) 
Represents shares repurchased from our employees in connection with the net issuance of shares to satisfy employee tax withholding obligations in connection with the vesting of restricted stock.
(c) 
Based on the weighted-average closing share prices of our common stock on the dates that the forfeiture restrictions lapsed.
(d) 
On November 3, 2014, we commenced a modified “Dutch Auction” tender offer pursuant to an offer to purchase dated November 3, 2014 and a related letter of transmittal, by which we offered to purchase up to $75.0 million of our common stock at a price per share not less than $3.25 and not greater than $3.75. The tender offer expired on December 3, 2014, and we accepted for payment an aggregate of 4,859,744 shares of our common stock at a purchase price of $3.75 per share for an aggregate purchase price of $18.2 million.
(e) 
Represents the cost per share of the tender offer including the purchase price and direct costs associated with the offer.
Distribution Policy
We currently qualify as a RIC for federal income tax purposes, which generally allows us to avoid paying corporate income taxes on any income or gains that we distribute to our stockholders. Generally, we intend to distribute sufficient distributions to eliminate taxable income and may distribute more than the taxable income which amounts would be considered a return of capital. As a RIC, we are subject to a 4% excise tax to the extent that we do not distribute on an actual or on deemed basis: (i) 98.0% of our current year ordinary income; and (ii) 98.2% of our current year net capital gain income.
We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions from time to time. In addition, we may be limited in our ability to make distributions due to the BDC asset coverage test for borrowings applicable to us as a BDC under the 1940 Act. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of favorable RIC tax treatment. We cannot assure stockholders that they will receive any distributions or distributions at a particular level. We may make distributions to our stockholders of certain net capital gains.

29



The following table summarizes our distributions declared since January 1, 2013:
Date Declared
Record Date
Payable Date
Dividends per Share
August 5, 2014
August 20, 2014
August 29, 2014
$
0.050

April 25, 2014
May 9, 2014
May 30, 2014
$
0.070

February 28, 2014
March 14, 2014
March 28, 2014
$
0.125

October 25, 2013
November 8, 2013
November 22, 2013
$
0.125

July 26, 2013
August 9, 2013
August 30, 2013
$
0.125

April 26, 2013
May 10, 2013
May 31, 2013
$
0.125

March 1, 2013
March 15, 2013
March 29, 2013
$
0.125

We will make future decisions with respect to the actual level of distributions after taking into account the minimum statutorily required level of distributions, gains and losses recognized for tax purposes, portfolio transactional events, our liquidity, cash earnings and our BDC asset coverage ratio at the time of such decision. For additional information about our distributions, see the Liquidity and Capital Resources and Distributions sections of our Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Equity Compensation Plan Information
Information relating to compensation plans under which our equity securities are authorized for issuance is set forth under Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters in our definitive proxy statement for our 2015 Annual Meeting of Stockholders.
Stock Performance Graph
The following comparative stock performance graph compares the cumulative total stockholder return (assuming reinvestment of dividends, if any) from investing $100 on December 31, 2009 through December 31, 2014, in each of: i) our common stock; ii) the Russell 2000 Index; and iii) the NASDAQ Financial 100 Index (capitalization weighted).
The information included under the heading Stock Performance Graph in Item 5 of this Annual Report on Form 10-K is “furnished” and not “filed,” and shall not be deemed to be “soliciting material” or subject to Regulation 14A, shall not be deemed “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Exchange Act.

30



ITEM 6.
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth in the following table with respect to our statement of operations data for the years ended December 31, 2014, 2013 and 2012 and the balance sheet data as of December 31, 2014 and 2013 are derived from our audited financial statements included in this Annual Report on Form 10-K. The statement of operations data for the years ended December 31, 2011 and 2010 and the balance sheet data as of December 31, 2012, 2011 and 2010 are derived from our audited financial statements, which are not included herein. Historical results are not necessarily indicative of future results. See the notes below and to the consolidated financial statements for an explanation of the method used to determine the number of shares used in computing NOI and net income (loss) per common share, basic and diluted. The selected consolidated financial data set forth below should be read in conjunction with, and is qualified in its entirety by, our audited consolidated financial statements and related notes thereto found at Item 8. Financial Statements and Supplementary Data and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(in thousands, except per share and other period-end data)
Years ended December 31,
 
2014
2013
2012
2011
2010
Income statement data
 
 
 
 
 
Revenue
$
26,813

$
50,485

$
60,993

$
85,696

$
89,569

Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax (benefit) provision
3,143

29,896

18,806

37,658

40,565

Net investment loss
(24,179
)
(28,594
)
(13,299
)
(129,873
)
(54,819
)
Net (loss) income
(20,843
)
1,176

4,998

(93,115
)
(13,072
)
Per common share data
 
 
 
 
 
Net operating income before net investment loss, (loss) gain on extinguishment of debt and income tax (benefit) provision per weighted-average common share—basic and diluted
$
0.06

$
0.42

$
0.25

$
0.49

$
0.54

Income (loss) per weighted-average common share—basic and diluted
$
(0.38
)
$
0.02

$
0.07

$
(1.22
)
$
(0.17
)
Cash dividends declared per common share
$
0.25

$
0.50

$
0.58

$
0.66

$
0.37

Selected period-end balances
 
 
 
 
 
Cash and cash equivalents
$
105,826

$
91,598

$
73,588

$
58,563

$
44,970

Investment portfolio balance
 
 
 
 
 
Fair value
75,332

368,873

477,724

741,166

1,009,705

Cost
234,640

566,438

668,787

1,017,218

1,245,673

Total assets
183,797

513,993

630,776

890,538

1,145,277

Borrowings

175,172

248,053

430,219

546,882

Total stockholders’ equity
178,901

333,954

371,728

434,952

578,016

Net asset value per common share outstanding(a)
$
4.69

$
4.74

$
5.18

$
5.65

$
7.54

Other period-end data
 
 
 
 
 
Average size of investment
 
 
 
 
 
Fair value
$
10,762

$
10,849

$
10,857

$
12,353

$
14,221

Cost
$
33,520

$
16,660

$
15,200

$
16,954

$
17,545

Number of portfolio companies
7

34

44

60

71

Weighted-average common shares outstanding—basic and diluted
55,504

71,232

74,859

76,259

75,422

Shares outstanding at end of year
38,136

70,510

71,721

76,997

76,662

    
(a)
Based on common shares outstanding at period-end.

31



ITEM 7.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information contained in this section should be read in conjunction with the Selected Financial Data and Other Data, and our Consolidated Financial Statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K.
This Annual Report on Form 10-K, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates, forecasts, projections, intentions, goals, strategies, plans, prospects and the beliefs and assumptions of our management including, without limitation: our expectations regarding our results of operations, including revenues, net operating income, net investment losses and general and administrative expenses and the factors that may affect such results; our expectations regarding the exploration of strategic alternatives when we cannot provide any assurance that the exploration of strategic alternatives will result in the identification or consummation of any transaction, or whether any strategic alternative, if identified, evaluated and consummated, will provide the anticipated benefits or otherwise enhance stockholder value; our expectation regarding the closing of our sale transaction involving Pharmalogic Holdings Corp.; our decisions to make dividend distributions after taking into account our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio; expected accretion to net asset value from our stock repurchase program; the sufficiency of liquidity to meet 2015 operating requirements, new origination opportunities and potential dividend distributions; our expectations regarding the full use of, and our belief that our operations, monetizations and unrestricted cash will provide sufficient liquidity to fund, as necessary, requests to draw on unused portions of commitments that obligate us to extend credit in the form of loans, participations in loans, guarantees, letters of credit and other financial commitments; our use of independent valuation firms to provide additional support for our internal analyses; our expectations regarding the outcome of legal proceedings incidental to our business; market conditions generally and specifically regarding the leveraged loan market; the state of the economy and other factors. Forward-looking statements can be identified by terminology such as “anticipate,” “believe,” “could,” “could increase the likelihood,” “hope,” “target,” “project,” “goals,” “potential,” “predict,” “might,” “estimate,” “expect,” “intend,” “is planned,” “may,” “should,” “will,” “will enable,” “would be expected,” “look forward,” “may provide,” “would” or similar terms, variations of such terms or the negative of those terms. These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict. Important factors could cause our actual results to differ materially from those indicated or implied by forward-looking statements. Such factors that could cause or contribute to such differences include those risk factors discussed in Item IA of Part I of this Annual Report on Form 10-K.
Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be incorrect. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this Annual Report on Form 10-K should not be regarded as a representation by us that our plans and objectives will be achieved. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Annual Report on Form 10-K. We undertake no obligation to update any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.
DESCRIPTION OF BUSINESS
We are a solutions-focused commercial finance company that provides capital and advisory services to lower middle-market companies throughout the United States. Generally, our portfolio companies use our capital investment to finance acquisitions, recapitalizations, buyouts, organic growth, working capital and other general corporate purposes.
We are an internally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. As a BDC we must meet various regulatory tests, which include investing at least 70% of our total assets in private or thinly traded public U.S.-based companies and limitations on our ability to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt generally may not exceed 50% of the value of our assets).
In addition, we have elected to be treated for federal income tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code. In order to continue to qualify as a RIC for federal income tax purposes and obtain favorable RIC tax treatment, we must meet certain requirements, including certain minimum distribution requirements. If we satisfy these requirements, we generally will not have to pay corporate-level taxes on any income we distribute to our stockholders as distributions, allowing us to substantially reduce or eliminate our corporate-level tax liability. From time to time, our wholly owned subsidiaries may execute transactions that trigger corporate-level tax liabilities. In such cases, we recognize a tax provision in the period when it becomes more likely than not that the taxable event will occur.

32



Significant Developments in 2014
Originations and Advances — For the three and twelve month periods ended December 31, 2014, we made $0.1 million and $10.0 million, respectively, in originations and advances to existing portfolio companies.
Loan Monetizations — For the three and twelve month periods ended December 31, 2014, we received $15.6 million and $265.4 million, respectively, in loan payoffs and amortization payments.
Equity Monetizations and Realizations — For the three and twelve month periods ended December 31, 2014, we received $5.7 million and $16.7 million, respectively, in proceeds from the sale of equity investments, principally the sale of securities in each of Accurate Group Holdings, Inc., C7 Data Centers, Inc., G&L Investment Holdings, LLC, Golden Knight II CLO, Ltd. and IDOC, LLC. With the exception of the publicly listed minority equity investment in Broadview Networks Holdings, Inc., in which we have a built-in capital tax loss of approximately $93 million, and the pending sale of our last control equity investment in RadioPharmacy Investors, LLC that we expect to close in March 2015, during the year ended December 31, 2014 we exited all of our equity positions.
Loans on Non-Accrual — As of December 31, 2014, we had no loans on non-accrual, at cost or fair value.
Reduced Leverage — As of December 31, 2014, we had no borrowings. During the twelve month period ended December 31, 2014, we (i) terminated our MCG Commercial Loan Trust 2006-1, or 2006-1 Trust; (ii) terminated our unsecured revolving credit facility with Bank of America, N.A. in the principal amount of $20.0 million, or the Bank of America Unsecured Revolver; (iii) prepaid in full the $150 million of small business investment company, or SBIC, debentures owed to the United States Small Business Administration, or SBA, by Solutions Capital I, L.P., or Solutions Capital and (iv) sold the remaining participating interest in our secured financing.
Open-Market Purchases of Our Stock — For the three and twelve month periods ended December 31, 2014, we repurchased 7,827,960 and 32,186,556 shares of our common stock at weighted average purchase prices of $3.74 and $3.73, respectively, including 4,859,744 shares purchased on December 10, 2014 in a modified "Dutch Auction" tender offer at $3.75 per share. In January 2015, we repurchased 1,061,075 shares of our common stock at a weighted average purchase price of $3.93, which we believe will contribute two cents per share in accretion to our net asset value in the first quarter of 2015. We acquired these shares from sellers in open market transactions or the modified "Dutch Auction" tender offer. We retired these shares upon settlement, thereby reducing the number of shares issued and outstanding.
Dividends — For the year ended December 31, 2014, we declared and paid $0.25 per share in dividends.
Operating Costs — For the three and twelve month periods ended December 31, 2014, our total operating costs were $3.0 million and $23.7 million, respectively. During the three month period ended December 31, 2014, we incurred $0.6 million in severance costs and $0.7 million in professional fees associated with the lawsuit against various defendants involved in our subordinated loan transaction with Color Star Growers of Colorado, Inc., or Color Star Litigation, all of which we included in general and administrative costs. During the twelve month period ended December 31, 2014, we incurred $1.3 million in salaries and benefits related to successful Solutions Capital investment exits and $1.1 million in amortization of employee restricted stock awards that accelerated upon termination of former employees, all of which we included in employee compensation. In addition, during the twelve month period ended December 31, 2014, we incurred $3.4 million in severance payments, $2.3 million in Color Star Litigation costs and $0.3 million in contractual payments due our former CEO tied to successful Solutions Capital investment exits, all of which we included in general and administrative costs.
Outlook
We continue to believe that current market conditions in our primary lending markets are consistent with a peak of a credit cycle. We believe that we have successfully monetized investments, some of which were challenging, into a very liquid market, improving the quality of our assets and our cash position and resulting in a stronger balance sheet. We also elected to use excess cash to repay all of our outstanding debt and to repurchase our stock in the open market, including a modified "Dutch Auction" tender offer in December 2014. As a result of these capital allocation decisions, we have meaningfully reduced the size of our balance sheet and our net earning assets.
In January 2015, we entered into a merger agreement to sell our largest equity investment, Pharmalogic Holdings Corp., a subsidiary of RadioPharmacy Investors, LLC. The merger agreement contains customary representations

33



and warranties of Pharmalogic Holdings Corp. and RadioPharmacy Investors, LLC as well as covenants of Pharmalogic Holdings Corp. to conduct its business in a commercially reasonable manner consistent with past practices. The transaction is subject to customary closing conditions including receipt of certain regulatory approvals. In connection with the sale transaction, we committed to amend and restate our existing senior debt to provide $17.5 million of first lien financing at 8.5% to support the sale transaction. We expect this transaction to close by March 31, 2015. Upon consummation of the transaction, we will have exited all of our control investments. See Note 13—Significant Subsidiary in Item 8. Financial Statements and Supplementary Data.
Though we continue to take steps to rationalize our cost infrastructure and to strengthen our balance sheet, our primary asset is unencumbered cash and we do not have sufficient net earning assets to generate positive net operating income at this time.
Based on a thorough business review, on February 9, 2015, our Board of Directors announced its intention to explore strategic alternatives for the Company to maximize value for stockholders, including a possible sale of the Company. We may receive offers or engage in a transaction in the ordinary course which may ultimately result in a sale of any or all of our assets, above or below the fair value on our balance sheet at that time. We may also consider a variety of extraordinary transactions, such as a sale of the Company, a restructuring, a recapitalization, a merger, a consolidation, a business combination, a special dividend to stockholders, a liquidation or other transaction or series of transactions. No timetable has been set for the Company's process and we do not expect to comment further or update the market with any additional information on the process unless and until the Board of Directors approves a specific transaction or otherwise deems disclosure appropriate or necessary.
There can be no assurance that this strategic alternatives review will result in the Company changing its current business plan, pursuing a particular transaction, completing any such transaction, or that any transaction we might enter will prove to be beneficial to our stockholders. Further, it is not certain what impact any potential strategic alternatives, or a decision not to pursue any potential strategic alternatives, may have on the Company's stock price, operating results, business or financial condition, liquidity, or business prospects.
Access to Capital and Liquidity
At December 31, 2014, we had $105.8 million of cash and cash equivalents available for general corporate purposes and $1.4 million of restricted cash held in escrow.
On September 2, 2014, we prepaid in full the $150.0 million of SBIC debentures owed to the SBA by Solutions Capital. In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense.
On January 21, 2014, we repaid and terminated our 2006-1 Trust. As of December 31, 2013, we had $25.2 million of securitized Class D Notes outstanding under the 2006-1 Trust, which was secured by $76.3 million of loans and equity investments and $13.9 million of cash. Upon termination, the assets of the 2006-1 Trust were transferred to MCG, the parent.
PORTFOLIO COMPOSITION AND INVESTMENT ACTIVITY
As of December 31, 2014, the fair value of our investment portfolio was $75.3 million, which represents a $293.6 million, or 79.6%, decrease from the $368.9 million fair value as of December 31, 2013. The following sections describe the composition of our investment portfolio as of December 31, 2014 and key changes in our portfolio during the twelve months ended December 31, 2014.

34



Portfolio Composition
The following table summarizes the composition of our investment portfolio at fair value:
 
December 31, 2014
December 31, 2013
(dollars in thousands)
Investments at
Fair Value
Percent of
Total Portfolio
Investments at
Fair Value
Percent of
Total Portfolio
Debt investments
 
 
 
 
Senior secured debt
$
40,562

53.8
%
$
185,524

50.3
%
Subordinated debt
 
 
 
 
Secured
22,460

29.8

108,338

29.4

Unsecured


42,452

11.5

Total debt investments
63,022

83.6

336,314

91.2

Equity investments
 
 
 
 
Preferred equity
12,044

16.0

28,390

7.7

Common/common equivalents equity
266

0.4

4,169

1.1

Total equity investments
12,310

16.4

32,559

8.8

Total investments
$
75,332

100.0
%
$
368,873

100.0
%
Our debt investments bear contractual interest rates ranging from 4.3% to 14.5%, a portion of which may be in the form of payment-in-kind, or PIK, interest. As of December 31, 2014, approximately 85.8% of the fair value of our loan portfolio had variable interest rates, based on either the London Interbank Offer Rate, or LIBOR, or the prime rate, and 14.2% of the fair value of our loan portfolio had fixed interest rates. As of December 31, 2014, approximately 59.9% of our loan portfolio, at fair value, had LIBOR floors between 1.5% and 2.0% on a LIBOR based index or prime floors between 2.75% and 4.50%. At origination, our loans generally have four- to six-year stated maturities. Borrowers typically pay an origination fee based on a percentage of the total commitment and a fee on undrawn commitments.
The following table summarizes our investment portfolio by industry at fair value:
 
December 31, 2014
December 31, 2013
(dollars in thousands)
Investments
at Fair Value
Percent of
Total Portfolio
Investments at
Fair Value
Percent of
Total Portfolio
Healthcare
$
44,566

59.2
%
$
84,922

23.0
%
Business services
14,172

18.8

64,108

17.4

Broadcasting
9,198

12.2

12,252

3.3

Manufacturing
7,130

9.5

51,735

14.0

Diversified financial services


3,298

0.9

Education


57,905

15.7

Publishing


25,312

6.9

Insurance


23,620

6.4

Restaurants


23,010

6.2

Information services


12,552

3.4

Home furnishings


4,730

1.3

Consumer products


4,657

1.3

Other
266

0.3

772

0.2

Total
$
75,332

100.0
%
$
368,873

100.0
%
 
 
 
 
 

35



During the twelve months ended December 31, 2014, we had concentrations in certain industries, including the healthcare, business services and broadcasting industries. The following table summarizes our fair value and revenue concentrations in each of those industries:
 
Investments at fair value
Revenue for the year ended
 
December 31, 2014
December 31, 2013
December 31, 2014
December 31, 2013
(dollars in thousands)
Amount
% of Total Portfolio
Amount
% of Total Portfolio
Amount
% of Total Revenue
Amount
% of Total Revenue
Industry
 
 
 
 
 
 
 
 
Healthcare
$
44,566

59.2
%
$
84,922

23.0
%
$
7,552

28.2
%
$
12,650

25.1
%
Business services
14,173

18.8

64,108

17.4

6,871

25.6

8,265

16.4

Broadcasting
9,198

12.2

12,252

3.3

574

2.1

1,616

3.2

Total
$
67,937

90.2
%
$
161,282

43.7
%
$
14,997

55.9
%
$
22,531

44.7
%
Changes in Investment Portfolio
During the twelve months ended December 31, 2014, we made $10.0 million of originations and advances compared to $128.1 million of originations and advances during the twelve months ended December 31, 2013. The following table summarizes our total portfolio investment activity during the twelve months ended December 31, 2014 and 2013:
 
Year ended
(in thousands)
December 31
 
2014
2013
Beginning investment portfolio
$
368,873

$
477,724

Originations and advances
10,025

128,089

Gross payments, reductions and sales of securities
(282,073
)
(210,124
)
Net realized loss(a)
(62,332
)
(21,686
)
Unrealized depreciation
(21,723
)
(14,443
)
Reversals of unrealized depreciation
59,979

7,940

Origination fees and amortization of unearned income
2,583

1,373

Ending investment portfolio
$
75,332

$
368,873

___________________________
(a) 
Net realized loss for each of the years ended December 31, 2014 and 2013 excludes $0.2 million of net realized loss related to other assets.
Originations and Advances
The following table shows our originations and advances during the twelve months ended December 31, 2014 and 2013 by security type:
 
Year ended December 31,
 
2014
2013
(dollars in thousands)
Amount
% of Total
Amount
% of Total
Debt investments
 
 
 
 
Senior secured debt
$
6,451

64.3
%
$
73,683

57.5
%
Subordinated debt
 
 
 
 
Secured
2,178

21.7

15,011

11.7

Unsecured
551

5.5

36,541

28.5

Total debt investments
9,180

91.5

125,235

97.7

Equity investments
 
 
 
 
Preferred equity
845

8.5

2,884

2.3

Common/common equivalents equity


(30
)

Total equity investments
845

8.5

2,854

2.3

Total originations and advances
$
10,025

100.0
%
$
128,089

100.0
%

36



The following table shows our significant originations and advances:
(in thousands)
Year ended
 
December 31, 2014
Company
Originations
Draws/
Advances
PIK Advances/ Dividends
Total
Debt
 
 
 
 
Oceans Acquisition, Inc.
$

$
3,250

$

$
3,250

Community Investors, Inc.

1,667


1,667

Other (< $1 million)

1,400

2,863

4,263

Total debt

6,317

2,863

9,180

Equity (< $1 million)

298

547

845

Total originations and advances
$

$
6,615

$
3,410

$
10,025

Repayments, Sales and Other Reductions of Investment Portfolio
The following table shows our gross payments, reductions and sales of securities during the twelve months ended December 31, 2014 and 2013 by security type:
 
Year ended December 31,
 
2014
2013
(dollars in thousands)
Amount
% of Total
Amount
% of Total
Debt investments
 
 
 
 
 
 
 
 
 
Senior secured debt
$
147,318

52.2
%
$
159,065

75.7
%
Subordinated debt
 
 
 
 
Secured
74,347

26.4

20,243

9.6

Unsecured
43,688

15.5

20,144

9.6

Total debt investments
265,353

94.1

199,452

94.9

Equity investments
 
 
 
 
Preferred equity
14,060

5.0

7,669

3.7

Common/common equivalents equity
2,660

0.9

3,003

1.4

Total equity investments
16,720

5.9

10,672

5.1

Total gross payments, reductions and sales of securities
$
282,073

100.0
%
$
210,124

100.0
%
During the twelve months ended December 31, 2014 and 2013, our gross payments, reductions and sales of securities by transaction type included:  
 
Year ended December 31,
(in thousands)
2014
2013
Principal repayments, reductions and loan sales
$
223,941

$
164,292

Sale of equity investments
16,001

9,803

Scheduled principal amortization
29,250

31,779

Collection of accrued paid-in-kind interest and dividends
12,881

4,250

Total gross payments, reductions and sales of securities
$
282,073

$
210,124


37



As shown in the following table, during the twelve months ended December 31, 2014, we monetized all, or part of, 28 portfolio investments with proceeds totaling $250.5 million:
 
Year ended
 
December 31, 2014
(in thousands)
Principal Repayments and Proceeds from Loan Sales
Sale or Settlement of Equity Investments
PIK Interest and Dividend Prepayments
Total
Monetizations
 
 
 
 
G&L Investment Holdings, LLC
$
17,500

$
4,196

$
2,060

$
23,756

Cruz Bay Publishing, Inc.
16,857


5,345

22,202

TCFI CP LLC
20,000


282

20,282

Miles Media Group, LLC
18,463



18,463

IDOC, LLC
13,832

1,500


15,332

Ted's Café Escondido Holdings, Inc.
14,306



14,306

Oceans Acquisition, Inc.
14,251



14,251

Huron Inc.
12,868


200

13,068

Midwest Technical Institute, Inc.
12,251



12,251

West World Media LLC
10,576

446

919

11,941

Accurate Group Holdings, Inc.
10,072

1,245


11,317

SC Academy Holdings, Inc.
9,534


1,530

11,064

Dorsey's School of Business Holdings, Inc.
9,653



9,653

Hammond's Candies Since 1920 II, LLC
9,000


508

9,508

Rita's Water Ice Franchise Company, LLC
9,282



9,282

Community Investors, Inc.
8,292

572


8,864

Visant Corporation
4,670



4,670

Advanced Sleep Concepts, Inc.
4,518



4,518

C7 Data Centers, Inc.

4,000


4,000

Education Management, Inc.
3,962



3,962

Mailsouth, Inc.
3,529



3,529

Golden Knight

1,600


1,600

Other < $1 Million
525

2,099

56

2,680

Total monetizations
223,941

15,658

10,900

250,499

Other scheduled payments
29,250

343

1,981

31,574

Total gross payments, sales and other reductions of investment portfolio
$
253,191

$
16,001

$
12,881

$
282,073

The proceeds from these monetizations correlated closely with the most recently reported fair value of the associated investments.
ASSET QUALITY
Asset quality is generally a function of portfolio company performance and economic conditions, as well as our underwriting and ongoing management of our investment portfolio. In addition to various risk management and monitoring tools, we use the following investment rating system to characterize and monitor our expected level of returns on each investment in our portfolio:
Investment
Rating
Summary Description
1
Capital gain expected or realized
2
Full return of principal and interest or dividend expected with customer performing in accordance with plan
3
Full return of principal and interest or dividend expected, but customer requires closer monitoring
4
Some loss of interest or dividend expected, but still expect an overall positive internal rate of return on the investment
5
Loss of interest or dividend and some loss of principal investment expected, which would result in an overall negative internal rate of return on the investment

38



The following table shows the distribution of our investments on our 1 to 5 investment rating scale at fair value as of December 31, 2014 and 2013:
(dollars in thousands)
December 31, 2014
December 31, 2013
Investment
Rating
Investments at
Fair Value
% of Total
Portfolio
Investments at
Fair Value
% of Total 
Portfolio
1(a)
$

%
$
104,657

28.4
%
2
22,460

29.8

137,586

37.3

3
40,562

53.8

94,102

25.5

4
12,044

16.0

25,976

7.0

5
266

0.4

6,552

1.8

Total
$
75,332

100.0
%
$
368,873

100.0
%
_________________________
(a) 
As of December 31, 2013, Investment Rating “1” included $83.4 million of loans to companies in which we also held equity securities.
When one of our loans becomes more than 90 days past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will, as a general matter, place all or a portion of the loan on non-accrual status and will cease recognizing interest income on that loan until all principal and interest have been brought current through payment or a restructuring such that the interest income is deemed to be collectible. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. If the fair value of a loan is below cost, we may cease recognizing PIK interest and/or the accretion of a discount on the debt investment until such time that the fair value equals or exceeds cost.
The following table summarizes the cost and fair value of loans more than 90 days past due and loans on non-accrual status:
 
COST BASIS
FAIR VALUE BASIS
 
December 31, 2014
December 31, 2013
December 31, 2014
December 31, 2013
(dollars in thousands)
Investments
at Cost
% of Loan
Portfolio
Investments
at Cost
% of Loan
Portfolio
Investments
at Fair Value
% of Loan
Portfolio
Investments
at Fair Value
% of Loan
Portfolio
Loans greater than 90 days past due
 
 
 
 
 
 
 
On non-accrual status
$

%
$
3,897

1.11
%
$

%
$

%
Total loans greater than 90 days past due
$

%
$
3,897

1.11
%
$

%
$

%
Loans on non-accrual status
 
 
 
 
 
 
 
 
0 to 90 days past due
$

%
$
17,531

4.98
%
$

%
$
4,493

1.34
%
Greater than 90 days past due


3,897

1.11





Total loans on non-accrual status
$

%
$
21,428

6.09
%
$

%
$
4,493

1.34
%
The following table summarizes the changes in the cost and fair value of the loans on non-accrual status from December 31, 2013 through December 31, 2014:
 
Year ended
 
December 31, 2014
(In thousands)
Cost
Fair Value
Non-accrual loan balance as of December 31, 2013
$
21,428

$
4,493

Additional loan on non-accrual status
19,856

4,879

Payments received on loans on non-accrual status
(9,469
)
(9,469
)
Change in unrealized gain (loss) on non-accrual loans

(515
)
Reversal of previously recognized unrealized loss on non-accrual loans

32,427

Realized loss on non-accrual loans
(31,815
)
(31,815
)
Total change in non-accrual loans
(21,428
)
(4,493
)
Non-accrual loan balance as of December 31, 2014
$

$


39



COMPARISON OF THE YEARS ENDED DECEMBER 31, 2014 AND 2013
The following table summarizes the components of our net income for the twelve months ended December 31, 2014 and 2013:
 
Years ended
 
 
December 31,
Variance
(dollars in thousands)
2014
2013
$
Percentage
Revenue
 
 
 
 
Interest and dividend income
 
 
 
 
Interest income
$
22,294

$
43,106

$
(20,812
)
(48.3
)%
Dividend income
547

2,554

(2,007
)
(78.6
)
Loan fees
2,675

3,165

(490
)
(15.5
)
Total interest and dividend income
25,516

48,825

(23,309
)
(47.7
)
Advisory fees and other income
1,297

1,660

(363
)
(21.9
)
Total revenue
26,813

50,485

(23,672
)
(46.9
)
Operating expenses
 
 
 
 
Interest expense
7,339

9,087

(1,748
)
(19.2
)
Employee compensation
 
 
 
 
Salaries and benefits
4,516

4,928

(412
)
(8.4
)
Amortization of employee restricted stock
1,804

1,179

625

53.0

Total employee compensation
6,320

6,107

213

3.5

General and administrative expense
10,011

5,381

4,630

86.0

Restructuring expense

14

(14
)
(100.0
)
Total operating expense
23,670

20,589

3,081

15.0

Net operating income before net investment loss, loss on extinguishment of debt and income tax (benefit) provision
3,143

29,896

(26,753
)
(89.5
)
Net investment loss before income tax (benefit) provision
(24,179
)
(28,594
)
4,415

(15.4
)
Income tax (benefit) provision
(193
)
126

(319
)
NM

Net income
$
(20,843
)
$
1,176

$
(22,019
)
NM

NM=Not Meaningful
 
 
 
 
TOTAL REVENUE
Total revenue includes interest and dividend income, loan fees, advisory fees and other income. The following sections describe the reasons for the variances in each major component of our revenue during the twelve months ended December 31, 2014 from the twelve months ended December 31, 2013.
INTEREST INCOME
The level of interest income that we earn depends upon the level of interest-bearing investments outstanding during the period, as well as the weighted-average yield on these investments. During each of the twelve months ended December 31, 2014 and December 31, 2013, the total yield on our average debt portfolio at fair value was 12.2%. The weighted-average yield may vary each period because of changes in the composition of our portfolio of debt investments, changes in stated interest rates, accelerations of unearned fees on paid-off/restructured loans and the balance of loans on non-accrual status for which we are not accruing interest.

40



The following table shows the various components of the total yield on our average debt portfolio at fair value for the twelve months ended December 31, 2014 and 2013:
 
Year ended
 
December 31
 
2014
2013
Average 90-day LIBOR
0.2
 %
0.3
 %
Spread to average LIBOR on average loan portfolio
11.3

11.9

Impact of fee accelerations of unearned fees on paid/restructured loans
0.7

0.3

Impact of non-accrual loans

(0.3
)
Total yield on average loan portfolio
12.2
 %
12.2
 %
During the twelve months ended December 31, 2014, interest income was $22.3 million, compared to $43.1 million during the twelve months ended December 31, 2013, which represented a $20.8 million, or 48.3%, decrease. This decrease reflected (i) an $18.7 million decrease resulting from a 45.7% decrease in our average loan balance, (ii) a $1.9 million decrease resulting from loans that were on non-accrual status during the twelve months ended December 31, 2014 but that had been accruing interest during the twelve months ended December 31, 2013 (iii) a $0.2 million decrease due to interest rate floors and (iv) a $0.1 million decrease related to the decrease in LIBOR. These decreases were partially offset by a $0.1 million increase in interest income attributable to our net spread to LIBOR.
PIK Income
Interest income includes certain amounts that we have not received in cash, such as PIK interest. PIK interest represents contractually deferred interest that is added to the principal balance of the loan and compounded if not paid on a current basis. Borrowers may in some instances be required to prepay PIK because of certain contractual provisions or they may choose to prepay; however, more typically, PIK is paid at the end of the loan term. The following table shows the PIK-related activity for the twelve months ended December 31, 2014 and 2013, at cost:
 
Year ended
 
December 31
(in thousands)
2014
2013
Beginning PIK loan balance
$
12,132

$
9,043

PIK interest earned during the period
2,863

6,480

Interest receivable converted to PIK

605

Payments received from PIK loans
(12,135
)
(3,381
)
Realized loss
(1,153
)
(615
)
Ending PIK loan balance
$
1,707

$
12,132

As of each of December 31, 2014 and 2013, all of our PIK loans were accruing interest. During the twelve months ended December 31, 2014, the payments received from PIK loans included $5.3 million collected in connection with the repayment of our loan to Cruz Bay Publishing, Inc., $2.1 million related to the repayment in full of our loan to G&L Investment Holdings, LLC, $1.5 million collected in connection with the sale of our loan to SC Academy Holdings, Inc., $0.9 million collected in connection with the repayment of our loan to West World Media, LLC, $0.9 million in payments on our loan to RadioPharmacy Investors, LLC and $0.5 million collected in connection with the repayment of our loan to Hammond's Candies Since 1920 II, LLC. The payments received from PIK loans during the twelve months ended December 31, 2013, included $1.0 million collected in conjunction with the partial repayment of our investment in Education Management, Inc., as well as $0.8 million and $0.5 million collected in conjunction with the repayments in full of our investments in NDSSI Holdings, LLC and Contract Datascan Holdings, Inc., respectively.
DIVIDEND INCOME
We accrete dividends on equity investments with stated dividend rates as they are earned, to the extent that we believe the dividends will be paid ultimately and the associated portfolio company has sufficient value to support the accretion. Dividend accretion is included in the cost basis of the related equity instrument on our Consolidated Balance Sheets and Consolidated Schedule of Investments. We record dividend income on common equity investments when the dividend has been declared and is required to be paid. Our dividend income varies from period to period because of changes in the size and composition of our equity investments, the yield from the investments in our equity portfolio and the ability of the portfolio companies to declare and pay dividends. During the twelve months ended December 31,

41



2014 and 2013, we recognized dividend income of $0.5 million and $2.6 million, respectively. In addition, during the twelve months ended December 31, 2014 and 2013, we received payments on accrued dividends of $0.7 million and $0.9 million, respectively. As of December 31, 2014, the balance of accrued dividends was $6.4 million, which was related to our equity investment in RadioPharmacy Investors, LLC.
ADVISORY FEES AND OTHER INCOME
Advisory fees and other income primarily include fees related to prepayment, advisory and management services, equity structuring, syndication, bank interest and other income. Generally, advisory fees and other income relate to specific transactions or services and, therefore, may vary from period to period depending on the level and types of services provided. During the twelve months ended December 31, 2014, we earned $1.3 million of advisory fees and other income, which represented a $0.4 million, or 21.9%, decrease from the twelve months ended December 31, 2013. This decrease resulted from a decrease in amendment and management fees of $0.3 million and a decrease in interest on cash of $0.1 million.
TOTAL OPERATING EXPENSES
Total operating expenses include interest, employee compensation and general and administrative expenses. The reasons for these variances are discussed in more detail below.
INTEREST EXPENSE
During the twelve months ended December 31, 2014, we incurred $7.3 million of interest expense, which represented a $1.7 million, or 19.2%, decrease from the same period in 2013. On September 2, 2014, we prepaid in full the $150.0 million of SBIC debentures owed to the SBA by Solutions Capital, which had a cost of funds, including the amortization of deferred financing costs, of 4.6%. In connection with the repayment of the SBIC debentures, we recorded $2.3 million of accelerated deferred financing costs in interest expense. In addition, interest expense for the twelve months ended December 31, 2014 includes $0.2 million of interest and deferred financing costs associated with our 2006-1 Trust, which we terminated in January 2014. As of December 31, 2014, we had no outstanding borrowings or borrowing facilities.
During the year ended December 31, 2014, our average borrowings declined to approximately $108 million from an average of approximately $201 million for the same period in 2013, which accounted for a $3.8 million reduction in our interest expense. In addition, interest expense decreased by $0.1 million due to a decrease in the average LIBOR rate from 0.27% to 0.23%. These decreases were offset by $1.7 million related to increased amortization of debt issuance costs and $0.4 million attributable to the spread to LIBOR increasing from approximately 3.63% to 3.83%.
EMPLOYEE COMPENSATION
Employee compensation expense includes base salaries and benefits, variable annual incentive compensation and amortization of employee stock awards. During the twelve months ended December 31, 2014, our employee compensation expense was $6.3 million, which represented a $0.2 million, or 3.5%, increase from the same period in 2013. Our salaries and benefits decreased by $0.4 million, or 8.4%, due to a $1.3 million decrease in base salaries and benefits, offset by a $0.9 million increase in incentive compensation. During the twelve months ended December 31, 2014, we incurred $1.3 million in incentive compensation tied to successful Solutions Capital investment exits. As of December 31, 2014, we had six employees compared to 17 employees as of December 31, 2013. Amortization of employee stock awards for the year ended December 31, 2014 includes $1.1 million of accelerated amortization related to the retirement of our former chief executive officer and other employee terminations.
GENERAL AND ADMINISTRATIVE
During the twelve months ended December 31, 2014, general and administrative expense was $10.0 million, which represented a $4.6 million, or 86.0%, increase compared to the same period in 2013.
General and administrative expense increased $2.6 million due to an increase in severance costs. General and administrative expense for the year ended December 31, 2014 includes $2.2 million in severance related to the retirement of our former chief executive officer and $1.2 million in severance related to other employee terminations.

42



General and administrative expense increased $2.0 million due to an increase in legal fees. Legal fees expense for the year ended December 31, 2014 included $2.3 million related to our lawsuit against various defendants involved in our subordinated loan transaction with Color Star Growers of Colorado, Inc., Vast, Inc. and Color Star LLC.
General and administrative expense increased $0.3 million due to an increase in professional services fees. Professional services fees expense for the year ended December 31, 2014 included $0.3 million in contractual payments due our former chief executive officer tied to successful Solutions Capital investment exits.
General and administrative expense decreased $0.3 million due to a reduction in audit and accounting fees, third party valuation fees, dues and subscriptions and other expense items of the business.
NET INVESTMENT (LOSS) GAIN BEFORE INCOME TAX (BENEFIT) PROVISION
During the twelve months ended December 31, 2014, we incurred $24.2 million of net investment losses before income tax (benefit) provision, compared to $28.6 million during the same period in 2013. These amounts represent the total of net realized gains and (losses), net unrealized appreciation (depreciation), and reversals of unrealized (appreciation) depreciation. We reverse unrealized (appreciation) depreciation at the time that we realize the gain or (loss). The following table summarizes our realized and unrealized gain and (loss) on investments and changes in our unrealized appreciation and depreciation on investments for the twelve months ended December 31, 2014:
 
 
 
Year ended December 31, 2014
(in thousands)
 
Industry
Type
Realized
Gain/(Loss)
Unrealized (Depreciation)/
Appreciation
Reversal of
Unrealized
Depreciation/
(Appreciation)
Net
(Loss)/
Gain
Portfolio Company
Note
Education Management, Inc.
1
Education
Affiliate
$
(20,727
)
$
(15,984
)
$
20,810

$
(15,901
)
SC Academy Holdings, Inc.
2
Education
Non-Affiliate
(4,037
)


(4,037
)
Golden Knight II CLO, Ltd.
3
Diversified Financial Services
Non-Affiliate
(429
)
(1,236
)
429

(1,236
)
RadioPharmacy Investors, LLC
4
Healthcare
Control

(1,131
)

(1,131
)
Maverick Healthcare Equity, LLC
5
Healthcare
Non-Affiliate
(1,177
)
(591
)
1,138

(630
)
Jet Plastica Investors, LLC
6
Plastic Products
Control
(3,371
)

3,897

526

C7 Data Centers, Inc.
7
Business Services
Affiliate
2,000

(207
)
(1,275
)
518

Summit Business Media Parent Holding Company LLC
8
Information Services
Non-Affiliate
(5,717
)
(27
)
5,305

(439
)
Advanced Sleep Concepts, Inc.
9
Home Furnishings
Non-Affiliate
(5,741
)
317

5,746

322

Legacy Cabinets Holdings II, Inc.
10
Home Furnishings
Non-Affiliate
(1,665
)
283

1,665

283

G&L Investment Holdings, LLC
11
Insurance
Non-Affiliate
(4,416
)

4,523

107

GMC Television Broadcasting, LLC
12
Broadcasting
Control
(16,046
)
35

16,046

35

Other (< $1.0 million net gain (loss))
 
 
 
(1,311
)
(3,285
)
2,000

(2,596
)
Total
 
 
 
$
(62,637
)
$
(21,826
)
$
60,284

$
(24,179
)
____________________________
1.
We sold our senior debt and preferred stock investment in Education Management, Inc. for net proceeds of $3.5 million resulting in a realized loss of $20.7 million and the reversal of previously recorded unrealized depreciation of $20.8 million.
2.
We sold our subordinated debt investment in SC Academy Holdings, Inc. for net proceeds of $11.1 million resulting in a realized loss of $4.0 million.
3.
We sold our investment in Golden Knight II CLO, Ltd. for proceeds of $1.6 million resulting in a realized loss of $0.4 million and the reversal of previously recorded unrealized depreciation of $0.4 million.
4.
In January 2015, we entered into a merger agreement to sell our largest equity investment, Pharmalogic Holdings Corp., a subsidiary of RadioPharmacy Investors, LLC. The sale transaction is subject to customary closing conditions, including receipt of certain regulatory approvals, and is anticipated to close by March 31, 2015. As of December 31, 2014, the fair value estimate of our investment in RadioPharmacy Investors, LLC reflects the net sales proceeds from this transaction.
5.
We sold our equity investment in Maverick Healthcare Equity, LLC for net proceeds of $0.8 million resulting in a realized loss of $1.2 million and the reversal of previously recorded unrealized depreciation of $1.1 million.
6.
We received the final proceeds for the sale of the assets of Jet Plastica Investors, LLC of $0.5 million resulting in a realized loss of $3.4 million and the reversal of previously recorded unrealized depreciation of $3.9 million.

43



7.
We sold our equity investment in C7 Data Centers, Inc. for net proceeds of $4.0 million resulting in a realized gain of $2.0 million and the reversal of previously recorded unrealized appreciation of $1.3 million.
8.
We sold our equity investment in Summit Business Media Parent Holding Company LLC for net proceeds of $0.2 million resulting in a realized loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.3 million.
9.
We sold our senior and subordinated debt investment in Advanced Sleep Concepts, Inc. for net proceeds of $4.5 million resulting in a realized loss of $5.7 million and the reversal of previously recorded unrealized depreciation of $5.7 million.
10.
We sold our equity investment in Legacy Cabinets Holdings II, Inc. for net proceeds of $0.5 million resulting in a realized loss of $1.7 million and the reversal of previously recorded unrealized depreciation of $1.7 million.
11.
We sold our preferred and common equity investments in G&L Investment Holdings, LLC resulting in a realized loss of $4.4 million and a reversal of previously recorded unrealized depreciation of $4.5 million.
12.
In addition, in December 2014, we wrote off our subordinated debt and equity investments in GMC Television Broadcasting, LLC resulting in a realized loss of $16.0 million and a reversal of previously recorded unrealized depreciation of $16.0 million.
The remaining unrealized depreciation and appreciation shown in the above table resulted predominantly from the change in the performance of certain of our portfolio companies and the multiples used to value certain of our investments.
The following table summarizes our realized and unrealized (loss) and gain on investments and changes in our unrealized appreciation and depreciation on investments for 2013:
 
 
 
Year ended December 31, 2013
(in thousands)
 
Industry
Type
Realized
Gain/(Loss)
Unrealized (Depreciation)/
Appreciation
Reversal of
Unrealized
Depreciation/
(Appreciation)
Net
(Loss)/
Gain
Portfolio Company
Note
Color Star Growers of Colorado, Inc.
1
Agriculture
Non-Affiliate
$
(13,522
)
$
(327
)
$
327

$
(13,522
)
Virtual Radiologic Corporation
2
Healthcare
Non-Affiliate
(6,298
)
(3,341
)
4,841

(4,798
)
RadioPharmacy Investors, LLC
3
Healthcare
Control

(4,655
)

(4,655
)
G&L Investment Holdings, LLC
4
Insurance
Non-Affiliate

(3,870
)

(3,870
)
Education Management, Inc.
5
Education
Affiliate

(3,627
)

(3,627
)
Advanced Sleep Concepts, Inc.
6
Home Furnishings
Non-Affiliate
(3,424
)
(2,381
)
3,249

(2,556
)
Maverick Healthcare Equity, LLC
7
Healthcare
Non-Affiliate

(1,144
)

(1,144
)
Miles Media Group, LLC
8
Business Services
Affiliate
2,877

1,192

(1,170
)
2,899

C7 Data Centers, Inc.
9
Business Services
Affiliate

1,114


1,114

Other (< $1 million net gain (loss))
 
 
 
(1,523
)
2,395

693

1,565