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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
☒
☐
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2019
Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Commission
File Number
814-01022
Exact name of registrant as specified in its charter, address of principal executive
office, telephone number and state or other jurisdiction of incorporation or organization
I.R.S. Employer
Identification Number
Capitala Finance Corp.
4201 Congress St., Suite 360
Charlotte, North Carolina 28209
Telephone: (704) 376-5502
State of Incorporation: Maryland
Securities registered pursuant to Section 12(b) of the Act:
90-0945675
Title of Each Class
Trading symbol(s)
Name of Each Exchange on Which Registered
Common Stock, par value $0.01 per share
5.75% Convertible Notes due 2022
6.00% Notes due 2022
CPTA
CPTAG
CPTAL
Securities registered pursuant to Section 12(g) of the Act: None
NASDAQ Global Select Market
NASDAQ Capital Market
NASDAQ Global Select Market
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
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 ☒
Yes ☐ No ☒
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.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of
Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes ☐ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging
growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the
Exchange Act.
Yes ☒ No ☐
Large accelerated filer ☐
Non-accelerated filer ☐
Accelerated filer ☒
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or
revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $141.5 million based on the number of shares held by
non-affiliates of the registrant as of June 28, 2019, which was the last business day of the registrant’s most recently completed second fiscal quarter. For the purposes of
calculating this amount only, all directors and executive officers of the registrant have been treated as affiliates.
The number of shares of Capitala Finance Corp.’s common stock, $0.01 par value, outstanding as of February 27, 2020 was 16,218,362.
Portions of the registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A relating to the
registrant’s 2020 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company’s fiscal
year, are incorporated by reference in Part III of this Annual Report on Form 10-K as indicated herein.
Documents Incorporated by Reference
Yes ☐ No ☒
TABLE OF CONTENTS
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.
Consolidated 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 Consolidated Financial Statement Schedules
Item 16.
Form 10-K Summary
Signatures
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PART I
In this Annual Report on Form 10-K, except as otherwise indicated, the terms:
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•
“we,” “us,” “our,” “Capitala Finance” and the “Company” refer to Capitala Finance Corp., together
with its consolidated subsidiaries;
The “Investment Advisor” and “Capitala Investment Advisors” refer to Capitala Investment Advisors,
LLC, our investment adviser; and
•
The “Administrator” refers to Capitala Advisors Corp., our administrator.
ITEM 1. BUSINESS
FORMATION OF OUR COMPANY
We are an externally managed non-diversified closed-end management investment company incorporated in
Maryland that has elected to be regulated as a business development company (“BDC”) under the Investment
Company Act of 1940, as amended (the “1940 Act”). We commenced operations on May 24, 2013 and completed
our initial public offering (“IPO”) on September 30, 2013. We are managed by Capitala Investment Advisors,
LLC (the “Investment Advisor”), an investment adviser that is registered as an investment adviser under the
Investment Advisers Act of 1940, as amended (the “Advisers Act”), and Capitala Advisors Corp. (the
“Administrator”) provides the administrative services necessary for us to operate. For U.S. federal income tax
purposes, we have elected to be treated, and intend to comply with the requirements to continue to qualify
annually, as a regulated investment company (“RIC”) under subchapter M of the Internal Revenue Code of 1986,
as amended (the “Code”).
Our investment objective is to generate both current income and capital appreciation through debt and equity
investments. Both directly and through our subsidiaries that are licensed by the U.S. Small Business
Administration (“SBA”) under the Small Business Investment Company (“SBIC”) Act, we offer customized
financing to business owners, management teams and financial sponsors for change of ownership transactions,
recapitalizations, strategic acquisitions, business expansion and other growth initiatives. We invest in first lien
loans, second lien loans and subordinated loans, and, to a lesser extent, equity securities issued by lower middle-
market companies and traditional middle-market companies.
We were formed for the purpose of: (i) acquiring, through a series of transactions, an investment portfolio
from the following entities: CapitalSouth Partners Fund I Limited Partnership (“Fund I”); CapitalSouth Partners
Fund II Limited Partnership (“Fund II”); CapitalSouth Partners Fund III, L.P. (“Fund III Parent”); CapitalSouth
Partners SBIC Fund III, L.P. (“Fund III”) and CapitalSouth Partners Florida Sidecar Fund I, L.P. (“Florida
Sidecar” and, collectively with Fund I, Fund II, Fund III and Fund III Parent, the “Legacy Funds”); (ii) raising
capital in the IPO and (iii) continuing and expanding the business of the Legacy Funds by making additional debt
and equity investments in lower middle-market and traditional middle-market companies.
On September 24, 2013, we acquired 100% of the limited partnership interests in Fund II, Fund III and
Florida Sidecar and each of their respective general partners, as well as certain assets from Fund I and Fund III
Parent, in exchange for an aggregate of 8,974,420 shares of our common stock (the “Formation Transactions”).
Fund II, Fund III and Florida Sidecar became our wholly owned subsidiaries. Fund II and Fund III retained their
SBIC licenses, continued to hold their existing investments at the time of the IPO and have continued to make
new investments. The IPO consisted of the sale of 4,000,000 shares of our common stock at a price of $20.00 per
share resulting in net proceeds to us of $74.25 million, after deducting underwriting fees and commissions
totaling $4.0 million and offering expenses totaling $1.75 million. The other costs of the IPO were borne by the
limited partners of the Legacy Funds. During the fourth quarter of 2017, Florida Sidecar transferred all of its
assets to Capitala Finance Corp. and was legally dissolved as a standalone partnership. On March 1, 2019,
Fund II repaid its outstanding SBA debentures and relinquished its SBIC license.
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The Company has formed and expects to continue to form certain consolidated taxable subsidiaries (the
“Taxable Subsidiaries”), which are taxed as corporations for income tax purposes. These Taxable Subsidiaries
allow the Company to make equity investments in companies organized as pass-through entities while continuing
to satisfy the requirements of a RIC under the Code.
OUR INVESTMENT STRATEGY
Our investment objective is to generate both current income and capital appreciation through debt and equity
investments. We expect the companies in which we invest will generally have between $4.5 million and
$30.0 million in trailing twelve-month earnings before interest, tax, depreciation and amortization (“EBITDA”).
We believe our focus on direct lending to private companies enables us to receive higher interest rates and more
substantial equity participation. As part of that strategy, we may invest in first lien loans, which have a first
priority security interest in all or some of the borrower’s assets. In addition, our first lien loans may include
positions in “stretch” senior secured loans, also referred to as “unitranche” loans, which combine characteristics
of traditional first lien senior secured loans and second lien loans, providing us with greater influence and
security in the primary collateral of a borrower and potentially mitigating loss of principal should a borrower
default. We also may invest in second lien loans, which have a second priority security interest in all or
substantially all of the borrower’s assets. In addition to first and second lien loans, we invest in subordinated
loans, which may include mezzanine and other types of junior debt investments. Like second lien loans, our
subordinated loans typically have a second lien on all or substantially all of the borrower’s assets; however, the
principal difference between subordinated loans and second lien loans is that in a subordinated loan, we may be
subject to the interruption of cash interest payments, at the discretion of the first lien lender, upon certain events
of default. In addition to debt securities, we may acquire equity or detachable equity-related interests (including
warrants) from a borrower. Typically, the debt in which we invest is not initially rated by any rating agency;
however, we believe that if such investments were rated, they would be rated below investment grade. Below
investment grade securities, which are often referred to as “high yield” or “junk,” have predominantly speculative
characteristics with respect to the issuer’s capacity to pay interest and repay principal. We intend to target
investments that mature in four to six years from our investment.
We typically will not limit the size of our loan commitments to a specific percentage of a borrower’s assets
that serve as collateral for our loan, although we attempt to protect against risk of loss on our debt investments by
structuring, underwriting and pricing loans based on anticipated cash flows of our borrowers. As of December 31,
2019, our Investment Advisor underwrote investments in approximately 160 lower middle-market and traditional
middle-market companies totaling approximately $1.8 billion of invested capital since 2000, and we believe that
a continuation of this strategy allows us to make structured investments with more attractive pricing and greater
opportunities for meaningful equity participation than traditional asset-based, senior secured loans. Further, we
believe that we benefit from our Investment Advisor’s long-standing relationships with many private equity fund
sponsors, whose participation in portfolio companies, we believe, makes repayment from refinancing, asset sales
and/or sales of the borrowers themselves more likely than a strategy whereby we consider investments only in
founder-owned or non-sponsored borrowers.
OUR INVESTMENT ADVISOR
We are managed by the Investment Advisor, whose investment team members have significant and diverse
experience financing, advising, operating and investing in lower middle-market and middle-market companies.
Moreover, our Investment Advisor’s investment team has refined its investment strategy by sourcing, reviewing,
acquiring and monitoring approximately 160 portfolio companies totaling approximately $1.8 billion of invested
capital from 2000 through December 31, 2019. The Investment Advisor’s investment team also manages
CapitalSouth Partners SBIC Fund IV, L.P. (“Fund IV”), a private investment limited partnership providing
financing solutions to smaller and lower middle-market companies. Fund IV had its first closing in March 2013
and obtained SBA approval for its SBIC license in April 2013. In addition to Fund IV, affiliates of the Investment
Advisor may manage several affiliated funds whereby institutional limited partners in Fund IV have the
opportunity to co-invest with Fund IV in portfolio investments. An affiliate of the Investment Advisor also
manages Capitala Private Credit Fund V, L.P. (“Fund V”), a private investment limited partnership, and a private
investment vehicle (referred to herein as “Capitala Specialty Lending Corp.” or “CSLC”), both of which provide
financing solutions to lower middle-market and traditional middle-market companies. The Investment Advisor
and its affiliates may also manage other funds in the future that
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may have investment mandates that are similar, in whole and in part, with ours. To the extent permitted by the
1940 Act and interpretation of the staff of the U.S. Securities and Exchange Commission (the “SEC”), the
Investment Advisor and its affiliates may determine that an investment is appropriate for us and for one or more
of those other funds. In such event, depending on the availability of such investment and other appropriate
factors, the Investment Advisor or its affiliates may determine that we should invest side-by-side with one or
more other funds. Any such investments will be made only to the extent permitted by applicable law and
interpretive positions of the SEC and its staff, and consistent with the Investment Advisor’s allocation
procedures. We expect to make, and have made, co-investments with Fund IV, Fund V and/or CSLC to the extent
their respective investment strategies align with ours.
On June 1, 2016, the SEC issued an exemptive order (the “Order”), which permits the Company to co-invest
in portfolio companies with certain funds or entities managed by the Investment Advisor or its affiliates in certain
negotiated transactions where co-investing would otherwise be prohibited under the 1940 Act, subject to the
conditions of the Order. Pursuant to the Order, the Company is permitted to co-invest with its affiliates if a
“required majority” (as defined in Section 57(o) of the 1940 Act) of the Company’s independent directors make
certain conclusions in connection with a co-investment transaction, including, but not limited to, that (1) the
terms of the potential co-investment transaction, including the consideration to be paid, are reasonable and fair to
the Company and its stockholders and do not involve overreaching in respect of the Company or its stockholders
on the part of any person concerned, and (2) the potential co-investment transaction is consistent with the
interests of the Company’s stockholders and is consistent with its then-current objectives and strategies.
Our Investment Advisor is led by Joseph B. Alala, III, our chief executive officer, chairman of our Board of
Directors (the “Board”), and the managing partner and chief investment officer of our Investment Advisor, M.
Hunt Broyhill, a member of the Board and a partner of our Investment Advisor, Stephen A. Arnall, our chief
financial officer and chief operating officer, and John F. McGlinn, a senior managing director of our Investment
Advisor. Messrs. Alala, Broyhill and McGlinn serve as our Investment Advisor’s investment committee. They are
assisted by nineteen investment professionals.
Our Investment Advisor’s investment committee, as well as certain key investment team members that are
involved in screening and underwriting portfolio transactions, have worked together for more than 15 years.
These investment professionals have an average of over 20 years of experience in various finance-related fields,
including operations, corporate finance, investment banking, business law and merchant banking, and have
collectively developed a broad network of contacts that can offer us investment opportunities. Much of our
Investment Advisor’s investment team has worked together screening opportunities, underwriting new
investments and managing a portfolio of investments in lower middle-market and traditional middle-market
companies through two recessions, a credit crunch, the dot-com boom and bust and a historic, leverage-fueled
asset valuation bubble.
INVESTMENTS
We will engage in various investment strategies from time to time in order to achieve our overall lending
and investment objectives. Our strategies will generally require current cash yields and sensible leverage and
fixed charge coverage ratios and either a first or second lien position (subject to limited instances in which we
will not obtain security) in the collateral of the portfolio company. The strategy we select will depend upon,
among other things, market opportunities, the skills and experience of our Investment Advisor’s investment team,
the result of our financial, operational and strategic evaluation of the opportunity, and our overall portfolio
composition. Most of our existing debt investments offer, and we expect most of our future debt investments will
offer, the opportunity to participate in a borrower’s equity performance through warrant participation, direct
equity ownership or otherwise, and many notes that we purchase will require the borrower to pay an early
termination fee. Collectively, these attributes have been, and are expected to be, important contributors to the
returns generated by our Investment Advisor’s investment team.
The Investment Advisor’s investment team uses a disciplined investment portfolio monitoring and risk
management process that emphasizes strict underwriting standards and guidelines, strong due diligence
investigation, regular portfolio review, analysis and performance-guided responses, and proper investment
diversification. We allocate capital among different industries, geographies and private equity sponsors on the
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basis of relative risk/reward profiles as a function of their associated downside risk, volatility, perceived
fundamental risk and our ability to obtain favorable investment protection terms.
Types of Investments
We will target debt investments that yield meaningful current income and, in many cases, provide the
opportunity for capital appreciation through equity securities. In each case, the following criteria and guidelines
are applied to the review of a potential investment; however, not all criteria are met in every single investment in
our portfolio, nor do we guarantee that all criteria will be met in the investments we will make in the future.
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Established Companies With Positive Cash Flow. We seek to invest in established companies with a
history of generating revenues and positive cash flows. We intend to focus on companies with a history of
profitability and minimum trailing twelve-month EBITDA of between $4.5 million and $30.0 million. We
do not intend to invest in start-up companies, distressed or “turn-around” situations or companies with
business plans that we do not understand.
Experienced Management Teams with Meaningful Investment. We seek to invest in companies in
which senior or key managers have significant company or industry-level experience and have significant
equity ownership. It has been our experience that these management teams are more committed to the
company’s success and more likely to manage the company in a manner that protects our debt and equity
investments.
Significant Invested Capital. We believe that the existence of an appropriate amount of equity beneath
our debt capital provides valuable support for our investment. In addition, the degree to which the
particular investment is a meaningful one for the portfolio company’s financial sponsor, and the financial
sponsor’s ability and willingness to invest additional equity capital as and to the extent necessary, are also
important considerations.
Appropriate Capital Structures. We seek to invest in companies that are appropriately capitalized. First,
we examine the amount of equity that is being invested by the company’s private equity sponsor to
determine whether there is a sufficient capital cushion beneath our invested capital. We also analyze the
amount of leverage and the characteristics of senior debt with lien priority over our investment.
Strong Competitive Position. We intend to invest in companies that have developed strong, defensible
product or service offerings within their respective market segments. These companies should be well
positioned to capitalize on organic and strategic growth opportunities, and should compete in industries
with strong fundamentals and meaningful barriers to entry. We further analyze prospective portfolio
investments in order to identify competitive advantages within their respective industries, which may
result in superior operating margins or industry-leading growth.
Customer and Supplier Diversification. We expect to invest in companies with sufficiently diverse
customer and supplier bases. We believe these companies will be better able to endure industry
consolidation, economic contraction and increased competition than those that are not sufficiently
diversified. However, we also recognize that from time to time, an attractive investment opportunity with
some concentration among its customer base or supply chain will present itself. We believe that
concentration issues can be evaluated and, in some instances (whether due to supplier or customer product
or platform diversification, the existence and quality of long-term agreements with such customers or
suppliers or other select factors), mitigated, thus presenting a superior risk-adjusted pricing scenario.
Debt Investments
The Investment Advisor’s investment team tailors the terms of each debt investment to the facts and
circumstances of the transaction, the needs of the prospective portfolio company and, as applicable, its financial
sponsor, negotiating a structure that seeks to protect our rights and manage our risk while creating incentives for
the portfolio company to achieve its business plan. We expect our primary source of return to be the monthly cash
interest we will collect on our debt investments. We also typically seek board observation rights with each
portfolio company and we offer (and have historically provided) managerial and strategic assistance to these
companies. We seek to further protect invested principal by negotiating appropriate
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affirmative, negative and financial covenants in our debt documents that are conservative enough to represent a
prudent cushion at closing or to budgeted projections, but that are flexible enough to afford our portfolio
companies and their financial sponsors sufficient latitude to allow them to grow their businesses. Typical
covenants include default triggers and remedies (including penalties), lien protection, leverage and fixed charge
coverage ratios, change of control provisions and put rights. Most of our loans feature call protection to enhance
our total return on debt investments that are repaid prior to maturity.
Most of our debt investments are structured as first lien loans, and as of December 31, 2019, 81.1% of the
fair value of our debt investments consisted of such investments. First lien loans may contain some minimum
amount of principal amortization, excess cash flow sweep feature, prepayment penalties, or any combination of
the foregoing. First lien loans are secured by a first priority lien in existing and future assets of the borrower and
may take the form of term loans, delayed draw facilities, or revolving credit facilities. In some cases, first lien
loans may be subordinated, solely with respect to the payment of cash interest, to an asset based revolving credit
facility. Unitranche debt, a form of first lien loan, typically involves issuing one debt security that blends the risk
and return profiles of both senior secured and subordinated debt in one debt security, bifurcating the loan into a
first-out tranche and last-out tranche. As of December 31, 2019, 18.1% of the fair value of our first lien loans
consisted of last-out loans. We believe that unitranche debt can be attractive for many lower middle-market and
traditional middle-market businesses, given the reduced structural complexity, single lender interface and
elimination of intercreditor or potential agency conflicts among lenders.
We may also invest in debt instruments structured as second lien loans. On a fair market value basis, 6.1% of
our debt investments consisted of second lien loans as of December 31, 2019. Second lien loans are loans which
have a second priority security interest in all or substantially all of the borrower’s assets, and which are not
subject to the blockage of cash interest payments to us at the first lien lender’s discretion.
In addition to first and second lien loans, we may also invest in subordinated loans. On a fair market value
basis, 12.8% of our debt investments consisted of subordinated loans as of December 31, 2019. Subordinated
loans typically have a second lien on all or substantially all of the borrower’s assets, but unlike second lien loans,
may be subject to the interruption of cash interest payments upon certain events of default, at the discretion of the
first lien lender. Our subordinated loans are typically issued with five year terms.
Some of our debt investments have payment-in-kind (“PIK”) interest, which is a form of interest that is not
paid currently in cash, but is accrued and added to the loan balance until paid at the end of the term. While we
generally seek to minimize the percentage of our fixed return that is in the form of PIK interest, we sometimes
receive PIK interest due to prevailing market conditions that do not support the overall blended interest yield on
our debt investments being paid in all-cash interest. As of December 31, 2019, our weighted average PIK yield
was 0.8%. As of December 31, 2019, the weighted average annualized cash yield on our debt portfolio was
10.7%. In addition to yield in the form of current cash and PIK interest, some of our debt investments include an
equity component, such as a warrant to purchase a common equity interest in the borrower for a nominal price.
The weighted annualized yield is calculated based on the effective interest rate as of period end, divided by
the fair value of our debt investments. The weighted average annualized yield of our debt investments is not the
same as a return on investment for our stockholders but, rather, relates to a portion of our investment portfolio
and is calculated before the payment of all of our fees and expenses. There can be no assurance that the weighted
average yield will remain at its current level.
Equity Investments
When we make a debt investment, we may be granted equity participation in the form of detachable
warrants to purchase common equity in the company in the same class of security that the owners or equity
sponsors receive upon funding. In addition, we may make non-control equity co-investments in conjunction with
a loan transaction with a borrower. The Investment Advisor’s investment team generally seeks to structure our
equity investments, such as direct equity co-investments, to provide us with minority rights provisions and, to the
extent available, event-driven put rights. They also seek to obtain limited registration rights in connection with
these investments, which may include “piggyback” registration rights. In addition to warrants and equity co-
investments, our debt investments in the future may contain a synthetic equity position.
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INVESTMENT PROCESS
Our Investment Advisor’s investment team is led by its investment committee and is responsible for all
aspects of our investment process. The current members of the investment committee are Joseph B. Alala, III, our
chief executive officer, chairman of our Board and the managing partner and chief investment officer of our
Investment Advisor, M. Hunt Broyhill, a partner of our Investment Advisor, and John F. McGlinn, a senior
managing director of our Investment Advisor. They are assisted by a team of nineteen investment professionals.
While the investment strategy involves a team approach, whereby potential transactions are screened by various
members of the investment team, Mr. Alala and one other member of the investment committee of the Investment
Advisor must approve investments in order for them to proceed. Messrs. Alala, McGlinn, and Broyhill meet on
an as needed basis, frequently multiple times a week, depending on the nature and volume of investment
opportunities. The Investment Advisor’s investment committee has worked together for over fifteen years. The
stages of our investment selection process are as follows:
Deal Generation/Origination
Deal generation and origination is maximized through long-standing and extensive relationships with
industry contacts, brokers, commercial and investment bankers, entrepreneurs, service providers (such as lawyers
and accountants), as well as current and former clients, portfolio companies and investors. Our Investment
Advisor’s investment team supplements these lead generators by also utilizing broader marketing efforts, such as
attendance at prospective borrower industry conventions, an active calling effort to investment banking
boutiques, private equity firms and independent sponsors that are also investing in high quality lower middle-
market and traditional middle-market companies, and, most importantly, based on our Investment Advisor’s track
record as a responsive, flexible, value-add lender and co-investor, as demonstrated by approximately 160
investments in lower middle-market and traditional middle-market businesses and equity co-investments with
reputed private equity firms since 2000. We believe we have developed a reputation as a knowledgeable and
reliable source of capital, providing value-added industry advice and financing assistance to borrowers’
businesses and in executing financial sponsors’ growth strategies. Furthermore, with offices throughout the
United States, we have the ability to cover a large geographical area and to market to unique groups from each
office. Specifically, our Charlotte, Raleigh, Fort Lauderdale, Atlanta, Los Angeles, New York, and Dallas offices
cover significant territory that is traditionally underserved, allowing us to source a high volume of direct deal
flow.
Screening
All potential investments that are received are screened for suitability and consistency with our investment
criteria (see “— Due Diligence and Underwriting,” below). In screening potential investments, our Investment
Advisor’s investment team utilizes the same value-oriented investment philosophy they employed in their work
with the Legacy Funds and commits resources to managing downside exposure. If a potential investment meets
our basic investment criteria, a deal team is assigned to perform preliminary due diligence. In doing so, we
consider some or all of the following factors:
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A comprehensive financial model that we prepare based on quantitative analysis of historical financial
performance, financial projections made by management or the financial sponsor, and pro forma financial
ratios assuming an investment consistent with possible structures. In analyzing our model, we test various
investment structures, pricing options, downside scenarios and other sensitivities in order to better
understand potential risks and possible financial covenant ratios;
The competitive landscape and industry dynamics impacting the potential portfolio company;
Strengths and weaknesses of the potential investment’s business strategy and industry outlook; and
Results of a broad qualitative analysis of the company’s products or services, market position and outlook,
customers, suppliers and quality of management.
If the results of this preliminary due diligence are satisfactory, the deal team prepares an executive summary
that is presented to our Investment Advisor’s investment committee in a meeting that includes all members of the
portfolio and investment teams. This executive summary includes the following areas:
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Company history and summary of product(s) and/or service(s);
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An overview of investors, anticipated capital sources and transaction timing;
Investment structure and expected returns, including initial projected financial ratios;
Analysis of historical financial results and key assumptions;
Analysis of the company’s business strategy;
Analysis of the financial sponsor’s relevant experience or expected strategy;
Investment strengths, weaknesses and priority issues to be addressed in due diligence; and
Pro forma capitalization and ownership.
If our investment committee recommends moving forward, we will issue a non-binding term sheet or
indication of interest to the potential portfolio company and, when applicable, its financial sponsor. If a term
sheet is successfully negotiated, we will begin more formal due diligence and underwriting as we progress
towards the ultimate investment approval and closing.
Due Diligence and Underwriting
The completion of due diligence deliverables is led by at least two investment professionals. However, all
investment and portfolio team members are regularly updated with due diligence progress, especially any issues
that emerge. The investment professionals leading the due diligence efforts are typically assigned to the original
deal team that worked on the executive summary. However, post-term sheet deal teams sometimes contain one or
more additional investment professionals and may include other professionals from business development,
portfolio or other areas if a particular skill or experience set would be especially valuable in the due diligence
process. The members of the underwriting team complete due diligence and analyze the relationships among the
prospective portfolio company’s business plan, operations and expected financial performance. Due diligence
consists of some or all of the following:
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On-site visits with management and relevant key employees;
In-depth review of historical and projected financial statements, including covenant calculation work
sheets;
Interviews with customers and suppliers;
Management background checks;
Review of reports by third-party accountants, outside counsel and other industry, operational or financial
experts, whether retained by us or the financial sponsor;
Review of material contracts; and
Review of financial sponsor’s due diligence package and internal executive summaries.
Typically, we utilize outside experts to analyze the legal affairs, accounting systems and financial results
and, where appropriate, we engage specialists to investigate certain issues. During the underwriting process,
significant, ongoing attention is devoted to sensitivity analyses regarding whether a company might bear a
significant “downside” case and remain profitable and in compliance with assumed financial covenants. These
“downside” scenarios typically involve assumptions regarding the loss of key customers and/or suppliers, an
economic downturn, adverse regulatory changes and other relevant stressors that we attempt to simulate in our
quantitative and qualitative analyses. Further, we continually examine the effect of these scenarios on financial
ratios and other metrics.
During the underwriting process, the executive summary that was completed for the initial investment
committee presentation is expanded upon into a full diligence memo and key findings are presented at
subsequent, weekly meetings of the investment committee for continued discussion and, to the extent applicable,
the investment committee issues new instructions to the underwriting team from the investment committee.
Approval, Documentation and Closing
The underwriting team for the proposed investment presents the full diligence memo and key findings from
due diligence to the investment committee on an ongoing basis. Prior to the commencement of
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TABLE OF CONTENTS
documentation, approval from the investment committee is sought and, if approved, the underwriting
professionals heretofore involved proceed to documentation.
At all times during the documentation process, the underwriting professionals who conducted the due
diligence remain involved; likewise, all extensively negotiated documentation decisions are made by the lead
underwriting team member, in accordance with input from at least one investment committee member and
guidance from outside counsel. As and to the extent necessary, key documentation challenges are brought before
the investment committee for prompt discussion and resolution. Upon the completion of satisfactory
documentation and the satisfaction of closing conditions, final approval is sought from the investment committee
before closing and funding.
PORTFOLIO COMPANIES
The following table sets forth certain information as of December 31, 2019 for each of our portfolio
companies. The general terms of our debt and equity investments are described in “Investments.” Other than
these investments, our only formal relationships with our portfolio companies will be the managerial assistance
we may provide upon request and the board observer or participation rights we may receive in connection with
our investment. Other than as indicated in the table below, we do not “control” and are not an “affiliate” of any of
these portfolio companies, each as defined in the 1940 Act. In general, under the 1940 Act, we would “control” a
portfolio company if we owned more than 25% of its voting securities and would be an “affiliate” of a portfolio
company if we owned more than 5% of its voting securities.
Name and Address of Portfolio Company
Nature of Business
3 Bridge Solutions, LLC
100 South Fifth Street
Minneapolis, Minnesota 55402
IT Consulting
Alternative Biomedical Solutions, LLC
1600 Wallace Drive
Carrollton, Texas 75006
Healthcare
Type of Investment and General
Terms
(1)(2)(3)(4)(5)
First Lien Debt (10.7% Cash (1 month
LIBOR + 9.0%, 1.0% Floor),
Due 12/4/22)
Preferred Units (965 units)
Membership Units (39,000 units)
First Lien Debt (8.0% Cash, 3.8% PIK,
Due 12/18/22)
First Lien Debt (8.0% Cash, 3.8% PIK,
Due 12/18/22)
(6)
% of Class Held
Cost
(in thousands)
Fair Value
(in thousands)
3.2
%
3.3
%
$13,274
$13,274
1,090
10
5,331
499
—
5,319
American Clinical Solutions, LLC
2424 N. Federal Highway
Boca Raton, Florida 33431
Healthcare
First Lien Debt (7.0% Cash,
Due 12/31/22)
Membership Units (20,092 units)
3.2
%
Amerimark Direct, LLC
100 Nixon Lane
Edison, New Jersey 08837
BigMouth, Inc
655 Winding Brook Drive
Glastonbury, Connecticut 06033
Consumer Products
Consumer Products
Bluestem Brands, Inc.
6509 Flying Cloud Drive
Eden Prairie, Minnesota 55344
(21)
Burgaflex Holdings, LLC
1101 Copper Avenue
Fenton, Michigan 48430
Online Merchandise
Retailer
Automobile
Part Manufacturer
First Lien Debt (12.0% Cash, 3.0%
PIK, Due 3/23/21)
First Lien Debt (2.0% PIK,
Due 12/31/22)
(7)
First Lien Debt (14.3% Cash,
Due 9/8/21)
First Lien Debt (10.3% Cash (1 month
LIBOR + 8.5%, 0.5% Floor,
(8)
Due 11/14/21)
First Lien Debt (10.2% Cash (1 month
LIBOR + 8.5%, 0.5% Floor,
Due 11/14/21)
First Lien Debt (9.3% Cash (1 month
LIBOR + 7.5%, 1.0% Floor),
Due 11/7/20)
13,125
800
10,624
—
3,500
3,500
3,485
3,485
15,974
15,633
857
857
8,784
8,628
3,529
2,877
14,421
14,421
Common Stock Class B (1,085,073
shares)
Common Stock Class A (1,253,198
shares)
11.5
%
8.3
%
362
1,504
635
—
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Name and Address of Portfolio Company
Nature of Business
Burke America Parts Group, LLC
5852 W. 51st Street
Chicago, Illinois 60638
Home Repair Parts
Manufacturer
CableOrganizer Acquisition, LLC
6250 NW 27th Way
Ft. Lauderdale, Florida 33309
California Pizza Kitchen, Inc.
12181 Bluff Creek Drive
Playa Vista, California 90094
Computer Supply
Retail
Restaurant
(22)
Capitala Senior Loan Fund II, LLC
Investment Funds
4201 Congress Street
Charlotte, North Carolina 28209
Type of Investment and General
Terms
(1)(2)(3)(4)(5)
% of Class Held
Cost
(in thousands)
Fair Value
(in thousands)
Membership Units (14 units)
1.8
%
$
5
$ 2,489
First Lien Debt
(9)
1,532
1,490
Second Lien Debt (11.9% Cash
(3 month LIBOR + 10.0%, 1.0%
Floor), Due 8/23/23)
Subordinated Debt (6.7% Cash
(1 month LIBOR + 5.0%),
Due 9/3/24)
(11)(20)
Membership Units (80.0%
ownership)
(11)(19)(23)
4,927
4,697
—
—
80.0
%
13,600
13,631
Chicken Soup for the Soul, LLC
132 East Putnam Avenue
Cos Cob, Connecticut 06807
Chief Fire Intermediate, Inc.
10 West Broad Street
Mount Vernon, New York 10552
(21)
City Gear, LLC
4841 Summer Avenue
Memphis, Tennessee 38122
CIS Secure Computing, Inc.
21050 Ashburn Crossing Dr.
Ashburn, Virginia 20147
Corporate Visions, Inc.
5455 Kietzke Lane
Reno, Nevada 89511
Multi-platform Media
and Consumer
Products
First Lien Debt (10.2% Cash (1 month
LIBOR + 8.5%, 1.5% Floor),
Due 12/13/20)
Security System
Services
First Lien Debt (8.7% Cash (1 month
LIBOR + 7.0%, 1.6% Floor),
Due 11/8/24)
Class A Preferred Units (34,740 units,
10.0% PIK Dividend)
(10)
Class B Common Units (3,510 units)
6.2
%
0.8
%
Footwear Retail
Membership Unit Warrants
(9)
Government Services
First Lien Debt (10.2% Cash (1 month
LIBOR + 8.5%, 1.0% Floor), 1.0%
PIK, Due 9/14/22)
Common Stock (46,163 shares)
4.0
%
Sales & Marketing
Services
Subordinated Debt (9.0% Cash, 2.0%
PIK, Due 11/29/21)
13,000
13,000
8,100
913
—
—
8,100
913
—
3,326
9,389
1,000
9,389
1,890
19,327
18,962
Common Stock (15,750 shares)
2.5
%
1,575
329
Currency Capital, LLC
12100 Wilshire Boulevard
Los Angeles, California 90025
Financial Services
(21)
Eastport Holdings, LLC
813 Ridge Lake Blvd.
Memphis, Tennessee 38120
Business Services
Flavors Holdings, Inc.
300 Jefferson Street
Camden, New Jersey 08104
Food Product
Manufacturer
First Lien Debt (13.7% Cash (1 month
LIBOR + 12.0%, 0.5% Floor), 2.0%
(11)
PIK, Due 1/2/20)
Class A Preferred Units
(2,000,000 units)
(11)
Subordinated Debt (14.9% Cash
(3 month LIBOR + 13.0%, 0.5%
Floor), Due 12/29/21)
(16)
Membership Units (22.9% ownership)
22.9
%
First Lien Debt (7.7% Cash (3 month
LIBOR + 5.8%, 1.0% Floor),
Due 4/3/20)
Second Lien Debt (11.9% Cash
(3 month LIBOR + 10.0%, 1.0%
Floor), Due 10/3/21)
Freedom Electronics, LLC
2205 May Ct. NW
Kennesaw, Georgia 30144
GA Communications, Inc.
2196 West Part Court
Stone Mountain, Georgia 30087
(21)
Electronic Machine
Repair
First Lien Debt (8.7% Cash,
Due 12/20/23)
(6)(12)
Membership Units (181,818 units)
Advertising &
Marketing Services
Series A-1 Preferred Stock (1,998 shares,
8.0% PIK Dividend)
(10)
Series B-1 Common Stock (200,000
shares)
9
0.6
%
8.3
%
8.3
%
16,269
16,269
2.0
%
2,000
2,504
16,155
3,263
16,500
17,822
5,778
5,767
11,878
11,842
5,940
5,940
182
160
3,476
3,761
2
501
TABLE OF CONTENTS
Name and Address of Portfolio Company
Nature of Business
Type of Investment and General
Terms
(1)(2)(3)(4)(5)
% of Class Held
Cost
(in thousands)
Fair Value
(in thousands)
HUMC Opco, LLC
308 Willow Avenue
Hoboken, New Jersey 07030
Installs, LLC
241 Main Street
Buffalo, New York 14203
J5 Infrastructure Partners, LLC
2030 Main Street
Irvine, California 92614
Jurassic Quest Holdings, LLC
200 River Point
Conroe, Texas 77304
(21)
LJS Partners, LLC
10350 Ormsby Park Place
Louisville, Kentucky 40223
Healthcare
Logistics
First Lien Debt (9.0% Cash,
Due 8/16/20)
First Lien Debt (9.3% Cash,
(6)
Due 6/20/23)
Wireless Deployment
Services
Entertainment
First Lien Debt (8.3% Cash (1 month
LIBOR + 6.5%, 1.8% Floor),
(13)
Due 12/20/24)
First Lien Debt (8.3% Cash (1 month
LIBOR + 6.5%, 1.8% Floor),
Due 12/20/24)
First Lien Debt (9.5% Cash (1 month
LIBOR + 7.5%, 2.0% Floor),
Due 5/1/24)
(14)
Preferred Units (375,000 units)
QSR Franchisor
Preferred Units (92,924 units)
MicroHoldco, LLC
1102 Windam Road
South Windam, Connecticut 06266
(21)
MMI Holdings, LLC
325 McGill Avenue, Suite 195
Concord, North Carolina 28027
General Industrial
Common Membership Units
(2,593,234 units)
(9)
Preferred Units
Medical Device
Distributor
First Lien Debt (12.0% Cash,
(16)
Due 1/31/21)
1.5
%
9.8
%
8.5
%
Subordinated Debt (6.0% Cash,
Due 1/31/21)
(16)
Preferred Units (1,000 units, 6.0% PIK
Dividend)
(10)
Common Membership Units (45 units)
100.0
%
5.0
%
Navis Holdings, Inc.
(21)
113 Woodside Drive
Lexington, North Carolina 27292
Textile Equipment
Manufacturer
First Lien Debt (11.0% Cash,
(16)
Due 6/30/23)
(21)
Nth Degree Investment Group, LLC
Business Services
Membership Units (6,088,000 Units)
Class A Preferred Stock (1,000 shares,
10% Cash Dividend)
(10)
Common Stock (60,000 shares)
$ 5,000
$ 5,000
2,924
2,924
—
—
7,000
7,000
10,827
10,827
388
293
85
372
1,224
838
1,509
838
2,600
2,600
388
1,572
—
400
1,710
194
10,100
10,100
3237 Satellite Blvd
Duluth, Georgia 30096
Portrait Studio, LLC
2101 Cambridge Beltway Drive
Charlotte, North Carolina 28273
(21)
RAM Payment, LLC
412 North Cedar Bluff Road
Knoxville, Tennessee 37923
Professional and
Personal Digital
Imaging
Financial Services
Rapid Fire Protection, Inc.
1530 Samco Road
Rapid City, South Dakota 57702
Security System
Services
First Lien Debt (9.2% Cash,
Due 11/22/24)
(6)(15)
Seitel, Inc.
10811 South Westview Circle Drive
Houston, Texas 77043
Sequoia Healthcare Management, LLC
10 Exchange Place
Jersey City, New Jersey 07032
Data Services
Common Stock (363 shares)
First Lien Debt (10.0% Cash (1 month
LIBOR + 8.3%, 1.0% Floor),
Due 3/15/23)
Healthcare
Management
First Lien Debt (12.8% Cash,
Due 6/26/20)
10
First Lien Debt
(9)
510
510
First Lien Debt (10.0% Cash,
Due 1/4/24)
(6)
Preferred Units (86,000 units, 8.0% PIK
Dividend)
(10)
100.0
%
13.8
%
5.6
%
1,000
—
6,088
1,000
464
6,088
6.1
%
3.6
%
9,019
9,019
928
6,550
500
1,725
6,550
500
4,749
4,749
12,744
12,607
TABLE OF CONTENTS
Name and Address of Portfolio Company
(21)
Sierra Hamilton Holdings Corporation
900 Threadneedle
Houston, Texas 77079
Nature of Business
Oil & Gas Engineering
and Consulting
Services
Type of Investment and General
Terms
(1)(2)(3)(4)(5)
% of Class Held
Cost
(in thousands)
Fair Value
(in thousands)
Second Lien Debt (15.0% PIK,
Due 9/12/23)
$
748
$
748
Common Stock (15,068,000 shares)
13.7
%
6,958
5,160
Sur La Table, Inc.
6100 4th Ave S Ste 500
Seattle, Washington 98108
Taylor Precision Products, Inc.
2311 W. 22nd Street
Oak Brook, Illinois 60523
U.S. BioTek Laboratories, LLC
16020 Linden Ave. N.
Shoreline, Washington 98133
U.S. Well Services, Inc.
1360 Post Oak Boulevard
Houston, Texas 77056
Retail
Household Product
Manufacturer
First Lien Debt (10.9% Cash (3 month
LIBOR + 9.0%, 1.0% Floor),
Due 7/31/22)
(16)(17)
Series C Preferred Stock (379 shares)
8.3
%
Testing Laboratories
First Lien Debt (9.3% Cash,
Due 12/14/23)
(6)(12)
Class A Preferred Units (500 Units)
Class C Units (500 Units)
Oil & Gas Services
Class A Common Stock (77,073 shares)
(11)(18)
V12 Holdings, Inc.
(21)
141 West Front Street, Suite 410
Red Bank, New Jersey 07701
Vology, Inc.
(22)
15950 Bay Vista Dr.
Clearwater, Florida 33760
Data Processing &
Digital Marketing
Information
Technology
Class B Common Stock (1,125,426
shares)
(11)(18)
Subordinated Debt
(9)
First Lien Debt (10.5% Cash (1 month
LIBOR + 8.5%, 2.0% Floor),
Due 12/31/21)
Class A Preferred Units
(9,041,810 Units)
Membership Units (5,363,982 Units)
Xirgo Technologies, LLC
188 Camino Ruiz
Camarillo, California 93012
Information Technology Membership Units (600,000 units)
10,528
758
10,045
758
6,930
6,822
540
1
771
6,701
655
3,877
5,215
—
600
204
—
146
2,127
708
3,877
5,215
—
917
$ 353,881
$ 362,532
2.5
%
2.2
%
0.1
%
1.6
%
51.6
%
32.6
%
1.0
%
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
All investments valued using unobservable inputs (Level 3), unless otherwise noted.
All investments valued by the Board of Directors.
All debt investments are income producing, unless otherwise noted. Equity and warrant investments are non-
income producing, unless otherwise noted.
Percentages are based on net assets of $148,113 as of December 31, 2019.
Capitala Finance Corp. generally acquires its investments in private transactions exempt from registration
under the Securities Act of 1933, as amended (the “Securities Act”). These investments are generally subject
to certain limitations on resale, and may be deemed to be “restricted securities” under the Security Act.
The cash rate equals the approximate current yield on our last-out portion of the unitranche facility.
The investment is convertible to preferred equity.
The investment has a $2.6 million unfunded commitment.
The investment has been exited or sold. The residual value reflects estimated earnout, escrow, or other
proceeds expected post-closing.
(10)
(11)
The equity investment is income producing, based on rate disclosed.
Indicates assets that the Company believes do not represent “qualifying assets” under Section 55(a) of the
Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of the
Company’s total assets at the time of acquisition of any additional non-qualifying assets. As of
December 31, 2019, 8.1% of the Company’s total assets were non-qualifying assets.
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TABLE OF CONTENTS
(12)
(13)
(14)
(15)
(16)
(17)
(18)
(19)
(20)
(21)
(22)
(23)
The investment has a $1.0 million unfunded commitment.
The investment has a $3.5 million unfunded commitment.
The investment has a $0.5 million unfunded commitment.
The investment has a $4.5 million unfunded commitment.
The maturity date of the original investment has been extended.
The company may elect to have 1.5% of its cash interest capitalized as paid-in-kind interest.
Investment is valued using observable inputs (Level 1). The stock of the company is traded on the NASDAQ
Capital Market under the ticker “USWS.”
The investment has a $6.4 million unfunded commitment.
The investment has a $5.0 million unfunded commitment.
“Affiliate Company” as defined under the 1940 Act.
“Control Company” as defined under the 1940 Act.
The investment is valued based on the net asset value of the company.
Set forth below is a brief description of each portfolio company representing greater than 5% of the fair
value of our portfolio as of December 31, 2019.
Eastport Holdings, LLC is a holding company consisting of marketing and advertising companies located
across the United States.
Corporate Visions, Inc. provides marketing and sales messaging, tools, and training services for global
companies, concentrating on training solutions for sales and marketing professionals.
Currency Capital, LLC operates an equipment financing exchange that seeks to connect buyers, sellers, and
lenders in order to simplify and enhance the buying and financing process for small businesses.
ONGOING RELATIONSHIPS WITH PORTFOLIO COMPANIES
Monitoring
Our Investment Advisor monitors our portfolio companies on an ongoing basis. It monitors the financial
trends of each portfolio company to determine if it is meeting its business plan and to assess the appropriate
course of action for each company. We generally require our portfolio companies to provide annual audited
financial statements and quarterly unaudited financial statements, in each case, with management discussion and
analysis and covenant compliance certificates, and monthly unaudited financial statements. Using the monthly
financial statements, we calculate and evaluate all financial covenants and additional financial coverage ratios
that might not be part of our covenant package in the loan documents. For purposes of analyzing a portfolio
company’s financial performance, we may adjust their financial statements to reflect pro forma results in the
event of a recent change of control, sale, acquisition or anticipated cost savings.
Our Investment Advisor has several methods of evaluating and monitoring the performance and fair value of
our investments, including the following:
•
•
•
•
•
Assessment of success in adhering to each portfolio company’s business plan and compliance with
covenants;
Periodic and regular contact with portfolio company management and, if appropriate, the financial or
strategic sponsor, to discuss financial position, requirements and accomplishments;
Comparisons to our other portfolio companies in the industry, if any;
Attendance at and participation in the board meetings; and
Review of monthly and quarterly financial statements and financial projections for portfolio companies.
In addition to various risk management and monitoring tools, our Investment Advisor also uses an
investment rating system to characterize and monitor our expected level of return on each investment in our
portfolio.
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TABLE OF CONTENTS
As part of our valuation procedures, we risk rate all of our investments. In general, our investment rating
system uses a scale of 1 to 5, with 1 being the lowest probability of default and principal loss. Our internal rating
is not an exact system but is used internally to estimate the probability of: (i) default on our debt securities and
(ii) loss of our debt principal, in the event of a default. In general, our internal rating system may also assist our
valuation team in its determination of the estimated fair value of equity securities or equity-like securities. Our
internal risk rating system generally encompasses both qualitative and quantitative aspects of our portfolio
companies.
Our internal investment rating system incorporates the following five categories:
Investment
Rating
Summary Description
1
2
3
4
5
In general, the investment may be performing above our internal expectations. Full
return of principal and interest is expected. Capital gain is expected.
In general, the investment may be performing within our internal expectations, and
potential risks to the applicable investment are considered to be neutral or favorable
compared to any potential risks at the time of the original investment. All new
investments are initially given this rating.
In general, the investment may be performing below our internal expectations and
therefore, investments in this category may require closer internal monitoring;
however, the valuation team believes that no loss of investment return (interest and/or
dividends) or principal is expected. The investment also may be out of compliance
with certain financial covenants.
In general, the investment may be performing below internal expectations and
quantitative or qualitative risks may have increased substantially since the original
investment. Loss of some or all principal is expected.
In general, the investment may be performing substantially below our internal
expectations and a number of quantitative or qualitative risks may have increased
substantially since the original investment. Loss of some or all principal is expected.
Our Investment Advisor will monitor and, when appropriate, change the investment ratings assigned to each
investment in our portfolio. In connection with our valuation process, our Investment Advisor will review these
investment ratings on a quarterly basis. The investment rating of a particular investment should not, however, be
deemed to be a guarantee of the investment’s future performance.
The following table shows the distribution of our investments on the 1 to 5 investment rating scale at fair
value as of December 31, 2019 and 2018 (dollars in thousands):
Investment Rating
1
2
3
4
5
Total
As of
December 31, 2019
As of
December 31, 2018
Investments
at Fair
Value
Percentage
of Total
Investments
Investments
at Fair
Value
Percentage
of Total
Investments
$ 85,688
219,855
56,989
—
—
$ 362,532
%
23.6
60.7
15.7
—
—
$ 171,829
194,411
73,325
9,362
—
%
38.3
43.3
16.3
2.1
—
100.0
%
$ 448,927
100.0
%
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AGREEMENTS
Investment Advisory Agreement
Our Investment Advisor is registered as an investment adviser under the Advisers Act. Subject to the overall
supervision of our Board, our Investment Advisor manages our day-to-day operations, and provides investment
advisory and management services to us. Under the terms of our Investment Advisory Agreement, the Investment
Advisor:
•
•
•
•
determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the
manner of implementing such changes;
identifies, evaluates and negotiates the structure of the investments we make (including performing due
diligence on our prospective portfolio companies);
closes and monitors the investments we make; and
provides us with other investment advisory, research and related services as we may from time to time
require.
The Investment Advisor’s services under the Investment Advisory Agreement are not exclusive, and it is
free to furnish similar services to other entities so long as its services to us are not impaired.
Management Fee
Pursuant to the Investment Advisory Agreement, we have agreed to pay the Investment Advisor a fee for
investment advisory and management services consisting of two components — a base management fee and an
incentive fee.
The base management fee is calculated at an annual rate of 1.75% of our gross assets, which is our total
assets as reflected on our consolidated statements of assets and liabilities and includes any borrowings for
investment purposes. Although we do not anticipate making significant investments in derivative financial
instruments, the fair value of any such investments, which will not necessarily equal their notional value, will be
included in our calculation of gross assets. For services rendered under the Investment Advisory Agreement, the
base management fee is payable quarterly in arrears. The base management fee is calculated based on the average
value of our gross assets at the end of the two most recently completed calendar quarters, and appropriately
adjusted for any share issuances or repurchases during the current calendar quarter.
Incentive Fee
The incentive fee consists of the following two parts:
The first part of the incentive fee is calculated and payable quarterly in arrears based on our pre-incentive
fee net investment income for the immediately preceding calendar quarter. For this purpose, pre-incentive fee net
investment income means interest income, dividend income and any other income (including any other fees
(other than fees for providing managerial assistance), such as commitment, origination, diligence and consulting
fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our
operating expenses for the quarter (including the base management fee, expenses payable under an administration
agreement between us and the administrator (the “Administration Agreement”), and any interest expense and
dividends paid on any issued and outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee
net investment income includes, in the case of investments with a deferred interest feature (such as original issue
discount, debt instruments with PIK interest and zero coupon securities), accrued income that we have not yet
received in cash. Pre-incentive fee net investment income does not include any realized capital gains, computed
net of all realized capital losses or unrealized capital appreciation or depreciation. Pre-incentive fee net
investment income, expressed as a rate of return on the value of our net assets at the end of the immediately
preceding calendar quarter, is compared to a hurdle of 2.0% per quarter (8.0% annualized). Our net investment
income used to calculate this part of the incentive fee is also included in the amount of our gross assets used to
calculate the 1.75% base management fee. We pay the Investment Advisor an incentive fee with respect to our
pre-incentive fee net investment income in each calendar quarter as follows:
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•
•
•
no incentive fee in any calendar quarter in which our pre-incentive fee net investment income does not
exceed the hurdle of 2.0%;
100% of our pre-incentive fee net investment income with respect to that portion of such pre-incentive fee
net investment income, if any, that exceeds the hurdle but is less than 2.5% in any calendar quarter (10.0%
annualized). We refer to this portion of our pre-incentive fee net investment income (which exceeds the
hurdle but is less than 2.5%) as the “catch-up.” The “catch-up” is meant to provide our Investment
Advisor with 20% of our pre-incentive fee net investment income as if a hurdle did not apply if this net
investment income exceeds 2.5% in any calendar quarter; and
20% of the amount of our pre-incentive fee net investment income, if any, that exceeds 2.5% in any
calendar quarter (10.0% annualized) is payable to the Investment Advisor (once the hurdle is reached and
the catch-up is achieved, 20% of all pre-incentive fee investment income thereafter is allocated to the
Investment Advisor).
The second part of the incentive fee is determined and payable in arrears as of the end of each calendar year
(or upon termination of the Investment Advisory Agreement, as of the termination date), and will equal 20% of
our realized capital gains, if any, on a cumulative basis from inception through the end of each calendar year,
computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the
aggregate amount of any previously paid capital gain incentive fees with respect to each of the investments in our
portfolio.
The Company will defer cash payment of the portion of any incentive fee otherwise earned by the
Investment Advisor that would, when taken together with all other incentive fees paid to the Investment Advisor
during the most recent 12 full calendar month period ending on or prior to the date such payment is to be made,
exceed 20% of the sum of (a) the pre-incentive fee net investment income during such period, (b) the net
unrealized appreciation or depreciation during such period and (c) the net realized capital gains or losses during
such period. Any deferred incentive fees will be carried over for payment in subsequent calculation periods to the
extent such payment is payable under the Investment Advisory Agreement.
The Investment Advisor has voluntarily agreed to waive all or such portion of the quarterly incentive fees
earned by the Investment Advisor that would otherwise cause our quarterly net investment income to be less than
the distribution payments declared by our Board. Quarterly incentive fees are earned by the Investment Advisor
pursuant to the Investment Advisory Agreement. Incentive fees subject to the waiver cannot exceed the amount
of incentive fees earned during the period, as calculated on a quarterly basis. The Investment Advisor will not be
entitled to recoup any amount of incentive fees that it waives. The waiver was effective in the fourth quarter of
2015 and will continue unless otherwise publicly disclosed by the Company.
The following is a graphical representation of the calculation of the income-related portion of the incentive
fee:
Quarterly Incentive Fee Based on Net Investment Income
Pre-incentive fee net investment income
(expressed as a percentage of the value of net assets)
Percentage of pre-incentive fee net investment income allocated to the Capitala Investment Advisors
These calculations are appropriately pro-rated for any period of less than three months and adjusted for any
share issuances or repurchases during the relevant quarter. You should be aware that a rise in the general level of
interest rates can be expected to lead to higher interest rates applicable to our debt investments. Accordingly, an
increase in interest rates would make it easier for us to meet or exceed the incentive fee hurdle rate and may result
in a substantial increase of the amount of incentive fees payable to our Investment Advisor with respect to pre-
incentive fee net investment income.
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Examples of Quarterly Incentive Fee Calculation
Example 1: Income Related Portion of Incentive Fee*
Alternative 1:
Assumptions
(1)
Investment income (including interest, dividends, fees, etc.) = 1.25%
Hurdle rate = 2.0%
Management fee = 0.50%
Other expenses (legal, accounting, custodian, transfer agent, etc.)
Pre-incentive fee net investment income
(2)
(3)
= 0.20%
(investment income – (management fee + other expenses)) = 0.55%
Pre-incentive net investment income does not exceed hurdle rate, therefore there is no incentive fee.
Alternative 2:
Assumptions
(1)
Investment income (including interest, dividends, fees, etc.) = 2.9%
Hurdle rate = 2.0%
Management fee = 0.50%
Other expenses (legal, accounting, custodian, transfer agent, etc.)
Pre-incentive fee net investment income
(2)
(3)
= 0.20%
(investment income − (management fee + other expenses)) = 2.2%
(4)
Incentive fee = 100% × pre-incentive fee net investment income, subject to the “catch-up”
= 100% × (2.2% – 2.0%)
= 0.20%
Pre-incentive fee net investment income exceeds the hurdle rate, but does not fully satisfy the “catch-up”
provision, therefore the income related portion of the incentive fee is 0.20%.
Alternative 3:
Assumptions
(1)
Investment income (including interest, dividends, fees, etc.) = 3.50%
Hurdle rate = 2.0%
Management fee = 0.50%
Other expenses (legal, accounting, custodian, transfer agent, etc.)
Pre-incentive fee net investment income
(2)
(3)
= 0.20%
(investment income – (management fee + other expenses)) = 2.80%
(4)
Incentive fee = 20% × pre-incentive fee net investment income, subject to “catch-up”
Incentive fee = 100% × “catch-up” + (20% × (pre-incentive fee net investment income – 2.5%))
Catch-up
= 2.5% – 2.0%
= 0.5%
Incentive fee = (100% × 0.5%) + (20% × (2.80% – 2.5%))
= 0.5% + (20%× 0.3%)
= 0.5% + 0.06%
= 0.56%
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Pre-incentive fee net investment income exceeds the hurdle rate, and fully satisfies the “catch-up” provision,
therefore the income related portion of the incentive fee is 0.56%.
*
(1)
(2)
(3)
(4)
The hypothetical amount of pre-incentive fee net investment income shown is based on a percentage of total
net assets.
Represents 8.0% annualized hurdle rate.
Represents 2.00% annualized management fee.
Excludes organizational and offering expenses.
The “catch-up” provision is intended to provide the Investment Advisor with an incentive fee of 20% on all
of Capitala Finance’s pre-incentive fee net investment income as if a hurdle rate did not apply when its net
investment income exceeds 2.5% in any calendar quarter.
Example 2: Capital Gains Portion of Incentive Fee
Alternative 1:
Assumptions
•
•
•
•
Year 1: $20 million investment made in Company A (“Investment A”), and $30 million investment made
in Company B (“Investment B”)
Year 2: Investment A sold for $50 million and fair market value (“FMV”) of Investment B determined to
be $32 million
Year 3: FMV of Investment B determined to be $25 million
Year 4: Investment B sold for $31 million
The capital gains portion of the incentive fee would be:
•
•
Year 1: None
Year 2: Capital gains incentive fee of $6 million ($30 million realized capital gains on sale of
Investment A multiplied by 20%)
•
Year 3: None
$5 million (20% multiplied by ($30 million cumulative capital gains less $5 million cumulative capital
depreciation)) less $6 million (previous capital gains fee paid in Year 2).
•
Year 4: Capital gains incentive fee of $200,000
$6.2 million ($31 million cumulative realized capital gains multiplied by 20%) less $6 million (capital gains
fee taken in Year 2).
Alternative 2:
Assumptions
•
•
•
•
•
Year 1: $20 million investment made in Company A (“Investment A”), $30 million investment made in
Company B (“Investment B”) and $25 million investment made in Company C (“Investment C”)
Year 2: Investment A sold for $50 million, FMV of Investment B determined to be $25 million and FMV
of Investment C determined to be $25 million
Year 3: FMV of Investment B determined to be $27 million and Investment C sold for $30 million
Year 4: FMV of Investment B determined to be $24 million
Year 5: Investment B sold for $20 million
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The capital gains incentive fee, if any, would be:
•
•
Year 1: None
Year 2: $5 million capital gains incentive fee
20% multiplied by $25 million ($30 million realized capital gains on Investment A less unrealized capital
depreciation on Investment B).
•
Year 3: $1.4 million capital gains incentive fee
(1)
$6.4 million (20% multiplied by $32 million ($35 million cumulative realized capital gains less $3 million
unrealized capital depreciation)) less $5 million capital gains fee received in Year 2.
•
•
Year 4: None
Year 5: None
$5 million (20% multiplied by $25 million (cumulative realized capital gains of $35 million less realized
capital losses of $10 million)) less $6.4 million cumulative capital gains fee paid in Year 2 and Year 3.
(1)
As illustrated in Year 3 of Alternative 2 above, if the Company were to be wound up on a date other than
December 31 of any year, the Company may have paid aggregate capital gain incentive fees that are more
than the amount of such fees that would be payable if the Company had been wound up on December 31 of
such year.
Example 3: Application of the Incentive Fee Deferral Mechanism
Assumptions
•
•
•
•
•
•
In each of Years 1 through 4 in this example pre-incentive fee net investment income equals $40.0 million
per year, which we recognized evenly in each quarter of each year and paid quarterly. This amount
exceeds the hurdle rate and the requirement of the “catch-up” provision in each quarter of such year. As a
result, the annual income related portion of the incentive fee before the application of the deferral
mechanism in any year is $8.0 million ($40.0 million multiplied by 20%). All income-related incentive
fees were paid quarterly in arrears.
In each year preceding Year 1, we did not generate realized or unrealized capital gains or losses, no capital
gain-related incentive fee was paid and there was no deferral of incentive fees.
Year 1: We did not generate realized or unrealized capital gains or losses.
Year 2: We realized a $30.0 million capital gain and did not otherwise generate realized or unrealized
capital gains or losses.
Year 3: We recognized $5.0 million of unrealized capital depreciation and did not otherwise generate
realized or unrealized capital gains or losses.
Year 4: We realized a $6.0 million capital gain and did not otherwise generate realized or unrealized
capital gains or losses.
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Income Related
Incentive Fee
Accrued Before
Application of
Deferral
Mechanism
$8.0 million
($40.0 million
multiplied by 20%)
$8.0 million
($40.0 million
multiplied by 20%)
$8.0 million
($40.0 million
multiplied by 20%)
Year 1
Year 2
Year 3
Year 4
$8.0 million
($40.0 million
multiplied by 20%)
Capital Gains Related
Incentive Fee
Accrued Before
Application of
Deferral Mechanism
Incentive Fee
Calculations
Incentive Fees Paid and
Deferred
None
$8.0 million
$6.0 million (20% of
$30.0 million)
$14.0 million
None (20% of
cumulative net capital
gains of $25.0 million
($30.0 million in
cumulative realized
gains less $5.0 million in
cumulative unrealized
capital depreciation) less
$6.0 million of capital
gains fee paid in Year 2)
$7.0 million (20% of the
sum of (a) our pre-
incentive fee net
investment income,
(b) our net unrealized
appreciation or
depreciation during such
period and (c) our net
realized capital gains or
losses during Year 3)
$8.2 million
$0.2 million (20% of
cumulative net capital
gains of $31.0 million
($36.0 million
cumulative realized
capital gains less
$5.0 million cumulative
unrealized capital
depreciation) less
$6.0 million of capital
gains fee paid in Year 2)
Incentive fees of
$8.0 million paid; no
incentive fees deferred
Incentive fees of
$14.0 million paid; no
incentive fees deferred
Incentive fees of
$7.0 million paid;
$8.0 million of incentive
fees accrued but
payment restricted to
$7.0 million;
$1.0 million of incentive
fees deferred
Incentive fees of
$9.2 million paid
($8.2 million of
incentive fees accrued in
Year 4 plus $1.0 million
of deferred incentive
fees); no incentive fees
deferred
Payment of Our Expenses
The investment team of our Investment Advisor and their respective staffs, when and to the extent engaged
in providing investment advisory and management services, and the compensation and routine overhead expenses
of such personnel allocable to such services, are provided and paid for by the Investment Advisor. We bear all
other costs and expenses of our operations and transactions, including (without limitation):
•
•
•
•
•
the cost of our organization;
the cost of calculating our net asset value, including the cost of any third-party valuation services;
the cost of effecting sales and repurchases of our shares and other securities;
interest payable on debt, if any, to finance our investments;
fees payable to third parties relating to, or associated with, making investments (such as legal, accounting,
and travel expenses incurred in connection with making investments), including fees and expenses
associated with performing due diligence reviews of prospective investments and advisory fees;
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•
•
•
•
•
•
•
•
•
•
•
transfer agent and custodial fees;
fees and expenses associated with marketing efforts;
costs associated with our reporting and compliance obligations under the 1940 Act, the Securities
Exchange Act of 1934, as amended (the “1934 Act”), and other applicable federal and state securities
laws, and ongoing stock exchange listing fees;
federal, state and local taxes;
independent directors’ fees and expenses;
brokerage commissions;
costs of proxy statements, stockholders’ reports and other communications with stockholders;
fidelity bond, directors’ and officers’ liability insurance, errors and omissions liability insurance and other
insurance premiums;
direct costs and expenses of administration, including printing, mailing, telephone and staff;
fees and expenses associated with independent audits and outside legal costs; and
all other expenses incurred by either our Administrator or us in connection with administering our
business, including payments under the Administration Agreement that will be based upon our allocable
portion of overhead and other expenses incurred by our Administrator in performing its obligations under
the Administration Agreement, including rent, the fees and expenses associated with performing
compliance functions, and our allocable portion of any costs of compensation and related expenses of our
chief compliance officer, our chief financial officer and their respective administrative support staff.
Duration and Termination
The Investment Advisory Agreement was initially approved by the Board on June 10, 2013 and signed on
September 24, 2013. The Investment Advisory Agreement was most recently re-approved by the Board,
including by a majority of our non-interested directors, at an in-person meeting on August 1, 2019. The Board’s
consideration for re-approval of the Investment Advisory Agreement will be included in our definitive proxy
statement filed for our 2020 meeting of stockholders. Unless earlier terminated as described below, the
Investment Advisory Agreement will remain in effect from year to year if approved annually by our Board or by
the affirmative vote of the holders of a majority of our outstanding voting securities, including, in either case,
approval by a majority of our directors who are not parties to such agreement or who are not “interested persons”
of any such party, as such term is defined in Section 2(a)(19) of the 1940 Act. The Investment Advisory
Agreement will automatically terminate in the event of its assignment. The Investment Advisory Agreement may
also be terminated by either party without penalty upon not less than 60 days’ written notice to the other party.
See “Risk Factors — Risks Relating to Our Business and Structure — Capitala Investment Advisors has the right
to resign on 60 days’ notice and we may not be able to find a suitable replacement within such time, resulting in a
disruption in our operations that could adversely affect our financial condition, business and results of
operations.”
Indemnification
The Investment Advisory Agreement provides that, absent willful misfeasance, bad faith or gross negligence
in the performance of its duties or by reason of the reckless disregard of its duties and obligations, the Investment
Advisor and its officers, managers, partners, agents, employees, controlling persons, members and any other
person or entity affiliated with it are entitled to indemnification from Capitala Finance for any damages,
liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement)
arising from the rendering of the Investment Advisor’s services under the Investment Advisory Agreement or
otherwise as an investment adviser of Capitala Finance.
Organization of the Investment Advisor
The Investment Advisor is a Delaware limited liability company. The principal executive offices of the
Investment Advisor are located at 4201 Congress Street, Suite 360, Charlotte, North Carolina 28209.
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Administration Agreement
Capitala Advisors Corp., a North Carolina corporation, serves as our administrator. The principal executive
offices of our Administrator are located at 4201 Congress Street, Suite 360, Charlotte, North Carolina 28209. The
Administrator, pursuant to a sub-administration agreement, has engaged U.S. Bank Global Fund Services to act
on behalf of the Administrator in its performance of certain administrative services for us. The principal office of
U.S. Bank Global Fund Services is 777 East Wisconsin Avenue, Milwaukee, Wisconsin 53202. Pursuant to the
Administration Agreement, our administrator furnishes us with office facilities, equipment and clerical,
bookkeeping and record keeping services at such facilities. Under the Administration Agreement, our
Administrator also performs, or oversees the performance of, our required administrative services, which include,
among other things, being responsible for the financial records that we are required to maintain and preparing
reports to our stockholders. In addition, our Administrator assists us in determining and publishing our net asset
value, oversees the preparation and filing of our tax returns and the printing and dissemination of reports to our
stockholders, and generally oversees the payment of our expenses and the performance of administrative and
professional services rendered to us by others. Payments under the Administration Agreement are equal to an
amount based upon our allocable portion of our Administrator’s overhead in performing its obligations under the
Administration Agreement, including rent, the fees and expenses associated with performing compliance
functions, and our allocable portion of the compensation of our chief financial officer, chief compliance officer
and our allocable portion of the compensation of their respective administrative support staff. Under the
Administration Agreement, our Administrator will also provide on our behalf managerial assistance to those
portfolio companies that request such assistance. Unless terminated earlier in accordance with its terms, the
Administration Agreement will remain in effect if approved annually by our Board. On August 1, 2019, the
Board approved the renewal of the Administration Agreement. The Administration Agreement may be terminated
by either party without penalty upon 60 days’ written notice to the other party. To the extent that our
Administrator outsources any of its functions, we will pay the fees associated with such functions on a direct
basis without any incremental profit to our Administrator. Stockholder approval is not required to amend the
Administration Agreement.
Our Administrator also provides administrative services to our Investment Advisor. As a result, the
Investment Advisor will also reimburse our Administrator for its allocable portion of our Administrator’s
overhead, including rent, the fees and expenses associated with performing compliance functions for the
Investment Advisor, and its allocable portion of the compensation of any administrative support staff.
The Administration Agreement provides that, absent willful misfeasance, bad faith or negligence in the
performance of its duties or by reason of the reckless disregard of its duties and obligations, our Administrator
and its officers, managers, partners, agents, employees, controlling persons, members and any other person or
entity affiliated with it are entitled to indemnification from Capitala Finance for any damages, liabilities, costs
and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the
rendering of our Administrator’s services under the Administration Agreement or otherwise as administrator for
Capitala Finance.
License Agreement
We have entered into a license agreement with the Investment Advisor pursuant to which the Investment
Advisor has agreed to grant us a non-exclusive, royalty-free license to use the name “Capitala.” Under this
agreement, we have a right to use the Capitala name for so long as the Investment Advisory Agreement with the
Investment Advisor is in effect. Other than with respect to this limited license, we will have no legal right to the
“Capitala” name.
Staffing
Capitala Finance has no employees. Mr. Alala, through his financial interests in the Investment Advisor, will
be entitled to a portion of any investment advisory fees paid by Capitala Finance to the Investment Advisor. Our
other executive officers are employees of our Administrator and perform their functions under the terms of our
Administration Agreement.
Our day-to-day investment operations are managed by the Investment Advisor. The Investment Advisor’s
investment team currently consists of the members of its investment committee, Messrs. Alala, McGlinn and
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Broyhill, and a team of nineteen additional investment professionals. The Investment Advisor may hire additional
investment professionals, based upon its needs, in the future. See “— Investment Advisory Agreement.”
In addition, we reimburse our Administrator for our allocable portion of overhead and other expenses
incurred by it in performing its obligations under the Administration Agreement, including rent, the fees and
expenses associated with performing compliance functions, and the compensation of our chief financial officer,
chief compliance officer, and their respective administrative support staff. See “— Administration Agreement.”
VALUATION PROCESS AND DETERMINATION OF NET ASSET VALUE
We determine the net asset value of our investment portfolio each quarter by subtracting our total liabilities
from the fair value of our gross assets.
We conduct the valuation of our assets, pursuant to which our net asset value shall be determined, at all
times consistent with U.S. generally accepted accounting principles (“U.S. GAAP”) and the 1940 Act. Our
valuation procedures are set forth in more detail below:
Securities for which market quotations are readily available on an exchange shall be valued at such price as
of the closing price on the day of valuation. We may also obtain quotes with respect to certain of our investments
from pricing services or brokers or dealers in order to value assets. When doing so, we determine whether the
quote obtained is sufficient according to U.S. GAAP to determine the fair value of the security. If determined
adequate, we use the quote obtained.
Securities for which reliable market quotations are not readily available or for which the pricing source does
not provide a valuation or methodology or provides a valuation or methodology that, in the judgment of our
Investment Advisor or the Board, does not represent fair value, which we expect will represent a substantial
majority of the investments in our portfolio, shall be valued as follows: (i) each portfolio company or investment
is initially valued by the investment professionals responsible for the portfolio investment; (ii) preliminary
valuation conclusions are documented and discussed with our senior management; (iii) independent third-party
valuation firms engaged by, or on behalf of, the Board will conduct independent appraisals, review management’s
preliminary valuations and prepare separate preliminary valuation conclusions on a selected basis such that each
portfolio investment shall be independently reviewed at least annually (investments will not be selected for such
review, however, if they (a) have a value as of the previous quarter of less than 1.0% of our gross assets as of the
previous quarter, or (b) have a value as of the current quarter of less than 1.0% of our gross assets as of the
previous quarter, after taking into account any repayment of principal during the current quarter); and (iv) the
Board will discuss valuations and determine the fair value of each investment in our portfolio in good faith based
on the input of the Investment Advisor and, where appropriate, the respective third-party valuation firms.
The recommendation of fair value will generally be based on the following factors, as relevant:
•
•
•
•
•
the nature and realizable value of any collateral;
the portfolio company’s ability to make payments;
the portfolio company’s earnings and discounted cash flow;
the markets in which the issuer does business; and
comparisons to publicly traded securities.
Securities for which market quotations are not readily available or for which a pricing source is not
sufficient may include, but are not limited to, the following:
•
•
•
•
private placements and restricted securities that do not have an active trading market;
securities whose trading has been suspended or for which market quotes are no longer available;
debt securities that have recently gone into default and for which there is no current market;
securities whose prices are stale;
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•
•
securities affected by significant events; and
securities that the Investment Advisor believes were priced incorrectly.
Determination of fair value involves subjective judgments and estimates not susceptible to substantiation by
auditing procedures. Accordingly, under current auditing standards, the notes to our financial statements will refer
to the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on our
financial statements. In addition, the SBA has established certain valuation guidelines for SBICs to follow when
valuing portfolio investments.
In making the good faith determination of the value of these securities, we start with the cost basis of the
security, which includes the amortized original issue discount and PIK interest or dividends, if any. We prepare
the valuations of our investments in portfolio companies using the most recent portfolio company financial
statements and forecasts. We also consult updates that we receive from senior management members at portfolio
companies, whether solicited for valuation purposes, or received in the ordinary course of our portfolio
monitoring or due diligence process. These updates include information such as industry trends, new product
development or service offerings and other operational or strategic issues.
For debt securities that are not publicly traded or for which there is no market, we begin with our investment
rating of the security as described above. Using this investment rating, we seek to determine the value of the
security as if we intended to sell the security in a current sale. The factors that may be taken into account in
arriving at fair value include the following, as applicable: the portfolio company’s ability to service its interest
and principal payment obligations, its estimated earnings and projected discounted cash flows, the nature and
realizable value of any collateral, the financial environment in which the portfolio company operates,
comparisons to securities of similar publicly traded companies, statistical ratios compared to lending standards
and to other similarly situated securities, and other relevant factors.
As part of the valuation process, the audit committee reviews the preliminary evaluations prepared by the
independent valuation firm engaged by the Board, as well as management’s valuation recommendations.
Management and the independent valuation firm respond to the preliminary evaluation to reflect comments
provided by the audit committee. The audit committee reviews the final valuation report and management’s
valuation recommendations and makes a recommendation to the Board based on its analysis of the methodologies
employed and the various weights that should be accorded to each portion of the valuation as well as factors that
the independent valuation firm and management may not have considered in their evaluation process. The Board
then evaluates the audit committee recommendations and undertakes a similar analysis to determine the fair value
of each investment in the portfolio in good faith.
Due to the inherent uncertainty of determining the fair value of investments that do not have a readily
available market value, the fair value of our investments may differ significantly from the values that would have
been used had a ready market existed for such investments, and the differences could be material. Additionally,
changes in the market environment and other events that may occur over the life of the investments may cause
the gains or losses ultimately realized on these investments to differ from the valuations assigned at any time. For
a discussion of the risks inherent in determining the fair value of securities for which readily available market
values do not exist, see “Risk Factors.”
Determinations in Connection with Offerings
In connection with certain future offerings of shares of our common stock, our Board, or an authorized
committee thereof, will be required to make the determination that we are not selling shares of our common stock
at a price below the then current net asset value of our common stock at the time at which the sale is made. Our
Board, or an authorized committee thereof, will consider the following factors, among others, in making such a
determination:
•
•
the net asset value of our common stock disclosed in the most recent periodic report that we filed with the
SEC;
our management’s assessment of whether any material change in the net asset value of our common stock
has occurred (including through the realization of gains on the sale of our portfolio securities)
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during the period beginning on the date of the most recently disclosed net asset value of our common
stock and ending as of a time within 48 hours (excluding Sundays and holidays) of the sale of our
common stock; and
•
the magnitude of the difference between (i) a value that our Board, or an authorized committee thereof,
has determined reflects the current (as of a time within 48 hours, excluding Sundays and holidays) net
asset value of our common stock, which is based upon the net asset value of our common stock disclosed
in the most recent periodic report that we filed with the SEC, as adjusted to reflect our management’s
assessment of any material change in the net asset value of our common stock since the date of the most
recently disclosed net asset value of our common stock, and (ii) the offering price of the shares of our
common stock in the proposed offering.
Moreover, to the extent that there is even a remote possibility that we may (i) issue shares of our common
stock at a price per share below the then current net asset value per share of our common stock at the time at
which the sale is made or (ii) trigger the undertaking (which we provide in certain registration statements we file
with the SEC) to suspend the offering of shares of our common stock if the net asset value per share of our
common stock fluctuates by certain amounts in certain circumstances until the prospectus is amended, our Board
will elect, in the case of clause (i) above, either to postpone the offering until such time that there is no longer the
possibility of the occurrence of such event or to undertake to determine the net asset value per share of our
common stock within two days prior to any such sale to ensure that such sale will not be below our then current
net asset value per share and, in the case of clause (ii) above, to comply with such undertaking or to undertake to
determine the net asset value per share of our common stock to ensure that such undertaking has not been
triggered.
These processes and procedures are part of our compliance policies and procedures. Records will be made
contemporaneously with all determinations described in this section and these records will be maintained with
other records that we are required to maintain under the 1940 Act.
COMPETITION
We compete for investments with other BDCs and investment funds (including private equity funds, private
credit funds, mezzanine funds and other SBICs), as well as traditional financial services companies such as
commercial banks and other sources of funding. Additionally, competition for investment opportunities has
emerged among alternative investment vehicles, such as collateralized loan obligations (“CLOs”) and other
BDCs, some of which are sponsored by other alternative asset investors, as these entities have begun to focus on
making investments in lower middle-market and traditional middle-market companies. As a result of these new
entrants, competition for our investment opportunities may intensify. Many of these entities have greater financial
and managerial resources than we do. We believe we will be able to compete with these entities primarily on the
basis of our experience and reputation, our willingness to make smaller investments than other specialty finance
companies, the contacts and relationships of our Investment Advisor, our responsive and efficient investment
analysis and decision-making processes, and the investment terms we offer.
We believe that certain of our competitors may make first lien and second lien loans with interest rates and
returns that will be comparable to or lower than the rates and returns that we will target. Therefore, we will not
seek to compete solely on the interest rates and returns that we offer to potential portfolio companies. For
additional information concerning the competitive risks we face, see “Risk Factors — Risks Relating to Our
Business and Structure — We operate in a highly competitive market for investment opportunities, which could
reduce returns and result in losses.”
ELECTION TO BE TAXED AS A RIC
As a BDC, the Company has elected to be treated, and intends to comply with the requirements to continue
to qualify annually, as a RIC under subchapter M of the Code. As a RIC, we generally will not have to pay
corporate-level U.S. federal income taxes on any income that we distribute to our stockholders as dividends. To
qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification
requirements (as described 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,”
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which generally is our ordinary income plus the excess of our realized net short-term capital gains over our
realized net long-term capital losses (the “Annual Distribution Requirement”).
TAXATION AS A RIC
For any taxable year in which we:
•
•
qualify as a RIC; and
satisfy the Annual Distribution Requirement,
we generally will not be subject to U.S. federal income tax on the portion of our income we distribute to
stockholders. We will be subject to U.S. federal income tax at the regular corporate rates on any income or capital
gains not distributed to our stockholders.
We will be subject to a 4% nondeductible U.S. federal excise tax on certain undistributed income unless we
distribute in a timely manner an amount at least equal to the sum of (1) 98% of our net ordinary income for each
calendar year, (2) 98.2% of our capital gain net income for the one-year period ending October 31 in that calendar
year and (3) any income recognized, but not distributed, in preceding years and on which we paid no corporate-
level U.S. federal income tax (the “Excise Tax Distribution Requirement”).
In order to qualify as a RIC for U.S. federal income tax purposes, we must, among other things:
•
•
continue to qualify as a BDC under the 1940 Act at all times during each taxable year;
derive in each taxable year at least 90% of our gross income from dividends, interest, payments with
respect to loans of certain securities, gains from the sale or other disposition of stock, securities or foreign
currencies, net income from certain “qualified publicly traded partnerships,” or other income derived with
respect to our business of investing in such stock or securities (the “90% Income Test”); and
•
diversify our holdings so that at the end of each quarter of the taxable year:
•
•
at least 50% of the value of our assets consists of cash, cash equivalents, U.S. Government securities,
securities of other RICs, and other securities if such other securities of any one issuer do not
represent more than 5% of the value of our assets or more than 10% of the outstanding voting
securities of the issuer; and
no more than 25% of the value of our assets is invested in the securities, other than U.S. government
securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as
determined under applicable Code rules, by us and that are engaged in the same or similar or related
trades or businesses or of certain “qualified publicly traded partnerships” (the “Diversification
Tests”).
Qualified earnings may exclude such income as management fees received in connection with our SBIC
subsidiaries or other potential outside managed funds and certain other fees.
In accordance with certain applicable Treasury regulations and other guidance issued by the Internal
Revenue Service (“IRS”), a RIC may treat a distribution of its own stock as fulfilling its RIC distribution
requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the
RIC, subject to a limitation that the aggregate amount of cash to be distributed to all stockholders must be at least
20% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder
electing to receive cash must receive a pro rata amount of cash (with the balance of the distribution paid in stock).
In no event will any stockholder, electing to receive cash, receive less than 20% of his or her entire distribution in
cash. If these and certain other requirements are met, for U.S. federal income tax purposes, the amount of the
dividend paid in stock will be equal to the amount of cash that could have been received instead of stock. We
have no current intention of paying dividends in shares of our stock in accordance with these Treasury regulations
or other applicable IRS guidance.
We may be required to recognize taxable income in circumstances in which we do not receive cash. For
example, if we hold debt obligations that are treated under applicable tax rules as having original issue discount
(such as debt instruments with PIK interest or, in certain cases, increasing interest rates or issued with
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warrants), we must include in income each year a portion of the original issue discount that accrues over the life
of the obligation, regardless of whether cash representing such income is received by us in the same taxable year.
We may also have to include in income other amounts that we have not yet received in cash, such as PIK interest,
deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation such
as warrants or stock, or certain income with respect to equity investments in foreign corporations. 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 distribution to our stockholders in order to satisfy the Annual
Distribution Requirement, even though we will not have received any corresponding cash amount.
Gain or loss realized by us from the sale or exchange of warrants acquired by us as well as any loss
attributable to the lapse of such warrants generally will be treated as capital gain or loss. Such gain or loss
generally will be long-term or short-term, depending on how long we held a particular warrant.
Although we do not presently expect to do so, we are authorized to borrow funds and to sell assets in order
to satisfy distribution requirements. However, under the 1940 Act, we are not permitted to make distributions to
our stockholders while our debt obligations and other senior securities are outstanding unless certain “asset
coverage” tests are met. Moreover, our ability to dispose of assets to meet our distribution requirements may be
limited by (1) the illiquid nature of our portfolio and/or (2) other requirements relating to our status as a RIC,
including the Diversification Tests. If we dispose of assets in order to meet the Annual Distribution Requirement
or the Excise Tax Distribution Requirement, we may make such dispositions at times that, from an investment
standpoint, are not advantageous. If we are prohibited from making distributions or are unable to obtain cash
from other sources to make the distributions, we may fail to qualify as a RIC, which would result in us becoming
subject to corporate-level U.S. federal income tax.
In addition, we will be partially dependent on our SBIC subsidiaries for cash distributions to enable us to
meet the RIC distribution requirements. Our SBIC subsidiaries may be limited by the Small Business Investment
Act of 1958, and SBA regulations governing SBICs, from making certain distributions to us that may be
necessary to maintain our tax treatment as a RIC. We may have to request a waiver of the SBA’s restrictions for
our SBIC subsidiaries to make certain distributions to maintain our RIC tax treatment. We cannot assure you that
the SBA will grant such waiver. If our SBIC subsidiaries are unable to obtain a waiver, compliance with the SBA
regulations may cause us to fail to qualify for tax treatment as a RIC, which would result in us becoming subject
to corporate-level U.S. federal income tax.
The remainder of this discussion assumes that we will qualify as a RIC and have satisfied the Annual
Distribution Requirement.
Any transactions in options, futures contracts, constructive sales, hedging, straddle, conversion or similar
transactions, and forward contracts will be subject to special tax rules, the effect of which may be to accelerate
income to us, defer losses, cause adjustments to the holding periods of our investments, convert long-term capital
gains into short-term capital gains, convert short-term capital losses into long-term capital losses or have other
tax consequences. These rules could affect the amount, timing and character of distributions to stockholders. We
do not currently intend to engage in these types of transactions.
A RIC is limited in its ability to deduct expenses in excess of its “investment company taxable income”
(which is, generally, ordinary income plus net realized short-term capital gains in excess of net realized long-term
capital losses). If our expenses in a given year exceed gross taxable income (e.g., as the result of large amounts of
equity-based compensation), we would experience a net operating loss for that year. However, a RIC is not
permitted to carry forward net operating losses to subsequent years. In addition, expenses can be used only to
offset investment company taxable income, not net capital gain. Due to these limits on the deductibility of
expenses, we may for tax purposes have aggregate taxable income for several years that we are required to
distribute and that is taxable to our stockholders even if such income is greater than the aggregate net income we
actually earned during those years. Such required distributions may be made from our cash assets or by
liquidation of investments, if necessary. We may realize gains or losses from such liquidations. In the event we
realize net capital gains from such transactions, you may receive a larger capital gain distribution than you would
have received in the absence of such transactions.
Investment income received from sources within foreign countries, or capital gains earned by investing in
securities of foreign issuers, may be subject to foreign income taxes withheld at the source. In this regard,
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withholding tax rates in countries with which the United States does not have a tax treaty are often as high as
35%. The United States has entered into tax treaties with many foreign countries that may entitle us to a reduced
rate of tax or exemption from tax on this related income and gains. The effective rate of foreign tax cannot be
determined at this time since the amount of our assets to be invested within various countries is not now known.
We do not anticipate being eligible for the special election that allows a RIC to treat foreign income taxes paid by
such RIC as paid by its stockholders.
If we acquire stock in certain foreign corporations that receive at least 75% of their annual gross income
from passive sources (such as interest, dividends, rents, royalties or capital gain) or hold at least 50% of their total
assets in investments producing such passive income (“passive foreign investment companies”), we could be
subject to U.S. federal income tax and additional interest charges on “excess distributions” received from such
companies or gain from the sale of stock in such companies, even if all income or gain actually received by us is
timely distributed to our stockholders. We would not be able to pass through to our stockholders any credit or
deduction for such a tax. Certain elections may, if available, ameliorate these adverse tax consequences, but any
such election requires us to recognize taxable income or gain without the concurrent receipt of cash. We intend to
limit and/or manage our holdings in passive foreign investment companies to minimize our tax liability. In
addition, under recently proposed regulations, income required to be included as a result of such an election
would not be qualifying income for purposes of the 90% Income Test unless we receive a distribution of such
income from the passive foreign investment company in the same taxable year to which the inclusion relates.
Foreign exchange gains and losses realized by us in connection with certain transactions involving non-
dollar debt securities, certain foreign currency futures contracts, foreign currency option contracts, foreign
currency forward contracts, foreign currencies, or payables or receivables denominated in a foreign currency are
subject to Code provisions that generally treat such gains and losses as ordinary income and losses and may affect
the amount, timing and character of distributions to our stockholders. Any such transactions that are not directly
related to our investment in securities (possibly including speculative currency positions or currency derivatives
not used for hedging purposes) could, under future Treasury regulations, produce income not among the types of
“qualifying income” from which a RIC must derive at least 90% of its annual gross income.
FAILURE TO QUALIFY AS A RIC
If we fail to satisfy the 90% Income Test or the Diversification Tests for any taxable year, we may
nevertheless continue to qualify as a RIC for such year if certain relief provisions are applicable (which may,
among other things, require us to pay certain corporate-level U.S. federal income taxes or to dispose of certain
assets).
If we were unable to qualify for treatment as a RIC and the foregoing relief provisions are not applicable, we
would be subject to tax 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 would be taxable
to our stockholders as ordinary dividend income to the extent of our current and accumulated earnings and profits
and, subject to certain limitations, may be eligible for the 20% maximum rate for noncorporate taxpayers
provided certain holding period and other requirements were met. 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. To requalify as a RIC
in a subsequent taxable year, we would be required to satisfy the RIC qualification requirements for that year and
dispose of any earnings and profits from any year in which we failed to qualify as a RIC. Subject to a limited
exception applicable to RICs that qualified as such under the Code for at least one year prior to disqualification
and that requalify as a RIC no later than the second year following the nonqualifying year, we could be subject to
tax on any unrealized net built-in gains in the assets held by us during the period in which we failed to qualify as
a RIC that are recognized within the subsequent five years, unless we made a special election to pay corporate-
level U.S. federal income tax on such built-in gain at the time of our requalification as a RIC.
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REGULATION
A BDC is regulated under the 1940 Act. A BDC must be organized in the U.S. for the purpose of investing
in or lending to primarily private companies and making significant managerial assistance available to them. A
BDC may use capital provided by public stockholders and from other sources to make long-term, private
investments in businesses. A BDC 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.
We may not 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 the outstanding voting securities, as required by the 1940 Act. A
majority of the outstanding voting securities of a company is defined under the 1940 Act as the lesser of: (a) 67%
or more of such company’s voting securities present at a meeting if more than 50% of the outstanding voting
securities of such company are present or represented by proxy, or (b) more than 50% of the outstanding voting
securities of such company. We do not anticipate any substantial change in the nature of our business.
As with other companies regulated by the 1940 Act, a BDC 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. Additionally, we are required to provide and maintain a bond issued by a reputable fidelity
insurance company to protect the BDC. Furthermore, as a BDC, we are prohibited from protecting any director or
officer against any liability to us or our stockholders arising from willful misfeasance, bad faith, gross negligence
or reckless disregard of the duties involved in the conduct of such person’s office.
As a BDC, we are generally required to meet an asset coverage ratio, defined under the 1940 Act as the ratio
of our gross assets (less all liabilities and indebtedness not represented by senior securities) to our outstanding
senior securities, of at least 150%, if certain conditions are met, after each issuance of senior securities. On
March 23, 2018, the Small Business Credit Availability Act (the “SBCA”) was signed into law, which included
various changes to regulations under the federal securities laws that impact BDCs. The SBCA included changes
to the 1940 Act to allow BDCs to decrease their asset coverage requirement from 200% to 150% (i.e. the amount
of debt may not exceed 66.7% of the value of our total assets), if certain requirements are met. On November 1,
2018, the Board, including a “required majority” (as such term is defined in Section 57(o) of the 1940 Act)
approved the application of the modified asset coverage. As a result, our asset coverage requirements for senior
securities were changed from 200% to 150%, effective November 1, 2019.
We may also be prohibited under the 1940 Act from knowingly 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. On June 1, 2016, the SEC issued the Order, which permits us and certain of our affiliates to
co-invest with one or more other affiliated investment funds, including future affiliated investment funds, where
co-investing would otherwise be prohibited under the 1940 Act. Pursuant to the Order, the Company is permitted
to co-invest with its affiliates if a “required majority” (as defined in Section 57(o) of the 1940 Act) of the
Company’s independent directors make certain conclusions in connection with a co-investment transaction,
including, but not limited to, that (1) the terms of the potential co-investment transaction, including the
consideration to be paid, are reasonable and fair to the Company and its stockholders and do not involve
overreaching in respect of the Company or its stockholders on the part of any person concerned, and (2) the
potential co-investment transaction is consistent with the interests of the Company’s stockholders and is
consistent with its then-current investment objectives and strategies.
We are generally not permitted to issue and sell our common stock at a price below net asset value per share.
See “Risk Factors — Risks Relating to Our Business and Structure — Regulations governing our operation as a
BDC affect our ability to raise additional capital and the way in which we do so. As a BDC, the necessity of
raising additional capital may expose us to risks, including the typical risks associated with leverage.” We may,
however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the
then-current net asset value of our common stock if our Board determines that such sale is in our best interests
and the best interests of our stockholders, and our stockholders approve our policy and practice of making such
sales. In any such case, under such circumstances, the price at which our common stock is to be issued and sold
may not be less than a price which, in the determination of our Board, closely approximates the market value of
such common stock. In addition, we may generally issue new shares of our common stock at a price below net
asset value in rights offerings to existing stockholders, in payment of dividends and in certain other limited
circumstances.
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We will be periodically examined by the SEC for compliance with the 1940 Act.
As a BDC, we are subject to certain risks and uncertainties. See “Risk Factors — Risks Relating to Our
Business and Structure.”
QUALIFYING ASSETS
Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in Section 55(a) of
the 1940 Act, which are referred to as qualifying assets, unless, immediately after such acquisition is made,
qualifying assets represent at least 70% of the BDC’s gross assets. The principal categories of qualifying assets
relevant to our proposed business are the following:
•
•
•
Securities purchased in transactions not involving any public offering, the issuer of which is an eligible
portfolio company;
Securities received in exchange for or distributed with respect to securities described in the bullet above
or pursuant to the exercise of options, warrants or rights relating to such securities; and
Cash, cash items, government securities or high quality debt securities (within the meaning of the 1940
Act), maturing in one year or less from the time of investment.
An eligible portfolio company is generally a domestic company that is not an investment company (other
than a SBIC wholly owned by a BDC) and that:
•
•
•
•
does not have a class of securities with respect to which a broker may extend margin credit at the time the
acquisition is made;
is controlled by the BDC and has an affiliate of the BDC on its board;
does not have any class of securities listed on a national securities exchange;
is a public company that lists its securities on a national securities exchange with a market capitalization
of less than $250 million; or
•
meets such other criteria as may be established by the SEC.
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.
In addition, a BDC must have been organized and have its principal place of business in the U.S. and must
be operated for the purpose of making investments in eligible portfolio companies, or in other securities that are
consistent with its purpose as a BDC.
SIGNIFICANT MANAGERIAL ASSISTANCE TO PORTFOLIO COMPANIES
BDCs generally must offer to make available to the issuer of the securities significant managerial assistance,
except in circumstances where either (i) the BDC controls such issuer of securities or (ii) the BDC purchases such
securities in conjunction with one or more other persons acting together and one of the other persons in the group
makes available such managerial assistance. Making available significant managerial assistance means, among
other things, any arrangement whereby the BDC, through its directors, officers or employees, offers to provide,
and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or
business objectives and policies of a portfolio company.
TEMPORARY INVESTMENTS
Pending investment in other types of “qualifying assets,” as described above, our investments may consist
of cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less
from the time of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets
are qualifying assets. Typically, we will invest in U.S. Treasury bills or in repurchase agreements, provided that
such agreements are fully collateralized by cash or securities issued by the U.S. government or its agencies. A
repurchase agreement involves the purchase by an investor, such as us, of a specified security and the
simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price which is
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greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage
restriction on the proportion of our assets that may be invested in such repurchase agreements. However, if more
than 25% of our gross assets constitute repurchase agreements from a single counterparty, we would not meet the
diversification tests in order to qualify as a RIC under the Code. Thus, we do not intend to enter into repurchase
agreements with a single counterparty in excess of this limit. Our Investment Advisor will monitor the
creditworthiness of the counterparties with which we enter into repurchase agreement transactions.
SENIOR SECURITIES
We are permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock
senior to our common stock if our asset coverage, as defined in the 1940 Act, is at least equal to 150%, if certain
requirements are met, immediately after each such issuance. On June 10, 2014, we received an exemptive order
from the SEC granting relief from the asset coverage requirements for certain indebtedness issued by Fund II and
Fund III as SBICs. In addition, while any senior securities remain outstanding, we must make provisions to
prohibit any distribution to our stockholders or the repurchase of such securities or shares unless we meet the
applicable asset coverage ratios at the time of the distribution or repurchase. We may also borrow amounts up to
5% of the value of our gross assets for temporary or emergency purposes without regard to asset coverage. For a
discussion of the risks associated with leverage, see “Risk Factors — Risks Relating to Our Business and
Structure.”
CODE OF ETHICS
We and our Investment Advisor have adopted a code of ethics pursuant to Rule 17j-1 under the 1940 Act
and Rule 204A-1 under the Advisers Act that establishes procedures for personal investments and restricts certain
transactions by our personnel. Our code of ethics generally does not permit investments by our employees in
securities that may be purchased or held by us. Our code of ethics is also available on our website at
www.Capitalagroup.com.
COMPLIANCE POLICIES AND PROCEDURES
We and our Investment Advisor have adopted and implemented written policies and procedures reasonably
designed to detect and prevent violation of the federal securities laws and are required to review these compliance
policies and procedures annually for their adequacy and the effectiveness of their implementation and designate a
chief compliance officer to be responsible for administering the policies and procedures. Kevin A. Koonts
currently serves as our chief compliance officer.
SARBANES-OXLEY ACT OF 2002
The Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) imposes a wide variety of regulatory
requirements on publicly-held companies and their insiders. Many of these requirements affect us. For example:
•
•
•
•
pursuant to Rule 13a-14 of the 1934 Act, our chief executive officer and chief financial officer must
certify the accuracy of the financial statements contained in our periodic reports;
pursuant to Item 307 of Regulation S-K, our periodic reports must disclose our conclusions about the
effectiveness of our disclosure controls and procedures;
pursuant to Rule 13a-15 of the 1934 Act, our management is required to prepare an annual report
regarding its assessment of our internal control over financial reporting, and is required to obtain an audit
of the effectiveness of internal control over financial reporting performed by our independent registered
public accounting firm; and
pursuant to Item 308 of Regulation S-K and Rule 13a-15 of the 1934 Act, our periodic reports must
disclose whether there were significant changes in our internal controls over financial reporting or in other
factors that could significantly affect these controls subsequent to the date of their evaluation, including
any corrective actions with regard to significant deficiencies and material weaknesses.
The Sarbanes-Oxley Act requires us to review our current policies and procedures to determine whether we
comply with the Sarbanes-Oxley Act and the regulations promulgated thereunder. We will continue to
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monitor our compliance with all regulations that are adopted under the Sarbanes-Oxley Act and will take actions
necessary to ensure that we are in compliance therewith.
PROXY VOTING POLICIES AND PROCEDURES
We have delegated our proxy voting responsibility to the Investment Advisor. The proxy voting policies and
procedures of the Investment Advisor are set forth below. The guidelines will be reviewed periodically by the
Investment Advisor and our non-interested directors, and, accordingly, are subject to change. For purposes of the
proxy voting policies and procedures described below, “we,” “our” and “us” refers to the Investment Advisor.
Introduction
An investment adviser registered under the Advisers Act has a fiduciary duty to act solely in the best
interests of its clients. As part of this duty, we recognize that we must vote client securities in a timely manner
free of conflicts of interest and in the best interests of our clients.
These policies and procedures for voting proxies for our investment advisory clients are intended to comply
with Section 206 of, and Rule 206(4)-6 under, the Advisers Act.
Proxy Policies
We will vote proxies relating to our portfolio securities in what we perceive to be the best interest of our
clients’ stockholders. We will review on a case-by-case basis each proposal submitted to a stockholder vote to
determine its impact on the portfolio securities held by our clients. Although we will generally vote against
proposals that may have a negative impact on our clients’ portfolio securities, we may vote for such a proposal if
there exist compelling long-term reasons to do so.
Our proxy voting decisions will be made by the senior officers who are responsible for monitoring each of
our clients’ investments. To ensure that our vote is not the product of a conflict of interest, we will require that:
(1) anyone involved in the decision making process disclose to our managing member any potential conflict that
he or she is aware of and any contact that he or she has had with any interested party regarding a proxy vote; and
(2) employees involved in the decision making process or vote administration are prohibited from revealing how
we intend to vote on a proposal in order to reduce any attempted influence from interested parties.
Proxy Voting Records
You may obtain information about how we voted proxies by making a written request for proxy voting
information to: Capitala Investment Advisors, LLC, 4201 Congress Street, Suite 360, Charlotte, North Carolina
28209.
PRIVACY PRINCIPLES
We are committed to maintaining the privacy of our stockholders and to 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 to anyone, except as permitted by
law or as is necessary in order to service stockholder accounts (for example, to a transfer agent or third-party
administrator).
We restrict access to non-public personal information about our stockholders to employees of our
Investment Advisor and its affiliates with a legitimate business need for the information. We maintain physical,
electronic and procedural safeguards designed to protect the non-public personal information of our stockholders.
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SMALL BUSINESS INVESTMENT COMPANY REGULATIONS
Fund III, which is our wholly owned subsidiary, is licensed to act as a SBIC and is regulated by the SBA. On
March 1, 2019, Fund II repaid its outstanding SBA debentures and relinquished its SBIC license. As of
December 31, 2019, investments in Fund III accounted for approximately 57.0% of the fair value of our portfolio.
As of December 31, 2019, Fund III had $150.0 million of SBA-guaranteed debentures outstanding under the
SBIC program. Fund III is fully drawn and may not make borrowings in excess of their aggregate $150.0 million
of SBA-guaranteed debentures outstanding as of December 31, 2019.
The SBIC licenses allow our SBIC subsidiaries to borrow funds by issuing SBA-guaranteed debentures,
subject to the issuance of a capital commitment by the SBA and other customary procedures. The SBA
regulations require, among other things, that a licensed SBIC be examined periodically and audited by an
independent auditor to determine the SBIC’s compliance with the relevant SBA regulations. SBA-guaranteed
debentures are non-recourse, interest-only debentures with interest payable semi-annually and have a ten year
maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may
be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed at the time of
issuance at a market-driven spread over U.S. Treasury Notes with 10-year maturities.
SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under current
SBA regulations, a licensed SBIC may provide capital to those entities that have a tangible net worth not
exceeding $19.5 million and an average annual net income after U.S. federal income taxes not exceeding
$6.5 million for the two most recent fiscal years. In addition, a licensed SBIC must devote 25.0% of its
investment activity to those entities that have a tangible net worth not exceeding $6.0 million and an average
annual net income after U.S. federal income taxes not exceeding $2.0 million for the two most recent fiscal years.
The SBA regulations also provide alternative industry size standard criteria to determine eligibility, which depend
on the industry in which the business is engaged and are based on the number of employees or gross sales. The
SBA regulations permit licensed SBICs to make long-term loans to small businesses, invest in the equity
securities of such businesses and provide them with consulting and advisory services.
The SBA prohibits an SBIC from providing funds to small businesses with certain characteristics, such as
relending or businesses with the majority of their employees located outside the U.S., business engaged in certain
prohibited industries, such as project finance, real estate, farmland, financial intermediaries, or “passive” (i.e.
non-operating) businesses. Without prior SBA approval, a SBIC may not invest an amount equal to more than
approximately 30.0% of the SBIC’s regulatory capital in any one company and its affiliates. Compliance with
SBA requirements may cause Fund III to forego attractive investment opportunities that are not permitted under
SBA regulations.
Further, the SBA regulations require that a licensed SBIC be periodically examined and audited by the SBA
to determine its compliance with the relevant SBA regulations. The SBA restricts the ability of an SBIC to
provide financing to an “associate” as defined in the SBA regulations, without prior written exemption from the
SBA. The SBA prohibits, without prior SBA approval, a “change of control” of an SBIC or transfers that would
result in any person (or a group of persons acting in concert) owning 10.0% or more of a class of capital stock of
a licensed SBIC. If Fund III fails to comply with applicable SBA regulations, the SBA could, depending on the
severity of the violation, limit or prohibit Fund III’s use of debentures, declare outstanding debentures
immediately due and payable, and/or limit Fund III from making new investments. Such actions by the SBA
would, in turn, negatively affect us because Fund III is our wholly owned subsidiary. Fund III was in compliance
with the terms of the SBA’s leverage as of December 31, 2019 as a result of having sufficient capital as defined
under the SBA regulations.
The maximum leverage available to a “family” of affiliated SBIC funds is $350.0 million, subject to SBA
approval. SBA regulations currently limit the amount that a SBIC subsidiary may borrow to a maximum of
$150 million when it has at least $75.0 million in regulatory capital. Affiliated SBICs are permitted to issue up to
a combined maximum amount of $350.0 million when they have at least $175.0 million in regulatory capital. As
of December 31, 2019, Fund III had $75.0 million in regulatory capital and $150.0 million in SBA-guaranteed
debentures outstanding.
On June 10, 2014, we received exemptive relief from the SEC to permit us to exclude the debt of our SBIC
subsidiaries guaranteed by the SBA from the definition of senior securities in the 150%, if certain conditions
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are met, asset coverage test under the 1940 Act. This provides us with increased flexibility under the 150%, if
certain conditions are met, asset coverage test by permitting us to borrow up to $150.0 million more than we
would otherwise be able to absent the receipt of this exemptive relief.
Our SBIC subsidiary is subject to regulation and oversight by the SBA, including requirements with respect
to maintaining certain minimum financial ratios and other covenants. Receipt of a SBIC licenses does not assure
that our SBIC subsidiary will receive SBA-guaranteed debenture funding, which is dependent upon our SBIC
subsidiary continuing to be in compliance with SBA regulations and policies. The SBA, as a creditor, will have a
superior claim to our SBIC subsidiary’s assets over our stockholders in the event we liquidate our SBIC
subsidiary or the SBA exercises its remedies under the SBA-guaranteed debentures issued by our SBIC
subsidiary upon an event of default.
NASDAQ GLOBAL SELECT MARKET REQUIREMENTS
We have adopted certain policies and procedures intended to comply with the NASDAQ Global Select
Market’s corporate governance rules. We will continue to monitor our compliance with all future listing standards
that are approved by the SEC and will take actions necessary to ensure that we are in compliance therewith.
AVAILABLE INFORMATION
Our executive offices are located at 4201 Congress Street, Suite 360, Charlotte, NC 28209. We maintain a
website located at www.Capitalagroup.com and our phone number is (704) 376-5502. We make available free of
charge on our website our proxy statement, annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and amendments to those reports as soon as reasonably practical after we file such material
with, or furnish to, the SEC. Information contained on our website is not incorporated by reference into this
Annual Report on Form 10-K and you should not consider information contained on our website to be part of this
Annual Report on Form 10-K or any other report we file with the SEC.
The SEC also maintains a website that contains reports, proxy and information statements and other
information we file with the SEC at www.sec.gov.
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ITEM 1A. RISK FACTORS
Investing in our securities involves a number of significant risks. Before you invest in our securities, you
should be aware of various risks, including those described below and elsewhere in this Annual Report on
Form 10-K. You should carefully consider these risk factors, together with all of the other information included in
this Annual Report on Form 10-K, before you decide whether to make an investment in our securities. The risks
set out below are not the only risks we face. Additional risks and uncertainties not presently known to us or not
presently deemed material by us may also impair our operations and performance. If any of the following events
occur, our business, financial condition, results of operations and cash flows could be materially and adversely
affected. In such case, our net asset value and the trading price of our securities could decline, and you may lose
all or part of your investment. The risk factors described below are the principal risk factors associated with an
investment in us as well as those factors generally associated with an investment company with investment
objectives, investment policies, capital structure, or trading markets similar to ours.
Risks Relating to Our Business and Structure
We have a limited operating history as a BDC.
Capitala Finance was formed in February 2013 and has only operated as a BDC since September 2013. As a
result, we are subject to many of the business risks and uncertainties associated with recently formed businesses,
including the risk that we will not achieve our investment objective and that the value of your investment could
decline substantially. As a BDC, we are subject to the regulatory requirements of the SEC, in addition to the
specific regulatory requirements applicable to BDCs under the 1940 Act and RICs under the Code. Our
management and that of the Investment Advisor did not have any prior experience operating under this regulatory
framework, and we incur substantial costs, and expend significant time or other resources, to operate under this
regulatory framework. From time to time, the Investment Advisor may pursue investment opportunities in which
it has more limited experience. We may also be unable to replicate the historical performance of prior investment
funds managed by our management team. In addition, we may be unable to generate sufficient revenue from our
operations to make or sustain distributions to our stockholders.
Our investment portfolio is recorded at fair value, with our Board having final responsibility for overseeing,
reviewing and approving, in good faith, its estimate of fair value and, as a result, there may be uncertainty as
to the value of our portfolio investments.
Under the 1940 Act, we are required to carry our portfolio investments at market value or, if there is no
readily available market value, at fair value as determined by us, with our Board having final responsibility for
overseeing, reviewing and approving, in good faith, our estimate of fair value. Typically, there will not be a
public market for the securities of the privately held companies in which we invest. As a result, we value these
securities quarterly at fair value based on input from management, a third-party independent valuation firm and
our audit committee, and with the oversight, review and approval of our Board.
The determination of fair value and, consequently, the amount of unrealized gains and losses in our
portfolio, are to a certain degree, subjective and dependent on a valuation process approved by our Board. Certain
factors that may be considered in determining the fair value of our investments include external events, such as
private mergers, sales and acquisitions involving comparable companies. Because such valuations, and
particularly valuations of private securities and private companies, are inherently uncertain, they may fluctuate
over short periods of time and may be based on estimates. Our fair value determinations may differ materially
from the values that would have been used if a ready market for these securities existed. Due to this uncertainty,
our fair value determinations may cause our net asset value on a given date to materially understate or overstate
the value that we may ultimately realize on one or more of our investments. As a result, investors purchasing our
common stock based on an overstated net asset value would pay a higher price than the value of our investments
might warrant. Conversely, investors selling shares during a period in which the net asset value understates the
value of our investments would receive a lower price for their shares than the value of our investments might
warrant. In addition, we may not be able to realize the values on our investments needed to pay interest on our
borrowings.
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Our financial condition and results of operations depend on our ability to effectively manage and deploy
capital.
Our ability to achieve our investment objective depends on our ability to effectively manage and deploy
capital, which depends, in turn, on our Investment Advisor’s ability to identify, evaluate and monitor, and our
ability to finance and invest in, companies that meet our investment criteria.
Accomplishing our investment objective on a cost-effective basis is largely a function of our Investment
Advisor’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, our Investment Advisor’s investment team may also be called upon, from time to time, to provide
managerial assistance to some of our portfolio companies as well as other funds that they manage. These
demands on their time may distract them or slow our rate of investment. See also “— There are significant
potential conflicts of interest that could negatively affect our investment returns.”
Even if we are able to grow and build upon our investment operations, any failure to manage our growth
effectively could have a material adverse effect on our business, financial condition, results of operations and
prospects. The results of our operations depend on many factors, including the availability of opportunities for
investment, readily accessible short and long-term funding alternatives in the financial markets, 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 make distributions.
We depend upon Capitala Investment Advisors’ key personnel for our future success.
We depend on the diligence, skill and network of business contacts of Joseph B. Alala, III, M. Hunt Broyhill
and John F. McGlinn, who serve as the members of the investment committee of the Investment Advisor and lead
the Investment Advisor’s investment team. Our success depends on the continued service of these individuals and
the other senior investment professionals available to the Investment Advisor. We cannot assure you that
unforeseen business, medical, personal or other circumstances would not lead Messrs. Alala, Broyhill or McGlinn
or any other such individual to terminate his relationship with us. Additionally, we cannot assure you that a
reduction in revenue to the Investment Advisor, including as a result of fee waivers or a decrease in our assets,
would not lead to a loss of investment professionals in the future. Such loss of members of the Investment
Advisor’s investment committee and other investment professionals could have a material adverse effect on our
ability to achieve our investment objective as well as on our financial condition and results of operations. In
addition, we can offer no assurance that the Investment Advisor will continue indefinitely as our investment
adviser.
The members of the Investment Advisor’s investment team are and may in the future become affiliated with
entities engaged in business activities similar to those intended to be conducted by us and may have conflicts of
interest in allocating their time. For example, an affiliate of the Investment Advisor also manages Fund IV and
Fund V, which are private investment limited partnerships and CSLC, a private investment vehicle, all of which
provide financing solutions to lower middle-market and traditional middle-market companies. Mr. Alala dedicates
a significant portion of his time to the activities of Capitala Finance; however, he may become engaged in other
business activities that could divert his time and attention in the future.
We operate in a highly competitive market for investment opportunities, which could reduce returns and result
in losses.
We compete for investments with other BDCs with similar investment strategies, private equity funds with
similar investment strategies, venture lending funds, finance companies with venture lending units and banks
focused on venture lending. Many of our potential competitors are substantially larger and have considerably
greater financial, technical and marketing resources than we have. For example, some competitors may have a
lower cost of capital and access to funding sources that are not available to us. In addition, some of our
competitors have higher risk tolerances or different risk assessments than we have. These characteristics might
allow our competitors to consider a wider variety of investments, establish more relationships or offer better
pricing and more flexible structuring than we are able to offer. We may lose investment opportunities if we do not
match our competitors’ pricing, terms or structure. If we are forced to match our competitors’ pricing, terms or
structure, we may not be able to achieve acceptable returns on our investments or may bear substantial risk of
capital loss. We believe a significant part of our competitive advantage stems from the fact
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that the market for investments in lower and traditional middle-market companies is underserved by traditional
commercial banks and other financing sources. A significant increase in the number and/or the size of our
competitors in this target market could force us to accept less attractive investment terms. Furthermore, many of
our potential competitors have greater experience operating under, or will not be subject to, the regulatory
restrictions that the 1940 Act impose on us as a BDC.
Any inability of Capitala Investment Advisors to maintain or develop strong referral relationships, or the
failure of these relationships to generate investment opportunities, could adversely affect our business.
We depend upon our Investment Advisor to maintain its relationships with venture capital and private equity
firms, placement agents, investment banks, management groups and other financial institutions, and we expect to
rely to a significant extent upon these relationships to provide us with potential investment opportunities. If our
Investment Advisor fails to maintain such relationships, or to develop new relationships with other sources of
investment opportunities, we will not be able to grow our investment portfolio. In addition, individuals with
whom our Investment Advisor has relationships are not obligated to provide us with investment opportunities,
and we can offer no assurance that these relationships will generate investment opportunities for us in the future.
Our success depends on the ability of Capitala Investment Advisors to attract and retain qualified personnel in
a competitive environment.
Our growth requires that the Investment Advisor retain and attract new investment and administrative
personnel in a competitive market. Its ability to attract and retain personnel with the requisite credentials,
experience and skills depends on several factors including, but not limited to, its ability to offer competitive
wages, benefits and professional growth opportunities. Many of the entities with which the Investment Advisor
competes for experienced personnel, including investment funds (such as private equity funds, credit funds and
mezzanine funds) and traditional financial services companies, have greater resources than the Investment
Advisor has. We cannot assure you that a reduction in revenue to the Investment Advisor, including as a result of
fee waivers or a decrease in our assets, would not lead to a loss of investment professionals in the future.
There are significant potential conflicts of interest that could negatively affect our investment returns.
The members of the Investment Advisor’s investment team also monitor and service other affiliated
investment funds. In addition, our executive officers and directors, as well as the current and future members of
our Investment Advisor’s investment team may serve as officers, directors or principals of other entities that
operate in the same or a related line of business as we do. Accordingly, they may have obligations to investors in
those entities, the fulfillment of which obligations may not be in the best interests of us or our stockholders.
In the course of our investing activities, we pay management and incentive fees to the Investment Advisor
and reimburse the Investment Advisor for certain expenses it incurs. As a result, investors in our common stock
invest on a “gross” basis and receive distributions on a “net” basis after expenses, resulting in a lower rate of
return than an investor might achieve through direct investments. Accordingly, there may be times when the
management team of the Investment Advisor will have interests that differ from those of our stockholders, giving
rise to a conflict. The Investment Advisor will not be reimbursed for any performance-related compensation for
its employees. We have entered into a royalty-free license agreement with our Investment Advisor, pursuant to
which the Investment Advisor grants us a non-exclusive royalty-free license to use the name “Capitala.” Under
the license agreement, we have the right to use the “Capitala” name for so long as the Investment Advisor or one
of its affiliates remains our Investment Advisor. In addition, we pay our Administrator our allocable portion of
overhead and other expenses incurred by our Administrator in performing its obligations under the
Administration Agreement, including rent, the fees and expenses associated with performing compliance
functions, and our allocable portion of the compensation of our chief financial officer, chief compliance officer
and their respective administrative support staff. These arrangements create conflicts of interest that our Board
must monitor.
In addition, an affiliate of the Investment Advisor also manages Fund IV, a private investment limited
partnership providing financing solutions to smaller and lower middle-market companies that had its first closing
in March 2013 and obtained SBA approval for its SBIC license in April 2013. In addition to Fund IV,
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affiliates of the Investment Advisor may manage several affiliated funds whereby institutional limited partners in
Fund IV have the opportunity to co-invest with Fund IV in portfolio investments. An affiliate of the Investment
Advisor also manages Fund V, a private investment limited partnership, and CSLC, both of which provide
financing solutions to lower middle-market and traditional middle-market companies. The Investment Advisor
and its affiliates may also manage other funds in the future that may have investment mandates that are similar, in
whole or in part to ours. To the extent permitted by the 1940 Act and interpretation of the SEC staff, the
Investment Advisor and its affiliates may determine that an investment is appropriate for us and for one or more
of those other funds. In such event, depending on the availability of such investment and other appropriate
factors, the Investment Advisor or its affiliates may determine that we should invest side-by-side with one or
more other funds. Any such investments will be made only to the extent permitted by applicable law and
interpretive positions of the SEC and its staff, and consistent with the Investment Advisor’s allocation
procedures. We expect to make, and have made, co-investments with Fund IV, Fund V, and/or CSLC to the extent
their respective investment strategies align with ours.
As a BDC, we are substantially limited in our ability to co-invest in privately negotiated transactions with
affiliated funds unless we obtain an exemptive order from the SEC. On June 1, 2016, the SEC issued the Order.
Subject to satisfaction of certain conditions to the Order, we and certain of our affiliates are now permitted,
together with any future BDCs, registered closed-end funds and certain private funds, each of whose investment
adviser is our investment adviser or an investment adviser controlling, controlled by, or under common control
with our investment adviser, to co-invest in negotiated investment opportunities where doing so would otherwise
be prohibited under the 1940 Act, providing our stockholders with access to a broader array of investment
opportunities. Pursuant to the Order, we are permitted to co-invest in such investment opportunities with our
affiliates if a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors make
certain conclusions in connection with a co-investment transaction, including, but not limited to, that (1) the
terms of the potential co-investment transaction, including the consideration to be paid, are reasonable and fair to
us and our stockholders and do not involve overreaching in respect of us or our stockholders on the part of any
person concerned, and (2) the potential co-investment transaction is consistent with the interests of our
stockholders and is consistent with our then-current investment objective and strategies.
In the ordinary course of business, we may enter into transactions with portfolio companies that may be
considered related party transactions. In order to ensure that we do not engage in any prohibited transactions with
any persons affiliated with us, we have implemented certain written policies and procedures whereby our
executive officers screen each of our transactions for any possible affiliations between the proposed portfolio
investment and us, companies controlled by us or our executive officers and directors. We will not enter into any
agreements unless and until we are satisfied that doing so will not raise concerns under the 1940 Act or, if such
concerns exist, we have taken appropriate actions to seek review and approval by our Board or exemptive relief
for such transaction. Our Board will review these procedures on an annual basis.
The investment committee and other investment professionals of Capitala Investment Advisors may, from time
to time, possess material non-public information about or related to our portfolio companies, limiting our
investment discretion.
Members of our Investment Advisor’s investment committee and other investment professionals of the
Investment Advisor may serve as directors of, or in a similar capacity to, portfolio companies in which we invest.
In the event that material nonpublic information is obtained with respect to such companies, or we become
subject to trading restrictions under the internal trading policies of those companies or as a result of applicable
law or regulations, we could be prohibited for a period of time from purchasing or selling the securities of such
companies, and this prohibition may have an adverse effect on us.
The involvement of our interested directors in the valuation process may create conflicts of interest.
We make many of our portfolio investments in the form of loans and securities that are not publicly traded
and for which no market-based price quotation is available. As a result, our Board determines the fair value of
these loans and securities in good faith as described in the section titled “Valuation of Investments” in Note 2 to
our consolidated financial statements. In connection with that determination, investment professionals from the
Investment Advisor may provide our Board with valuations based upon the most recent
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portfolio company financial statements available and projected financial results of each portfolio company. While
the valuation for certain portfolio investments is reviewed by an independent valuation firm quarterly, the
ultimate determination of fair value is made by our Board, including our interested directors, and not by such
third-party valuation firm. The participation of the Investment Advisor’s investment professionals in our
valuation process could result in conflicts of interest as the Investment Advisor’s management fee is based, in
part, on the value of our gross assets, and its incentive fees will be based, in part, on realized and unrealized gains
and depreciation.
The terms of the Investment Advisory Agreement with Capitala Investment Advisors and the Administration
Agreement with our Administrator were not negotiated on an arm’s length basis and may not be as favorable
to us as if they had been negotiated with an unaffiliated third-party, including an incentive fee structure that
may induce Capitala Investment Advisors to pursue speculative investments, and to use leverage when it may
be unwise to do so.
The Investment Advisory Agreement and the Administration Agreement were negotiated between related
parties. Consequently, their terms, including fees payable to the Investment Advisor and the Administrator, may
not be as favorable to us as if they had been negotiated with an unaffiliated third-party.
The incentive fee payable by us to the Investment Advisor may create an incentive for the Investment
Advisor to pursue investments on our behalf that are riskier or more speculative than would be the case in the
absence of such compensation arrangement. The incentive fee payable to our Investment Advisor is calculated
based on a percentage of our return on invested capital. This may encourage our Investment Advisor to use
leverage to increase the return on our investments. Under certain circumstances, the use of leverage may increase
the likelihood of default, which would impair the value of our common stock. In addition, our Investment
Advisor receives the incentive fee based, in part, upon net capital gains realized on our investments. Unlike that
portion of the incentive fee based on income, there is no hurdle rate applicable to the portion of the incentive fee
based on net capital gains. As a result, the Investment Advisor may have a tendency to invest more capital in
investments that are likely to result in capital gains as compared to income-producing securities. Such a practice
could result in our investing in more speculative securities than would otherwise be the case, which could result
in higher investment losses, particularly during economic downturns.
Although we currently do not anticipate doing so, we may invest, to the extent permitted by law, in the
securities and instruments of other investment companies, including private funds, and, to the extent we so invest,
will bear our ratable share of any such investment company’s expenses, including management and performance
fees. We also remain obligated to pay management and incentive fees to our Investment Advisor with respect to
the assets invested in the securities and instruments of other investment companies. With respect to each of these
investments, each of our stockholders will bear his or her share of the management and our Investment Advisor’s
incentive fee as well as indirectly bearing the management and performance fees and other expenses of any
investment companies in which we invest.
Capitala Investment Advisors’ liability is limited under the Investment Advisory Agreement, and we have
agreed to indemnify Capitala Investment Advisors against certain liabilities, which may lead Capitala
Investment Advisors to act in a riskier manner on our behalf than it would when acting for its own account.
Under the Investment Advisory Agreement, the Investment Advisor has not assumed any responsibility to us
other than to render the services called for under that agreement. It is not responsible for any action of our Board
in following or declining to follow the Investment Advisor’s advice or recommendations. Under the Investment
Advisory Agreement, the Investment Advisor, its officers, members and personnel, and any person controlling or
controlled by the Investment Advisor are not liable to us, any subsidiary of ours, our directors, our stockholders
or any subsidiary’s stockholders or partners for acts or omissions performed in accordance with and pursuant to
the Investment Advisory Agreement, except those resulting from acts constituting gross negligence, willful
misfeasance, bad faith or reckless disregard of the duties that the Investment Advisor owes to us under the
Investment Advisory Agreement. In addition, as part of the Investment Advisory Agreement, we have agreed to
indemnify the Investment Advisor and each of its officers, directors, members, managers and employees from
and against any claims or liabilities, including reasonable legal fees and other expenses reasonably incurred,
arising out of or in connection with our business and operations or any action taken or omitted on our behalf
pursuant to authority granted by the Investment Advisory Agreement, except where
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attributable to gross negligence, willful misfeasance, bad faith or reckless disregard of such person’s duties under
the Investment Advisory Agreement. These protections may lead the Investment Advisor to act in a riskier
manner when acting on our behalf than it would when acting for its own account.
A general increase in interest rates will likely have the effect of making it easier for our Investment Advisor to
receive incentive fees, without necessarily resulting in an increase in our net earnings.
Under the structure of our Investment Advisory Agreement with our Investment Advisor, any general
increase in interest rates will likely have the effect of making it easier for our Investment Advisor to meet the
quarterly hurdle rate for payment of income incentive fees under the Investment Advisory Agreement without
any additional increase in relative performance on the part of our Investment Advisor. In addition, in view of the
catch-up provision applicable to income incentive fees under the Investment Advisory Agreement, our
Investment Advisor could potentially receive a significant portion of the increase in our investment income
attributable to such a general increase in interest rates. If that were to occur, our increase in net earnings, if any,
would likely be significantly smaller than the relative increase in our Investment Advisor’s income incentive fee
resulting from such a general increase in interest rates.
PIK interest payments we receive will increase our assets under management and, as a result, will increase the
amount of base management fees and incentive fees payable by us to Capitala Investment Advisors.
Certain of our debt investments contain provisions providing for the payment of contractual PIK interest.
Because PIK interest results in an increase in the size of the loan balance of the underlying loan, the receipt by us
of PIK interest will have the effect of increasing our assets under management. As a result, because the base
management fee that we pay to the Investment Advisor is based on the value of our gross assets, the receipt by us
of PIK interest will result in an increase in the amount of the base management fee payable by us. In addition,
any such increase in a loan balance due to the receipt of PIK interest will cause such loan to accrue interest on the
higher loan balance, which will result in an increase in our pre-incentive fee net investment income and, as a
result, an increase in incentive fees that are payable by us to the Investment Advisor.
Capitala Investment Advisors has the right to resign on 60 days’ notice, and we may not be able to find a
suitable replacement within such time, resulting in a disruption in our operations that could adversely affect
our financial condition, business and results of operations.
Our Investment Advisor has the right, under the Investment Advisory Agreement, to resign at any time on
60 days’ written notice, whether we have found a replacement or not. If our Investment Advisor resigns, we may
not be able to find a new investment adviser or hire internal management with similar expertise and ability to
provide the same or equivalent services on acceptable terms within 60 days, or at all. If we are unable to do so
quickly, our operations are likely to experience a disruption, our financial condition, business and results of
operations as well as our ability to pay distributions are likely to be adversely affected and the market price of our
shares may decline. In addition, the coordination of our internal management and investment activities is likely to
suffer if we are unable to identify and reach an agreement with a single institution or group of executives having
the expertise possessed by our Investment Advisor and its affiliates. Even if we are able to retain comparable
management, whether internal or external, the integration of such management and their lack of familiarity with
our investment objective may result in additional costs and time delays that may adversely affect our financial
condition, business and results of operations.
Capitala Investment Advisors may not be able to achieve the same or similar returns as those achieved for
other funds it currently manages or by its investment team while they were employed at prior positions.
The Investment Advisor manages other funds and may manage other entities in the future. The track record
and achievements of these other entities are not necessarily indicative of future results that will be achieved by
the Investment Advisor because these other entities may have investment objectives and strategies that differ
from ours. Additionally, although in the past Mr. Alala and other members of our Investment Advisor’s
investment team have held senior positions at a number of investment firms, including the Legacy Funds, their
track record and achievements are not necessarily indicative of future results that will be achieved by our
Investment Advisor. We cannot assure you that we will be able to achieve the results realized by prior vehicles
managed by our Investment Advisor’s investment team, including the Legacy Funds.
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Any failure on our part to maintain our status as a BDC would reduce our operating flexibility.
We have elected to be regulated as a BDC under the 1940 Act. The 1940 Act imposes numerous constraints
on the operations of BDCs. For example, BDCs are required to invest at least 70% of their gross assets in
specified types of securities, primarily in private companies or thinly traded U.S. public companies, cash, cash
equivalents, U.S. government securities and other high quality debt investments that mature in one year or less.
Furthermore, any failure to comply with the requirements imposed on BDCs by the 1940 Act could cause the
SEC to bring an enforcement action against us and/or expose us to claims of private litigants. In addition, upon
approval of a majority of our stockholders, we may elect to withdraw our status as a BDC. If we decide to
withdraw our election, or if we otherwise fail to qualify, or maintain our qualification, as a BDC, we may be
subject to the substantially greater regulation under the 1940 Act as a closed-end investment company.
Compliance with such regulations would significantly decrease our operating flexibility and could significantly
increase our costs of doing business.
Regulations governing our operation as a BDC affect our ability to raise additional capital and the way in
which we do so. As a BDC, the necessity of raising additional capital may expose us to risks, including the
typical risks associated with leverage.
We may issue debt securities or preferred stock and/or borrow money from banks or other financial
institutions, which we refer to collectively as “senior securities,” up to the maximum amount permitted by the
1940 Act. Under the provisions of the 1940 Act, we are permitted, as a BDC, to issue senior securities in amounts
such that our asset coverage ratio, as defined in the 1940 Act, equals at least 150%, if certain conditions are met,
of gross assets less all liabilities and indebtedness not represented by senior securities, after each issuance of
senior securities. If the value of our assets declines, we may be unable to satisfy this test. If that happens, we may
be required to sell a portion of our investments and, depending on the nature of our leverage, repay a portion of
our indebtedness at a time when such sales may be disadvantageous. Also, any amounts that we use to service our
indebtedness would not be available for distributions to our common stockholders. Furthermore, as a result of
issuing senior securities, we would also be exposed to typical risks associated with leverage, including an
increased risk of loss.
As of December 31, 2019, we had $150.0 million of outstanding SBA-guaranteed debentures, $75.0 million
of 6.0% fixed rate notes due May 31, 2022 (the “2022 Notes”) outstanding, $52.1 million of 5.75% fixed rate
convertible notes due May 31, 2022 (the “2022 Convertible Notes”) outstanding, and $0.0 outstanding under the
Credit Facility that provides for borrowings of up to $60.0 million on a revolving basis and may be increased up
to $150.0 million pursuant to its “accordion” feature. The Order received from the SEC grants us relief from the
asset coverage requirements for certain indebtedness issued by Fund II and Fund III as SBICs. If we issue
preferred stock, the preferred stock would rank “senior” to common stock in our capital structure, preferred
stockholders would have separate voting rights on certain matters and might have other rights, preferences, or
privileges more favorable than those of our common stockholders, and the issuance of preferred stock could have
the effect of delaying, deferring or preventing a transaction or a change of control that might involve a premium
price for holders of our common stock or otherwise be in your best interest.
We generally may not issue and sell our common stock at a price below net asset value per share. We may,
however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the
then-current net asset value per share of our common stock if our Board determines that such sale is in our best
interests and in the best interests of our stockholders, and our stockholders approve such sale. In any such case,
the price at which our securities are to be issued and sold may not be less than a price that, in the determination of
our Board, closely approximates the market value of such securities (less any commission or discount). If we
raise additional funds by issuing more common stock or senior securities convertible into, or exchangeable for,
our common stock, then the percentage ownership of our stockholders at that time will decrease, and you may
experience dilution.
At our 2020 Annual Stockholders Meeting, subject to certain determinations required to be made by our
Board, we will ask our stockholders to approve our ability to sell or otherwise issue shares of our common stock,
not exceeding 25% of our then outstanding common stock immediately prior to each such offering, at a price
below the then current net asset value per share during a period beginning on April 30, 2020 and
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expiring on the earlier of the one year anniversary of the date of the 2020 Annual Stockholders Meeting and the
date of our 2021 Annual Stockholders Meeting, which is expected to be held in April 2021.
In certain limited circumstances, pursuant to an SEC staff interpretation, we may also issue shares at a price
below net asset value in connection with a transferable rights offering so long as: (1) the offer does not
discriminate among stockholders; (2) we use our best efforts to ensure an adequate trading market exists for the
rights; and (3) the ratio of the offering does not exceed one new share for each three rights held. If we raise
additional funds by issuing more common stock or senior securities convertible into, or exchangeable for, our
common stock, the percentage ownership of our stockholders at that time would decrease and they may
experience dilution. Moreover, we can offer no assurance that we will be able to issue and sell additional equity
securities in the future, on favorable terms or at all.
We borrow money, which magnifies the potential for gain or loss on amounts invested and may increase the
risk of investing in us, and the calculation of our base management fee, which is based upon our gross assets,
may have the effect of encouraging our Investment Advisor to utilize leverage when it may not be advisable to
do so.
The use of leverage magnifies the potential for gain or loss on amounts invested and, therefore, increases the
risks associated with investing in our securities. In addition to the existing SBA-guaranteed debentures, the 2022
Notes, the 2022 Convertible Notes and the Credit Facility, we may borrow from and issue senior debt securities
to banks, insurance companies and other lenders in the future. Holders of these senior securities will have fixed
dollar claims on our assets that are superior to the claims of our common stockholders, and we would expect such
lenders to seek recovery against our assets in the event of a default. If the value of our assets decreases, leverage
would cause net asset value to decline more sharply than it otherwise would have had we not been leveraged.
Similarly, any decrease in our income would cause net income to decline more sharply than it would have had we
not borrowed. Such a decline could also negatively affect our ability to make distributions on our common stock.
Leverage is generally considered a speculative investment technique. Our ability to service any debt that we incur
will depend largely on our financial performance and will be subject to prevailing economic conditions and
competitive pressures. Moreover, as the management fee payable to our Investment Advisor will be payable
based on our gross assets, including those assets acquired through the use of leverage, our Investment Advisor
will have a financial incentive to incur leverage that may not be consistent with our stockholders’ interests. In
addition, our common stockholders will bear the burden of any increase in our expenses as a result of leverage,
including any increase in the management fee payable to our Investment Advisor.
The Credit Facility, and any other credit facility into which we may enter, imposes financial and operating
covenants that restrict our business activities, including limitations that could hinder our ability to finance
additional loans and investments or to make the distributions required to maintain our tax treatment as a RIC
under the Code. Even though our Board has approved a resolution permitting the Company to be subject to a
150% asset coverage ratio, contractual leverage limitations under our existing Credit Facility or future
borrowings may limit our ability to incur additional indebtedness.
The following table illustrates the effect of leverage on returns from an investment in our common stock
assuming various annual returns, net of expenses. The calculations in the table below are hypothetical and actual
returns may be higher or lower than those appearing below.
Assumed Return on Our Portfolio (net of expenses)
(1)
(10.0)%
(5.0)%
0.0%
5.0%
10.0%
Corresponding net return to common stockholder
(40.0
)%
(24.7
)%
(9.5
)%
5.8
%
21.1
%
(1)
Assumes $452.3 million in total assets, $302.1 million in debt outstanding and $148.1 million in net assets
as of December 31, 2019, adjusted to reflect borrowings of $25.0 million under the Credit Facility. Assumes
an average cost of funds of 4.64% which includes the stated interest rate and the SBA annual charge. Actual
interest payments may be different.
To the extent we borrow money to finance our investments, changes in interest rates will affect our cost of
capital and net investment income.
To the extent we borrow money to finance our investments, our net investment income will depend, in part,
upon the difference between the rate at which we borrow funds and the rate at which we invest those
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funds. As a result, we can offer no assurance that a significant change in market interest rates will not have a
material adverse effect on our net investment income in the event we borrow money to finance our investments.
In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment
income. We expect that our long-term fixed-rate investments will be financed primarily with equity and long-
term debt. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate
fluctuations. Such techniques may include various interest rate hedging activities to the extent permitted by the
1940 Act. Our Investment Advisor does not have significant experience with utilizing these techniques and did
not implement these techniques to any significant extent with our portfolio. If we do not implement these
techniques properly, we could experience losses on our hedging positions, which could be material.
A disruption in the capital markets and the credit markets could impair our ability to raise capital and
negatively affect our business.
As a BDC, we have to maintain our ability to raise additional capital for investment purposes. Without
sufficient access to the capital markets or credit markets, we may be forced to curtail our business operations, or
we may not be able to pursue new business opportunities.
In the past, the capital markets and the credit markets have experienced periods of extreme volatility and
disruption and, accordingly, there has been and may continue to be uncertainty in the financial markets in general.
Continuing U.S. debt ceiling and budget deficit concerns, including automatic spending cuts stemming from
sequestration, together with signs of deteriorating sovereign debt conditions in Europe, have increased the
possibility of additional credit-rating downgrades and economic slowdowns, or a recession in the U.S. The
impact of this or any further downgrades to the U.S. government’s sovereign credit rating or its perceived
creditworthiness could adversely affect the U.S. and global financial markets and economic conditions. These
developments, along with the European sovereign debt crisis, could cause interest rates and borrowing costs to
rise, which may negatively impact our ability to access the debt markets on favorable terms. Continued adverse
economic conditions could have a material adverse effect on our business, financial condition and results of
operations. Any further disruptive conditions in the financial industry and the impact of new legislation in
response to those conditions could restrict our business operations and could adversely impact our results of
operations and financial condition.
If the fair value of our assets declines substantially, we may fail to maintain the asset coverage ratios
imposed upon us by the 1940 Act. Any such failure would affect our ability to issue senior securities, including
borrowings, and pay dividends, which could materially impair our business operations. Our liquidity could be
impaired further by an inability to access the capital markets or to consummate new borrowing facilities to
provide capital for normal operations, including new originations. In recent years, reflecting concern about the
stability of the financial markets, many lenders and institutional investors have reduced or ceased providing
funding to borrowers.
We have fully drawn on our SBA-guaranteed debentures and, absent changes to legislation or regulation,
may not make borrowings in excess of their aggregate $150.0 million of SBA-guaranteed debentures outstanding
as of December 31, 2019. We also had approximately $75.0 million and $52.1 million, respectively, of the 2022
Notes and 2022 Convertible Notes outstanding as of December 31, 2019. In addition, as of December 31, 2019,
we had approximately $0.0 outstanding under the Credit Facility that provides for borrowings of up to
$60.0 million on a revolving basis and may be increased up to $150.0 million pursuant to its “accordion” feature.
If we are unable to secure additional debt financing on commercially reasonable terms, our liquidity could be
reduced significantly. If we are unable to repay amounts outstanding under any debt facilities we may obtain and
are declared in default or are unable to renew or refinance these facilities, we may not be able to operate our
business in the normal course. These situations may arise due to circumstances that we may be unable to control,
such as lack of access to the credit markets, a severe decline in the value of the U.S. dollar, another economic
downturn or an operational problem that affects third parties or us and could materially damage our business.
You should also be aware that a rise in the general level of interest rates can be expected to lead to higher
interest rates applicable to our debt investments. Accordingly, an increase in interest rates would make it easier
for us to meet or exceed the incentive fee hurdle rate and may result in a substantial increase of the amount of
incentive fees payable to our Investment Advisor with respect to our pre-incentive fee net investment income.
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Global economic, political and market conditions may adversely affect our business, results of operations and
financial condition, including our revenue growth and profitability.
The current worldwide financial market situation, as well as various social and political tensions in the
United States and around the world, may contribute to increased market volatility, may have long-term effects on
the United States and worldwide financial markets, and may cause economic uncertainties or deterioration in the
United States and worldwide. The U.S. and global capital markets experienced extreme volatility and disruption
during the economic downturn that began in mid-2007, and the U.S. economy was in a recession for several
consecutive calendar quarters during the same period. In 2010, a financial crisis emerged in Europe, triggered by
high budget deficits and rising direct and contingent sovereign debt, which created concerns about the ability of
certain nations to continue to service their sovereign debt obligations. Risks resulting from such debt crisis and
any future debt crisis in Europe or any similar crisis elsewhere could have a detrimental impact on the global
economic recovery, sovereign and non-sovereign debt in certain countries and the financial condition of financial
institutions generally. In June 2016, the United Kingdom held a referendum in which voters approved an exit
from the European Union (“Brexit”) and, subsequently, on March 29, 2017, the U.K. government began the
formal process of leaving the European Union. Brexit created political and economic uncertainty and instability
in the global markets (including currency and credit markets), and especially in the United Kingdom and the
European Union. Under current Prime Minister Boris Johnson, the House of Commons passed the Brexit deal on
December 20, 2019 and the U.K. formally left the European Union on January 31, 2020. The U.K. is currently in
a transition period until December 31, 2020, where agreements surrounding trade and other aspects of the U.K.’s
future relationship with the European Union will need to be finalized. Failure to come to terms on a free trade
deal could result in checks and tariffs on U.K. goods traveling to the European Union and thus prolong the
economic uncertainty. There is continued concern about national-level support for the Euro and the
accompanying coordination of fiscal and wage policy among European Economic and Monetary Union member
countries. In addition, the fiscal policy of foreign nations, such as Russia and China, may have a severe impact on
the worldwide and U.S. financial markets.
The Republican Party currently controls the executive branch and the Senate portion of the legislative
branch of government, which increases the likelihood that legislation may be adopted that could significantly
affect the regulation of U.S. financial markets. Areas subject to potential change, amendment or repeal include
the Dodd-Frank Act and the authority of the Federal Reserve and the Financial Stability Oversight Council. For
example, in March 2018, the U.S. Senate passed a bill that eased financial regulations and reduced oversight for
certain entities. The United States may also potentially withdraw from or renegotiate various trade agreements
and take other actions that would change current trade policies of the United States We cannot predict which, if
any, of these actions will be taken or, if taken, their effect on the financial stability of the United States. Such
actions could have a significant adverse effect on our business, financial condition and results of operations. We
cannot predict the effects of these or similar events in the future on the U.S. economy and securities markets or
on our investments. We monitor developments and seek to manage our investments in a manner consistent with
achieving our investment objective, but there can be no assurance that we will be successful in doing so.
Further downgrades of the U.S. credit rating, impending automatic spending cuts, another government
shutdown or a failure to raise the statutory debt limit of the United States could negatively impact our liquidity,
financial condition and earnings.
Recent U.S. debt ceiling and budget deficit concerns have increased the possibility of additional credit-rating
downgrades and economic slowdowns, or a recession in the U.S. In the future, the U.S. government may not be
able to meet its debt payments unless the federal debt ceiling is raised. If legislation increasing the debt ceiling is
not enacted, as needed, and the debt ceiling is reached, the U.S. federal government may stop or delay making
payments on its obligations, which could negatively impact the U.S. economy and our portfolio companies. Any
default by the U.S. government on its obligations or any prolonged U.S. government shutdown could negatively
impact the U.S. economy and our portfolio companies. In addition, disagreement over the federal budget has
caused the U.S. federal government to shut down for periods of time. Continued adverse political and economic
conditions could have a material adverse effect on our business, financial condition and results of operations.
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We may experience fluctuations in our quarterly and annual results.
We may experience fluctuations in our quarterly and annual operating results due to a number of factors,
including our ability or inability to make investments in companies that meet our investment criteria, any sales,
dispositions or liquidity events of our portfolio companies, the interest rate payable on the debt securities we
acquire, the level of portfolio dividend and fee income, the level of our expenses, variations in and the timing of
the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our
markets and general economic conditions. Given that the portfolio is concentrated, distributions, dispositions or
liquidity events affecting a portfolio company in which we own a significant position may adversely affect our
net asset value and results of operations. As a result of these factors, results for any period should not be relied
upon as being indicative of performance in future periods.
Our Board may change our investment objective, operating policies and strategies without prior notice or
stockholder approval, the effects of which may be adverse.
Our Board has the authority to modify or waive our investment objective, operating policies, investment
criteria and strategies without prior notice and without stockholder approval. We cannot predict the effect any
changes to our current operating policies, investment criteria and strategies would have on our business, net asset
value, operating results and value of our stock. However, the effects might be adverse, which could negatively
impact our ability to make distributions and cause you to lose all or part of your investment.
We will be subject to corporate-level U.S. federal income tax if we are unable to qualify or maintain our RIC
tax treatment under the Code.
Although we have elected to be treated as a RIC beginning with our taxable year ended August 31, 2014, no
assurance can be given that we will be able to continue to qualify for and maintain our RIC tax treatment under
the Code. To continue to maintain our RIC tax treatment under the Code, we must meet the following source-of-
asset diversification, and distribution requirements.
The income source requirement will be satisfied if we obtain at least 90% of our income for each year from
dividends, interest, gains from the sale or other disposition of stock or securities or similar sources. The asset
diversification requirement will be satisfied if we meet certain asset diversification requirements at the end of
each quarter of our taxable year. Failure to meet those requirements may result in our having to dispose of certain
investments quickly in order to prevent the loss of our RIC tax treatment under the Code. Because most of our
investments will be in private companies, and therefore will be relatively illiquid, any such dispositions could be
made at disadvantageous prices and could result in substantial losses.
The annual distribution requirement for a RIC will be satisfied if we distribute to our stockholders on an
annual basis at least 90% of our net ordinary income and net short-term capital gains in excess of our net long-
term capital losses, if any. Because we may use debt financing, we are subject to certain asset coverage ratio
requirements under the 1940 Act, as well as future financial covenants under loan and credit agreements that
could, under certain circumstances, restrict us from making distributions necessary to satisfy the distribution
requirement. If we are unable to obtain cash from other sources, we could fail to qualify for tax treatment as a
RIC under the Code.
If we fail to qualify for tax treatment as a RIC under the Code for any reason and remain or become subject
to corporate-level U.S. federal income tax on all of our income, the resulting corporate taxes could substantially
reduce our net assets, the amount of income available for distribution or reinvestment and the amount of our
distributions.
We cannot predict how tax reform legislation will affect us, our investments, or our stockholders, and any such
legislation could adversely affect our business.
Legislative or other actions relating to taxes could have a negative effect on us. The rules dealing with U.S.
federal income taxation are constantly under review by persons involved in the legislative process and by the IRS
and the U.S. Treasury Department. In December 2017, the U.S. House of Representatives and U.S. Senate passed
tax reform legislation, which the President signed into law. Such legislation made many changes to the Internal
Revenue Code, including significant changes to the taxation of business entities, the deductibility of
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interest expense, and the tax treatment of capital investment. We cannot predict with certainty how any changes
in the tax laws might affect us, our stockholders, or our portfolio investments. New legislation and any U.S.
Treasury regulations, administrative interpretations or court decisions interpreting such legislation could
significantly and negatively affect our ability to qualify for tax treatment as a RIC or the U.S. federal income tax
consequences to us and our stockholders of such qualification or could have other adverse consequences.
Stockholders are urged to consult with their tax advisor regarding tax legislative, regulatory, or administrative
developments and proposals and their potential effect on an investment in our securities.
We may not be able to pay our stockholders distributions, our distributions may not grow over time and a
portion of our distributions may be a return of capital.
We intend to pay distributions to our stockholders out of assets legally available for distribution. We cannot
assure you that we will achieve investment results that will allow us to make a specified level of cash
distributions or year-to-year increases in cash distributions. Our ability to pay distributions might be adversely
affected by, among other things, the impact of one or more of the risk factors described herein. In addition, the
inability to satisfy the asset coverage test applicable to us as a BDC can limit our ability to pay distributions. All
distributions will be paid at the discretion of our Board and will depend on our earnings, our financial condition,
maintenance of our RIC tax treatment, compliance with applicable BDC regulations and such other factors as our
Board may deem relevant from time to time. We cannot assure you that we will pay distributions to our
stockholders in the future. In the event we liquidate or dispose of a significant equity position in our portfolio, we
may distribute a special dividend relating to the realized capital gains from such investment in order to minimize
to the greatest extent possible our U.S. federal income or excise tax liability.
When we make distributions, we will be required to determine the extent to which such distributions are
paid out of current or accumulated earnings and profits. Distributions in excess of current and accumulated
earnings and profits will be treated as a non-taxable return of capital, which is a return of a portion of a
stockholder’s original investment in our common stock, to the extent of an investor’s basis in our stock and,
assuming that an investor holds our stock as a capital asset, thereafter as a capital gain. Generally, a non-taxable
return of capital will reduce an investor’s basis in our stock for U.S. federal income tax purposes, which will
result in higher tax liability when the stock is sold.
We may have difficulty paying our required distributions if we recognize income before or without receiving
cash representing such income.
For U.S. federal income tax purposes, we include in our taxable income certain amounts that we have not
yet received in cash, such as PIK interest or original issue discount, which may arise if we receive warrants in
connection with the origination of a loan or possibly in other circumstances. Such original issue discount or
increases in loan balances as a result of contractual PIK arrangements are included in our taxable income before
we receive any corresponding cash payments. We also may be required to include in our taxable income certain
other amounts that we will not receive in cash.
Since, in certain cases, we may recognize taxable income before or without receiving corresponding cash
payments, we may have difficulty meeting the annual distribution requirement necessary to maintain our RIC tax
treatment under the Code. Accordingly, to satisfy our RIC distribution requirements, we may have to sell some of
our investments at times and/or at prices we would not consider advantageous, raise additional debt or equity
capital or forgo new investment opportunities. If we are not able to obtain cash from other sources, we may fail to
qualify as a RIC for tax treatment under the Code and thus become subject to corporate-level U.S. federal income
tax.
Capitala Investment Advisors is not obligated to reimburse us for any part of the incentive fee it receives that is
based on accrued income that we never receive.
Part of the incentive fee payable by us to our Investment Advisor that relates to our net investment income is
computed and paid on income that may include interest that has been accrued but not yet received in cash, such
as market discount, debt instruments with PIK interest, preferred stock with PIK dividends and zero coupon
securities. If a portfolio company defaults on a loan that is structured to provide accrued interest, it is possible
that accrued interest previously used in the calculation of the incentive fee will become uncollectible. Our
Investment Advisor will not be under any obligation to reimburse us for any part of the
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incentive fees it received that was based on accrued income that we never receive as a result of a default by an
entity on the obligation that resulted in the accrual of such income.
We may in the future choose to pay dividends in our own stock, in which case you may be required to pay tax
in excess of the cash you receive.
We may distribute taxable dividends that are payable in part in our stock. In accordance with certain
applicable Treasury regulations and guidance issued by the IRS, a RIC may treat a distribution of its own stock as
fulfilling the RIC distribution requirements if each stockholder may elect to receive his or her entire distribution
in either cash or stock of the RIC, subject to a limitation that the aggregate amount of cash to be distributed to all
stockholders must be at least 20% of the aggregate declared distribution. If too many stockholders elect to receive
cash, the cash available for distribution must be allocated among the stockholders electing to receive cash (with
the balance of the distribution paid in stock). Any stockholder electing to receive cash will receive at least the
lesser of (a) the portion of the distribution such stockholder has elected to receive in cash or (b) an amount equal
to his or her entire distribution times the percentage limitation on cash available for distribution. If these and
certain other requirements are met, for U.S. federal income tax purposes, the amount of the dividend paid in stock
will be equal to the amount of cash that could have been received instead of stock. Taxable stockholders receiving
such dividends (whether received in cash, our stock, or a combination thereof) will be required to include the full
amount of the dividend as ordinary income (or as long-term capital gain to the extent such distribution is properly
reported as a capital gain dividend) to the extent of our current and accumulated earnings and profits for U.S.
federal income tax purposes. As a result, a U.S. stockholder may be required to pay tax with respect to such
dividends in excess of any cash received. If a U.S. stockholder sells the stock it receives as a dividend in order to
pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend,
depending on the market price of our stock at the time of the sale. Furthermore, with respect to non-U.S.
stockholders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all
or a portion of such dividend that is payable in stock. In addition, if a significant number of our stockholders
determine to sell shares of our stock in order to pay taxes owed on dividends, it may put downward pressure on
the trading price of our stock.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to
accurately report our financial results or prevent fraud. As a result, stockholders and noteholders could lose
confidence in our financial and other public reporting, which would harm our business.
Effective internal controls over financial reporting are necessary for us to provide reliable financial reports
and, together with adequate disclosure controls and procedures, are designed to prevent fraud. Any failure to
implement required new or improved controls, or difficulties encountered in their implementation could cause us
to fail to meet our reporting obligations. In addition, any testing by us conducted in connection with Section 404
of the Sarbanes-Oxley Act, or the subsequent testing by our independent registered public accounting firm (when
undertaken, as noted below), may reveal deficiencies in our internal controls over financial reporting that are
deemed to be material weaknesses or that may require prospective or retroactive changes to our consolidated
financial statements or identify other areas for further attention or improvement. Inferior internal controls could
also cause investors to lose confidence in our reported financial information, which could have a negative effect
on our business.
We are required to disclose changes made in our internal controls and procedures over financial reporting on
a quarterly basis and our management is required to assess the effectiveness of these controls annually. Our
independent registered public accounting firm is required to attest to the effectiveness of our internal controls
over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act.
An independent assessment of the effectiveness of our internal controls could detect problems that our
management’s assessment might not. Undetected material weaknesses in our internal controls could lead to
financial statement restatements and require us to incur the expense of remediation. As a public company, may
incur significant additional expenses in the near term, which may negatively impact our financial performance
and our ability to make distributions to our stockholders. This process also will result in a diversion of
management’s time and attention. We cannot be certain as to the timing of completion of any evaluation, testing
and remediation actions or the impact of the same on our operations, and we may not be able to ensure that the
process is effective or that our internal controls over financial reporting are or will be
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effective in a timely manner. In the event that we are unable to maintain or achieve compliance with Section 404
of the Sarbanes-Oxley Act and related rules, the market price of our common stock may be adversely affected.
Changes in laws or regulations governing our operations may adversely affect our business or cause us to
alter our business strategy.
We and our portfolio companies will be subject to applicable local, state and federal laws and regulations.
New legislation may be enacted, or new interpretations, rulings or regulations could be adopted, including those
governing the types of investments we are permitted to make, any of which could harm us and our stockholders,
potentially with retroactive effect. Additionally, any changes to the laws and regulations governing our operations
relating to permitted investments may cause us to alter our investment strategy in order to avail ourselves of new
or different opportunities. Such changes could result in material differences to the strategies and plans set forth
herein and may result in our investment focus shifting from the areas of expertise of our Investment Advisor’s
investment team to other types of investments in which the investment team may have less expertise or little or
no experience. Thus, any such changes, if they occur, could have a material adverse effect on our results of
operations and the value of your investment. In addition, any change to the SBA’s current debenture SBIC
program could have a significant impact on our ability to obtain lower-cost financing and, therefore, our
competitive advantage over other finance companies.
Over the last several years, there has been an increase in regulatory attention to the extension of credit
outside of the traditional banking sector, raising the possibility that some portion of the non-bank financial sector
will be subject to new regulation. While it cannot be known at this time whether these regulations will be
implemented or what form they will take, increased regulation of non-bank credit extension could negatively
impact our operations, cash flows or financial condition, impose additional costs on us, intensify the regulatory
supervision of us or otherwise adversely affect our business.
One of our wholly owned subsidiaries is licensed by the U.S. Small Business Administration, and as a result,
we are subject to SBA regulations.
Fund II and Fund III, became our wholly owned subsidiaries after the completion of the Formation
Transactions. Fund II was licensed to act as an SBIC and was regulated by the SBA until March 1, 2019, when
we prepaid all remaining SBIC debts related to Fund II and relinquished Fund II’s license to act as an SBIC.
Fund III is currently licensed to act as an SBIC and is regulated by the SBA. As of December 31, 2019, Fund III
portfolio companies accounted for 57.0% of the fair value of our aggregate portfolio. An SBIC license allows an
SBIC to borrow funds by issuing SBA-guaranteed debentures, subject to the issuance of a capital commitment by
the SBA and other customary procedures. The SBA regulations require, among other things, that a licensed SBIC
be examined periodically and audited by an independent auditor to determine the SBIC’s compliance with the
relevant SBA regulations.
Under current SBA regulations, a licensed SBIC may provide capital to those entities that have a tangible
net worth not exceeding $19.5 million and an average annual net income after U.S. federal income taxes not
exceeding $6.5 million for the two most recent fiscal years. In addition, a licensed SBIC must devote 25.0% of its
investment activity to those entities that have a tangible net worth not exceeding $6.0 million and an average
annual net income after U.S. federal income taxes not exceeding $2.0 million for the two most recent fiscal years.
The SBA regulations also provide alternative size standard criteria to determine eligibility, which depend on the
industry in which the business is engaged and are based on factors such as the number of employees and gross
sales. The SBA regulations permit licensed SBICs to make long term loans to small businesses, invest in the
equity securities of such businesses and provide them with consulting and advisory services. The SBA also places
certain limitations on the financing terms of investments by SBICs in portfolio companies and prohibits SBICs
from providing funds for certain purposes or to businesses in a few prohibited industries. Compliance with SBA
requirements may cause a Legacy Fund to forego attractive investment opportunities that are not permitted under
SBA regulations.
The SBA also prohibits, without prior SBA approval, a “change of control” of an SBIC or transfers that
would result in any person (or a group of persons acting in concert) owning 10.0% or more of a class of capital
stock of a licensed SBIC. Fund III was in compliance with the terms of the SBA’s leverage requirements as of
December 31, 2019 as a result of having sufficient capital as defined under the SBA regulations. If, in the future,
Fund III fails to comply with applicable SBA regulations, Fund III could, depending on the severity of
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the violation, limit or prohibit Fund III’s use of debentures, declare outstanding debentures immediately due and
payable, and/or limit Fund III from making new investments. Such actions by Fund III would, in turn, negatively
affect us because Fund III is our wholly owned subsidiary.
On June 10, 2014, we received an exemptive order from the SEC exempting us, Fund II and Fund III from
certain provisions of the 1940 Act (including an exemptive order granting relief from the asset coverage
requirements for certain indebtedness issued by Fund II and Fund III as SBICs) and from certain reporting
requirements mandated by the 1934 Act with respect to Fund II and Fund III. We intend to comply with the
conditions of the order. As a result, we will generally be permitted to incur a greater amount of leverage relative
to our total assets and net asset value, which may expose us to a greater degree of risk.
Our wholly owned SBIC subsidiaries may be unable to make distributions to us that will enable us to meet or
maintain RIC tax treatment, which could result in the imposition of a corporate-level U.S. federal income tax.
In order for us to continue to qualify for RIC tax treatment under the Code and to minimize corporate-level
U.S. federal income taxes, we will be required to distribute substantially all of our net ordinary income and net
capital gain income, including income from certain of our subsidiaries, which includes the income from our SBIC
subsidiaries. We will be partially dependent on our SBIC subsidiaries for cash distributions to enable us to meet
the RIC distribution requirements. Our SBIC subsidiaries may be limited by the Small Business Investment Act
of 1958, and SBA regulations governing SBICs, from making certain distributions to us that may be necessary to
maintain our tax treatment as a RIC. We may have to request a waiver of the SBA’s restrictions for our SBIC
subsidiaries to make certain distributions to maintain our RIC tax treatment. We cannot assure you that the SBA
will grant such waiver and if our SBIC subsidiaries are unable to obtain a waiver, compliance with the SBA
regulations may result in loss of RIC tax treatment and a consequent imposition of a corporate-level U.S. federal
income tax on all of our income.
Our business is subject to increasingly complex corporate governance, public disclosure and accounting
requirements that are costly and could adversely affect our business and financial results.
As a publicly traded company, we incur legal, accounting and other expenses, including costs associated
with the periodic reporting requirements applicable to a company whose securities are registered under the 1934
Act, or the Exchange Act, as well as additional corporate governance requirements, including requirements under
the Sarbanes Oxley Act, and other rules implemented by the SEC. Also, 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. Our efforts to comply with these existing requirements, or any revised or amended
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.
We are highly dependent on information systems and systems failures could significantly disrupt our business,
which may, in turn, negatively affect the market price of our common stock and our ability to make
distributions to our stockholders.
Our business is highly dependent on the communications and information systems of the Investment
Advisor. Certain of these systems are provided to the Investment Advisor by third-party service providers. Any
failure or interruption of such systems, including as a result of the termination of an agreement with any such
third-party service provider, sudden electrical or telecommunications outages, natural disasters such as
earthquakes, tornadoes, and hurricanes, events arising from local or larger scale political or social matters,
including terrorist attacks, and cyber-attacks could cause delays or other problems in our activities. Any of the
above, in turn, could have a material adverse effect on our operating results and negatively affect the market price
of our common stock and our ability to make distributions to our stockholders.
Internal and external cyber threats, as well as other disasters, could impair our ability to conduct business
effectively.
The occurrence of a disaster, such as a cyber-attack against us or against a third-party that has access to our
data or networks, a natural catastrophe, an industrial accident, failure of our disaster recovery systems, or
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consequential employee error, could have an adverse effect on our ability to communicate or conduct business,
negatively impacting our operations and financial condition. This adverse effect can become particularly acute if
those events affect our electronic data processing, transmission, storage, and retrieval systems, or impact the
availability, integrity, or confidentiality of our data.
We depend heavily upon computer systems to perform necessary business functions. Despite our
implementation of a variety of security measures, our computer systems, networks, and data, like those of other
companies, could be subject to cyber-attacks and unauthorized access, use, alteration, or destruction, such as from
physical and electronic break-ins or unauthorized tampering. If one or more of these events occurs, it could
potentially jeopardize the confidential, proprietary, and other information processed, stored in, and transmitted
through our computer systems and networks. Such an attack could cause interruptions or malfunctions in our
operations, which could result in financial losses, litigation, regulatory penalties, client dissatisfaction or loss,
reputational damage, and increased costs associated with mitigation of damages and remediation. If unauthorized
parties gain access to such information and technology systems, they may be able to steal, publish, delete or
modify private and sensitive information, including nonpublic personal information related to stockholders (and
their beneficial owners) and material nonpublic information. The systems we have implemented to manage risks
relating to these types of events could prove to be inadequate and, if compromised, could become inoperable for
extended periods of time, cease to function properly or fail to adequately secure private information. Breaches
such as those involving covertly introduced malware, impersonation of authorized users and industrial or other
espionage may not be identified even with sophisticated prevention and detection systems, potentially resulting in
further harm and preventing them from being addressed appropriately. The failure of these systems or of disaster
recovery plans for any reason could cause significant interruptions in our and our Investment Advisor’s
operations and result in a failure to maintain the security, confidentiality or privacy of sensitive data, including
personal information relating to stockholders, material nonpublic information and other sensitive information in
our possession.
A disaster or a disruption in the infrastructure that supports our business, including a disruption involving
electronic communications or other services used by us or third parties with whom we conduct business, or
directly affecting our headquarters, could have a material adverse impact on our ability to continue to operate our
business without interruption. Our disaster recovery programs may not be sufficient to mitigate the harm that may
result from such a disaster or disruption. In addition, insurance and other safeguards might only partially
reimburse us for our losses, if at all.
Third parties with which we do business may also be sources of cybersecurity or other technological risk.
We outsource certain functions and these relationships allow for the storage and processing of our information, as
well as client, counterparty, employee, and borrower information. While we engage in actions to reduce our
exposure resulting from outsourcing, ongoing threats may result in unauthorized access, loss, exposure,
destruction, or other cybersecurity incident that affects our data, resulting in increased costs and other
consequences as described above.
In addition, cybersecurity has become a top priority for regulators around the world, and some jurisdictions
have enacted laws requiring companies to notify individuals of data security breaches involving certain types of
personal data. If we fail to comply with the relevant laws and regulations, we could suffer financial losses, a
disruption of our businesses, liability to investors, regulatory intervention or reputational damage.
Economic sanction laws in the United States and other jurisdictions may prohibit us and our affiliates from
transacting with certain countries, individuals and companies.
Economic sanction laws in the United States and other jurisdictions may prohibit us or our affiliates from
transacting with certain countries, individuals and companies. In the United States, the U.S. Department of the
Treasury’s Office of Foreign Assets Control administers and enforces laws, executive orders and regulations
establishing U.S. economic and trade sanctions, which prohibit, among other things, transactions with, and the
provision of services to, certain non-U.S. countries, territories, entities and individuals. These types of sanctions
may significantly restrict or completely prohibit investment activities in certain jurisdictions, and if we, our
portfolio companies or other issuers in which we invest were to violate any such laws or regulations, we may face
significant legal and monetary penalties.
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The Foreign Corrupt Practices Act, or FCPA, and other anti-corruption laws and regulations, as well as anti-
boycott regulations, may also apply to and restrict our activities, our portfolio companies and other issuers of our
investments. If an issuer or we were to violate any such laws or regulations, such issuer or we may face
significant legal and monetary penalties. The U.S. government has indicated that it is particularly focused on
FCPA enforcement, which may increase the risk that an issuer or us becomes the subject of such actual or
threatened enforcement. In addition, certain commentators have suggested that private investment firms and the
funds that they manage may face increased scrutiny and/or liability with respect to the activities of their
underlying portfolio companies. As such, a violation of the FCPA or other applicable regulations by us or an
issuer of our portfolio investments could have a material adverse effect on us. We are committed to complying
with the FCPA and other anti-corruption laws and regulations, as well as anti-boycott regulations, to which it is
subject. As a result, we may be adversely affected because of our unwillingness to enter into transactions that
violate any such laws or regulations.
Terrorist attacks, acts of war or natural disasters may affect the market for our common stock, impact the
businesses in which we invest and harm our business, operating results and financial condition.
Terrorist acts, acts of war or natural disasters may disrupt our operations, as well as the operations of the
businesses in which we invest. Such acts have created, and continue to create, economic and political
uncertainties and have contributed to global economic instability. Future terrorist activities, military or security
operations, or natural disasters could further weaken the domestic/global economies and create additional
uncertainties, which may negatively impact the businesses in which we invest directly or indirectly and, in turn,
could have a material adverse impact on our business, operating results and financial condition. Losses from
terrorist attacks and natural disasters are generally uninsurable.
To the extent original issue discount and PIK interest constitute a portion of our income, we will be exposed to
typical risks associated with such income being required to be included in taxable and accounting income
prior to receipt of cash representing such income.
Our investments may include original issue discount (“OID”) instruments and contractual PIK interest,
which represents contractual interest added to a loan balance and due at the end of such loan’s term. To the extent
OID or PIK interest constitute a portion of our income, we are exposed to typical risks associated with such
income being required to be included in taxable and accounting income prior to receipt of cash, including the
following:
•
•
•
OID instruments may have higher yields, which reflect the payment deferral and credit risk associated
with these instruments;
OID accruals may create uncertainty about the source of our distributions to stockholders;
OID and PIK instruments may have unreliable valuations because their continuing accruals require
continuing judgments about the collectability of the deferred payments and the value of the collateral; and
•
OID and PIK instruments may represent a higher credit risk than coupon loans.
If we cannot obtain additional capital because of either regulatory or market price constraints, we could be
forced to curtail or cease our new lending and investment activities, our net asset value could decrease and our
level of distributions and liquidity could be affected adversely.
Our ability to secure additional financing and satisfy our financial obligations under indebtedness
outstanding from time to time will depend upon our future operating performance, which is subject to the
prevailing general economic and credit market conditions, including interest rate levels and the availability of
credit generally, and financial, business and other factors, many of which are beyond our control. The prolonged
continuation or worsening of current economic and capital market conditions could have a material adverse effect
on our ability to secure financing on favorable terms, if at all.
If we are unable to obtain additional 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.
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Our Board is authorized to reclassify any unissued shares of common stock into one or more classes of
preferred stock, which could convey special rights and privileges to its owners.
Under Maryland General Corporation Law and our charter, our Board is authorized to classify and reclassify
any authorized but unissued shares of stock into one or more classes of stock, including preferred stock. Prior to
the issuance of shares of each class or series, our Board will be required by Maryland law and our charter to set
the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other
distributions, qualifications and terms or conditions of redemption for each class or series. Thus, our Board could
authorize the issuance of shares of preferred stock with terms and conditions that could have the effect of
delaying, deferring or preventing a transaction or a change in control that might involve a premium price for
holders of our common stock or otherwise be in their best interest. The cost of any such reclassification would be
borne by our common stockholders. Certain matters under the 1940 Act require the separate vote of the holders
of any issued and outstanding preferred stock. For example, holders of preferred stock would vote separately
from the holders of common stock on a proposal to cease operations as a BDC. In addition, the 1940 Act provides
that holders of preferred stock are entitled to vote separately from holders of common stock to elect two preferred
stock directors. We currently have no plans to issue preferred stock. The issuance of preferred shares convertible
into shares of common stock may also reduce the net income and net asset value per share of our common stock
upon conversion, provided, that we will only be permitted to issue such convertible preferred stock to the extent
we comply with the requirements of Section 61 of the 1940 Act, including obtaining common stockholder
approval. These effects, among others, could have an adverse effect on your investment in our common stock.
Provisions of the Maryland General Corporation Law and of our charter and bylaws could deter takeover
attempts and have an adverse impact on the price of our common stock.
The Maryland General Corporation Law and our charter and bylaws contain provisions that may discourage,
delay or make more difficult a change in control of Capitala Finance or the removal of our directors. We are
subject to the Maryland Business Combination Act, subject to any applicable requirements of the 1940 Act. Our
Board has adopted a resolution exempting from the Maryland Business Combination Act any business
combination between us and any other person, subject to prior approval of such business combination by our
Board, including approval by a majority of our independent directors. If the resolution exempting business
combinations is repealed or our Board does not approve a business combination, the Maryland Business
Combination Act may discourage third parties from trying to acquire control of us and increase the difficulty of
consummating such an offer. Our bylaws exempt from the Maryland Control Share Acquisition Act acquisitions
of our stock by any person. If we amend our bylaws to repeal the exemption from the Maryland Control Share
Acquisition Act, the Maryland Control Share Acquisition Act also may make it more difficult for a third-party to
obtain control of us and increase the difficulty of consummating such a transaction. It is the position of the staff
of the SEC’s Division of Investment Management that if a BDC fails to opt-out of the Maryland Control Share
Acquisition Act, it acts in a manner inconsistent with Section 18(i) of the 1940 Act.
We have also adopted measures that may make it difficult for a third-party to obtain control of us, including
provisions of our charter classifying our Board in three classes serving staggered three-year terms, and
authorizing our Board to classify or reclassify shares of our stock in one or more classes or series, to cause the
issuance of additional shares of our stock, to amend our charter without stockholder approval and to increase or
decrease the number of shares of stock that we have authority to issue. These provisions, as well as other
provisions of our charter and bylaws, may delay, defer or prevent a transaction or a change in control that might
otherwise be in the best interests of our stockholders.
The foregoing provisions are expected to discourage certain coercive takeover practices and inadequate
takeover bids and to encourage persons seeking to acquire control of us to negotiate first with our Board.
However, these provisions may deprive a stockholder of the opportunity to sell such stockholder’s shares at a
premium to a potential acquirer. We believe that the benefits of these provisions outweigh the potential
disadvantages of discouraging any such acquisition proposals because, among other things, the negotiation of
such proposals may improve their terms. Our Board has considered both the positive and negative effects of the
foregoing provisions and determined that they are in the best interest of our stockholders.
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Risks Related to Our Investments
Our investments are very risky and highly speculative.
We invest primarily in first lien loans, second lien loans, subordinated debt investments and select equity
investments issued by leveraged companies, each of which carries with it a significant degree of risk.
First Lien Loans. There is a risk that the collateral securing our loans may decrease in value over time,
may be difficult to sell in a timely manner, may be difficult to appraise and may fluctuate in value based upon the
success of the business and market conditions, including as a result of the inability of the portfolio company to
raise additional capital, and, in some circumstances, our lien could be subordinated to claims of other creditors. In
addition, deterioration in a portfolio company’s financial condition and prospects, including its inability to raise
additional capital, may be accompanied by deterioration in the value of the collateral for the loan. Consequently,
the fact that a loan is secured does not guarantee that we will receive principal and interest payments according to
the loan’s terms, or at all, or that we will be able to collect on the loan should we be forced to enforce our
remedies. Our first lien loans may also include unitranche loans. Unitranche loans combine characteristics of
traditional first lien senior secured loans as well as second lien and subordinated loans. Unitranche loans will
expose us to the risks associated with second lien and subordinated loans to the extent we invest in the “last out”
tranche. These first lien loans and bonds may include payment-in-kind (“PIK”) interest, which represents
contractual interest accrued and added to the principal that generally becomes due at maturity.
Second Lien Loans. Our second lien loans have a second priority security interest in all or substantially all
of the assets of the borrower. As such, other creditors may rank senior to us in the event of an insolvency, which
could likely in many cases result in a substantial or complete loss on such investment in the case of such
insolvency. This may result in an above average amount of risk and loss of principal.
Subordinated Loans. Our subordinated loans are generally subordinated to first lien loans and may be
unsecured. As such, other creditors may rank senior to us in the event of an insolvency, which could likely in
many cases result in a substantial or complete loss on such investment in the case of such insolvency. This may
result in an above average amount of risk and loss of principal.
Equity Investments. When we invest in loans, we may acquire equity securities as well. In addition, we
may invest directly in the equity securities of portfolio companies.
The equity interests we receive may not appreciate in value and, in fact, may decline in value. Accordingly,
we may not be able to realize gains from our equity interests, and any gains that we do realize on the disposition
of any equity interests may not be sufficient to offset any other losses we experience. The portfolio currently has
several significant equity positions. Distributions, dispositions, or liquidity events of these investments may affect
our results of operations and cause us to have to pay a special dividend relating to the realized gains from such
investment in order to minimize to the greatest extent possible our U.S. federal income or excise tax liability.
In addition, investing in lower and traditional middle-market companies involves a number of significant
risks, including:
•
•
•
•
these companies may have limited financial resources and may be unable to meet their obligations under
their debt securities that we hold, which may be accompanied by a deterioration in the value of any
collateral and a reduction in the likelihood of us realizing any guarantees we may have obtained in
connection with our investment;
they typically have shorter operating histories, narrower product lines and smaller market shares than
larger businesses, which tend to render them more vulnerable to competitors’ actions and market
conditions, as well as general economic downturns;
they are more likely to depend on the management talents and efforts of a small group of persons;
therefore, the death, disability, resignation or termination of one or more of these persons could have a
material adverse impact on our portfolio company and, in turn, on us;
they generally have less predictable operating results, may from time to time be parties to litigation, may
be engaged in rapidly changing businesses with products subject to a substantial risk of
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obsolescence, and may require substantial additional capital to support their operations, finance expansion
or maintain their competitive position;
they may have difficulty accessing the capital markets to meet future capital needs, which may limit their
ability to grow or to repay their outstanding indebtedness upon maturity; and
our executive officers, directors and our Investment Advisor may, in the ordinary course of business, be
named as defendants in litigation arising from our investments in the portfolio companies.
•
•
An investment strategy focused primarily on smaller privately held companies involves a high degree of risk
and presents certain challenges, including the lack of available information about these companies, a
dependence on the talents and efforts of only a few key portfolio company personnel and a greater
vulnerability to economic downturns.
Our portfolio consists primarily of debt and equity investments in smaller privately owned venture capital-
backed companies. Investing in venture capital-backed companies involves a number of significant risks.
Typically, the debt in which we will invest is not initially rated by any rating agency; however, we believe that if
such investments were rated, they would be rated below investment grade. Below investment grade securities,
which are often referred to as “high yield” or “junk,” have predominantly speculative characteristics with respect
to the issuer’s capacity to pay interest and repay principal. Compared to larger publicly owned companies, these
venture capital-backed companies may be in a weaker financial position and experience wider variations in their
operating results, which may make them more vulnerable to economic downturns. Typically, these companies
need more capital to compete; however, their access to capital is limited and their cost of capital is often higher
than that of their competitors. Our portfolio companies often face intense competition from larger companies with
greater financial, technical and marketing resources and their success typically depends on the managerial talents
and efforts of an individual or a small group of persons. Therefore, any loss of its key employees could affect a
portfolio company’s ability to compete effectively and harm its financial condition. Further, some of these
companies conduct business in regulated industries that are susceptible to regulatory changes. These factors could
impair the cash flow of our portfolio companies and result in other events, such as bankruptcy. These events
could limit a portfolio company’s ability to repay its obligations to us, which may have an adverse effect on the
return on, or the recovery of, our investment in these businesses. Deterioration in a borrower’s financial condition
and prospects may be accompanied by deterioration in the value of the loan’s collateral.
Generally, little public information exists about these companies, and we are required to rely on the ability of
our Investment Advisor’s investment team to obtain adequate information to evaluate the potential returns from
investing in these companies. If we are unable to uncover all material information about these companies, we
may not make a fully informed investment decision, and we may lose money on our investments. Also, privately
held companies frequently have less diverse product lines and smaller market presence than larger competitors.
These factors could adversely affect our investment returns as compared to companies investing primarily in the
securities of public companies.
Many of our loans are not fully amortizing and if a borrower cannot repay or refinance such loans at
maturity, our results will suffer.
Most of the loans in which we invest are not structured to fully amortize during their lifetime. Accordingly, a
significant portion of the principal amount of such a loan may be due at maturity. As of December 31, 2019, all
debt instruments in our portfolio, on a fair value basis, will not fully amortize prior to maturity. In order to create
liquidity to pay the final principal payment, borrowers typically must raise additional capital. If they are unable to
raise sufficient funds to repay us or we have not elected to enter into a new loan agreement providing for an
extended maturity, the loan will go into default, which will require us to foreclose on the borrower’s assets, even
if the loan was otherwise performing prior to maturity. This will deprive Capitala Finance from immediately
obtaining full recovery on the loan and prevent or delay the reinvestment of the loan proceeds in other, more
profitable investments.
Our investments in leveraged portfolio companies may be risky, and you could lose all or part of your
investment.
Investment in leveraged companies involves a number of significant risks. Leveraged companies in which
we invest may have limited financial resources and may be unable to meet their obligations under their loans
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and debt securities that we hold. Such developments may be accompanied by a deterioration in the value of any
collateral and a reduction in the likelihood of our realizing any guarantees that we may have obtained in
connection with our investment. Smaller leveraged companies also may have less predictable operating results
and may require substantial additional capital to support their operations, finance their expansion or maintain
their competitive position.
Our portfolio companies may incur debt that ranks equally with, or senior to, our investments in such
companies.
Our portfolio companies may have, or may be permitted to incur, other debt that ranks equally with, or in
some cases senior to, the debt in which we invest. By their terms, such debt instruments may entitle the holders to
receive payment of interest or principal on or before the dates on which we are entitled to receive payments with
respect to the debt instruments in which we invest. Also, in the event of insolvency, liquidation, dissolution,
reorganization or bankruptcy of a portfolio company, holders of debt instruments ranking senior to our
investment in that portfolio company would typically be entitled to receive payment in full before we receive any
distribution. After repaying such senior creditors, such portfolio company may not have sufficient remaining
assets to repay its obligation to us. In the case of debt ranking equally with debt instruments in which we invest,
we would have to share on an equal basis any distributions with other creditors holding such debt in the event of
an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company.
Second priority liens on collateral securing loans that we make to our portfolio companies may be subject to
control by senior creditors with first priority liens. If there is a default, the value of the collateral may not be
sufficient to repay in full both the first priority creditors and us.
Certain loans that we make are secured by a second priority security interest in the same collateral pledged
by a portfolio company to secure senior debt owed by the portfolio company to commercial banks or other
traditional lenders. Often the senior lender has procured covenants from the portfolio company prohibiting the
incurrence of additional secured debt without the senior lender’s consent. Prior to and as a condition of permitting
the portfolio company to borrow money from us secured by the same collateral pledged to the senior lender, the
senior lender may require assurances that it will control the disposition of any collateral in the event of
bankruptcy or other default. In many such cases, the senior lender requires us to enter into an “intercreditor
agreement” prior to permitting the portfolio company to borrow from us. Typically the intercreditor agreements
we are requested to execute expressly subordinate our debt instruments to those held by the senior lender and
further provide that the senior lender shall control: (i) the commencement of foreclosure or other proceedings to
liquidate and collect on the collateral; (ii) the nature, timing and conduct of foreclosure or other collection
proceedings; (iii) the amendment of any collateral document; (iv) the release of the security interests in respect of
any collateral; and (v) the waiver of defaults under any security agreement. Because of the control we may cede
to senior lenders under intercreditor agreements we may enter, we may be unable to realize the proceeds of any
collateral securing some of our loans.
If we make subordinated investments, the obligors or the portfolio companies may not generate sufficient cash
flow to service their debt obligations to us.
We have made, and may make, subordinated investments that rank below other obligations of the obligor in
right of payment. Subordinated investments are subject to greater risk of default than senior obligations as a result
of adverse changes in the financial condition of the obligor or economic conditions in general. If we make a
subordinated investment in a portfolio company, the portfolio company may be highly leveraged, and its
relatively high debt-to-equity ratio may create increased risks that its operations might not generate sufficient
cash flow to service all of its debt obligations.
The disposition of our investments may result in contingent liabilities.
Substantially all of our investments involve loans and private securities. In connection with the disposition
of an investment in loans and 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 to the extent that any such representations
turn out to be inaccurate or with respect to potential liabilities. These arrangements may result
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in contingent liabilities that ultimately result in funding obligations that we must satisfy through our return of
distributions previously made to us.
There may be circumstances where our debt investments could be subordinated to claims of other creditors or
we could be subject to lender liability claims.
Even though we may have structured most of our investments as secured loans, if one of our portfolio
companies were to go bankrupt, depending on the facts and circumstances, and based upon principles of equitable
subordination as defined by existing case law, a bankruptcy court could subordinate all or a portion of our claim
to that of other creditors and transfer any lien securing such subordinated claim to the bankruptcy estate. The
principles of equitable subordination defined by case law have generally indicated that a claim may be
subordinated only if its holder is guilty of misconduct or where the senior loan is re-characterized as an equity
investment and the senior lender has actually provided significant managerial assistance to the bankrupt debtor.
We may also be subject to lender liability claims for actions taken by us with respect to a borrower’s business or
instances where we exercise control over the borrower. It is possible that we could become subject to a lender’s
liability claim, including as a result of actions taken in rendering significant managerial assistance or actions to
compel and collect payments from the borrower outside the ordinary course of business. Such risk of equitable
subordination may be potentially heightened with respect to various portfolio investments that we may be
deemed to control. See also “— Because we will not hold controlling equity interests in most of our portfolio
companies, we may not be in a position to exercise control over our portfolio companies or to prevent decisions
by management of our portfolio companies that could decrease the value of our investments.”
Economic recessions could impair our portfolio companies and harm our operating results.
Certain of our portfolio companies may be susceptible to an economic downturn and may be unable to repay
our loans during this period. Therefore, assets may become non-performing and the value of our portfolio may
decrease during this period. The adverse economic conditions also may decrease the value of collateral securing
some of our loans and the value of our equity investments. A recession could lead to financial losses in our
portfolio and a decrease in our revenues, net income and the value of our assets.
Adverse economic conditions also may decrease the value of collateral securing some of our loans and the
value of our equity investments at fair value. Unfavorable economic conditions also could increase our funding
costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These
events could prevent us from increasing investments and harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders
could lead to defaults and, potentially, acceleration of the time when the loans are due and foreclosure on its
secured assets, which could trigger cross-defaults under other agreements and jeopardize the portfolio company’s
ability to meet its obligations under the debt that we hold. We may incur additional expenses to the extent
necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company. In
addition, if one of our portfolio companies were to go bankrupt, depending on the facts and circumstances,
including the extent to which we actually provided significant managerial assistance to that portfolio company, a
bankruptcy court might re-characterize our debt holdings and subordinate all or a portion of our claim to that of
other creditors.
These portfolio companies may face intense competition, including competition from companies with
greater financial resources, more extensive research and development, manufacturing, marketing and service
capabilities and greater number of qualified and experienced managerial and technical personnel. They may need
additional financing which they are unable to secure and which we are unable or unwilling to provide, or they
may be subject to adverse developments unrelated to the technologies they acquire.
The health and performance of our portfolio companies could be adversely affected by political and economic
conditions in the countries in which they conduct business.
Some of the products of our portfolio companies are developed, manufactured, assembled, tested or
marketed outside the U.S. Any conflict or uncertainty in these countries, including due to natural disasters, public
health concerns, political unrest or safety concerns, could harm their business, financial condition and
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results of operations. In addition, if the government of any country in which their products are developed,
manufactured or sold sets technical or regulatory standards for products developed or manufactured in or
imported into their country that are not widely shared, it may lead some of their customers to suspend imports of
their products into that country, require manufacturers or developers in that country to manufacture or develop
products with different technical or regulatory standards and disrupt cross-border manufacturing, marketing or
business relationships which, in each case, could harm their businesses.
The lack of liquidity in our investments may adversely affect our business.
We generally invest in companies whose securities are not publicly traded, and whose securities will be
subject to legal and other restrictions on resale or will otherwise be less liquid than publicly traded securities.
There is no established trading market for the securities in which we invest. The illiquidity of these investments
may make it difficult for us to sell these investments when desired. In addition, if we are required to liquidate all
or a portion of our portfolio quickly, we may realize significantly less than the value at which we had previously
recorded these investments. As a result, we do not expect to achieve liquidity in our investments in the near-term.
Further, we may face other restrictions on our ability to liquidate an investment in a portfolio company to the
extent that we have material non-public information regarding such portfolio company.
Our failure to make follow-on investments in our portfolio companies could impair the value of our portfolio.
Following an initial investment in a portfolio company, we may make additional investments in that
portfolio company as “follow-on” investments, in order to: (i) increase or maintain in whole or in part our equity
ownership percentage; (ii) exercise warrants, options or convertible securities that were acquired in the original or
a subsequent financing; or (iii) attempt to preserve or enhance the value of our investment. We may elect not to
make follow-on investments or otherwise lack sufficient funds to make those investments. We will have the
discretion to make any follow-on investments, subject to the availability of capital resources. The failure to make
follow-on investments may, in some circumstances, jeopardize the continued viability of a portfolio company and
our initial investment, or may result in a missed opportunity for us to increase our participation in a successful
operation. Even if we have sufficient capital to make a desired follow-on investment, we may elect not to make a
follow-on investment because we do not want to increase our concentration of risk, we prefer other opportunities,
we are subject to BDC requirements that would prevent such follow-on investments, or the follow-on investment
would affect our qualification as a RIC. For example, we may be prohibited under the 1940 Act from making
follow-on investments in our portfolio companies that we may be deemed to “control” or in which affiliates of
our Investment Advisor are also invested.
Our ability to enter into new transactions with our affiliates, and to restructure or exit our investments in
portfolio companies that we are deemed to “control” under the 1940 Act, will be restricted by the 1940 Act,
which may limit the scope of investment opportunities available to us.
We are prohibited under the 1940 Act from participating in certain transactions with our affiliates without
the prior approval of our independent directors and, in some cases, the SEC. Any person that owns, directly or
indirectly, 5% or more of our outstanding voting securities will be our affiliate for purposes of the 1940 Act and
we are generally prohibited from buying or selling any security from or to such affiliate without the prior
approval of our independent directors. The 1940 Act also prohibits certain “joint” transactions with certain of our
affiliates, which could include concurrent investments in the same company, without prior approval of our
independent directors and, in some cases, the SEC. We are prohibited from buying or selling any security from or
to any person that controls us or who owns more than 25% of our voting securities or certain of that person’s
affiliates, or entering into prohibited joint transactions with such persons, absent the prior approval of the SEC.
As a result of these restrictions, we may be prohibited from buying or selling any security (other than any security
of which we are the issuer) from or to any company that is advised or managed by our Investment Advisor or its
affiliates without the prior approval of the SEC, which may limit the scope of investment opportunities that
would otherwise be available to us.
In the future, we may co-invest with investment funds, accounts and vehicles managed by our Investment
Advisor or its affiliates when doing so is consistent with our investment strategy as well as applicable law and
SEC staff interpretations. We generally will only be permitted to co-invest with such investment funds, accounts
and vehicles where the only term that is negotiated is price. On June 1, 2016, the SEC issued the
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Order. Subject to satisfaction of certain conditions to the Order, we and certain of our affiliates are now
permitted, together with any future BDCs, registered closed-end funds and certain private funds, each of whose
investment adviser is our investment adviser or an investment adviser controlling, controlled by, or under
common control with our investment adviser, to co-invest in negotiated investment opportunities where doing so
would otherwise be prohibited under the 1940 Act, providing our stockholders with access to a broader array of
investment opportunities. Pursuant to the Order, we are permitted to co-invest in such investment opportunities
with our affiliates if a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent
directors make certain conclusions in connection with a co-investment transaction, including, but not limited to,
that (1) the terms of the potential co-investment transaction, including the consideration to be paid, are reasonable
and fair to us and our stockholders and do not involve overreaching in respect of us or our stockholders on the
part of any person concerned, and (2) the potential co-investment transaction is consistent with the interests of
our stockholders and is consistent with our then-current investment objective and strategies.
In addition, within our portfolio there are investments that may be deemed to be “controlled” investments
under the 1940 Act. To the extent that our investments in such portfolio companies need to be restructured or that
we choose to exit these investments in the future, our ability to do so may be limited if such restructuring or exit
also involves the affiliates of our Investment Advisor because such a transaction could be considered a joint
transaction prohibited by the 1940 Act in the absence of our receipt of relief from the SEC in connection with
such transaction. For example, if an affiliate of our Investment Advisor were required to approve a restructuring
of an investment in the portfolio and the affiliate of our Investment Advisor was deemed to be our affiliate, such a
restructuring transaction may constitute a prohibited joint transaction under the 1940 Act.
Our portfolio may lack diversification among portfolio companies, which may subject us to a risk of
significant loss if one or more of these companies defaults on its obligations under any of its debt instruments.
Our portfolio may be concentrated in a limited number of portfolio companies. Beyond the asset
diversification requirements associated with our RIC tax treatment under the Code, we do not have fixed
guidelines for diversification, and our investments may be concentrated in relatively few companies. As our
portfolio is less diversified than the portfolios of some larger funds, we are more susceptible to failure if a single
loan fails. The disposition or liquidity of a significant investment may also adversely impact our net asset value
and our results of operations. Similarly, the aggregate returns we realize may be significantly adversely affected if
a small number of investments perform poorly or if we need to write down the value of any one investment.
We are a non-diversified investment company within the meaning of the 1940 Act, and therefore we are not
limited with respect to the proportion of our assets that may be invested in securities of a single issuer.
We are classified as a non-diversified investment company within the meaning of the 1940 Act, which
means that we are not limited by the 1940 Act with respect to the proportion of our assets that we may invest in
securities of a single issuer. Beyond the asset diversification requirements associated with our RIC tax treatment
under the Code, we do not have fixed guidelines for diversification. To the extent that we assume large positions
in the securities of a small number of issuers or our investments are concentrated in relatively few industries, our
net asset value may fluctuate to a greater extent than that of a diversified investment company as a result of
changes in the financial condition or the market’s assessment of the issuer. We may also be more susceptible to
any single economic or regulatory occurrence than a diversified investment company.
Our portfolio may be concentrated in a limited number of industries, which may subject us to a risk of
significant loss if there is a downturn in a particular industry in which a number of our investments are
concentrated.
Our portfolio may be concentrated in a limited number of industries. A downturn in any particular industry
in which we are invested could significantly impact the aggregate returns we realize. If an industry in which we
have significant investments suffers from adverse business or economic conditions, as these industries have to
varying degrees, a material portion of our investment portfolio could be affected adversely, which, in turn, could
adversely affect our financial position and results of operations.
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Because we will not hold controlling equity interests in most of our portfolio companies, we may not be in a
position to exercise control over our portfolio companies or to prevent decisions by management of our
portfolio companies that could decrease the value of our investments.
We currently hold controlling equity positions in two portfolio companies. Although we may do so in the
future, we expect that we will not hold controlling equity positions in most of our portfolio companies. If we do
not hold a controlling equity position in a portfolio company, we are subject to the risk that the portfolio company
may make business decisions with which we disagree, and that the management and/or stockholders of the
portfolio company may take risks or otherwise act in ways that are adverse to our interests. Due to the lack of
liquidity of the debt and equity investments that we typically hold in our portfolio companies, we may not be able
to dispose of our investments in the event we disagree with the actions of a portfolio company and may therefore
suffer a decrease in the value of our investments.
Our equity ownership in a portfolio company may represent a control investment. Our ability to exit a control
investment in a timely manner could result in a realized loss on the investment.
We currently have, and may acquire in the future, control investments in portfolio companies. Our ability to
divest ourselves from a debt or equity investment in a controlled portfolio company could be restricted due to
illiquidity in a private stock, limited trading volume on a public company’s stock, inside information on a
company’s performance, insider blackout periods, or other factors that could prohibit us from disposing of the
investment as we would if it were not a control investment. Additionally, we may choose not to take certain
actions to protect a debt investment in a control investment portfolio company. As a result, we could experience a
decrease in the value of our portfolio company holdings and potentially incur a realized loss on the investment.
If the assets securing the loans that we make decrease in value, then we may lack sufficient collateral to cover
losses.
To attempt to mitigate credit risks, we will typically take a security interest in the available assets of our
portfolio companies. There is no assurance that we will obtain or properly perfect our liens.
There is a risk that the collateral securing our loans may decrease in value over time, may be difficult to sell
in a timely manner, may be difficult to appraise and may fluctuate in value based upon the success of the business
and market conditions, including as a result of the inability of a portfolio company to raise additional capital. In
some circumstances, our lien could be subordinated to claims of other creditors. Consequently, the fact that a loan
is secured does not guarantee that we will receive principal and interest payments according to the loan’s terms,
or that we will be able to collect on the loan should we be forced to enforce our remedies.
In addition, because we may invest in technology-related companies, a substantial portion of the assets
securing our investment may be in the form of intellectual property, if any, inventory and equipment and, to a
lesser extent, cash and accounts receivable. Intellectual property, if any, that is securing our loan could lose value
if, among other things, the company’s rights to the intellectual property are challenged or if the company’s license
to the intellectual property is revoked or expires, the technology fails to achieve its intended results or a new
technology makes the intellectual property functionally obsolete. Inventory may not be adequate to secure our
loan if our valuation of the inventory at the time that we made the loan was not accurate or if there is a reduction
in the demand for the inventory.
Similarly, any equipment securing our loan may not provide us with the anticipated security if there are
changes in technology or advances in new equipment that render the particular equipment obsolete or of limited
value, or if the company fails to adequately maintain or repair the equipment. Any one or more of the preceding
factors could materially impair our ability to recover principal in a foreclosure.
Defaults by our portfolio companies will harm our operating results.
A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders
could lead to defaults and, potentially, termination of its loans and foreclosure on its secured assets, which could
trigger cross-defaults under other agreements and jeopardize our portfolio company’s ability to meet its
obligations under the debt securities that we hold. We may incur expenses to the extent necessary to seek
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recovery upon default or to negotiate new terms with a defaulting portfolio company. Any extension or
restructuring of our loans could adversely affect our cash flows. In addition, if one of our portfolio companies
were to go bankrupt, even though we may have structured our interest as senior debt, depending on the facts and
circumstances, including the extent to which we actually provided managerial assistance to that portfolio
company, a bankruptcy court might recharacterize our debt holding and subordinate all or a portion of our claim
to that of other creditors. If any of these occur, it could materially and adversely affect our operating results and
cash flows.
If our portfolio companies are unable to protect their proprietary, technological and other intellectual property
rights, our business and prospects could be harmed, and if portfolio companies are required to devote
significant resources to protecting their intellectual property rights, the value of our investment could be
reduced.
Our future success and competitive position will depend in part upon the ability of our portfolio companies
to obtain, maintain and protect proprietary technology used in their products and services. The intellectual
property held by our portfolio companies often represents a substantial portion of the collateral securing our
investments and/or constitutes a significant portion of the portfolio companies’ value that may be available in a
downside scenario to repay our loans. Our portfolio companies will rely, in part, on patent, trade secret and
trademark law to protect that technology, but competitors may misappropriate their intellectual property, and
disputes as to ownership of intellectual property may arise. Portfolio companies may, from time to time, be
required to institute litigation to enforce their patents, copyrights or other intellectual property rights, protect their
trade secrets, determine the validity and scope of the proprietary rights of others or defend against claims of
infringement. Such litigation could result in substantial costs and diversion of resources. Similarly, if a portfolio
company is found to infringe or misappropriate a third-party’s patent or other proprietary rights, it could be
required to pay damages to the third-party, alter its products or processes, obtain a license from the third-party
and/or cease activities utilizing the proprietary rights, including making or selling products utilizing the
proprietary rights. Any of the foregoing events could negatively affect both the portfolio company’s ability to
service our debt investment and the value of any related debt and equity securities that we own, as well as any
collateral securing our investment.
Any unrealized depreciation we experience on our loan portfolio may be an indication of future realized
losses, which could reduce our income available for distribution.
As a BDC, we are required to carry our investments at market value or, if no market value is ascertainable,
at the fair value as determined in good faith by our Board. Decreases in the market values or fair values of our
investments will be recorded as unrealized depreciation. Any unrealized depreciation in our loan portfolio could
be an indication of a portfolio company’s inability to meet its repayment obligations to us with respect to the
affected loans. This could result in realized losses in the future and ultimately in reductions of our income
available for distribution in future periods.
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 will generally reinvest these proceeds in temporary investments or repay any
revolving credit facility, depending on expected future investment in new portfolio companies. Temporary
investments will typically have substantially lower yields than the debt being prepaid, and we could experience
significant delays in reinvesting these amounts. Any future investment 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.
We may not realize gains from our equity investments.
Certain investments that we may make include warrants or other equity securities. Investments in equity
securities involve a number of significant risks, including the risk of further dilution as a result of additional
issuances, inability to access additional capital and failure to pay current distributions. Investments in preferred
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securities involve special risks, such as the risk of deferred distributions, credit risk, illiquidity and limited voting
rights. In addition, we may from time to time make non-control, equity investments in portfolio companies. Our
goal is ultimately to realize gains upon our disposition of such equity interests. However, the equity interests we
receive may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize
gains from our equity interests, and any gains that we do realize on the disposition of any equity interests may not
be sufficient to offset any other losses we experience. We also may be unable to realize any value if a portfolio
company does not have a liquidity event, such as a sale of the business, recapitalization or public offering, which
would allow us to sell the underlying equity interests. We will often seek puts or similar rights to give us the right
to sell our equity securities back to the portfolio company issuer. We may be unable to exercise these put rights
for the consideration provided in our investment documents if the issuer is in financial distress.
We may expose ourselves to risks if we engage in hedging transactions.
If we engage in hedging transactions, we may expose ourselves to risks associated with such transactions.
We may utilize instruments such as forward contracts, currency options and interest rate swaps, caps, collars and
floors to seek to hedge against fluctuations in the relative values of our portfolio positions from changes in
currency exchange rates and market interest rates. Hedging against a decline in the values of our portfolio
positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the
values of such positions decline. However, such hedging can establish other positions designed to gain from those
same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging
transactions may also limit the opportunity for gain if the values of the underlying portfolio positions increase. It
may not be possible to hedge against an exchange rate or interest rate fluctuation that is so generally anticipated
that we are not able to enter into a hedging transaction at an acceptable price. Moreover, for a variety of reasons,
we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings
being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us
to risk of loss. In addition, it may not be possible to hedge fully or perfectly against currency fluctuations
affecting the value of securities denominated in non-U.S. currencies because the value of those securities is likely
to fluctuate as a result of factors not related to currency fluctuations.
In November 2019, the SEC proposed a rule regarding the ability of a BDC (or a registered investment
company) to use derivatives and other transactions that create future payment or delivery obligations (except
reverse repurchase agreements and similar financing transactions). If adopted as proposed, BDCs that use
derivatives would be subject to a value-at-risk (“VaR”) leverage limit, certain other derivatives risk management
program and testing requirements and requirements related to board reporting. These new requirements would
apply unless the BDC qualified as a “limited derivatives user,” as defined in the SEC’s proposal. A BDC that
enters into reverse repurchase agreements or similar financing transactions would need to aggregate the amount
of indebtedness associated with the reverse repurchase agreements or similar financing transactions with the
aggregate amount of any other senior securities representing indebtedness when calculating the BDC’s asset
coverage ratio. Under the proposed rule, a BDC may enter into an unfunded commitment agreement that is not a
derivatives transaction, such as an agreement to provide financing to a portfolio company, if the BDC has a
reasonable belief, at the time it enters into such an agreement, that it will have sufficient cash and cash
equivalents to meet its obligations with respect to all of its unfunded commitment agreements, in each case as it
becomes due. If the BDC cannot meet this test, it is required to treat unfunded commitments as a derivatives
transaction subject to the requirements of the rule. Collectively, these proposed requirements, if adopted, may
limit our ability to use derivatives and/or enter into certain other financial contracts.
Uncertainty relating to the LIBOR calculation process may adversely affect the value of our portfolio of the
LIBOR-indexed, floating-rate debt securities.
In the recent past, concerns have been publicized that some of the member banks surveyed by the British
Bankers’ Association (“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
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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.
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.
On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced
that it intends to phase out LIBOR by the end of 2021. It is expected that a transition away from the widespread
use of LIBOR to alternative rates will occur over the course of the next several years. As a result of this
transition, interest rates on financial instruments tied to LIBOR rates, as well as the revenue and expenses
associated with those financial instruments, may be adversely affected. Further, any uncertainty regarding the
continued use and reliability of LIBOR as a benchmark interest rate could adversely affect the value of our
financial instruments tied to LIBOR rates. The U.S. Federal Reserve, in conjunction with the Alternative
Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering
replacing U.S. dollar LIBOR with a new index calculated by short term repurchase agreements, backed by
Treasury securities, called the Secured Overnight Financing Rate (“SOFR”). The first publication of SOFR was
released in April 2018. Whether or not SOFR attains market traction as a LIBOR replacement remains a question
and the future of LIBOR at this time is uncertain.
Additionally, on June 12, 2019 the Staff of the SEC’s Division of Corporate Finance, Division of Investment
Management, Division of Trading and Markets, and Office of the Chief Accountant issued a statement about the
potentially significant effects on financial markets and market participants when LIBOR is discontinued in 2021
and is no longer available as a reference benchmark rate. The Staff encouraged all market participants to identify
contracts that reference LIBOR and begin transitions to alternative rates. On December 30, 2019, the SEC’s
Chairman, Division of Corporate Finance and Office of the Chief Accountant issued a statement to encourage
audit committees in particular to understand management’s plans to identify and address the risks associated with
the elimination of LIBOR, and, specifically, the impact on accounting and financial reporting and any related
issues associated with financial products and contracts that reference LIBOR, as the risks associated with the
discontinuation of LIBOR and transition to an alternative reference rate will be exacerbated if the work is not
completed in a timely manner.
Our Credit Facility currently provides for borrowings up to $60.0 million and may be increased up to
$150.0 million pursuant to its “accordion” feature. Borrowings under the Credit Facility bear interest, at the
Company’s election, at a rate per annum equal to (i) the one, two, three or six month LIBOR, as applicable, plus
3.50% or (ii) 2.00% plus the highest of (A) a prime rate, (B) the Federal Funds rate plus 0.5%, and (C) three
month LIBOR plus 1.0%. The Company’s ability to elect LIBOR indices with various tenors (e.g., one, two, three
or six month LIBOR) on which the interest rates for borrowings under the Credit Facility are based, provides the
company with increased flexibility to manage interest rate risks as compared to a borrowing arrangement that
does not provide for such optionality. Once a particular LIBOR has been selected, the interest rate on the
applicable amount borrowed will reset after the applicable tenor period and be based on the then applicable
selected LIBOR (e.g., borrowings for which the Company has elected the one month LIBOR will reset on the one
month anniversary of the period based on the then selected LIBOR). For any given borrowing under the Credit
Facility, the Company intends to elect what it believes to be an appropriate LIBOR taking into account the
Company’s needs at the time as well as the Company’s view of future interest rate movements. The Credit
Facility provides for the ability to step-down the pricing of the Credit Facility from LIBOR plus 3.50% to LIBOR
plus 3.00% when certain conditions are met.
The Credit Facility provides for a Benchmark Replacement Rate (the “Benchmark Rate”) to replace LIBOR
when there is a public statement that LIBOR will cease to exist. The Credit Facility will transition to the new
Benchmark Rate 90 days after the applicable public statement that LIBOR will cease to exist has been made, or
earlier if agreed to by the Administrative Agent and the Company. The Benchmark Replacement Rate will be an
alternate benchmark rate (which may include SOFR) that has been selected by the Administrative Agent and the
Company. The applicable spread to the Benchmark Rate will be based on the
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spread announced by the relevant governmental body governing the new Benchmark Rate or prevailing market
convention for determining a spread to the new Benchmark Rate. The applicable spread or method for calculating
the spread adjustment for the Benchmark Rate will be selected by the Administrative Agent and the Company.
Approximately 63% of the fair value of our debt investment portfolio is variable rate based on LIBOR. In
the event LIBOR ceases to exist, our credit agreements typically either provide for use of an alternative rate
based on Prime or allow the Company and other lenders in the facility to select a replacement index for LIBOR.
Other than our Credit Facility and variable rate loans, the Company has no other direct exposure to LIBOR
based financial instruments.
The elimination of LIBOR or any other changes or reforms to the determination or supervision of LIBOR
could have an adverse impact on the market for or value of any LIBOR-linked securities, loans, and other
financial obligations or extensions of credit held by or due to us, or on our overall financial condition or results of
operations. If LIBOR ceases to exist, we may need to renegotiate the credit agreements extending beyond 2021
with our portfolio companies that utilize LIBOR as a factor in determining the interest rate to replace LIBOR
with the new standard that is established. In addition, the cessation of LIBOR could:
•
•
•
•
•
Adversely impact the pricing, liquidity, value of, return on and trading for a broad array of financial
products, including any LIBOR-linked securities, loans and derivatives that are included in our assets and
liabilities;
Require extensive changes to documentation that governs or references LIBOR or LIBOR-based
products, including, for example, pursuant to time-consuming renegotiations of existing documentation to
modify the terms of outstanding investments;
Result in inquiries or other actions from regulators in respect of our preparation and readiness for the
replacement of LIBOR with one or more alternative reference rates;
Result in disputes, litigation or other actions with portfolio companies, or other counterparties, regarding
the interpretation and enforceability of provisions in our LIBOR-based investments, such as fallback
language or other related provisions, including, in the case of fallbacks to the alternative reference rates,
any economic, legal, operational or other impact resulting from the fundamental differences between
LIBOR and the various alternative reference rates;
Require the transition and/or development of appropriate systems and analytics to effectively transition
our risk management processes from LIBOR-based products to those based on one or more alternative
reference rates, which may prove challenging given the limited history of the proposed alternative
reference rates; and
•
Cause us to incur additional costs in relation to any of the above factors.
There is no guarantee that a transition from LIBOR to an alternative will not result in financial market
disruptions, significant increases in benchmark rates, or borrowing costs to borrowers, any of which could have a
material adverse effect on our business, result of operations, financial condition, and unit price.
The effect of global climate change may impact the operations of our portfolio companies.
There may be evidence of global climate change. Climate change creates physical and financial risk and
some of our portfolio companies may be adversely affected by climate change. For example, the needs of
customers of energy companies vary with weather conditions, primarily temperature and humidity. To the extent
weather conditions are affected by climate change, energy use could increase or decrease depending on the
duration and magnitude of any changes. Increases in the cost of energy could adversely affect the cost of
operations of our portfolio companies if the use of energy products or services is material to their business. A
decrease in energy use due to weather changes may affect some of our portfolio companies’ financial condition,
through decreased revenues. Extreme weather conditions in general require more system backup, adding to costs,
and can contribute to increased system stresses, including service interruptions. Energy companies could also be
affected by the potential for lawsuits against or taxes or other regulatory costs imposed on greenhouse gas
emitters, based on links drawn between greenhouse gas emissions and climate change.
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In December 2015 the United Nations, of which the U.S. is a member, adopted a climate accord (the “Paris
Agreement”) with the long-term goal of limiting global warming and the short-term goal of significantly reducing
greenhouse gas emissions. Although the U.S. ratified the Paris Agreement on November 4, 2016, the current
administration announced the U.S. would cease participation. As a result, some of our portfolio companies may
become subject to new or strengthened regulations or legislation, at least through November 4, 2020 (the earliest
date the U.S. may withdraw from the Paris Agreement), which could increase their operating costs and/or
decrease their revenues.
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 operations and financial condition and
cause the loss of all or part of your investment.
Our investments in securities rated below investment grade are speculative in nature and are subject to
additional risk factors such as increased possibility of default, illiquidity of the security, and changes in value
based on changes in interest rates.
The securities that we invest in are typically rated below investment grade. Securities rated below
investment grade are often referred to as “leveraged loans,” “high yield” or “junk” securities and may be
considered “high risk” compared to debt instruments that are rated investment grade. High yield securities are
regarded as having predominantly speculative characteristics with respect to the issuer’s capacity to pay interest
and repay principal in accordance with the terms of the obligations and involve major risk exposure to adverse
conditions. In addition, high yield securities generally offer a higher current yield than that available from higher
grade issues, but typically involve greater risk. These securities are especially sensitive to adverse changes in
general economic conditions, to changes in the financial condition of their issuers and to price fluctuation in
response to changes in interest rates. During periods of economic downturn or rising interest rates, issuers of
below investment grade instruments may experience financial stress that could adversely affect their ability to
make payments of principal and interest and increase the possibility of default.
Our investments may be in portfolio companies which may have limited operating histories and financial
resources.
We expect that our portfolio will continue to consist of investments that may have relatively limited
operating histories. These companies may be particularly vulnerable to U.S. and foreign economic downturns
such as the U.S. recession that began in mid-2007 and the European financial crisis, may have more limited
access to capital and higher funding costs, may have a weaker financial position and may need more capital to
expand or compete. These businesses also may experience substantial variations in operating results. They may
face intense competition, including from companies with greater financial, technical and marketing resources.
Furthermore, some of these companies do business in regulated industries and could be affected by changes in
government regulation. Accordingly, these factors could impair their cash flow or result in other events, such as
bankruptcy, which could limit their ability to repay their obligations to us, and may adversely affect the return on,
or the recovery of, our investment in these companies. We cannot assure you that any of our investments in our
portfolio companies will be successful. Our portfolio companies compete with larger, more established
companies with greater access to, and resources for, further development in these new technologies. We may lose
our entire investment in any or all of our portfolio companies.
Risks Relating to our Securities
The market price of our common stock may fluctuate significantly.
The market price and liquidity of the expected market for shares of our common stock may be significantly
affected by numerous factors, some of which are beyond our control and may not be directly related to our
operating performance. These factors include:
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•
•
•
•
•
•
•
•
•
•
price and volume fluctuations in the overall stock market from time to time;
investor demand for our shares;
significant volatility in the market price and trading volume of securities of BDCs or other companies in
our sector, which are not necessarily related to the operating performance of these companies;
changes in regulatory policies or tax guidelines with respect to RICs, BDCs or SBICs;
failure to qualify as a RIC, or the loss of RIC tax treatment;
any shortfall in revenue or net income or any increase in losses from levels expected by investors or
securities analysts;
changes, or perceived changes, in the value of our portfolio investments;
departures of the Investment Advisor’s key personnel;
operating performance of companies comparable to us; or
general economic conditions and trends and other external factors.
Our business and operation could be negatively affected if we become subject to any securities litigation or
stockholder activism, which could cause us to incur significant expense, hinder execution of investment
strategy and impact our stock price.
In the past, following periods of volatility in the market price of a company’s securities, securities class
action litigation has often been brought against that company. Stockholder activism, which could take many
forms or arise in a variety of situations, increased in the BDC space recently. Specifically, we are currently
subject to class action litigation.
In the ordinary course of business, the Company may directly or indirectly be a defendant or plaintiff in
legal actions with respect to bankruptcy, insolvency or other types of proceedings. Such lawsuits may involve
claims that could adversely affect the value of certain financial instruments owned by the Company or result in
direct losses to the Company. The nature of litigation can make it difficult to predict the impact a particular
lawsuit will have on the Company. There are many reasons that the Company cannot make these assessments,
including, among others, one or more of the following: the proceeding is in its early stages; the damages sought
are unspecified, unsupportable, unexplained or uncertain; discovery has not started or is not complete; there are
significant facts in dispute; and there are other parties who may share in any ultimate liability.
Securities litigation and corresponding stockholder activism, if any, including potential proxy contests, could
result in substantial costs and divert management’s and our Board’s attention and resources from our business.
Additionally, such securities litigation and stockholder activism could give rise to perceived uncertainties as to
our future, adversely affect our relationships with service providers and make it more difficult to attract and retain
qualified personnel. Also, we may be required to incur significant legal fees and other expenses related to any
securities litigation and activist stockholder matters. Further, our stock price could be subject to significant
fluctuation or otherwise be adversely affected by the events, risks and uncertainties of any securities litigation and
stockholder activism.
Investing in our common stock may involve an above average degree of risk.
The investments we make may result in a higher amount of risk, volatility, or loss of principal than
alternative investment options. These investments in portfolio companies may be highly speculative and
aggressive, and therefore, an investment in our common stock may not be suitable for investors with lower risk
tolerance.
Our shares of common stock have a limited trading history and we cannot assure you that the market price of
shares of our common stock will not decline.
Our shares of common stock have a limited trading history and we cannot assure you that a public trading
market will be sustained for such shares. We cannot predict the prices at which our common stock will trade. We
cannot assure you that the market price of shares of our common stock will not decline at any time.
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In addition, our common stock has from time to time traded below its net asset value since our inception and if
our common stock continues to trade below its net asset value, we will generally not be able to sell additional
shares of our common stock to the public at its market price without first obtaining the approval of our
stockholders (including our unaffiliated stockholders) and our independent directors for such issuance.
Our common stockholders will bear the expenses associated with our borrowings, and the holders of our debt
securities will have certain rights senior to our common stockholders.
All of the costs of offering and servicing our debt securities, including interest thereon, is borne by our
common stockholders. The interests of the holders of any debt we may issue will not necessarily be aligned with
the interests of our common stockholders. In particular, the rights of holders of our debt to receive interest or
principal repayment will be senior to those of our common stockholders. In addition, we may grant a lender a
security interest in a significant portion or all of our assets, even if the total amount we may borrow from such
lender is less than the amount of such lender’s security interest in our assets.
Sales of substantial amounts of our common stock in the public market may have an adverse effect on the
market price of our common stock.
Sales of substantial amounts of our common stock, or the availability of such common stock for sale, could
adversely affect the prevailing market prices for our common stock. If this occurs and continues for a sustained
period of time, it could impair our ability to raise additional capital through the sale of securities should we desire
to do so.
Shares of our common stock have traded at a discount from net asset value and may do so in the future.
Shares of closed-end investment companies have frequently traded at a market price that is less than the net
asset value that is attributable to those shares. In part as a result of adverse economic conditions and increasing
pressure within the financial sector of which we are a part, our common stock has at times traded below its net
asset value per share since our IPO on September 30, 2013. Our shares could continue trade at a discount to net
asset value. The possibility that our shares of common stock may trade at a discount from net asset value over the
long term is separate and distinct from the risk that our net asset value will decrease. We cannot predict whether
shares of our common stock will trade above, at or below its net asset value. If our common stock trades below
its net asset value, we will generally not be able to issue additional shares of our common stock at its market price
without first obtaining the approval for such issuance from our stockholders and our independent directors. If
additional funds are not available to us, we could be forced to curtail or cease our new lending and investment
activities, and our net asset value could decrease and our level of distributions could be impacted.
You may not receive distributions, or our distributions may decline or may not grow over time, and you will
experience dilution in your ownership percentage if you opt out of our dividend reinvestment plan.
We intend to make distributions on a monthly basis to our stockholders out of assets legally available for
distribution. We cannot assure you that we will achieve investment results that will allow us to make a specified
level of cash distributions or year-to-year increases in cash distributions. Our ability to pay distributions might be
materially and adversely affected by the impact of one or more of the risks described herein. Due to the asset
coverage test applicable to us under the 1940 Act as a BDC, we may be limited in our ability to make
distributions. All distributions will be made at the discretion of our Board and will depend on our earnings,
financial condition, maintenance of RIC tax treatment, compliance with applicable BDC, SBA regulations and
such other factors as our Board may deem relevant from time to time. We cannot assure you that we will make
distributions to our stockholders in the future.
All dividends declared in cash payable to stockholders that are participants in our dividend reinvestment
plan are automatically reinvested in shares of our common stock. As a result, our stockholders that opt out of our
dividend reinvestment plan will experience dilution in their ownership percentage of our common stock over
time.
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We will have broad discretion over the use of proceeds of any successful offering of securities.
We will have significant flexibility in applying the proceeds of any successful offering of our securities. We
will also pay operating expenses, and may pay other expenses such as due diligence expenses of potential new
investments, from net proceeds. Our ability to achieve our investment objective may be limited to the extent that
the net proceeds of any offering, pending full investment, are used to pay operating expenses. In addition, we can
provide you no assurance that the any offering will be successful, or that by increasing the size of our available
equity capital, our aggregate expenses, and correspondingly, our expense ratio, will be lowered.
The net asset value per share of our common stock may be diluted if we sell shares of our common stock in
one or more offerings at prices below the then current net asset value per share of our common stock.
At our 2020 Annual Stockholders Meeting, subject to certain determinations required to be made by our
Board, we will ask our stockholders to approve our ability to sell or otherwise issue shares of our common stock,
not exceeding 25% of our then outstanding common stock immediately prior to each such offering, at a price
below the then current net asset value per share during a period beginning on April 30, 2020 and expiring on the
earlier of the one year anniversary of the date of the 2020 Annual Stockholders Meeting and the date of our 2021
Annual Stockholders Meeting, which is expected to be held in April 2021. Although our Board is generally
required to make certain determinations prior to any issuance of our common stock at a price below the then
current net asset value (“NAV”) per share, we may sell shares of our common stock at a price per share below the
then current NAV in reliance on our stockholder approval obtained at the 2019 Annual Stockholders Meeting
where the Board approved the Company’s ability to sell below NAV in a $50.0 million “at the market offering”
(the “ATM Program”). However, if stockholders do not approve the ability to sell below NAV at the 2020 Annual
Stockholders Meeting, then we will not be able to sell below NAV in the ATM Program after April 30, 2020.
If we were to sell shares of our common stock below its then current net asset value per share would be
subject to the determination by our Board that such issuance is in our and our stockholders’ best interests. If we
were to sell shares of our common stock below its then current net asset value per share, such sales would result
in an immediate dilution to the net asset value per share of our common stock. This dilution would occur as a
result of the sale of shares at a price below the then current net asset value per share of our common stock and a
proportionately greater decrease in the stockholders’ interest in our earnings and assets and their voting interest in
us than the increase in our assets resulting from such issuance. Because the number of shares of common stock
that could be so issued, and the timing of any issuance is not currently known, the actual dilutive effect cannot be
predicted.
Further, if our current stockholders do not purchase any shares to maintain their percentage interest,
regardless of whether such offering is above or below the then current net asset value per share, their voting
power will be diluted. For example, if we sell an additional 10% of our common shares at a 10% discount from
net asset value, a stockholder who does not participate in that offering for its proportionate interest will suffer net
asset value dilution of up to 1.0% or $10 per $1,000 of net asset value.
Your interest in Capitala Finance may be diluted if you do not fully exercise your subscription rights in any
rights offering.
In the event we issue subscription rights to purchase shares of our common stock, stockholders who do not
fully exercise their rights should expect that they will, at the completion of the offer, own a smaller proportional
interest in Capitala Finance than would otherwise be the case if they fully exercised their rights.
We cannot state precisely the amount of any such dilution in share ownership because we do not know at
this time what proportion of the shares would be purchased as a result of a rights offering.
In addition, if the subscription price in a rights offering is less than our net asset value per share, then our
stockholders would experience an immediate dilution of the aggregate net asset value of their shares as a result of
the rights offering. The amount of any decrease in net asset value is not predictable because it is not known at this
time what the subscription price and net asset value per share will be on the expiration date of any rights offering
or what proportion of the shares will be purchased as a result of such rights offering. Such dilution could be
substantial.
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If we issue preferred stock, the net asset value and market value of our common stock will likely become more
volatile.
We cannot assure you that the issuance of preferred stock would result in a higher yield or return to the
holders of our common stock. The issuance of preferred stock would likely cause the net asset value and market
value of the common stock to become more volatile. If the dividend rate on the preferred stock were to approach
the net rate of return on our investment portfolio, the benefit of leverage to the holders of the common stock
would be reduced. If the dividend rate on the preferred stock were to exceed the net rate of return on our
portfolio, the leverage would result in a lower rate of return to the holders of common stock than if we had not
issued preferred stock. Any decline in the net asset value of our investments would be borne entirely by the
holders of common stock. Therefore, if the market value of our portfolio were to decline, the leverage would
result in a greater decrease in net asset value to the holders of common stock than if we were not leveraged
through the issuance of preferred stock. This greater net asset value decrease would also tend to cause a greater
decline in the market price for the common stock. We might be in danger of failing to maintain the required asset
coverage of the preferred stock or of losing our ratings, if any, on the preferred stock or, in an extreme case, our
current investment income might not be sufficient to meet the dividend requirements on the preferred stock. In
order to counteract such an event, we might need to liquidate investments in order to fund a redemption of some
or all of the preferred stock. In addition, we would pay (and the holders of common stock would bear) all costs
and expenses relating to the issuance and ongoing maintenance of the preferred stock, including higher advisory
fees if our total return exceeds the dividend rate on the preferred stock. Holders of preferred stock may have
different interests than holders of common stock and may at times have disproportionate influence over our
affairs.
Holders of any preferred stock we might issue would have the right to elect members of our Board and class
voting rights on certain matters.
Holders of any preferred stock we might issue, voting separately as a single class, would have the right to
elect two members of our Board at all times and in the event dividends become two full years in arrears would
have the right to elect a majority of the directors until such arrearage is completely eliminated. In addition,
preferred stockholders have class voting rights on certain matters, including changes in fundamental investment
restrictions and conversion to open-end status, and accordingly can veto any such changes. Restrictions imposed
on the declarations and payment of dividends or other distributions to the holders of our common stock and
preferred stock, both by the 1940 Act and by requirements imposed by rating agencies, if any, or the terms of our
credit facilities, if any, might impair our ability to maintain our RIC tax treatment under the Code for U.S. federal
income tax purposes. While we would intend to redeem our preferred stock to the extent necessary to enable us to
distribute our income as required to maintain our qualification as a RIC, there can be no assurance that such
actions could be effected in time to meet the tax requirements.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our executive offices are located at 4201 Congress Street, Suite 360, Charlotte, North Carolina 28209, and
are provided by our Administrator in accordance with the terms of the Administration Agreement. We believe
that our office facilities are suitable and adequate for our business as it is contemplated to be conducted.
ITEM 3. LEGAL PROCEEDINGS
We and our subsidiaries are not currently subject to any material legal proceedings, nor, to our knowledge, is
any material legal proceeding threatened against us or our subsidiaries. From time to time, we, or our subsidiaries
may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to
the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal
proceedings, if any, cannot be predicted 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
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
COMMON STOCK
Our common stock is traded on the NASDAQ Global Select Market under the symbol “CPTA.”
HOLDERS
The last reported price for our common stock on February 27, 2020 was $7.78 per share. As of February 27,
2020 there were 37 holders of record of our common stock.
PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS
The following table sets forth, for each fiscal quarter within the two most recent fiscal years and the current
fiscal quarter, the range of high and low intraday sales prices of our common stock as reported on the Nasdaq
Global Select Market, the premium (discount) of sales price to our net asset value and the distributions declared
by us for each fiscal quarter.
Fiscal Year Ended
December 31, 2020
First Quarter (through February 27,
2020)
December 31, 2019
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
December 31, 2018
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
NAV
Per Share
(1)
Sales Price
High
Low
Premium or
(Discount) of
High Sales
Price to
(2)
NAV
Premium or
(Discount) of
Low Sales
Price to
(2)
NAV
Declared
Distributions
(3)
Per Share
$
*
$9.20
$7.69
*
*
$0.25
$ 9.14
$ 9.40
$ 9.55
$11.61
$11.88
$12.71
$13.71
$13.66
$9.12
$9.99
$9.69
$8.74
$8.80
$9.05
$8.60
$8.15
$8.07
$7.34
$7.97
$6.83
$6.46
$8.29
$7.66
$6.88
(0.2
6.3
1.5
)%
%
%
(24.7
)%
(25.9
)%
(28.8
)%
(37.3
)%
(40.3
)%
(11.7
(21.9
(16.5
)%
)%
)%
(41.2
)%
(45.6
)%
(34.8
)%
(44.1
)%
(49.6
)%
$0.25
$0.25
$0.25
$0.25
$0.25
$0.25
$0.25
$0.25
(1)
(2)
(3)
Net asset value per share is determined as of the last day in the relevant quarter and therefore may not reflect
the net asset value per share on the date of the high and low sales prices. The net asset values shown are
based on outstanding shares at the end of each period.
Calculated as of the respective high or low intraday sales price divided by the quarter end NAV and
subtracting 1.
Unless otherwise noted, represents the distribution paid or to be paid in the specified quarter. See
“Distributions” for detail related to tax characteristics of distributions paid.
*
Not determinable at the time of filing
Shares of BDCs may trade at a market price that is less than the value of the net assets attributable to those
shares. The possibility that our shares of common stock will trade at a discount from NAV or at premiums that are
unsustainable over the long term are separate and distinct from the risk that our NAV will decrease. Since our
initial public offering on September 25, 2013, our shares of common stock have traded at
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times at both a discount and a premium to the net assets attributable to those shares. As of February 27, 2020,
shares of our common stock traded at a discount of approximately (14.9%) of the NAV attributable to those
shares as of December 31, 2019. It is not possible to predict whether the shares offered hereby will trade at,
above, or below NAV.
DISTRIBUTIONS
In order to qualify as a RIC and to avoid corporate-level U.S. federal income tax on the income we distribute
to our stockholders, we are required to distribute at least 90% of our net ordinary income and our net short-term
capital gains in excess of net long-term capital losses, if any, to our stockholders on an annual basis. Additionally,
we must distribute an amount at least equal to the sum of 98% of our net ordinary income (during the calendar
year) plus 98.2% of our net capital gain income (during each 12-month period ending on October 31) plus any net
ordinary income and capital gain net income for preceding years that were not distributed during such years and
on which we paid no U.S. federal income tax to avoid a U.S. federal excise tax. We made quarterly distributions
to our stockholders for the first four full quarters subsequent to our IPO. To the extent we have income available,
we have made and intend to make monthly distributions thereafter. Our monthly stockholder distributions, if any,
will be determined by our Board on a quarterly basis. Any distribution to our stockholders will be declared out of
assets legally available for distribution.
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 our distributions from time to time, and from time to time we may decrease the amount
of our distributions. In addition, we may be limited in our ability to make distributions due to the asset coverage
requirements 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 the possible loss of our qualification as a
RIC. We cannot assure stockholders that they will receive any distributions.
To the extent our taxable earnings fall below the total amount of our distributions for that fiscal year, a
portion of those distributions may be deemed a return of capital to our stockholders for U.S. federal income tax
purposes. Thus, the source of a distribution to our stockholders may be the original capital invested by the
stockholder rather than our income or gains. Stockholders should read any written disclosure accompanying any
stockholder distribution carefully and should not assume that the source of any distribution is our ordinary
income or capital gains.
We have adopted an “opt out” dividend reinvestment plan (“DRIP”) for our common stockholders. As a
result, if we declare a distribution, then stockholders’ cash distributions will be automatically reinvested in
additional shares of our common stock unless a stockholder specifically “opts out” of our DRIP. If a stockholder
opts out, that stockholder will receive cash distributions. Although distributions paid in the form of additional
shares of our common stock will generally be subject to U.S. federal, state and local taxes in the same manner as
cash distributions, stockholders participating in our DRIP will not receive any corresponding cash distributions
with which to pay any such applicable taxes.
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The following tables summarize our distributions declared from January 1, 2017 through December 31,
2019:
Date Declared
January 2, 2019
January 2, 2019
January 2, 2019
April 1, 2019
April 1, 2019
April 1, 2019
July 1, 2019
July 1, 2019
July 1, 2019
October 1, 2019
October 1, 2019
October 1, 2019
Total Distributions Declared and
Distributed for 2019
Date Declared
January 2, 2018
January 2, 2018
January 2, 2018
April 2, 2018
April 2, 2018
April 2, 2018
July 2, 2018
July 2, 2018
July 2, 2018
October 1, 2018
October 1, 2018
October 1, 2018
Total Distributions Declared and
Distributed for 2018
Record Date
January 24, 2019
February 20, 2019
March 21, 2019
April 22, 2019
May 23, 2019
June 20, 2019
July 23, 2019
August 22, 2019
September 20, 2019
October 22, 2019
November 22, 2019
December 23, 2019
Payment Date
January 30, 2019
February 27, 2019
March 28, 2019
April 29, 2019
May 30, 2019
June 27, 2019
July 30, 2019
August 29, 2019
September 27, 2019
October 29, 2019
November 29, 2019
December 30, 2019
Record Date
January 22, 2018
February 20, 2018
March 23, 2018
April 19, 2018
May 22, 2018
June 20, 2018
July 23, 2018
August 23, 2018
September 20, 2018
October 23, 2018
November 21, 2018
December 20, 2018
Payment Date
January 30, 2018
February 27, 2018
March 29, 2018
April 27, 2018
May 30, 2018
June 28, 2018
July 30, 2018
August 30, 2018
September 27, 2018
October 30, 2018
November 29, 2018
December 28, 2018
Amount
Per Share
$0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
$
1.00
Amount
Per Share
$0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
$
1.00
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Date Declared
January 3, 2017
January 3, 2017
January 3, 2017
April 3, 2017
April 3, 2017
April 3, 2017
July 3, 2017
July 3, 2017
July 3, 2017
October 2, 2017
October 2, 2017
October 2, 2017
Total Distributions Declared and
Distributed for 2017
Record Date
January 20, 2017
February 20, 2017
March 23, 2017
April 19, 2017
May 23, 2017
June 21, 2017
July 21, 2017
August 23, 2017
September 20, 2017
October 23, 2017
November 21, 2017
December 20, 2017
Payment Date
January 30, 2017
February 27, 2017
March 30, 2017
April 27, 2017
May 29, 2017
June 29, 2017
July 28, 2017
August 30, 2017
September 28, 2017
October 30, 2017
November 29, 2017
December 28, 2017
Amount
Per Share
$0.1300
0.1300
0.1300
0.1300
0.1300
0.1300
0.1300
0.1300
0.1300
0.0833
0.0833
0.0833
$
1.42
Tax characteristics of all distributions paid are reported to stockholders on Form 1099 after the end of the
calendar year. For the years ended December 31, 2018 and December 31, 2017 total distributions of $16.0 million
and $22.6 million, respectively, were comprised 100% of ordinary income. For the year ended December 31,
2019, we estimate that total distributions of $16.1 million were comprised of approximately $13.4 million from
ordinary income and $2.7 million from return of capital.
PERFORMANCE GRAPH
The following graph compares the cumulative return on our common stock with that of the Standard &
Poor’s 500 Stock Index and the NASDAQ Financial 100 index, as we do not believe there is an appropriate index
of companies with an investment strategy similar to our own with which to compare the return on our common
stock, for the period from December 31, 2014 through December 31, 2019. The graph assumes that on
December 31, 2014, a person invested $100 in each of our common stock, the Standard & Poor’s 500 Stock
Index and the NASDAQ Financial 100 index. The graph measures total stockholder return, which takes into
account both changes in stock price and dividends. The graph also assumes that dividends paid are reinvested in
the same class of equity securities at the frequency with which dividends are paid on such securities during the
applicable fiscal year.
The graph and other information furnished under this Part II Item 5 of this Annual Report on Form 10-K
shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C
under, or to the liabilities of Section 18 of, the 1934 Act. The stock price performance included in the above
graph is not necessarily indicative of future stock price performance.
FEES AND EXPENSES
The following table is intended to assist you in understanding the costs and expenses that you will bear
directly or indirectly. We caution you that some of the percentages indicated in the table below are estimates
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and may vary. Except where the context suggests otherwise, whenever this report contains a reference to fees or
expenses paid by “you”, “Capitala Finance”, or “us” or that “we” or “Capitala Finance” will pay fees or
expenses, Capitala Finance will pay such fees and expenses out of our net assets and, consequently, you will
indirectly bear such fees or expenses as an investor in Capitala Finance. However, you will not be required to
deliver any money or otherwise bear personal liability or responsibility for such fees or expenses.
Stockholder transaction expenses:
Sales load (as a percentage of offering price)
Offering expenses borne by us (as a percentage of offering price)
Dividend reinvestment plan fees (per sales transaction fee)
Total stockholder transaction expenses (as a percentage of offering price)
Annual expenses (as a percentage of net assets attributable to common stock):
Base management fee
Incentive fees payable from Net Investment Income
Incentive fee payable from Capital Gains
Interest payments on borrowed funds
Other expenses
Acquired funds fees and expenses
Total annual expenses
N/A
N/A
$15.00
(1)
(2)
(3)
—
%
4.79
0.90
—
8.43
3.20
0.14
17.46
%(4)
%(5)
%(5)
%(6)
%(7)
%(8)
%(9)
(1)
(2)
(3)
(4)
(5)
In the event that any shares are sold to or through underwriters, a prospectus supplement will disclose the
applicable sales load.
The prospectus supplement corresponding to each offering will disclose the applicable estimated amount of
offering expenses of the offering and the offering expenses borne by us as a percentage of the offering price.
If a participant elects by written notice to the plan administrator to have the plan administrator sell part or all
of the shares held by the plan administrator in the participant’s account and remit the proceeds to the
participant, the plan administrator is authorized to deduct a transaction fee of $15.00 plus a $.10 per share
brokerage commission from the proceeds. The expenses of the dividend reinvestment plan are included in
“other expenses.” The plan administrator’s fees will be paid by us. There will be no brokerage charges or
other charges to stockholders who participate in the plan.
Reflects our gross base management fee as a percentage of net assets. Our base management fee under the
Investment Advisory Agreement is calculated at an annual rate of 1.75% of our gross assets, which is our
total assets as reflected on our balance sheet and includes any borrowings for investment purposes. The
gross base management fee reflected in the table above is based on the fiscal year ended December 31, 2019.
See “Investment Advisory Agreement.”
Assumes that annual incentive fees earned by Capitala Investment Advisors remain consistent with the
incentive fees earned by Capitala Investment Advisors during the fiscal year ended December 31, 2019 and
includes accrued capital gains incentive fee. As of December 31, 2019, Capitala Investment Advisors has
accrued no capital gains incentive fee. As we cannot predict whether we will meet the thresholds for
incentive fees under the Investment Advisory Agreement, the incentive fees paid in subsequent periods, if
any, may be substantially different than the fees incurred during the fiscal year ended December 31, 2019.
On January 4, 2016, Capitala Investment Advisors voluntarily agreed to waive all or such portion of the
quarterly incentive fees earned by Capitala Investment Advisors that would otherwise cause the Company’s
quarterly net investment income to be less than the distribution payments declared by the Company’s Board
of Directors. Quarterly incentive fees are earned by Capitala Investment Advisors pursuant to the Investment
Advisory Agreement. Incentive fees subject to the waiver cannot exceed the amount of incentive fees earned
during the period, as calculated on a quarterly basis. Capitala Investment Advisors will not be entitled to
recoup any amount of incentive fees that it waives. This waiver was effective in the fourth quarter of 2015
and will continue unless otherwise publicly disclosed by the Company. However, because this is a voluntary
waiver that is not guaranteed to last indefinitely, the
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(6)
(7)
(8)
incentive fee reflected in the above table is presented on a gross basis and does not take into account the
voluntary fee waiver. For more detailed information about the incentive fee calculations, see Part I, Item 1.
Business, Agreements, Investment Advisory Agreement section of this Annual Report on Form 10-K.
In addition to our existing SBA-guaranteed debentures, 2022 Notes, and 2022 Convertible Notes, we may
borrow funds from time to time to make investments to the extent we determine that additional capital
would allow us to take advantage of additional investment opportunities or if the economic situation is
otherwise conducive to doing so. The costs associated with any borrowings are indirectly borne by our
stockholders. As of December 31, 2019, we had approximately $75.0 million of 2022 Notes, and
$52.1 million of Convertible Notes outstanding. For purposes of this calculation, we have assumed that the
December 31, 2019 amounts of 2022 Notes and 2022 Convertible Notes remain outstanding, and have
computed interest expense using an assumed interest rate of 6.0% for the 2022 Notes, and 5.75% for the
2022 Convertible Notes which were the rates payable as of December 31, 2019. We have assumed
$150.0 million of SBA guaranteed debentures outstanding and have computed interest expense using an
assumed interest rate of 3.56%. We have also assumed borrowings of $25.0 million under the Credit Facility
at an interest rate equal to 4.75% per annum.
“Other expenses” include our overhead expenses, including payments by us under the Administration
Agreement based on the allocable portion of overhead and other expenses incurred by the Administrator in
performing its obligations to us under the Administration Agreement, and expenses relating to the Dividend
Reinvestment Plan, for the fiscal year ended December 31, 2019.
The holders of shares of our common stock indirectly bear the expenses of our investment in CSLF II. No
management fee is charged on our investment in CSLF II in connection with the administrative services
provided to CSLF II. As CSLF II is structured as a private joint venture, no management fees are paid by
CSLF II. Future expenses for CSLF II may be substantially higher or lower because certain expenses may
fluctuate over time.
(9)
The holders of shares of our common stock indirectly bear the cost associated with our annual expenses.
Example
The following example demonstrates the projected dollar amount of total cumulative expenses that would be
incurred over various periods with respect to a hypothetical investment in our common stock. In calculating the
following expense amounts, we have assumed that our borrowings and annual operating expenses would remain
at the levels set forth in the table above. In the event that shares are sold to or through underwriters, a prospectus
supplement will restate this example to reflect the applicable sales load and offering expenses. See Note 6 above
for additional information regarding certain assumptions regarding our level of leverage.
You would pay the following expenses on a $1,000 investment, assuming
a 5.0% annual return
$166
$442
$658
$1,013
1 Year
3 Years
5 Years
10 Years
The example should not be considered a representation of future expenses, and actual expenses may be
greater or less than those shown.
While the example assumes, as required by the applicable rules of the SEC, a 5.0% annual return, our
performance will vary and may result in a return greater or less than 5.0%. The incentive fee under the
Investment Advisory Agreement, which, assuming a 5.0% annual return, would either not be payable or would
have an insignificant impact on the expense amounts shown above, is not included in the above example. The
above illustration assumes that we will not realize any capital gains (computed net of all realized capital losses
and unrealized capital depreciation) in any of the indicated time periods. If we achieve sufficient returns on our
investments, including through the realization of capital gains, to trigger an incentive fee of a material amount,
our expenses and returns to our investors would be higher. For example, if we assumed that we received our 5.0%
annual return completely in the form of net realized capital gains on our investments, computed net of all
cumulative unrealized depreciation on our investments, the projected dollar amount of total cumulative expenses
set forth in the above illustration would be as follows:
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You would pay the following expenses on a $1,000 investment, assuming
a 5.0% annual return
$176
$464
$684
$1,033
1 Year
3 Years
5 Years
10 Years
The example assumes no sales load. However, in the event that securities are sold with a sales load, a
prospectus supplement will provide a revised expense example that will include the effect of the sales load. In
addition, while the examples assume reinvestment of all dividends and distributions at net asset value,
participants in our dividend reinvestment plan will receive a number of shares of our common stock, generally
determined by dividing the total dollar amount of the dividend payable to a participant by the market price per
share of our common stock at the close of trading on the dividend payment date, which may be at, above or
below net asset value.
SALES OF UNREGISTERED SECURITIES
During the year ended December 31, 2019, we issued 152,222 shares of common stock under our DRIP. The
issuances were not subject to the registration requirements under the Securities Act of 1933, as amended. The
cash paid for shares of common stock issued under our DRIP during the year ended December 31, 2019 was
approximately $1.2 million. Other than the shares issued under our DRIP during the year ended December 31,
2019, we did not sell any unregistered equity securities.
ISSUER PURCHASES OF EQUITY SECURITIES
None.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data of the Company as of and for the years ended
December 31, 2019, 2018, 2017, 2016, and 2015 are derived from our consolidated financial statements that have
been audited by Ernst & Young LLP, our independent registered public accounting firm. This consolidated
financial data should be read in conjunction with our consolidated financial statements and related notes thereto
included elsewhere in this Form 10-K and with Management’s Discussion and Analysis of Financial Condition
and Results of Operations which follows (dollars in thousands except share and per share data):
Consolidated statements of operations data:
Total investment income
Total expenses, net of fee waivers
Net investment income
Net realized (loss) gain from investments
Net unrealized appreciation (depreciation) on
investments and written call option
Tax (provision) benefit
Net (decrease) increase in net assets resulting from
As of and for the years ended December 31,
2019
2018
2017
2016
2015
$ 44,035
$ 47,293
$ 51,089
$ 68,312
$ 63,976
30,992
13,043
31,271
16,022
35,565
15,524
39,272
29,040
(19,756
)
(34,804
)
(24,189
)
(22,766
)
38,649
25,327
5,436
(20,306
)
(628
)
840
1,916
2,970
(1,289
)
2,878
(16,913
)
—
—
operations
$ (27,647
)
$ (16,026
)
$ (6,984
)
$
9,152
$ 13,850
Per share data:
Net investment income
Net (decrease) increase in net assets resulting from
operations
Distributions declared
Net asset value per share
Consolidated statements of assets and liabilities
$
$
$
$
0.81
(1.72
)
1.00
9.14
$
$
$
$
1.00
(1.00
)
1.00
11.88
$
$
$
$
0.98
(0.44
)
1.42
13.91
$
$
$
$
1.84
0.58
1.80
15.79
$
$
$
$
1.67
0.91
2.38
17.04
data:
Total assets
Total net assets
Other data:
Total return
(1)
$427,337
$493,165
$534,595
$584,415
$632,818
$148,113
$190,644
$221,887
$250,582
$268,802
37.75
%
12.14
%
(35.68
)%
24.07
%
(20.43
)%
Number of portfolio company investments at year
end
43
44
47
53
57
Total portfolio investments for the year
$ 77,831
$107,802
$ 82,750
$120,844
$260,640
Investment repayments for the year
$128,122
$123,517
$115,810
$163,564
$142,713
(1)
Total investment return is calculated assuming a purchase of common shares at the current market value on
the first day and a sale at the current market value on the last day of the period reported. Dividends and
distributions, if any, are assumed for purposes of this calculation to be reinvested at prices obtained under
the Company’s dividend reinvestment plan. Total investment return does not reflect brokerage commissions.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our consolidated financial
statements and related notes and other financial information appearing elsewhere in this Annual Report on Form
10-K.
Except as otherwise specified, references to “we,” “us,” “our,” “Capitala,” or the “Company”, refer to
Capitala Finance Corp.
Forward-Looking Statements
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 and projections about the Company, our current and prospective portfolio investments,
our industry, our beliefs, and our assumptions. Words such as “anticipates,” “expects,” “intends,” “plans,” “will,”
“may,” “continue,” “believes,” “seeks,” “estimates,” “would,” “could,” “should,” “targets,” “projects,” and
variations of these words and similar expressions are intended to identify forward-looking statements.
Some of the statements in this Annual Report on Form 10-K constitute forward-looking statements, which
relate to future events or our performance or financial condition. The forward-looking statements contained in our
Annual Report on Form 10-K involve risks and uncertainties, including statements as to:
•
•
•
•
•
•
•
•
•
our future operating results;
our business prospects and the prospects of our portfolio companies;
the impact of investments that we expect to make;
our contractual arrangements and relationships with third parties;
the dependence of our future success on the general economy and its impact on the industries in which we
invest;
the ability of our portfolio companies to achieve their objectives;
our expected financings and investments;
the adequacy of our cash resources and working capital; and
the timing of cash flows, if any, from the operations of our portfolio companies.
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 and could cause actual results to differ
materially from those expressed or forecasted in the forward-looking statements, including without limitation:
•
•
•
•
an economic downturn could impair our portfolio companies’ ability to continue to operate or repay their
borrowings, which could lead to the loss of some or all of our investments in such portfolio companies;
a contraction of available credit and/or an inability to access the equity markets could impair our lending
and investment activities;
interest rate volatility could adversely affect our results, particularly if we use leverage as part of our
investment strategy; and
the risks, uncertainties and other factors we identify in “Risk Factors” and elsewhere in 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 inaccurate. Important assumptions include our ability
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to originate new loans and investments, certain margins and levels of profitability and the availability of
additional capital. 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. These risks and uncertainties include those described or identified in “Risk Factors”
and elsewhere in our Annual Report on Form 10-K. 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 revise or update any forward-looking statements, whether as a result of new information, future
events or otherwise, unless required by law or U.S. Securities and Exchange Commission (“SEC”) rule or
regulation.
Overview
We are a Maryland corporation that has elected to be regulated as a business development company
(“BDC”) under the Investment Company Act of 1940 as amended (the “1940 Act”). Our investment objective is
to generate both current income and capital appreciation through debt and equity investments. We are managed
by Capitala Investment Advisors, LLC (the “Investment Advisor”), and Capitala Advisors Corp. (the
“Administrator”) provides the administrative services necessary for us to operate.
We provide capital to lower and traditional middle-market companies in the United States (“U.S.”), with a
non-exclusive emphasis on the Southeast, Southwest, and Mid-Atlantic regions. We invest primarily in
companies with a history of earnings growth and positive cash flow, proven management teams, products or
services with competitive advantages and industry-appropriate margins. We primarily invest in companies with
between $4.5 million and $30.0 million in trailing twelve-month earnings before interest, tax, depreciation, and
amortization (“EBITDA”).
We invest in first lien loans, second lien loans and subordinated loans, and, to a lesser extent, equity
securities issued by lower middle-market companies and traditional middle-market companies.
As a BDC, we are required to comply with certain regulatory requirements. For instance, we generally must
invest at least 70% of our total assets in “qualifying assets,” including securities of private or thinly traded public
U.S. companies, cash, cash equivalents, U.S. government securities and high-quality debt investments that mature
in one year or less. In addition, we are only allowed to borrow money such that our asset coverage, as defined in
the 1940 Act, equals at least 150%, if certain requirements are met, after such borrowing, with certain limited
exceptions. On March 23, 2018, the Small Business Credit Availability Act (the “SBCA”) was signed into law,
which included various changes to regulations under the federal securities laws that impact BDCs. The SBCA
included changes to the 1940 Act to allow BDCs to decrease their asset coverage requirement from 200% to
150% (i.e. the amount of debt may not exceed 66.7% of the value of our total assets), if certain requirements are
met. On November 1, 2018, the Board, including a “required majority” (as such term is defined in Section 57(o)
of the 1940 Act) approved the application of the modified asset coverage. As a result, our asset coverage
requirements for senior securities changed from 200% to 150%, effective November 1, 2019. As of December 31,
2019, our asset coverage ratio was 216.5%. To maintain our regulated investment company (“RIC”) status, we
must meet specified source-of-income and asset diversification requirements. To maintain our RIC tax treatment
under subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”) for U.S. federal income tax
purposes, we must distribute at least 90% of our net ordinary income and realized net short-term capital gains in
excess of realized net long-term capital losses, if any, for the taxable year.
Corporate History
We commenced operations on May 24, 2013 and completed our initial public offering (“IPO”) on
September 30, 2013. The Company was formed for the purpose of (i) acquiring, through a series of transactions,
an investment portfolio from the following entities: CapitalSouth Partners Fund I Limited Partnership (“Fund I”);
CapitalSouth Partners Fund II Limited Partnership (“Fund II”); CapitalSouth Partners Fund III, L.P. (“Fund III
Parent”); CapitalSouth Partners SBIC Fund III, L.P. (“Fund III”) and CapitalSouth Partners Florida Sidecar
Fund I, L.P. (“Florida Sidecar” and, collectively with Fund I, Fund II, Fund III and Fund III Parent, the “Legacy
Funds”); (ii) raising capital in the IPO and (iii) continuing and expanding the business of the Legacy Funds by
making additional debt and equity investments in lower middle-market and traditional middle-market companies.
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On September 24, 2013, the Company acquired 100% of the limited partnership interests in Fund II,
Fund III and Florida Sidecar and each of their respective general partners, as well as certain assets from Fund I
and Fund III Parent, in exchange for an aggregate of 8,974,420 shares of the Company’s common stock (the
“Formation Transactions”). Fund II, Fund III and Florida Sidecar became the Company’s wholly owned
subsidiaries. Fund II and Fund III retained their SBIC licenses, and continued to hold their existing investments at
the time of IPO and have continued to make new investments after the IPO. The IPO consisted of the sale of
4,000,000 shares of the Company’s common stock at a price of $20.00 per share resulting in net proceeds to the
Company of $74.25 million, after deducting underwriting fees and commissions totaling $4.0 million and
offering expenses totaling $1.75 million. The other costs of the IPO were borne by the limited partners of the
Legacy Funds. During the fourth quarter of 2017, Florida Sidecar transferred all of its assets to the Company and
was legally dissolved as a standalone partnership. On March 1, 2019, Fund II repaid its outstanding SBA
debentures and relinquished its SBIC license.
At the time of the Formation Transactions, our portfolio consisted of: (1) approximately $326.3 million in
investments; (2) an aggregate of approximately $67.1 million in cash, interest receivable and other assets; and
(3) liabilities of approximately $202.2 million of U.S. Small Business Administration (“SBA”) guaranteed debt
payable. Fund III, our subsidiary, is licensed under the Small Business Investment Company (“SBIC”) Act and
has elected to be regulated as BDC under the 1940 Act. Fund II, our subsidiary, was licensed under the SBIC Act
until March 1, 2019 and has elected to be regulated as a BDC under the 1940 Act.
The Company has formed and expects to continue to form certain consolidated taxable subsidiaries (the
“Taxable Subsidiaries”), which are taxed as corporations for income tax purposes. The Taxable Subsidiaries
allow the Company to make equity investments in companies organized as pass-through entities while continuing
to satisfy the requirements of a RIC under the Code.
Basis of Presentation
The Company is considered an investment company as defined in Accounting Standards Codification
(“ASC”) Topic 946 — Financial Services — Investment Companies (“ASC 946”). The accompanying
consolidated financial statements have been prepared on the accrual basis of accounting in conformity with U.S.
generally accepted accounting principles (“U.S. GAAP”) and pursuant to the requirements for reporting on Form
10-K and Article 6 of Regulation S-X. The consolidated financial statements of the Company include the
accounts of the Company and its wholly owned subsidiaries.
The Company’s financial statements as of December 31, 2019 and 2018, and for the years ended
December 31, 2019, 2018, and 2017 are presented on a consolidated basis. The effects of all intercompany
transactions between the Company and its subsidiaries (Fund II, Fund III, and the Taxable Subsidiaries) have
been eliminated in consolidation. All financial data and information included in these consolidated financial
statements have been presented on the basis described above. In the opinion of management, the consolidated
financial statements reflect all adjustments that are necessary for the fair presentation of financial results as of
and for the periods presented.
Consolidation
As provided under ASC 946, the Company will generally not consolidate its investment in a company other
than an investment company subsidiary or a controlled operating company whose business consists of providing
services to the Company. Accordingly, the Company consolidated the results of the Company’s wholly owned
investment company subsidiaries (Fund II, Fund III, and the Taxable Subsidiaries) in its consolidated financial
statements. The Company does not consolidate its interest in Capitala Senior Loan Fund II, LLC (“CSLF II”)
because the investment is not considered a substantially wholly owned investment company subsidiary. Further,
CSLF II is a joint venture for which shared power exists relating to the decisions that most significantly impact
the economic performance of the entity. See Note 4 to the consolidated financial statements for a description of
the Company’s investment in CSLF II.
Revenues
We generate revenue primarily from the periodic cash interest we collect on our debt investments. In
addition, most of our debt investments offer the opportunity to participate in a borrower’s equity performance
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through warrant participation, direct equity ownership or otherwise, which we expect to result in revenue in the
form of dividends and/or capital gains. Further, we may generate revenue in the form of commitment, origination,
amendment, diligence fees, monitoring fees, fees for providing managerial assistance and possibly consulting
fees and performance-based fees. These fees will be recognized as they are earned.
Expenses
Our primary operating expenses include the payment of investment advisory fees to our Investment Advisor,
our allocable portion of overhead and other expenses incurred by our Administrator in performing its obligations
under an administration agreement between us and the Administrator (the “Administration Agreement”) and
other operating expenses as detailed below. Our investment advisory fee will compensate our Investment Advisor
for its work in identifying, evaluating, negotiating, closing, monitoring and servicing our investments. We will
bear all other expenses of our operations and transactions, including (without limitation):
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
the cost of our organization;
the cost of calculating our net asset value, including the cost of any third-party valuation services;
the cost of effecting sales and repurchases of our shares and other securities;
interest payable on debt, if any, to finance our investments;
fees payable to third parties relating to, or associated with, making investments (such as legal, accounting,
and travel expenses incurred in connection with making investments), including fees and expenses
associated with performing due diligence reviews of prospective investments and advisory fees;
transfer agent and custodial fees;
fees and expenses associated with marketing efforts;
costs associated with our reporting and compliance obligations under the 1940 Act, the Securities
Exchange Act of 1934, as amended (the “1934 Act”) other applicable federal and state securities laws and
ongoing stock exchange listing fees;
federal, state and local taxes;
independent directors’ fees and expenses;
brokerage commissions;
costs of proxy statements, stockholders’ reports and other communications with stockholders;
fidelity bond, directors’ and officers’ liability insurance, errors and omissions liability insurance and other
insurance premiums;
direct costs and expenses of administration, including printing, mailing, telephone and staff;
fees and expenses associated with independent audits and outside legal costs; and
all other expenses incurred by either our Administrator or us in connection with administering our
business, including payments under the Administration Agreement that will be based upon our allocable
portion of overhead and other expenses incurred by our Administrator in performing its obligations under
the Administration Agreement, including rent, the fees and expenses associated with performing
compliance functions, and our allocable portion of any costs of compensation and related expenses of our
chief compliance officer, our chief financial officer, and their respective administrative support staff.
Critical Accounting Policies and Use of Estimates
In the preparation of our consolidated financial statements and related disclosures, we have adopted various
accounting policies that govern the application of U.S. GAAP. Our significant accounting policies are described
in Note 2 to the consolidated financial statements. While all of these policies are important to understanding our
consolidated financial statements, certain accounting policies and estimates are considered
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critical due to their impact on the reported amounts of assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses for the periods covered by such financial statements. We have
identified investment valuation, revenue recognition, and income taxes as our most critical accounting estimates.
We continuously evaluate our estimates, including those related to the matters described below. Because of the
nature of the judgments and assumptions we make, actual results could materially differ from those estimates
under different assumptions or conditions. A discussion of our critical accounting policies follows.
Valuation of Investments
The Company applies fair value accounting to all of its financial instruments in accordance with the 1940
Act and ASC Topic 820 — Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 defines fair value,
establishes a framework used to measure fair value and requires disclosures for fair value measurements. In
accordance with ASC 820, the Company has categorized its financial instruments carried at fair value, based on
the priority of the valuation technique, into a three-level fair value hierarchy as discussed in Note 4 to our
consolidated financial statements.
In determining fair value, our board of directors (the “Board”) uses various valuation approaches, and
engages a third-party independent valuation firm, which provides positive assurance on the investments it
reviews. In accordance with U.S. GAAP, a fair value hierarchy for inputs is used in measuring fair value that
maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most
observable inputs be used when available.
Observable inputs are those that market participants would use in pricing the asset or liability based on
market data obtained from sources independent of the Board. Unobservable inputs reflect the Board’s
assumptions about the inputs market participants would use in pricing the asset or liability developed based upon
the best information available in the circumstances. The fair value hierarchy is categorized into three levels based
on the inputs as follows:
Level 1 — Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities
that the Company has the ability to access. Valuation adjustments and block discounts are not applied to
Level 1 securities. Since valuations are based on quoted prices that are readily and regularly available in an
active market, valuation of these securities does not entail a significant degree of judgment.
Level 2 — Valuations based on quoted prices in markets that are not active or for which all significant inputs
are observable, either directly or indirectly.
Level 3 — Valuations based on inputs that are unobservable and significant to the overall fair value
measurement.
The availability of valuation techniques and observable inputs can vary from security to security and is
affected by a wide variety of factors including the type of security, whether the security is new and not yet
established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation
is based on models or inputs that are less observable or unobservable in the market, the determination of fair
value requires more judgment. Those estimated values do not necessarily represent the amounts that may be
ultimately realized due to the occurrence of future circumstances that cannot be reasonably determined. Because
of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values
that would have been used had a market for the securities existed. Accordingly, the degree of judgment exercised
by the Company in determining fair value is greatest for securities categorized in Level 3. In certain cases, the
inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for
disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety
falls is determined based on the lowest level input that is significant to the fair value measurement.
Fair value is a market-based measure considered from the perspective of a market participant rather than an
entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own
assumptions are set to reflect those that market participants would use in pricing the asset or liability at the
measurement date. We use prices and inputs that are current as of the measurement date, including periods
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of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for
many securities. This condition could cause a security to be reclassified to a lower level within the fair value
hierarchy.
In estimating the fair value of portfolio investments, the Company starts with the cost basis of the
investment, which includes original issue discount and payment-in-kind (“PIK”) income, if any. The transaction
price is typically the best estimate of fair value at inception. When evidence supports a subsequent change to the
carrying value from the original transaction price, adjustments are made to reflect the expected fair values.
As a practical expedient, the Company uses net asset value (“NAV”) as the fair value for its equity
investment in CSLF II. CSLF II records its underlying investments at fair value on a quarterly basis in
accordance with the 1940 Act and ASC 820.
Valuation Techniques
Enterprise Value Waterfall Approach
The enterprise value waterfall approach determines an enterprise value based on EBITDA multiples of
publicly traded companies that are considered similar to the subject portfolio company. The Company considers a
variety of items in determining a reasonable pricing multiple, including, but not limited to, operating results,
budgeted projections, growth, size, risk, profitability, leverage, management depth, diversification, market
position, supplier or customer dependence, asset utilization, liquidity metrics, and access to capital markets.
EBITDA of the portfolio company is adjusted for non-recurring items in order to reflect a normalized level of
earnings that is representative of future earnings. In certain instances, the Company may also utilize revenue
multiples to determine enterprise value. When available, the Company may assign a pricing multiple or value its
investments based on the value of recent investment transactions in the subject portfolio company or offers to
purchase the portfolio company. The enterprise value is adjusted for financial instruments with seniority to the
Company’s ownership and for the effect of any instrument which may dilute the Company’s investment in the
portfolio company. The adjusted enterprise value is then apportioned based on the seniority and privileges of the
Company’s investments within the portfolio company.
Income Approach
The income approach utilizes a discounted cash flow methodology in which the Company estimates fair
value based on the present value of expected cash flows discounted at a market rate of interest. The determination
of a discount rate, or required rate of return, takes into account the portfolio company’s fundamentals and
perceived credit risk. Because the majority of the Company’s portfolio companies do not have a public credit
rating, determining a discount rate often involves assigning an implied credit rating based on the portfolio
company’s operating metrics compared to average metrics of similar publicly rated debt. Operating metrics
include, but are not limited to, EBITDA, interest coverage, leverage ratio, return on capital, and debt to equity
ratios. The implied credit rating is used to assign a base discount rate range based on publicly available yields on
similarly rated debt securities. The Company may apply a premium to the discount rate utilized in determining
fair value when performance metrics and other qualitative information indicate that there is an additional level of
uncertainty about collectability of cash flows.
Asset Approach
The asset approach values an investment based on the value of the underlying collateral securing the
investment.
Revenue Recognition
The Company’s revenue recognition policies are as follows:
Interest income and paid-in-kind interest income: Interest income is recorded on the accrual basis to the
extent that such amounts are expected to be collected. The Company has loans in the portfolio that contain a PIK
interest provision. The PIK interest, which represents contractually deferred interest added to the loan
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balance that is generally due at maturity, is recorded on the accrual basis to the extent that such amounts are
expected to be collected. PIK interest is not accrued if the Company does not expect the issuer to be able to pay
all principal and interest when due.
Non-accrual investments: Management reviews all loans that become 90 days or more past due, or when
there is reasonable doubt that principal or interest will be collected, for possible placement on non-accrual status.
When the Company otherwise does not expect the borrower to be able to service its debt and other obligations,
the Company will place the loan on non-accrual status and will generally cease recognizing interest income and
PIK interest on that loan for financial reporting purposes. Interest payments received on non-accrual loans may
be recognized as income or applied to principal depending upon management’s judgment. The Company writes
off any previously accrued and uncollected cash interest when it is determined that interest is no longer
considered collectible. The Company may elect to cease accruing PIK interest and continue accruing interest
income in cases where a loan is currently paying its interest but, in management’s judgment, there is a reasonable
likelihood of principal loss on the loan. Non- accrual loans are returned to accrual status when the borrower’s
financial condition improves such that management believes current interest and principal payments are expected
to be collected.
Gains and losses on investment sales and paydowns: Realized gains and losses on investments are
recognized using the specific identification method.
Dividend income and paid-in-kind dividends: Dividend income is recognized on the date dividends are
declared. The Company holds preferred equity investments in the portfolio that contain a PIK dividend provision.
PIK dividends, which represent contractually deferred dividends added to the equity balance, are recorded on the
accrual basis to the extent that such amounts are expected to be collected. The Company will typically cease
accrual of PIK dividends when the fair value of the equity investment is less than the cost basis of the investment
or when it is otherwise determined by management that PIK dividends are unlikely to be collected. If
management determines that a decline in fair value is temporary in nature and the PIK dividends are more likely
than not to be collected, management may elect to continue accruing PIK dividends.
Original issue discount: Discounts received to par on loans purchased are capitalized and accreted into
income over the life of the loan. Any remaining discount is accreted into income upon prepayment of the loan.
Other income: Origination fees (to the extent services are performed to earn such income), amendment
fees, consent fees, and other fees associated with investments in portfolio companies are recognized as income
when the investment transaction closes. Prepayment penalties received by the Company for debt instruments
repaid prior to the maturity date are recorded as income upon receipt.
Income Taxes
Prior to the Formation Transactions, the Legacy Funds were treated as partnerships for U.S. federal, state
and local income tax purposes and, therefore, no provision has been made in the accompanying consolidated
financial statements for federal, state or local income taxes. In accordance with the partnership tax law
requirements, each partner would include their respective components of the Legacy Funds’ taxable profits or
losses, as shown on their Schedule K-1 in their respective tax or information returns. The Legacy Funds are
disregarded entities for tax purposes prior to and post the Formation Transactions.
The Company has elected to be treated for U.S. federal income tax purposes and intends to comply with the
requirement to qualify annually as a RIC under subchapter M of the Code and, among other things, intends to
make the requisite distributions to its stockholders which will relieve the Company from U.S. federal income
taxes.
In order to qualify as a RIC, among other requirements, the Company is required to timely distribute to its
stockholders at least 90.0% of its investment company taxable income, as defined by the Code, for each fiscal tax
year. The Company will be subject to a nondeductible U.S. federal excise tax of 4.0% on undistributed income if
it does not distribute at least 98.0% of its ordinary income in any calendar year and 98.2% of its capital gain net
income for each one-year period ending on October 31.
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Depending on the level of taxable income earned in an excise tax year, the Company may choose to carry
forward taxable income in excess of current year dividend distributions into the next excise tax year and pay a
4.0% excise tax on such income, as required. To the extent that the Company determines that its estimated current
year annual taxable income will be in excess of estimated current year dividend distributions for excise tax
purposes, the Company accrues excise tax, if any, on estimated excess taxable income as taxable income is
earned. Since the Company’s IPO, the Company has not accrued or paid excise tax.
In 2017, the Company elected to amend its tax year end from August 31 to December 31 and filed a tax
return for the four months ended December 31, 2017.
The tax periods ended December 31, 2019, December 31, 2018, December 31, 2017, and August 31, 2017,
remain subject to examination by U.S. federal, state, and local tax authorities. No interest expense or penalties
have been assessed for the years ended December 31, 2019 and 2018. If the Company was required to recognize
interest and penalties, if any, related to unrecognized tax benefits this would be recognized as income tax expense
in the consolidated statements of operations.
The Company’s Taxable Subsidiaries record deferred tax assets or liabilities related to temporary book
versus tax differences on the income or loss generated by the underlying equity investments held by the Taxable
Subsidiaries. As of December 31, 2019 and 2018, the Company recorded a net deferred tax asset of $0.0 and
$0.6 million, respectively. For the years ended December 31, 2019 and 2018, the Company recorded a deferred
tax benefit (provision) of $(0.6) million and $1.9 million, respectively. As of December 31, 2019 and 2018, the
valuation allowance on the Company’s deferred tax asset was $3.2 million and $0.4 million, respectively. During
the years ended December 31, 2019 and December 31, 2018, the Company recognized an increase in the
valuation allowance of $2.8 million and $0.0 million, respectively.
In accordance with certain applicable U.S. treasury regulations and private letter rulings issued by the
Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution
requirements if each stockholder may elect to receive its entire distribution in either cash or stock of the RIC,
subject to a limitation on the aggregate amount of cash to be distributed to all stockholders, which limitation must
be at least 20.0% of the aggregate declared distribution. If too many stockholders elect to receive cash, each
stockholder electing to receive cash will receive a pro rata amount of cash (with the balance of the distribution
paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20.0% of its entire
distribution in cash. If these and certain other requirements are met, for U.S. federal income tax purposes, the
amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of
stock.
ASC Topic 740 — Income Taxes (“ASC 740”), provides guidance for how uncertain tax positions should be
recognized, measured, presented and disclosed in the consolidated financial statements. ASC 740 requires the
evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to
determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority.
Tax positions deemed to meet a “more-likely-than-not” threshold would be recorded as a tax benefit or expense in
the current period. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits as
income tax expense in the consolidated statements of operations. As of December 31, 2019 and 2018, there were
no uncertain tax positions.
The Company is required to determine whether a tax position of the Company is more likely-than-not to be
sustained upon examination by the applicable taxing authority, including resolution of any related appeals or
litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as
the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement.
De-recognition of a tax benefit previously recognized could result in the Company recording a tax liability that
could negatively impact the Company’s net assets.
U.S. GAAP provides guidance on thresholds, measurement, de-recognition, classification, interest and
penalties, accounting in interim periods, disclosure, and transition that is intended to provide better financial
statement comparability among different entities.
The Company has concluded that it was not necessary to record a liability for any such tax positions as of
December 31, 2019 or 2018. However, the Company’s conclusions regarding this policy may be subject to
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review and adjustment at a later date based on factors including, but not limited to, ongoing analyses of, and
changes to, tax laws, regulations and interpretations thereof.
Portfolio and Investment Activity
The Company’s investment objective is to generate both current income and capital appreciation through
debt and equity investments. The Company offers customized financing to business owners, management teams
and financial sponsors for change of ownership transactions, recapitalizations, strategic acquisitions, business
expansion and other growth initiatives. The Company invests in first lien loans, second lien loans, and
subordinated loans and, to a lesser extent, equity securities issued by lower middle-market companies and
traditional middle-market companies. As of December 31, 2019, our portfolio consisted of investments in 43
portfolio companies with a fair value of approximately $362.5 million.
Most of the Company’s debt investments are structured as first lien loans. First lien loans may contain some
minimum amount of principal amortization, excess cash flow sweep feature, prepayment penalties, or any
combination of the foregoing. First lien loans are secured by a first priority lien in existing and future assets of
the borrower and may take the form of term loans, delayed draw facilities, or revolving credit facilities.
Unitranche debt, a form of first lien loan, typically involves issuing one debt security that blends the risk and
return profiles of both senior secured and subordinated debt in one debt security, bifurcating the loan into a first-
out tranche and last-out tranche. As of December 31, 2019, 18.1% of the fair value of our first lien loans
consisted of last-out loans. As of December 31, 2018, 13.7% of the fair value of our first lien loans consisted of
last-out loans. In some cases, first lien loans may be subordinated, solely with respect to the payment of cash
interest, to an asset based revolving credit facility.
The Company also invests in debt instruments structured as second lien loans. Second lien loans are loans
which have a second priority security interest in all or substantially all of the borrower’s assets, and which are not
subject to the blockage of cash interest payments to the Company at the first lien lender’s discretion.
In addition to first and second lien loans, the Company may also invest in subordinated loans. Subordinated
loans typically have a second lien on all or substantially all of the borrower’s assets, but unlike second lien loans,
may be subject to the interruption of cash interest payments upon certain events of default, at the discretion of the
first lien lender.
During the year ended December 31, 2019, we made approximately $77.8 million of investments and had
approximately $128.1 million in repayments and sales of investments resulting in net repayments and sales of
approximately $50.3 million for the year. During the year ended December 31, 2018, we made approximately
$107.8 million of investments and had approximately $123.5 million in repayments and sales resulting in net
repayments and sales of approximately $15.7 million for the year.
On August 31, 2016, we sold a portion of 14 securities across 10 portfolio companies to CapitalSouth
Partners Florida Sidecar Fund II, L.P. (“FSC II”), including granting an option to acquire a portion of our equity
investment in Eastport Holdings, LLC (the “Written Call Option”), in exchange for 100% of the partnership
interests in FSC II. Concurrent with the sale of these assets to FSC II, we received cash consideration of
$47.6 million from an affiliated third-party purchaser in exchange for 100% of the partnership interests of FSC II.
These assets were sold to FSC II at their June 30, 2016 fair market values, resulting in a net realized gain of
$0.1 million. Our Board pre-approved this transaction pursuant to Section 57(f) of the 1940 Act.
The Company collected and will periodically collect principal and interest payments related to certain of the
securities purchased by FSC II. Such principal and interest payments will be remitted timely to FSC II based on
its proportionate share of the security. FSC II does not have any recourse to the Company related to the non-
payment of principal or interest by the underlying issuers of the securities.
The Written Call Option granted FSC II the right to purchase up to 31.25% of our equity investment in
Eastport Holdings, LLC. The Written Call Option had a strike price of $1.5 million and a termination date of
August 31, 2018. On August 27, 2018, FSC II exercised its option at a strike price of $1.5 million.
As of December 31, 2019, our debt investment portfolio, which represented 78.6% of the fair value of our
total portfolio, had a weighted average annualized yield of approximately 11.5%. As of December 31, 2019,
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37.2% of the fair value of our debt investment portfolio was bearing a fixed rate of interest. As of December 31,
2018, our debt investment portfolio, which represented 76.4% of the fair value of our total portfolio, had a
weighted average annualized yield of approximately 11.9%. As of December 31, 2018, 41.4% of the fair value of
our debt investment portfolio was bearing a fixed rate of interest.
The weighted average annualized yield is calculated based on the effective interest rate as of period end,
divided by the fair value of our debt investments. The weighted average annualized yield of our debt investments
is not the same as a return on investment for our stockholders but, rather, relates to a portion of our investment
portfolio and is calculated before the payment of all of our fees and expenses. There can be no assurance that the
weighted average annualized yield will remain at its current level.
The following table summarizes the amortized cost and the fair value of investments as of December 31,
2019 (dollars in thousands):
First Lien Debt
Second Lien Debt
Subordinated Debt
Equity and Warrants
Capitala Senior Loan Fund II, LLC
Total
$235,646
17,553
36,526
50,556
13,600
$353,881
Investments
at
Amortized Cost
Percentage of
Total
Investments
at
Fair Value
$ 231,203
17,287
36,570
63,841
13,631
Percentage of
Total
%
63.8
4.7
10.1
17.6
3.8
%
66.6
5.0
10.3
14.3
3.8
100.0
%
$ 362,532
100.0
%
The following table summarizes the amortized cost and the fair value of investments as of December 31,
2018 (dollars in thousands):
Investments
at
Amortized Cost
Percentage of
Total
Investments
at
Fair Value
$ 237,570
32,495
73,113
92,054
13,695
Percentage of
Total
%
52.9
7.2
16.3
20.5
3.1
%
60.0
7.9
17.3
11.6
3.2
100.0
%
$ 448,927
100.0
%
First Lien Debt
Second Lien Debt
Subordinated Debt
Equity and Warrants
Capitala Senior Loan Fund II, LLC
Total
$252,174
33,040
72,562
48,594
13,600
$419,970
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The following table shows the portfolio composition by industry grouping at fair value as of December 31,
2019 and 2018 (dollars in thousands):
December 31, 2019
December 31, 2018
Investments at
Fair Value
Percentage of
Total Portfolio
Investments at
Fair Value
Percentage of
Total Portfolio
Business Services
Financial Services
Healthcare
Consumer Products
Sales & Marketing Services
Food Product Manufacturer
Security System Services
Automobile Part Manufacturer
IT Consulting
Investment Funds
Multi-platform media and consumer products
Healthcare Management
Textile Equipment Manufacturer
Government Services
Entertainment
Retail
Information Technology
Testing laboratories
Wireless Deployment Services
Electronic Machine Repair
Oil & Gas Engineering and Consulting Services
Medical Device Distributor
Data Services
Restaurant
Advertising & Marketing Services
Footwear Retail
Logistics
Online Merchandise Retailer
Home Repair Parts Manufacturer
Oil & Gas Services
QSR Franchisor
Computer Supply Retail
General Industrial
Household Product Manufacturer
Data Processing & Digital Marketing
Professional and Personal Digital Imaging
Telecommunications
Industrial Equipment Rental
Building Products
Conglomerate
Produce Distribution
Farming
Total
%
11.2
8.1
7.7
6.9
5.3
4.9
4.4
4.2
3.8
3.8
3.6
3.5
3.2
3.1
3.0
2.8
2.8
1.9
1.9
1.7
1.6
1.4
1.3
1.3
1.2
0.9
0.8
0.8
0.7
0.6
0.5
0.4
0.2
0.2
0.2
0.1
—
—
—
—
—
—
$ 57,946
21,666
16,972
27,746
19,496
17,335
—
14,384
15,233
13,695
13,000
13,792
12,848
12,109
—
14,979
25,232
7,503
—
6,432
6,854
4,797
—
4,903
8,712
3,184
2,984
3,499
1,722
9,861
3,018
10,597
—
758
742
6,674
18,000
16,327
14,833
9,004
6,210
5,880
%
12.9
4.8
3.8
6.2
4.3
3.9
—
3.2
3.4
3.0
2.9
3.1
2.8
2.7
—
3.3
5.6
1.7
—
1.4
1.5
1.1
—
1.1
1.9
0.7
0.7
0.8
0.4
2.2
0.7
2.4
—
0.2
0.2
1.5
4.0
3.6
3.3
2.0
1.4
1.3
100.0
%
$ 448,927
100.0
%
$ 40,410
29,517
27,928
25,118
19,291
17,609
16,063
15,056
13,773
13,631
13,000
12,607
11,564
11,279
10,912
10,045
10,009
7,026
7,000
6,100
5,908
4,904
4,749
4,697
4,262
3,326
2,924
2,877
2,489
2,273
1,881
1,490
838
758
708
510
—
—
—
—
—
—
$ 362,532
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With the exception of the international investment holdings noted below, all investments made by the
Company as of December 31, 2019 and 2018 were made in portfolio companies located in the U.S. The
geographic composition is determined by the location of the corporate headquarters of the portfolio company,
which may not be indicative of the primary source of the portfolio company’s business. The following table
shows the portfolio composition by geographic region at fair value as of December 31, 2019 and 2018 (dollars in
thousands):
South
Northeast
West
Midwest
International
Total
December 31, 2019
December 31, 2018
Investments at
Fair Value
Percentage of
Total Portfolio
Investments at
Fair Value
Percentage of
Total Portfolio
$ 165,963
71,184
70,102
55,283
—
$ 362,532
%
45.8
19.6
19.3
15.3
—
100.0
%
$ 224,856
66,303
77,353
77,537
2,878
$ 448,927
%
50.1
14.8
17.2
17.3
0.6
100.0
%
In addition to various risk management tools, our Investment Advisor uses an investment rating system to
characterize and monitor our expected level of return on each investment in our portfolio.
As part of our valuation procedures, we risk rate all of our investments. In general, our investment rating
system uses a scale of 1 to 5, with 1 being the lowest probability of default and principal loss. Our internal rating
is not an exact system, but it is used internally to estimate the probability of: (i) default on our debt securities and
(ii) loss of our debt principal, in the event of a default. In general, our internal rating system may also assist our
valuation team in its determination of the estimated fair value of equity securities or equity-like securities. Our
internal risk rating system generally encompasses both qualitative and quantitative aspects of our portfolio
companies.
Our internal investment rating system incorporates the following five categories:
Investment
Rating
Definition
1
2
3
4
5
In general, the investment may be performing above our internal expectations. Full
return of principal and interest is expected. Capital gain is expected.
In general, the investment may be performing within our internal expectations, and
potential risks to the applicable investment are considered to be neutral or favorable
compared to any potential risks at the time of the original investment. All new
investments are initially given this rating.
In general, the investment may be performing below our internal expectations and
therefore, investments in this category may require closer internal monitoring;
however, the valuation team believes that no loss of investment return (interest and/or
dividends) or principal is expected. The investment also may be out of compliance
with certain financial covenants.
In general, the investment may be performing below internal expectations and
quantitative or qualitative risks may have increased substantially since the original
investment. Loss of some or all principal is expected.
In general, the investment may be performing substantially below our internal
expectations and a number of quantitative or qualitative risks may have increased
substantially since the original investment. Loss of some or all principal is expected.
Our Investment Advisor will monitor and, when appropriate, change the investment ratings assigned to each
investment in our portfolio. In connection with our valuation process, our Investment Advisor will review these
investment ratings on a quarterly basis. The investment rating of a particular investment should not, however, be
deemed to be a guarantee of the investment’s future performance.
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The following table shows the distribution of our investments on the 1 to 5 investment rating scale at fair
value as of December 31, 2019 and 2018 (dollars in thousands):
Investment Rating
1
2
3
4
5
Total
As of December 31, 2019
As of December 31, 2018
Investments at
Fair Value
Percentage of
Total
Investments
Investments at
Fair Value
Percentage of
Total
Investments
$ 85,688
219,855
56,989
—
—
$ 362,532
%
23.6
60.7
15.7
—
—
$ 171,829
194,411
73,325
9,362
—
%
38.3
43.3
16.3
2.1
—
100.0
%
$ 448,927
100.0
%
As of December 31, 2019, we had no investments on non-accrual status. As of December 31, 2018, we had
two debt investments on non-accrual status with an aggregate amortized cost of $20.7 million and an aggregate
fair value of $9.4 million, which represented 4.9% and 2.1% of the investment portfolio, respectively.
Capitala Senior Loan Fund II, LLC
On December 20, 2018, Capitala and Trinity Universal Insurance Company (“Trinity”), a subsidiary of
Kemper Corporation, entered into a limited liability company agreement (the “LLC Agreement”) to co-manage
Capitala Senior Loan Fund II, LLC (“CSLF II”). The purpose and design of the joint venture is to invest
primarily in senior secured first-out loans. Capitala and Trinity have committed to provide $25.0 million of equity
to CSLF II, with Capitala providing $20.0 million and Trinity providing $5.0 million. Capitala and Trinity each
appointed two members to CSLF II’s four-person board of directors and investment committee. All material
decisions with respect to CSLF II, including those involving its investment portfolio, require approval of a
member on the board of directors and investment committee of at least one member representing Capitala and
Trinity, respectively.
As of December 31, 2019 and 2018, $13.6 million and $3.4 million in equity capital had been contributed by
Capitala and Trinity, respectively. As of December 31, 2019 and 2018, the Company and Trinity had $6.4 million
and $1.6 million of unfunded equity capital commitments outstanding, respectively. The Company’s equity
investment in CSLF II is not redeemable.
For the year ended December 31, 2019 and December 31, 2018, the Company received $1.0 million and
$0.0, respectively, in dividend income from its equity interest in CSLF II.
On September 3, 2019, CSLF II entered into a senior secured revolving credit facility (the “CSLF II Credit
Facility”) with KeyBank Specialty Finance Lending, an affiliate of KeyCorp. The CSLF II Credit Facility
currently provides for borrowings up to $60.0 million, subject to certain borrowing base restrictions. Borrowings
under the CSLF II Credit Facility bear interest at a rate of 1-month LIBOR + 2.25%. Beginning the quarter ended
March 31, 2020, CSLF II will incur unused fees of .35% when utilization of the CSLF II Credit Facility exceeds
50% and .65% when utilization of the CSLF II Credit Facility is less than 50%. The CSLF II Credit Facility
matures on September 2, 2024.
As of December 31, 2019, $12.7 million was outstanding under the CSLF II Credit Facility. For the year
ended December 31, 2019, CSLF II incurred $0.2 million of interest and financing expenses.
On September 3, 2019, Capitala and Trinity committed to provide $25.0 million of subordinated debt (the
“Subordinated Notes”) to CSLF II, with Capitala providing $5.0 million and Trinity providing $20.0 million. The
Subordinated Notes currently bear interest at a rate of 1-month LIBOR + 5.00%. Beginning the quarter ended
June 30, 2020, the Subordinated Notes will bear interest at a rate of 1-month LIBOR + 6.00%. The Subordinated
Notes mature on September 3, 2024.
As of December 31, 2019, $0.0 was outstanding on the Subordinated Notes. As of December 31, 2019, the
Company and Trinity had $5.0 million and $20.0 million of unfunded commitments related to the
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Subordinated Notes, respectively. For the year ended December 31, 2019, the Company did not incur any interest
and financing expenses related to the Subordinated Notes.
Below is a summary of CSLF II’s portfolio as of December 31, 2019 and 2018 (dollars in thousands):
First lien loans
(1)
Weighted average current interest rate on first lien loans
Number of portfolio companies
Largest portfolio company investment
(1)
Total of five largest portfolio company investments
(1)(2)
(1)
Based on principal amount outstanding at year end.
(2)
Only two investments held as of December 31, 2018.
December 31, 2019
December 31, 2018
%
$28,396
6.4
5
$ 7,443
$28,396
%
$10,000
7.6
2
$ 5,550
$10,000
Below is CSLF II’s schedule of investments as of December 31, 2019 (dollars in thousands):
Portfolio Company
Industry
Type of Investment
Principal
Amount
Cost
Fair
Value
Investments at Fair Value
Freedom Electronics, LLC
Electronics
Installs, LLC
Logistics
RAM Payment, LLC
Rapid Fire Protection, Inc.
(1)
U.S. BioTek Laboratories, LLC
TOTAL INVESTMENTS
Financial
Services
Security
System
Services
Testing
Laboratories
First Lien Debt (7.0%
Cash (1 month LIBOR +
5.0%, 2.0% Floor),
Due 12/20/23)
First Lien Debt (5.8%
Cash (1 month LIBOR +
4.0%, 1.8% Floor),
Due 6/20/23)
First Lien Debt (6.7%
Cash (1 month LIBOR +
5.0%, 1.5% Floor),
Due 1/4/24)
First Lien Debt (5.5%
Cash (1 month LIBOR +
3.8%, 1.8% Floor),
Due 11/22/24)
First Lien Debt (7.0%
Cash (3 month LIBOR +
5.0%, 2.0% Floor),
Due 12/14/23)
(1)
The investment has a $3.0 million unfunded commitment.
$ 5,445
$ 5,445
$ 5,445
7,443
7,443
7,443
6,653
6,653
6,653
4,400
4,400
4,400
4,455
4,455
4,455
$28,396
$28,396
$28,396
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Below is CSLF II’s schedule of investments as of December 31, 2018 (dollars in thousands):
Portfolio Company
Industry
Type of Investment
Principal
Amount
Cost
Fair Value
Investments at Fair Value
Freedom Electronics, LLC
Electronics
U.S. BioTek Laboratories, LLC
Testing
Laboratories
TOTAL INVESTMENTS
First Lien Debt (7.5%
Cash (1 month LIBOR +
5.0%, 2.0% Floor),
Due 12/20/23)
First Lien Debt (7.8%
Cash (3 month LIBOR +
5.0%, 2.0% Floor),
Due 12/14/23)
$ 5,500
$ 5,500
$ 5,500
4,500
4,500
4,500
$10,000
$10,000
$10,000
Below are the statements of assets and liabilities for CSLF II as of December 31, 2019 and 2018 (dollars in
thousands):
December 31, 2019
December 31, 2018
ASSETS
Investments at fair value (amortized cost of $28,396 and $10,000,
respectively)
Cash and cash equivalents
Interest receivable
Other assets
Total assets
LIABILITIES
Credit facility (net of deferred financing costs of $621 and $0,
respectively)
Interest and financing fees payable
Accounts payable
Total liabilities
NET ASSETS
Members’ capital
Total net assets
$28,396
$10,000
704
151
7
7,100
31
—
$29,258
$17,131
$12,079
$ —
113
27
$12,219
$
—
12
12
$17,039
$17,039
$17,119
$17,119
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Below are the statements of operations for CSLF II (dollars in thousands):
INVESTMENT INCOME
Interest income
Fee income
Total investment income
EXPENSES
Interest and financing expenses
General and administrative expenses
Total expenses
NET INVESTMENT INCOME
NET INCREASE IN NET ASSETS RESULTING FROM
OPERATIONS
Results of Operations
For the period from
December 20, 2018
(commencement of
operations) to
December 31, 2018
For the Year Ended
December 31, 2019
$1,372
175
$1,547
$ 151
176
$ 327
$1,220
$1,220
$ 31
100
$ 131
$ —
12
$ 12
$ 119
$ 119
Our operating results for the years ended December 31, 2019 and 2018 were as follows (dollars in
thousands):
Total investment income
Total expenses, net of incentive fee waiver
Net investment income
Net realized loss on investments
Net unrealized depreciation on investments
Net unrealized appreciation on Written Call Option
Tax benefit (provision)
For the Years Ended December 31,
2019
$ 44,035
30,992
13,043
(19,756
(20,306
—
(628
)
)
)
2018
$ 47,293
31,271
)
)
16,022
(34,804
(5,955
6,795
1,916
Net decrease in net assets resulting from operations
$(27,647
)
$(16,026
)
Investment income
The composition of our investment income for the years ended December 31, 2019 and 2018 was as follows
(dollars in thousands):
Interest income
Fee income
Payment-in-kind interest and dividend income
Dividend income
Interest from cash and cash equivalents
Total investment income
For the Years Ended December 31,
2019
$36,106
1,470
2,962
3,299
198
$44,035
2018
$ 40,357
2,044
4,348
397
147
$ 47,293
The income reported as interest income and PIK interest and PIK dividend income is generally based on the
stated rates as disclosed in our consolidated schedules of investments. Accretion of discounts received for
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purchased loans are included in interest income as an adjustment to yield. As a general rule, our interest income,
PIK interest and PIK dividend income are recurring in nature.
We also generate fee income primarily through origination fees charged for new investments, and
secondarily via amendment fees, consent fees, prepayment penalties, and other fees. While fee income is
typically non-recurring for each investment, most of our new investments include an origination fee; as such, fee
income is dependent upon our volume of directly originated investments and the fee structure associated with
those investments.
We earn dividends on certain equity investments within our investment portfolio. As noted in our
consolidated schedules of investments, some investments are scheduled to pay a periodic dividend, though these
recurring dividends do not make up a significant portion of our total investment income. We may, and have
received, more substantial one-time dividends from our equity investments.
For the year ended December 31, 2019, total investment income decreased by $3.3 million, or 6.9%,
compared to the year ended December 31, 2018. The decrease from the prior year was driven primarily by a
decrease in interest income, from $40.4 million for the year ended December 31, 2018 to $36.1 million for the
year ended December 31, 2019. The decline in interest income was due to a decline in the overall debt portfolio
and a decline in the weighted average yield of the portfolio. PIK income declined from $4.3 million for the year
ended December 31, 2018, to $3.0 million for the year ended December 31, 2019. The decrease in PIK income
was due to a decline in investments with a contractual PIK rate. For the year ended December 31, 2019, we
generated $1.2 million in origination fees from new deployments and $0.3 million in other fees. Comparatively,
for the year ended December 31, 2018, we generated $1.7 million in origination fees from new deployments and
$0.3 million in other fees. Dividend income increased from $0.4 million for the year ended December 31, 2018 to
$3.3 million for the year ended December 31, 2019, due to $1.0 million in dividends from CSLF II and several
one-time dividends received from portfolio companies.
Operating expenses
The composition of our expenses for the years ended December 31, 2019 and 2018 was as follows (dollars
in thousands):
Interest and financing expenses
Base management fee
Incentive fees, net of incentive fee waiver
General and administrative expenses
Total expenses, net of incentive fee waiver
For the Years Ended December 31,
2019
$17,121
7,967
1,209
4,695
$30,992
2018
$ 17,283
9,049
244
4,695
$ 31,271
For the year ended December 31, 2019, operating expenses decreased by $0.3 million, or 0.9%, compared to
the year ended December 31, 2018. Interest and financing expenses declined from $17.3 million for the year
ended December 31, 2018 to $17.1 million for the year ended December 31, 2019 due primarily to lower average
debt outstanding during the period. Our base management fee declined from $9.0 million for the year ended
December 31, 2018 to $8.0 million for the year ended December 31, 2019 due to lower average assets under
management. Incentive fees, net of incentive fee waiver, increased from $0.2 million to $1.2 million primarily
due to better net investment income returns in relation to our net asset value. General and administrative expenses
were $4.7 million for the year ended December 31, 2019 and December 31, 2018.
Net realized gains (losses) on sales of investments
During the years ended December 31, 2019 and 2018, we recognized $(19.8) million and $(34.8) million of
net realized losses on our portfolio investments, respectively.
Net unrealized appreciation (depreciation) on investments
Net change in unrealized appreciation (depreciation) on investments reflects the net change in the fair value
of our investment portfolio. For the years ended December 31, 2019 and 2018, we had $(20.3) million and $(6.0)
million of unrealized depreciation on investments, respectively.
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Net unrealized appreciation on Written Call option
For the years ended December 31, 2019 and 2018, we had net unrealized appreciation on the Written Call
Option of $0.0 and $6.8 million, respectively.
Tax benefit (provision)
For the years ended December 31, 2019 and 2018, we recorded a tax benefit (provision) of $(0.6) million
and $1.9 million, respectively.
Changes in net assets resulting from operations
For the years ended December 31, 2019 and 2018, we recorded a net decrease in net assets resulting from
operations of $(27.6) million and $(16.0) million, respectively. Based on the weighted average shares of common
stock outstanding for the years ended December 31, 2019 and 2018, our per share net decrease in net assets
resulting from operations was $(1.72) and $(1.00), respectively.
For the years ended December 31, 2018 and 2017
The comparison of our results of operations for the fiscal years ended December 31, 2018 and 2017 can be
found in our annual report on Form 10-K for the fiscal year ended December 31, 2018 located within Part II,
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, which is
incorporated by reference herein.
Summarized Financial Information of Our Unconsolidated Subsidiaries
During the year ended December 31, 2019, the Company sold or exited four portfolio companies that were
considered significant subsidiaries under the guidance in Regulation S-X. During the year ended December 31,
2019, the Company wrote off its investment in AAE Acquisition, LLC and realized a loss of $(20.4) million.
During the year ended December 31, 2019, the Company sold its investments in Portrait Studio, LLC,
CableOrganizer Acquisition, LLC, and Micro Precision, LLC and realized a gain/(loss) of $(6.2) million, $(14.6)
million, and $0.0, respectively.
Financial Condition, Liquidity and Capital Resources
We use and intend to use existing cash primarily to originate investments in new and existing portfolio
companies, pay distributions to our stockholders, and repay indebtedness.
Since our IPO, we have raised approximately $136.0 million in net proceeds from equity offerings through
December 31, 2019.
On October 17, 2014, the Company entered into a senior secured revolving credit agreement (as amended
the “Credit Facility”) with ING Capital, LLC, as administrative agent, arranger, and bookrunner, and the lenders
party thereto. The Credit Facility was amended on May 22, 2015, June 16, 2017, July 19, 2018, February 22,
2019, and December 23, 2019 (the “Amendments”). The Amendments were affected, among other things, in
order to increase the total borrowings allowed under the Credit Facility, allow for stock repurchases, extend the
maturity date, reduce the minimum required interest coverage ratio, reduce the minimum required net asset value,
and reduce the minimum required asset coverage ratio. The Credit Facility currently provides for borrowings up
to $60.0 million and may be increased up to $150.0 million pursuant to its “accordion” feature. The Credit
Facility matures on April 30, 2022. As of December 31, 2019, we had $0.0 outstanding and $60.0 million
available under the Credit Facility.
On May 16, 2017, we issued $70.0 million in aggregate principal amount of 6.0% fixed-rate notes due
May 31, 2022 (the “2022 Notes”). On May 25, 2017, we issued an additional $5.0 million in aggregate principal
amount of the 2022 Notes pursuant to a partial exercise of the underwriters’ overallotment option. The 2022
Notes will mature on May 31, 2022 and may be redeemed in whole or in part at any time or from time to time at
our option on or after May 31, 2019 at a redemption price equal to 100% of the outstanding principal, plus
accrued and unpaid interest. Interest on the 2022 Notes is payable quarterly. The 2022 Notes are listed on the
NASDAQ Global Select Market under the trading symbol “CPTAL” with a par value of $25.00 per share.
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On May 26, 2017, we issued $50.0 million in aggregate principal amount of 5.75% fixed-rate convertible
notes due May 31, 2022 (the “2022 Convertible Notes”). On June 26, 2017, we issued an additional $2.1 million
in aggregate principal amount of the 2022 Convertible Notes pursuant to a partial exercise of the underwriters’
overallotment option. Interest on the 2022 Convertible Notes is payable quarterly. The 2022 Convertible Notes
are listed on the NASDAQ Capital Market under the trading symbol “CPTAG” with a par value of $25.00 per
share.
As of December 31, 2019, Fund III had $75.0 million in regulatory capital and $150.0 million in SBA-
guaranteed debentures outstanding. In addition to our existing SBA-guaranteed debentures, we may, if permitted
by regulation, seek to issue additional SBA-guaranteed debentures as well as other forms of leverage and borrow
funds to make investments. On June 10, 2014, we received an exemptive order from the SEC exempting us,
Fund II and Fund III from certain provisions of the 1940 Act (including an exemptive order granting relief from
the asset coverage requirements for certain indebtedness issued by Fund II and Fund III as SBICs) and from
certain reporting requirements mandated by the 1934 Act, with respect to Fund II and Fund III. We intend to
comply with the conditions of the order.
On December 31, 2019, we entered into an open market sale agreement
with Jefferies LLC pursuant to
which we may issue and sell up to $50,000,000 in aggregate amount of shares of our common stock in amounts,
and at times, to be determined by us (the “ATM Program”). Actual sales in this ATM Program will depend on a
variety of factors to be determined by us including market conditions, the trading price of our common stock and
determinations by us of the appropriate sources of funding. We may issue shares of our common stock at a price
below the then current net asset value per share pursuant to the ATM Program.
SM
We are only allowed to borrow money such that our asset coverage, as defined in the 1940 Act, equals at
least 150% if certain requirements are met, after such borrowing, with certain limited exceptions. On March 23,
2018, the SBCA was signed into law, which included various changes to regulations under the federal securities
laws that impact BDCs. The SBCA included changes to the 1940 Act to allow BDCs to decrease their asset
coverage requirement from 200% to 150% (i.e. the amount of debt may not exceed 66.7% of the value of our
total assets), if certain requirements are met. On November 1, 2018, the Board, including a “required majority”
(as such term is defined in Section 57(o) of the 1940 Act) approved the application of the modified asset
coverage. As a result, our asset coverage requirements for senior securities changed from 200% to 150%,
effective November 1, 2019. As of December 31, 2019, our asset coverage ratio was 216.5%.
As of December 31, 2019, we had $62.3 million in cash and cash equivalents, and our net assets totaled
$148.1 million.
Contractual Obligations
We have entered into two contracts under which we have material future commitments: the Investment
Advisory Agreement, pursuant to which the Investment Advisor serves as our investment adviser, and the
Administration Agreement, pursuant to which our Administrator agrees to furnish us with certain administrative
services necessary to conduct our day-to-day operations. Payments under the Investment Advisory Agreement in
future periods will be equal to: (1) a percentage of the value of our gross assets; and (2) an incentive fee based on
our performance. Payments under the Administration Agreement will occur on an ongoing basis as expenses are
incurred on our behalf by our Administrator.
The Investment Advisory Agreement and the Administration Agreement are each terminable by either party
without penalty upon 60 days’ written notice to the other. If either of these agreements is terminated, the costs we
incur under new agreements may increase. In addition, we will likely incur significant time and expense in
locating alternative parties to provide the services we expect to receive under both our Investment Advisory
Agreement and our Administration Agreement. Any new investment advisory agreement would also be subject to
approval by our stockholders.
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A summary of our significant contractual payment obligations as of December 31, 2019 are as follows
(dollars in thousands):
Contractual Obligations Payments Due by Period
SBA Debentures
2022 Notes
2022 Convertible Notes
Credit Facility
Less Than
1 Year
$19,000
—
—
—
$106,000
75,000
52,088
—
$25,000
—
—
—
1 – 3
Years
3 – 5
Years
More Than
5 Years
Total Contractual Obligations
$19,000
$233,088
$25,000
Total
$150,000
75,000
52,088
—
$277,088
$—
—
—
—
$—
Senior Securities
Information about the Company’s senior securities as of December 31, 2019, 2018, 2017, 2016, 2015, 2014
and 2013, and information about Fund II’s and Fund III’s senior securities as of December 31, 2012, 2011 and
2010 are shown in the following table.
Class and Year
Capitala Finance Corp.
Credit Facility
(5)
2019
2018
2017
2016
2015
2014
2022 Notes
2019
2018
2017
2022 Convertible Notes
2019
2018
2017
SBA-guaranteed debentures
2019
2018
2017
2016
2015
2014
2013
Total Amount
Outstanding Exclusive
of Treasury Securities
(1)(6)
Assets Coverage
Per Unit
(2)(6)
(in thousands)
$
—
10,000
9,000
44,000
70,000
—
$ 75,000
75,000
75,000
$ 52,088
52,088
52,088
$150,000
165,700
170,700
170,700
184,200
192,200
202,200
96
$2,200
2,400
2,600
2,600
2,500
1,800
$2,200
2,400
2,600
$2,200
2,400
2,600
N/A
N/A
N/A
N/A
N/A
$1,800
2,300
Involuntary
Liquidation
Preference per Unit
(3)
Average Market
(4)
Value per Unit
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
N/A
N/A
N/A
N/A
N/A
N/A
$1,000
996
1,014
$ 994
984
1,001
N/A
N/A
N/A
N/A
N/A
N/A
N/A
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Class and Year
2021 Notes
2016
2015
2014
Total Amount
Outstanding Exclusive
of Treasury Securities
(1)(6)
Assets Coverage
Per Unit
(2)(6)
(in thousands)
$113,438
113,438
113,438
$ 52,200
52,200
36,500
$125,000
90,000
33,000
$2,600
2,500
1,800
$2,000
1,600
1,600
$1,700
1,700
1,900
Involuntary
Liquidation
Preference per Unit
(3)
Average Market
(4)
Value per Unit
—
—
—
—
—
—
—
—
—
$1,006
1,020
1,036
N/A
N/A
N/A
N/A
N/A
N/A
Fund II SBA-guaranteed debentures
2012
2011
2010
Fund III SBA-guaranteed debentures
2012
2011
2010
(1)
(2)
(3)
(4)
(5)
(6)
Total amount of each class of senior securities outstanding at the end of the period presented.
Asset coverage per unit is the ratio of the carrying value of our total consolidated assets, less all liabilities
and indebtedness not represented by senior securities, to the aggregate amount of senior securities
representing indebtedness. Asset coverage per unit is expressed in terms of dollar amounts per $1,000 of
indebtedness. Amounts are rounded to the nearest $1,000.
The amount to which such class of senior security would be entitled upon the involuntary liquidation of the
issuer in preference to any security junior to it. The “—” indicates information that the SEC expressly does
not require to be disclosed for certain types of senior securities.
Not applicable except for the 2021 Notes, the 2022 Notes and the 2022 Convertible Notes which are
publicly traded. The Average Market Value Per Unit is calculated by taking the daily average closing price
during the period and dividing it by twenty-five dollars per share and multiplying the result by one thousand
to determine a unit price per thousand consistent with Asset Coverage Per Unit.
As of December 31, 2019, there was no outstanding balance on the Credit Facility. As of February 27, 2020
there was no outstanding balance on the Credit Facility.
We have excluded our SBA-guaranteed debentures from the asset coverage calculation as of December 31,
2019, 2018, 2017, 2016, and 2015 pursuant to the exemptive relief granted by the SEC in June 2014 that
permits us to exclude such debentures from the definition of senior securities in the asset coverage ratio we
are required to satisfy under the 1940 Act.
Distributions
In order to qualify as a RIC and to avoid corporate-level U.S. federal income tax on the income we distribute
to our stockholders, we are required to distribute at least 90% of our net ordinary income and our net short-term
capital gains in excess of net long-term capital losses, if any, to our stockholders on an annual basis. Additionally,
we must distribute an amount at least equal to the sum of 98% of our net ordinary income (during the calendar
year) plus 98.2% of our net capital gain income (during each 12-month period ending on October 31) plus any net
ordinary income and capital gain net income for preceding years that were not distributed during such years and
on which we paid no U.S. federal income tax to avoid a U.S. federal excise tax. We made quarterly distributions
to our stockholders for the first four full quarters subsequent to our IPO. To the extent we have income available,
we have made and intend to make monthly distributions thereafter. Our monthly stockholder distributions, if any,
will be determined by our Board on a quarterly basis. Any distribution to our stockholders will be declared out of
assets legally available for distribution.
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 our distributions from time to time, and from time to time we may decrease the
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amount of our distributions. In addition, we may be limited in our ability to make distributions due to the asset
coverage requirements 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 the possible loss of our qualification
as a RIC. We cannot assure stockholders that they will receive any distributions.
To the extent our taxable earnings fall below the total amount of our distributions for that fiscal year, a
portion of those distributions may be deemed a return of capital to our stockholders for U.S. federal income tax
purposes. Thus, the source of a distribution to our stockholders may be the original capital invested by the
stockholder rather than our income or gains. Stockholders should read any written disclosure accompanying any
stockholder distribution carefully and should not assume that the source of any distribution is our ordinary
income or capital gains.
We have adopted an “opt out” dividend reinvestment plan (“DRIP”) for our common stockholders. As a
result, if we declare a distribution, then stockholders’ cash distributions will be automatically reinvested in
additional shares of our common stock unless a stockholder specifically “opts out” of our DRIP. If a stockholder
opts out, that stockholder will receive cash distributions. Although distributions paid in the form of additional
shares of our common stock will generally be subject to U.S. federal, state and local taxes in the same manner as
cash distributions, stockholders participating in our DRIP will not receive any corresponding cash distributions
with which to pay any such applicable taxes.
The following tables summarize our distributions declared from January 1, 2017 through December 31,
2019:
Date Declared
January 2, 2019
January 2, 2019
January 2, 2019
April 1, 2019
April 1, 2019
April 1, 2019
July 1, 2019
July 1, 2019
July 1, 2019
October 1, 2019
October 1, 2019
October 1, 2019
Total Distributions Declared
and Distributed for 2019
Date Declared
January 2, 2018
January 2, 2018
January 2, 2018
April 2, 2018
April 2, 2018
April 2, 2018
July 2, 2018
July 2, 2018
July 2, 2018
October 1, 2018
October 1, 2018
October 1, 2018
Total Distributions Declared
and Distributed for 2018
Record Date
January 24, 2019
February 20, 2019
March 21, 2019
April 22, 2019
May 23, 2019
June 20, 2019
July 23, 2019
August 22, 2019
September 20, 2019
October 22, 2019
November 22, 2019
December 23, 2019
Payment Date
January 30, 2019
February 27, 2019
March 28, 2019
April 29, 2019
May 30, 2019
June 27, 2019
July 30, 2019
August 29, 2019
September 27, 2019
October 29, 2019
November 29, 2019
December 30, 2019
Record Date
January 22, 2018
February 20, 2018
March 23, 2018
April 19, 2018
May 22, 2018
June 20, 2018
July 23, 2018
August 23, 2018
September 20, 2018
October 23, 2018
November 21, 2018
December 20, 2018
Payment Date
January 30, 2018
February 27, 2018
March 29, 2018
April 27, 2018
May 30, 2018
June 28, 2018
July 30, 2018
August 30, 2018
September 27, 2018
October 30, 2018
November 29, 2018
December 28, 2018
98
Amount
Per Share
$0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
$
1.00
Amount
Per Share
$0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
$
1.00
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Date Declared
January 3, 2017
January 3, 2017
January 3, 2017
April 3, 2017
April 3, 2017
April 3, 2017
July 3, 2017
July 3, 2017
July 3, 2017
October 2, 2017
October 2, 2017
October 2, 2017
Total Distributions Declared
and Distributed for 2017
Record Date
January 20, 2017
February 20, 2017
March 23, 2017
April 19, 2017
May 23, 2017
June 21, 2017
July 21, 2017
August 23, 2017
September 20, 2017
October 23, 2017
November 21, 2017
December 20, 2017
Payment Date
January 30, 2017
February 27, 2017
March 30, 2017
April 27, 2017
May 29, 2017
June 29, 2017
July 28, 2017
August 30, 2017
September 28, 2017
October 30, 2017
November 29, 2017
December 28, 2017
Amount
Per Share
$0.1300
0.1300
0.1300
0.1300
0.1300
0.1300
0.1300
0.1300
0.1300
0.0833
0.0833
0.0833
$
1.42
Tax characteristics of all distributions paid are reported to stockholders on Form 1099 after the end of the
calendar year. For the years ended December 31, 2018 and 2017 total distributions of $16.0 million and
$22.6 million, respectively, were comprised 100% of ordinary income. For the year ended December 31, 2019,
we estimate that total distributions of $16.1 million were comprised of approximately $13.4 million from
ordinary income and $2.7 million from return of capital.
Related Parties
We have entered into the Investment Advisory Agreement with the Investment Advisor. Joseph B. Alala, our
chief executive officer and chairman of our Board, is the managing partner and chief investment officer of the
Investment Advisor, and M. Hunt Broyhill, a member of our Board, has an indirect controlling interest in the
Investment Advisor.
In addition, an affiliate of the Investment Advisor also manages CapitalSouth Partners SBIC Fund IV, L.P.
(“Fund IV”), a private investment limited partnership which provides financing solutions to smaller and lower
middle-market companies that had its first closing in March 2013 and obtained SBA approval for its SBIC
license in April 2013. In addition to Fund IV, affiliates of the Investment Advisor may manage several affiliated
funds whereby institutional limited partners in Fund IV have the opportunity to co-invest with Fund IV in
portfolio investments. An affiliate of the Investment Advisor also manages Capitala Private Credit Fund V, L.P.
(“Fund V”), a private investment limited partnership, and a private investment vehicle (referred to herein as
“Capitala Specialty Lending Corp” or “CSLC”), both of which provide financing solutions to lower middle-
market and traditional middle-market companies. The Investment Advisor and its affiliates may also manage
other funds in the future that may have investment mandates that are similar, in whole and in part, with ours. To
the extent permitted by the 1940 Act and interpretation of the SEC staff, the Investment Advisor and its affiliates
may determine that an investment is appropriate for us and for one or more of those other funds. In such event,
depending on the availability of such investment and other appropriate factors, the Investment Advisor or its
affiliates may determine that we should invest side-by-side with one or more other funds. Any such investments
will be made only to the extent permitted by applicable law and interpretive positions of the SEC and its staff,
and consistent with the Investment Advisor’s allocation procedures. We expect to make, and have made, co-
investments with Fund IV, Fund V, and/or CSLC to the extent their respective investment strategies align with
ours.
On September 10, 2015, we, Fund II, Fund III, Fund V, and the Investment Advisor filed an application for
exemptive relief with the SEC to permit an investment fund and one or more other affiliated investment funds,
including future affiliated investment funds, to participate in the same investment opportunities through a
proposed co-investment program where such participation would otherwise be prohibited under the 1940 Act. On
June 1, 2016, the SEC issued an order (the “Order”) permitting this relief. Pursuant to the Order, we are permitted
to co-invest in such investment opportunities with our affiliates if a “required majority” (as defined in
Section 57(o) of the 1940 Act) of our independent directors make certain conclusions in connection with a co-
investment transaction, including, but not limited to, that (1) the terms of the potential co-investment
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transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not
involve overreaching in respect of us or our stockholders on the part of any person concerned, and (2) the
potential co-investment transaction is consistent with the interests of our stockholders and is consistent with our
then-current investment objective and strategies.
The Company may invest in the same unitranche facility as CSLF II, whereby CSLF II provides the first-out
portion of the unitranche facility and the Company and other lenders provide the last-out portion of the
unitranche facility. Under a guarantee agreement, the Company may be required to purchase its pro-rata portion
of first-out loans from CSLF II upon certain triggering events, including acceleration upon payment default of the
underlying borrower. As of December 31, 2019, the Company has evaluated the fair value of the guarantee under
the guidance of ASC Topic 460 — Guarantees and determined that the fair value of the guarantee is immaterial as
the risk of payment default for first-out loans in CSLF II is considered remote. The maximum exposure to credit
risk as of December 31, 2019 and 2018, was $10.3 million and $4.3 million, respectively, and extends to the
stated maturity of the underlying loans in CSLF II.
We have entered into a license agreement with the Investment Advisor, pursuant to which the Investment
Advisor has agreed to grant us a non-exclusive, royalty-free license to use the name “Capitala.”
We have entered into the Administration Agreement with our Administrator. Pursuant to the terms of the
Administration Agreement, our Administrator provides us with the office facilities and administrative services
necessary to conduct our day-to-day operations. Mr. Alala, our chief executive officer, and chairman of our
Board, is the chief executive officer, president and a director of our Administrator.
Off-Balance Sheet Arrangements
As of December 31, 2019, the Company had outstanding unfunded commitments related to debt and equity
investments in existing portfolio companies of $11.4 million (CSLF II), $4.5 million (Rapid Fire Protection, Inc),
$3.5 million (J5 Infrastructure Partners, LLC), $2.6 million (BigMouth, Inc.), $1.0 million (Freedom Electronics,
LLC), $1.0 million (U.S. BioTek Laboratories, LLC), and $0.5 million (Jurassic Quest Holdings, LLC). As of
December 31, 2018, the Company had outstanding unfunded commitments related to debt and equity investments
in existing portfolio companies of $6.4 million (CSLF II), $5.0 million (Portrait Studio, LLC), $1.1 million (MC
Sign Lessor, Corp), $1.0 million (U.S. BioTek Laboratories, LLC), $0.8 million (Freedom Electronics, LLC), and
$0.3 million (CableOrganizer Acquisition, LLC).
We have no other off-balance sheet arrangements that have or are reasonably likely to have a current or
future effect on our financial condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources.
Recent Developments
Distributions
On January 2, 2020 our Board declared the following distributions:
Date Declared
January 2, 2020
January 2, 2020
January 2, 2020
Record Date
Payment Date
January 24, 2020
February 20, 2020
March 23, 2020
January 30, 2020
February 27, 2020
March 30, 2020
Distributions per
Share
$0.0833
$0.0833
$0.0833
100
TABLE OF CONTENTS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to financial market risks, including changes in interest rates. Changes in interest rates may
affect both our cost of funding and our interest income from portfolio investments and cash and cash equivalents.
We may hedge against interest rate fluctuations by using standard hedging instruments such as futures, options
and forward contracts subject to the requirements of the 1940 Act. For the year ended December 31, 2019, we did
not engage in hedging activities.
As of December 31, 2019, we held 24 securities bearing a variable rate of interest. Our variable rate
investments represent approximately 62.8% of the fair value of total debt investments. As of December 31, 2019,
20.6% of variable rate securities were yielding interest at a rate equal to the established interest rate floor and
79.4% of variable rate securities were yielding interest at a rate above its interest rate floor or were not subject to
an interest rate floor. As of December 31, 2019, we had $0.0 outstanding on our Credit Facility, which has a
variable rate of interest at one-month LIBOR + 3.0%. As of December 31, 2019, all of our other interest paying
liabilities, consisting of $150.0 million in SBA-guaranteed debentures, $75.0 million in 2022 Notes, and
$52.1 million in 2022 Convertible Notes, were bearing interest at a fixed rate.
Interest rate sensitivity refers to the change in earnings that may result from changes in the level of interest
rates. Because we fund a portion of our investments with borrowings, our net investment income is affected by
the difference between the rate at which we invest and the rate at which we borrow. As a result, there can be no
assurance that a significant change in market interest rates will not have a material adverse effect on our net
investment income.
Based on our December 31, 2019 consolidated statement of assets and liabilities, the following table shows
the annual impact on net income (excluding the potential related incentive fee impact) of base rate changes in
interest rates (considering interest rate floors for variable rate securities) assuming no changes in our investment
and borrowing structure (dollars in thousands):
Basis Point Change
Up 300 basis points
Up 200 basis points
Up 100 basis points
Down 100 basis points
Down 200 basis points
Down 300 basis points
Increase
(decrease)
in interest
income
(Increase)
decrease in
interest
expense
Increase
(decrease)
in net income
$ 5,444
$ 3,611
$ 1,777
$(1,050
)
$(1,187
)
$(1,187
)
$—
$—
$—
$—
$—
$—
$ 5,444
$ 3,611
$ 1,777
$(1,050
)
$(1,187
)
$(1,187
)
101
TABLE OF CONTENTS
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
Audited Financial Statements:
Consolidated Statements of Assets and Liabilities as of December 31, 2019 and 2018
Consolidated Statements of Operations for the years ended December 31, 2019, 2018, and 2017
Consolidated Statements of Changes in Net Assets for the years ended December 31, 2019, 2018, and
2017
Consolidated Statements of Cash Flows for the years ended December 31, 2019, 2018, and 2017
Consolidated Schedules of Investments as of December 31, 2019 and 2018
Notes to Consolidated Financial Statements
Page
F-1
F-2
F-3
F-4
F-5
F-6
F-7
F-18
102
TABLE OF CONTENTS
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Capitala Finance Corp.
Opinion on the Financial Statements
We have audited the accompanying consolidated statements of assets and liabilities of Capitala Finance
Corp. (the “Company”), including the consolidated schedules of investments, as of December 31, 2019 and 2018,
the related consolidated statements of operations, changes in net assets, and cash flows for each of the three years
in the period ended December 31, 2019, and the related notes (collectively referred to as the “consolidated
financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects,
the financial position of the Company at December 31, 2019 and 2018, and the results of its operations, changes
in its net assets, and its cash flows for each of the three years in the period ended December 31, 2019, in
conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019,
based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission 2013 framework and our report dated March 2, 2020 expressed an
unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to
express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm
registered with the PCAOB and are required to be independent with respect to the Company in accordance with
the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange
Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the
risks of material misstatement of the financial statements, whether due to error or fraud, and performing
procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding
the amounts and disclosures in the financial statements. Our procedures included confirmation of investments
owned as of December 31, 2019 and 2018, by correspondence with the custodians, agents and/or directly with
management or designees of the portfolio companies, as applicable. Our audits also included evaluating the
accounting principles used and significant estimates made by management, as well as evaluating the overall
presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2013.
Charlotte, North Carolina
March 2, 2020
F-1
TABLE OF CONTENTS
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Capitala Finance Corp.
Opinion on Internal Control over Financial Reporting
We have audited Capitala Finance Corp.’s internal control over financial reporting as of December 31, 2019,
based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Capitala
Finance Corp. (the “Company”) maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2019, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States) (PCAOB), the consolidated balance sheets of the Company, including the consolidated schedules
of investments, as of December 31, 2019 and 2018, and the related consolidated statements of operations,
changes in net assets, and cash flows for each of the three years in the period ended December 31, 2019, and the
related notes and our report dated March 2, 2020, expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over financial reporting included in the
accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to
express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public
accounting firm registered with the PCAOB and are required to be independent with respect to the Company in
accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and
Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial
reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control
based on the assessed risk, and performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company’s internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
/s/ Ernst & Young LLP
Charlotte, North Carolina
March 2, 2020
F-2
TABLE OF CONTENTS
Capitala Finance Corp.
Consolidated Statements of Assets and Liabilities
(in thousands, except share and per share data)
ASSETS
Investments at fair value
Non-control/non-affiliate investments (amortized cost of $250,433 and
$280,114, respectively)
Affiliate investments (amortized cost of $80,756 and $72,300, respectively)
Control investments (amortized cost of $22,692 and $67,556, respectively)
Total investments at fair value (amortized cost of $353,881 and $419,970,
respectively)
Cash and cash equivalents
Interest and dividend receivable
Prepaid expenses
Deferred tax asset, net
Other assets
Total assets
LIABILITIES
SBA Debentures (net of deferred financing costs of $1,006 and $1,688,
respectively)
2022 Notes (net of deferred financing costs of $1,447 and $1,987,
respectively)
2022 Convertible Notes (net of deferred financing costs of $916 and $1,259,
respectively)
Credit Facility (net of deferred financing costs of $1,165 and $983,
respectively)
Management and incentive fees payable
Interest and financing fees payable
Accounts payable and accrued expenses
Total liabilities
As of
December 31,
2019
December 31,
2018
$ 241,046
$ 286,843
98,763
22,723
92,939
69,145
362,532
448,927
62,321
1,745
624
—
115
39,295
3,778
454
628
83
$ 427,337
$ 493,165
$ 148,994
$ 164,012
73,553
73,013
51,172
50,829
(1,165
)
3,713
2,439
518
9,017
2,487
3,063
100
$ 279,224
$ 302,521
Commitments and contingencies (Note 2)
NET ASSETS
Common stock, par value $0.01, 100,000,000 common shares authorized,
16,203,769 and 16,051,547 common shares issued and outstanding, respectively
$
162
$
161
Additional paid in capital
Total distributable loss
Total net assets
Total liabilities and net assets
Net asset value per share
237,886
)
(89,935
$ 148,113
$ 427,337
241,757
(51,274
)
$ 190,644
$ 493,165
$
9.14
$
11.88
See accompanying notes to consolidated financial statements.
F-3
TABLE OF CONTENTS
Capitala Finance Corp.
Consolidated Statements of Operations
(in thousands, except share and per share data)
For the Years Ended December 31,
2018
2019
2017
$
INVESTMENT INCOME
Interest and fee income:
Non-control/non-affiliate investments
Affiliate investments
Control investments
Total interest and fee income
Payment-in-kind interest and dividend income:
Non-control/non-affiliate investments
Affiliate investments
Control investments
Total payment-in-kind interest and dividend income
Dividend income:
Non-control/non-affiliate investments
Affiliate investments
Control investments
Total dividend income
Other income
Interest income from cash and cash equivalents
Total investment income
EXPENSES
Interest and financing expenses
Loss on extinguishment of debt
Base management fee
Incentive fees
General and administrative expenses
Expenses before incentive fee waiver
Incentive fee waiver (See Note 6)
Total expenses, net of incentive fee waiver
NET INVESTMENT INCOME
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
AND WRITTEN CALL OPTION:
Net realized gain (loss) on investments:
Non-control/non-affiliate investments
Affiliate investments
Control investments
Net realized loss on investments
Net unrealized appreciation (depreciation) on investments:
Non-control/non-affiliate investments
Affiliate investments
Control investments
Net unrealized appreciation (depreciation) on investments
Net unrealized appreciation (depreciation) on written call option
Net realized and unrealized loss on investments and written call
option
Tax benefit (provision)
Total net realized and unrealized loss on investments and written call
option, net of taxes
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS
NET DECREASE IN NET ASSETS PER SHARE RESULTING FROM
OPERATIONS – BASIC AND DILUTED
$
$
27,659
8,351
1,566
37,576
1,721
869
372
2,962
1,345
50
1,904
3,299
—
198
44,035
17,121
—
7,967
1,497
4,695
31,280
(288
30,992
13,043
)
16,529
2,288
(38,573
(19,756
)
)
)
)
)
)
(16,116
(2,632
(1,558
(20,306
—
(40,062
(628
)
)
(40,690
(27,647
)
)
(1.72
)
$
$
$
27,754
7,945
6,702
42,401
2,248
1,251
849
4,348
59
238
100
397
—
147
47,293
17,283
—
9,049
244
4,695
31,271
—
31,271
16,022
(15,714
2,920
(22,010
(34,804
)
)
)
16,487
(5,982
(16,460
(5,955
6,795
)
)
)
)
(33,964
1,916
(32,048
(16,026
)
)
(1.00
)
$
31,084
4,509
6,896
42,489
4,503
1,898
742
7,143
225
641
355
1,221
125
111
51,089
18,825
2,732
9,780
1,308
3,878
36,523
(958
35,565
15,524
(6,682
4,926
(22,433
(24,189
(11,577
4,436
14,190
7,049
(4,079
)
)
)
)
)
)
(21,219
(1,289
)
)
(22,508
(6,984
)
)
(0.44
)
$
$
WEIGHTED AVERAGE COMMON STOCK OUTSTANDING – BASIC
AND DILUTED
DISTRIBUTIONS PAID PER SHARE
16,117,719
1.00
$
15,993,436
1.00
$
15,903,167
1.42
$
See accompanying notes to consolidated financial statements.
F-4
TABLE OF CONTENTS
Capitala Finance Corp.
Consolidated Statements of Changes in Net Assets
(in thousands, except share data)
For the Years Ended December 31, 2017, 2018, and 2019
BALANCE, December 31, 2016
Net investment income
Net realized loss on investments
Net unrealized appreciation on investments
Net unrealized depreciation on written call option
Tax provision
Distributions to Shareholders:
Stock issued under dividend reinvestment plan
Distributions declared
Tax reclassification of stockholders’ equity in
accordance with generally accepted accounting
principles
BALANCE, December 31, 2017
Net investment income
Net realized loss on investments
Net unrealized depreciation on investments
Net unrealized appreciation on written call option
Tax benefit
Distributions to Shareholders:
Stock issued under dividend reinvestment plan
Distributions declared
Tax reclassification of stockholders’ equity in
accordance with generally accepted accounting
principles
BALANCE, December 31, 2018
Net investment income
Net realized loss on investments
Net unrealized depreciation on investments
Tax provision
Distributions to Shareholders:
Stock issued under dividend reinvestment plan
Distributions declared
Return of capital
Tax reclassification of stockholders’ equity in
accordance with generally accepted accounting
principles
Common Stock
Number of
Shares
15,868,045
—
—
—
—
—
Par Value
$159
—
—
—
—
—
Additional
Paid in
Capital
Total
Distributable
Loss
$240,184 $ 10,239
— 15,524
— (24,189
7,049
—
(4,079
—
(1,289
—
)
)
)
Total
$250,582
15,524
(24,189
7,049
(4,079
(1,289
)
)
)
83,186
—
1
—
—
864
— (22,576
)
865
(22,576
)
—
15,951,231
—
—
—
—
—
—
$160
—
—
—
—
—
(21
)
21
—
)
)
)
$241,027 $ (19,300
— 16,022
— (34,804
(5,955
—
6,795
—
1,916
—
$221,887
16,022
(34,804
(5,955
6,795
1,916
)
)
100,316
—
1
—
768
—
— (15,986
)
769
(15,986
)
—
—
(38
)
38
—
16,051,547
—
—
—
—
152,222
—
—
$161
—
—
—
—
1
—
—
$241,757 $ (51,274
— 13,043
— (19,756
— (20,306
(628
—
)
)
)
)
$190,644
13,043
(19,756
(20,306
(628
)
)
)
1,225
—
— (16,110
2,659
)
)
1,226
(16,110
—
)
(2,659
—
—
(2,437
)
2,437
—
BALANCE, December 31, 2019
16,203,769
$162
)
$237,886 $ (89,935
$148,113
See accompanying notes to consolidated financial statements.
F-5
TABLE OF CONTENTS
Capitala Finance Corp.
Consolidated Statements of Cash Flows
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net decrease in net assets resulting from operations
Adjustments to reconcile net decrease in net assets resulting from operations
to net cash provided by operating activities:
Purchase of investments
Repayments and sales of investments
Net realized loss on investments
Net unrealized (appreciation) depreciation on investments
Payment-in-kind interest and dividends
Accretion of original issue discount on investments
Payments from written call option
Net unrealized (appreciation) depreciation on written call option
Amortization of deferred financing fees
Loss on extinguishment of debt
Tax provision (benefit)
Changes in assets and liabilities:
Interest and dividend receivable
Due from related parties
Prepaid expenses
Other assets
Due to related parties
Management and incentive fees payable
Interest and financing fees payable
Trade settlement payable
Accounts payable and accrued expenses
NET CASH PROVIDED BY OPERATING ACTIVITIES
CASH FLOWS FROM FINANCING ACTIVITIES
Paydowns on SBA debentures
Proceeds from Credit Facility
Repayments on Credit Facility
Issuance of 2022 Notes
Issuance of 2022 Convertible Notes
Repayment of 2021 Notes
Distributions paid to shareholders
Deferred financing fees paid
NET CASH USED IN FINANCING ACTIVITIES
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS, beginning of year
CASH AND CASH EQUIVALENTS, end of year
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
For the Years Ended December 31,
2018
2019
2017
$ (27,647 $ (16,026 $
)
)
)
)
)
(77,831
128,122
19,756
20,306
(2,962
(996
—
—
2,370
—
628
(107,802
123,517
34,804
5,955
(4,348
(1,114
(20
(6,795
1,885
—
(1,916
)
)
)
2,033
—
(170
(32
—
1,226
(624
—
418
64,597
(802
95
(145
(28
—
315
(78
(175
100
27,422
)
)
)
)
)
)
)
)
)
)
)
(6,984
)
)
)
)
)
(82,750
115,810
24,189
(7,049
(7,143
(1,357
—
4,079
2,100
2,732
1,289
2,759
87
197
17
(35
(4,254
484
175
(536
43,810
)
)
)
)
(5,000
31,000
(30,000
(15,700
16,500
(26,500
—
—
—
(14,884
(987
(41,571
23,026
39,295
—
9,000
(44,000
— 75,000
— 52,088
— (113,438
(21,711
(15,217
(5,809
(131
(48,870
(19,348
(5,060
8,074
36,281
31,221
$ 62,321 $ 39,295 $ 31,221
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
Cash paid for interest
$ 13,784 $ 14,139 $ 15,503
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
FINANCING TRANSACTIONS
Distributions paid through dividend reinvestment plan share issuances
$
1,226 $
769 $
865
See accompanying notes to consolidated financial statements.
F-6
TABLE OF CONTENTS
Capitala Finance Corp.
Consolidated Schedule of Investments
(in thousands, except for units/shares)
December 31, 2019
Type of Investment
Principal
Amount
Cost
Fair Value
% of
Net Assets
(1),(2),(3),(4),(5)
Portfolio Company, Country
Non-control/non-affiliated investments – 162.8%
Non-control/non-affiliated investments – United States
3 Bridge Solutions, LLC
IT Consulting
Industry
3 Bridge Solutions, LLC
3 Bridge Solutions, LLC
IT Consulting
IT Consulting
Alternative Biomedical Solutions, LLC
Healthcare
Alternative Biomedical Solutions, LLC
Healthcare
Alternative Biomedical Solutions, LLC
Healthcare
American Clinical Solutions, LLC
Healthcare
American Clinical Solutions, LLC
Healthcare
AmeriMark Direct, LLC
Consumer Products
BigMouth, Inc.
Consumer Products
BigMouth, Inc.
Consumer Products
First Lien Debt (10.7% Cash
(1 month LIBOR + 9.0%, 1.0% Floor),
Due 12/4/22)
Preferred Units (965 units)
Membership Units (39,000 units)
First Lien Debt (8.0% Cash, 3.8% PIK,
Due 12/18/22)
First Lien Debt (8.0% Cash, 3.8% PIK,
Due 12/18/22)
Membership Units (20,092 units)
(6)
First Lien Debt (7.0% Cash,
Due 12/31/22)
First Lien Debt (2.0% PIK,
Due 12/31/22)
(7)
First Lien Debt (14.3% Cash,
Due 9/8/21)
(8)
First Lien Debt (10.3% Cash
(1 month LIBOR + 8.5%, 0.5% Floor,
Due 11/14/21)
First Lien Debt (10.2% Cash
(1 month LIBOR + 8.5%, 0.5% Floor,
Due 11/14/21)
Bluestem Brands, Inc.
Online Merchandise
Retailer
First Lien Debt (9.3% Cash
(1 month LIBOR + 7.5%, 1.0% Floor),
Due 11/7/20)
3,529
Burke America Parts Group, LLC
Home Repair Parts
Manufacturer
Membership Units (14 units)
CableOrganizer Acquisition, LLC
Computer Supply
Retail
First Lien Debt
(9)
California Pizza Kitchen, Inc.
Restaurant
Second Lien Debt (11.9% Cash
(3 month LIBOR + 10.0%, 1.0%
Floor), Due 8/23/23)
Chicken Soup for the Soul, LLC
Multi-platform Media
and Consumer
Products
First Lien Debt (10.2% Cash
(1 month LIBOR + 8.5%, 1.5% Floor),
Due 12/13/20)
Chief Fire Intermediate, Inc.
Chief Fire Intermediate, Inc.
Security System
Services
Security System
Services
First Lien Debt (8.7% Cash
(1 month LIBOR + 7.0%, 1.6% Floor),
Due 11/8/24)
Class A Preferred Units (34,740 units,
10.0% PIK Dividend)
(10)
See accompanying notes to consolidated financial statements.
F-7
$ 13,274 $13,274
1,090
10
14,374
$13,274
499
—
13,773
9.0
0.3
0.0
9.3
%
%
%
%
5,491
5,331
5,319
3.6
%
13,125
13,125
800
19,256
10,624
—
15,943
7.2
0.0
10.8
%
%
%
3,500
3,500
3,500
2.3
%
6,000
3,485
6,985
3,485
6,985
16,123
15,974
15,974
15,633
15,633
2.4
4.7
%
%
10.6
10.6
%
%
857
857
857
0.6
%
8,784
8,784
9,641
8,628
9,485
5.8
6.4
%
%
1.9
1.9
1.7
%
%
%
1.7
1.0
%
%
3,529
3,529
5
5
1,532
2,877
2,877
2,489
2,489
1,490
1,532
1,490
1.0
%
5,000
4,927
4,927
4,697
4,697
13,000
13,000
13,000
13,000
13,000
3.2
3.2
%
%
8.8
8.8
%
%
8,100
8,100
8,100
5.5
%
913
913
0.6
%
Type of Investment
Class B Common Units (3,510 units)
Principal
Amount
Cost
Fair Value
$ — $ —
% of
Net Assets
%
0.0
TABLE OF CONTENTS
Capitala Finance Corp.
Consolidated Schedule of Investments – (continued)
(in thousands, except for units/shares)
December 31, 2019
Portfolio Company, Country
Chief Fire Intermediate, Inc.
(1),(2),(3),(4),(5)
Industry
Security System
Services
CIS Secure Computing, Inc.
Government Services
CIS Secure Computing, Inc.
Government Services
First Lien Debt (10.2% Cash
(1 month LIBOR + 8.5%, 1.0% Floor),
1.0% PIK, Due 9/14/22)
Common Stock (46,163 shares)
Corporate Visions, Inc.
Corporate Visions, Inc.
Sales & Marketing
Services
Sales & Marketing
Services
Subordinated Debt (9.0% Cash, 2.0%
PIK, Due 11/29/21)
Common Stock (15,750 shares)
Currency Capital, LLC
Financial Services
Currency Capital, LLC
Financial Services
First Lien Debt (13.7% Cash
(1 month LIBOR + 12.0%, 0.5%
(11)
Floor), 2.0% PIK, Due 1/2/20)
Class A Preferred Units
(2,000,000 units)
(11)
Flavors Holdings, Inc.
Flavors Holdings, Inc.
Food Product
Manufacturer
Food Product
Manufacturer
First Lien Debt (7.7% Cash
(3 month LIBOR + 5.8%, 1.0% Floor),
Due 4/3/20)
Second Lien Debt (11.9% Cash
(3 month LIBOR + 10.0%, 1.0%
Floor), Due 10/3/21)
Freedom Electronics, LLC
Freedom Electronics, LLC
Electronic Machine
Repair
Electronic Machine
Repair
First Lien Debt (8.7% Cash,
Due 12/20/23)
Membership Units (181,818 units)
(6)(12)
HUMC Opco, LLC
Healthcare
Installs, LLC
Logistics
First Lien Debt (9.0% Cash,
Due 8/16/20)
First Lien Debt (9.3% Cash,
(6)
Due 6/20/23)
J5 Infrastructure Partners, LLC
J5 Infrastructure Partners, LLC
Wireless Deployment
Services
Wireless Deployment
Services
(13)
First Lien Debt (8.3% Cash
(1 month LIBOR + 6.5%, 1.8% Floor),
Due 12/20/24)
First Lien Debt (8.3% Cash
(1 month LIBOR + 6.5%, 1.8% Floor),
Due 12/20/24)
9,013
9,013
6.1
%
$ 9,389
9,389
1,000
10,389
9,389
1,890
11,279
6.3
1.3
7.6
%
%
%
19,327
19,327
1,575
18,962
329
12.8
0.2
%
%
20,902
19,291
13.0
%
16,269
16,269
16,269
11.0
%
2,000
18,269
2,504
18,773
1.7
12.7
%
%
5,789
5,778
5,767
3.9
%
12,000
11,878
17,656
11,842
17,609
5,940
5,940
182
5,940
160
8.0
11.9
%
%
4.0
0.1
%
%
6,122
6,100
4.1
%
5,000
2,924
5,000
5,000
2,924
2,924
5,000
5,000
2,924
2,924
3.4
3.4
%
%
2.0
2.0
%
%
—
—
—
0.0
%
7,000
7,000
7,000
7,000
7,000
4.7
4.7
%
%
7.3
0.1
7.4
%
%
%
0.6
0.6
%
%
Jurassic Quest Holdings, LLC
Entertainment
Jurassic Quest Holdings, LLC
Entertainment
First Lien Debt (9.5% Cash
(1 month LIBOR + 7.5%, 2.0% Floor),
Due 5/1/24)
Preferred Units (375,000 units)
(14)
10,827
MicroHoldco, LLC
General Industrial
Preferred Units
(9)
10,827
388
11,215
838
838
10,827
85
10,912
838
838
See accompanying notes to consolidated financial statements.
F-8
TABLE OF CONTENTS
Portfolio Company, Country
Portrait Studio, LLC
(1),(2),(3),(4),(5)
Rapid Fire Protection, Inc.
Rapid Fire Protection, Inc.
Seitel, Inc.
Capitala Finance Corp.
Consolidated Schedule of Investments – (continued)
(in thousands, except for units/shares)
December 31, 2019
Industry
Professional and
Personal Digital
Imaging
Security System
Services
Security System
Services
Data Services
Type of Investment
First Lien Debt
(9)
First Lien Debt (9.2% Cash,
Due 11/22/24)
Common Stock (363 shares)
(6)(15)
First Lien Debt (10.0% Cash
(1 month LIBOR + 8.3%, 1.0% Floor),
Due 3/15/23)
Sequoia Healthcare Management, LLC
Healthcare
Management
First Lien Debt (12.8% Cash,
Due 6/26/20)
Sur La Table, Inc.
Retail
First Lien Debt (10.9% Cash
(3 month LIBOR + 9.0%, 1.0% Floor),
Due 7/31/22)
(16)(17)
Taylor Precision Products, Inc.
Household Product
Manufacturer
Series C Preferred Stock (379 shares)
U.S. BioTek Laboratories, LLC
Testing laboratories
U.S. BioTek Laboratories, LLC
U.S. BioTek Laboratories, LLC
Testing laboratories
Testing laboratories
(6)(12)
First Lien Debt (9.3% Cash,
Due 12/14/23)
Class A Preferred Units (500 Units)
Class C Units (500 Units)
U.S. Well Services, Inc.
Oil & Gas Services
U.S. Well Services, Inc.
Oil & Gas Services
(11)(18)
Class A Common Stock (77,073
shares)
Class B Common Stock (1,125,426
shares)
(11)(18)
Xirgo Technologies, LLC
Information
Technology
Membership Units (600,000 units)
Sub Total Non-control/non-affiliated investments – United States
Affiliate Investments – 66.7%
Affiliate investments – United States
Burgaflex Holdings, LLC
Burgaflex Holdings, LLC
Burgaflex Holdings, LLC
Automobile
Part Manufacturer
Automobile
Part Manufacturer
Automobile
Part Manufacturer
First Lien Debt (12.0% Cash, 3.0%
PIK, Due 3/23/21)
Common Stock Class B (1,085,073
shares)
Common Stock Class A (1,253,198
shares)
City Gear, LLC
Footwear Retail
Membership Unit Warrants
(9)
Eastport Holdings, LLC
Business Services
Eastport Holdings, LLC
Business Services
Subordinated Debt (14.9% Cash
(3 month LIBOR + 13.0%, 0.5%
Floor), Due 12/29/21)
Membership Units (22.9% ownership)
(16)
Principal
Amount
Cost
$
510 $
Fair Value
510
% of
Net Assets
%
0.3
510
510
0.3
%
$ 6,550
6,550
500
6,550
500
4.4
0.4
%
%
7,050
7,050
4.8
%
4,749
12,744
10,528
6,930
4,749
4,749
4,749
4,749
12,744
12,744
12,607
12,607
10,528
10,528
758
10,045
10,045
758
3.2
3.2
%
%
8.5
8.5
%
%
6.8
6.8
0.5
%
%
%
758
758
0.5
%
6,930
540
1
7,471
6,822
204
—
7,026
4.6
0.1
0.0
4.7
%
%
%
%
771
146
0.1
%
6,701
7,472
600
2,127
2,273
917
1.4
1.5
0.6
%
%
%
600
917
$250,433 $241,046
0.6
162.8
%
%
$ 14,421 $ 14,421 $ 14,421
362
635
1,504
16,287
—
—
—
15,056
3,326
3,326
16,500
16,155
3,263
19,418
16,500
17,822
34,322
9.7
%
0.4
%
0.0
10.1
%
%
2.2
2.2
%
%
11.2
12.0
23.2
%
%
%
See accompanying notes to consolidated financial statements.
F-9
TABLE OF CONTENTS
Capitala Finance Corp.
Consolidated Schedule of Investments – (continued)
(in thousands, except for units/shares)
December 31, 2019
Portfolio Company, Country
GA Communications, Inc.
(1),(2),(3),(4),(5)
GA Communications, Inc.
Industry
Advertising &
Marketing Services
Advertising &
Marketing Services
Type of Investment
Series A-1 Preferred Stock (1,998
shares, 8.0% PIK Dividend)
Series B-1 Common Stock (200,000
shares)
(10)
LJS Partners, LLC
LJS Partners, LLC
MMI Holdings, LLC
MMI Holdings, LLC
MMI Holdings, LLC
MMI Holdings, LLC
Navis Holdings, Inc.
Navis Holdings, Inc.
Navis Holdings, Inc.
QSR Franchisor
QSR Franchisor
Medical Device
Distributor
Medical Device
Distributor
Medical Device
Distributor
Medical Device
Distributor
Textile Equipment
Manufacturer
Textile Equipment
Manufacturer
Textile Equipment
Manufacturer
Preferred Units (92,924 units)
Common Membership Units
(2,593,234 units)
First Lien Debt (12.0% Cash,
(16)
Due 1/31/21)
Subordinated Debt (6.0% Cash,
Due 1/31/21)
Preferred Units (1,000 units, 6.0% PIK
Dividend)
Common Membership Units (45 units)
(16)
(10)
First Lien Debt (11.0% Cash,
(16)
Due 6/30/23)
Class A Preferred Stock (1,000 shares,
10.0% Cash Dividend)
Common Stock (60,000 shares)
(10)
Nth Degree Investment Group, LLC
Business Services
Membership Units (6,088,000 Units)
RAM Payment, LLC
Financial Services
RAM Payment, LLC
Financial Services
Sierra Hamilton Holdings Corporation
Sierra Hamilton Holdings Corporation
Oil & Gas Engineering
and Consulting
Services
Oil & Gas Engineering
and Consulting
Services
(6)
First Lien Debt (10.0% Cash,
Due 1/4/24)
Preferred Units (86,000 units, 8.0% PIK
Dividend)
(10)
Second Lien Debt (15.0% PIK,
Due 9/12/23)
Principal
Amount
Cost
Fair Value
% of
Net Assets
$ 3,476
$ 3,761
2
3,478
293
1,224
1,517
501
4,262
372
1,509
1,881
2.6
%
0.3
2.9
0.3
%
%
%
1.0
1.3
%
%
$ 2,600
2,600
2,600
1.8
%
400
388
400
0.3
%
1,572
—
1,710
194
1.1
0.1
%
%
4,560
4,904
3.3
%
10,100
10,100
10,100
6.8
%
1,000
—
1,000
464
11,100
6,088
6,088
11,564
6,088
6,088
0.7
0.3
%
%
7.8
4.1
4.1
%
%
%
9,019
9,019
9,019
6.1
%
928
9,947
748
1,725
10,744
748
1.2
7.3
0.5
%
%
%
782
Common Stock (15,068,000 shares)
6,958
5,160
3.5
%
V12 Holdings, Inc.
Data Processing &
Digital Marketing
Subordinated Debt
(9)
Sub Total Affiliate investments – United States
Control Investments – 15.3%
Control investments – United States
Capitala Senior Loan Fund II, LLC
Investment Funds
Capitala Senior Loan Fund II, LLC
Investment Funds
Subordinated Debt (6.7% Cash
(1 month LIBOR + 5.0)%,
Due 9/3/24)
Membership Units (80.0%
ownership)
(11)(20)(21)
(11)(19)
7,706
655
5,908
708
655
$80,756
708
$98,763
4.0
0.5
%
%
0.5
66.7
%
%
$
— $ — $ —
0.0
%
13,600
13,600
13,631
13,631
9.2
9.2
%
%
See accompanying notes to consolidated financial statements.
F-10
TABLE OF CONTENTS
Portfolio Company, Country
Vology, Inc.
(1),(2),(3),(4),(5)
Vology, Inc.
Vology, Inc.
Sub Total Control investments – United States
TOTAL INVESTMENTS – 244.8%
Capitala Finance Corp.
Consolidated Schedule of Investments – (continued)
(in thousands, except for units/shares)
December 31, 2019
Industry
Type of Investment
Principal
Amount
Cost
Fair Value
% of
Net Assets
Information
Technology
Information
Technology
Information
Technology
First Lien Debt (10.5% Cash
(1 month LIBOR + 8.5%, 2.0% Floor),
Due 12/31/21)
Class A Preferred Units
(9,041,810 Units)
Membership Units (5,363,982 Units)
$ 3,877
$
3,877 $
3,877
5,215
—
5,215
—
2.6
%
3.5
0.0
%
%
9,092
9,092
$ 22,692 $ 22,723
6.1
15.3
%
%
$353,881 $362,532
244.8
%
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
All investments valued using unobservable inputs (Level 3), unless otherwise noted.
All investments valued by the Board of Directors.
All debt investments are income producing, unless otherwise noted. Equity and warrant investments are non-
income producing, unless otherwise noted.
Percentages are based on net assets of $148,113 as of December 31, 2019.
Capitala Finance Corp. generally acquires its investments in private transactions exempt from registration
under the Securities Act of 1933, as amended (the “Securities Act”). These investments are generally subject
to certain limitations on resale, and may be deemed to be “restricted securities” under the Security Act.
The cash rate equals the approximate current yield on our last-out portion of the unitranche facility.
The investment is convertible to preferred equity.
The investment has a $2.6 million unfunded commitment.
The investment has been exited or sold. The residual value reflects estimated earnout, escrow, or other
proceeds expected post-closing.
(10)
The equity investment is income producing, based on rate disclosed.
(11)
Indicates assets that the Company believes do not represent “qualifying assets” under Section 55(a) of the
Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of the
Company’s total assets at the time of acquisition of any additional non-qualifying assets. As of
December 31, 2019, 8.1% of the Company’s total assets were non-qualifying assets.
(12)
The investment has a $1.0 million unfunded commitment.
(13)
The investment has a $3.5 million unfunded commitment.
(14)
The investment has a $0.5 million unfunded commitment.
(15)
The investment has a $4.5 million unfunded commitment.
(16)
The maturity date of the original investment has been extended.
(17)
The company may elect to have 1.5% of its cash interest capitalized as paid-in-kind interest.
(18)
Investment is valued using observable inputs (Level 1). The stock of the company is traded on the NASDAQ
Capital Market under the ticker “USWS.”
(19)
The investment has a $5.0 million unfunded commitment.
(20)
The investment has a $6.4 million unfunded commitment.
(21)
The investment is valued based on the net asset value of the company.
See accompanying notes to consolidated financial statements.
F-11
Type of Investment
Principal
Amount
Cost
Fair Value
% of
Net Assets
TABLE OF CONTENTS
Capitala Finance Corp.
Consolidated Schedule of Investments
(in thousands, except for units/shares)
December 31, 2018
(1),(2),(3),(4),(19)
Portfolio Company, Country
Non-control/non-affiliated investments – 150.4%
Non-control/non-affiliated investments – United States
3 Bridge Solutions, LLC
IT Consulting
Industry
3 Bridge Solutions, LLC
3 Bridge Solutions, LLC
IT Consulting
IT Consulting
Alternative Biomedical Solutions, LLC
Healthcare
Alternative Biomedical Solutions, LLC
Healthcare
Alternative Biomedical Solutions, LLC
Healthcare
American Clinical Solutions, LLC
Healthcare
AmeriMark Direct, LLC
Consumer Products
B&W Quality Growers, LLC
Farming
First Lien Debt (11.3% Cash (1 month
LIBOR + 9.0%, 1.0% Floor),
Due 12/4/22)
Preferred Units (965 units, 8.0%
PIK)
Membership Units (39,000 units)
(5)
First Lien Debt (9.5% Cash (1 month
LIBOR + 7.0%, 1.0% Floor),
Due 12/18/22)
First Lien Debt (12.4% Cash,
(6)
Due 12/18/22)
Membership Units (20,092 units)
First Lien Debt (10.5% Cash, 2.0%
PIK, Due 6/11/20)
(7)
First Lien Debt (12.8% Cash,
Due 9/8/21)
Membership Unit Warrants
(91,739 Units)
BigMouth, Inc.
BigMouth, Inc.
Bluestem Brands, Inc.
Consumer Products
Consumer Products
First Lien Debt (14.3% Cash,
(6)
Due 11/14/21)
Series A Preferred Stock (350,000
shares, 8.0% PIK)
(5)
Online Merchandise
Retailer
First Lien Debt (10.0% Cash (1 month
LIBOR + 7.5%, 1.0% Floor),
Due 11/7/20)
3,779
Burke America Parts Group, LLC
Home Repair Parts
Manufacturer
Membership Units (14 units)
California Pizza Kitchen, Inc.
Restaurant
Second Lien Debt (12.5% Cash
(1 month LIBOR + 10.0%, 1.0%
Floor), Due 8/23/23)
Cedar Ultimate Parent, LLC
Consumer Electronics
Cedar Ultimate Parent, LLC
Consumer Electronics
Cedar Ultimate Parent, LLC
Consumer Electronics
Series C Preferred Stock
(4,759,250 units)
Series D Preferred Stock
(16,562,190 units)
Series E Common Units (190,370 units)
Chicken Soup for the Soul, LLC
Multi-platform Media
and Consumer
Products
First Lien Debt (10.9% Cash (1 month
LIBOR + 8.5%, 1.5% Floor),
Due 12/13/20)
$ 13,954 $13,954
$13,954
7.3
%
1,049
10
15,013
1,049
230
15,233
0.6
0.1
8.0
%
%
%
118
118
118
0.1
%
13,000
13,000
800
13,918
10,370
—
10,488
9,293
8,918
8,918
6,484
6,484
18,300
18,029
18,029
18,300
18,300
—
—
5,880
5,880
5.4
0.0
5.5
%
%
%
3.4
3.4
%
%
9.6
9.6
%
%
3.1
3.1
%
%
9,094
9,094
9,094
4.8
%
411
9,505
352
9,446
3,762
3,762
5
3,499
3,499
1,722
0.2
5.0
%
%
1.8
1.8
0.9
%
%
%
5
1,722
0.9
%
5,000
4,903
4,903
4,903
4,903
958
—
—
958
—
—
—
—
13,000
13,000
13,000
13,000
13,000
2.6
2.6
%
%
0.0
%
0.0
0.0
0.0
%
%
%
6.8
6.8
%
%
CIS Secure Computing, Inc.
Government Services
First Lien Debt (10.8% Cash (1 month
LIBOR + 8.5%, 1.0% Floor), 1.0%
PIK, Due 9/14/22)
10,428
10,428
10,428
5.5
%
See accompanying notes to consolidated financial statements.
F-12
TABLE OF CONTENTS
Capitala Finance Corp.
Consolidated Schedule of Investments – (continued)
(in thousands, except for units/shares)
December 31, 2018
Portfolio Company, Country
CIS Secure Computing, Inc.
(1),(2),(3),(4),(19)
Industry
Government Services
Type of Investment
Common Stock (46,163 shares)
Principal
Amount
Cost
$ 1,000
11,428
Fair Value
$ 1,681
12,109
% of
Net Assets
%
0.9
%
6.4
Corporate Visions, Inc.
Corporate Visions, Inc.
Sales & Marketing
Services
Sales & Marketing
Services
Subordinated Debt (9.0% Cash, 2.0%
PIK, Due 11/29/21)
Common Stock (15,750 shares)
$ 18,940
18,940
1,575
18,679
817
9.8
0.4
%
%
Currency Capital, LLC
Financial Services
Currency Capital, LLC
Financial Services
Flavors Holdings, Inc.
Flavors Holdings, Inc.
Freedom Electronics, LLC
Freedom Electronics, LLC
Freedom Electronics, LLC
Food Product
Manufacturer
Food Product
Manufacturer
Electronic Machine
Repair
Electronic Machine
Repair
Electronic Machine
Repair
Installs, LLC
Logistics
First Lien Debt (13.4% Cash (1 month
LIBOR + 11.0%, 0.5% Floor),
Due 1/2/20)
Class A Preferred Units
(2,000,000 units)
(8)
(8)
First Lien Debt (8.6% Cash (3 month
LIBOR + 5.8%, 1.0% Floor),
Due 4/3/20)
Second Lien Debt (12.8% Cash
(3 month LIBOR + 10.0%, 1.0%
Floor), Due 10/3/21)
First Lien Debt (8.7% Cash (1 month
LIBOR + 6.3%, 2.0% Floor),
(9)
Due 12/20/23)
First Lien Debt (9.1% Cash,
(6)
Due 12/20/23)
Membership Units (181,818 units)
First Lien Debt (9.3% Cash (1 month
LIBOR + 7.0%, 1.8% Floor),
Due 6/20/23)
MC Sign Lessor Corp.
MC Sign Lessor Corp.
Advertising &
Marketing Services
Advertising &
Marketing Services
First Lien Debt (9.3% Cash (1 month
LIBOR + 7.0%, 1.0% Floor),
(10)
Due 12/22/22)
First Lien Debt (9.3% Cash (1 month
LIBOR + 7.0%, 1.0% Floor),
(11)
Due 12/22/22)
Nth Degree, Inc.
Business Services
Nth Degree, Inc.
Business Services
First Lien Debt (13.9% Cash (1 month
LIBOR + 11.5%, 1.0% Floor), 2.0%
PIK, Due 3/29/23)
Preferred Stock (2,400 Units, 10.0%
PIK dividend)
(12)
(5)
Sequoia Healthcare Management, LLC
Healthcare
Management
First Lien Debt (10.8% Cash (1 month
LIBOR + 8.5%, 1.8% Floor),
Due 8/21/23)
Sunset Digital Holdings, LLC
Telecommunications
First Lien Debt (9.6% Cash (1 month
LIBOR + 7.3%, 1.5% Floor),
Due 8/2/19)
See accompanying notes to consolidated financial statements.
F-13
20,515
19,496
10.2
%
16,788
16,788
16,788
8.8
%
2,000
18,788
2,000
18,788
1.0
9.8
%
%
6,300
6,241
6,070
3.2
%
12,000
11,809
18,050
11,265
17,335
5.9
9.1
%
%
250
250
250
0.1
%
6,000
6,000
182
6,000
182
3.1
0.1
%
%
6,432
6,432
3.3
%
2,984
2,984
2,984
2,984
2,984
1.6
1.6
%
%
—
—
—
0.0
%
3,905
3,905
3,905
3,905
3,905
2.0
2.0
%
%
7,346
7,346
7,346
3.9
%
3,244
10,590
16,490
23,836
8.6
12.5
%
%
13,792
13,792
13,792
13,792
13,792
18,000
18,000
18,000
18,000
18,000
7.2
7.2
%
%
9.4
9.4
%
%
TABLE OF CONTENTS
Capitala Finance Corp.
Consolidated Schedule of Investments – (continued)
(in thousands, except for units/shares)
December 31, 2018
Portfolio Company, Country
Sur La Table, Inc.
(1),(2),(3),(4),(19)
Industry
Retail
Type of Investment
First Lien Debt (12.0% Cash,
Due 7/28/20)
Taylor Precision Products, Inc.
Household Product
Manufacturer
Series C Preferred Stock (379 shares)
Principal
Amount
Cost
Fair Value
% of
Net Assets
$ 15,000 $ 15,000 $ 14,979
14,979
15,000
758
758
758
758
7.9
7.9
%
%
0.4
0.4
%
%
7,000
7,000
7,000
3.7
%
502
1
7,503
502
1
7,503
0.3
0.0
4.0
%
%
%
771
632
0.3
%
(6)(13)
First Lien Debt (10.1% Cash,
Due 12/14/23)
Class A Preferred Units (500 Units,
10.0% PIK)
Class C Units (500 Units)
(5)
(8)
Class A Common Stock (77,073
shares)
Class B Common Stock (1,125,426
shares)
(8)
U.S. BioTek Laboratories, LLC
Testing laboratories
U.S. BioTek Laboratories, LLC
Testing laboratories
U.S. BioTek Laboratories, LLC
Testing laboratories
U.S. Well Services, Inc.
Oil & Gas Services
U.S. Well Services, Inc.
Oil & Gas Services
Vology, Inc.
Xirgo Technologies, LLC
Xirgo Technologies, LLC
Information
Technology
Information
Technology
Information
Technology
Subordinated Debt (15.0% Cash
(1 month LIBOR + 14.0%, 1.0%
Ceiling), 4.0% PIK Due 6/30/20)
8,720
Subordinated Debt (11.5% Cash,
Due 3/1/22)
Membership Units (600,000 units)
15,750
15,750
600
15,750
837
6,701
7,472
8,720
8,720
9,229
9,861
8,645
8,645
4.9
5.2
%
%
4.5
4.5
%
%
8.3
0.4
%
%
Sub Total Non-control/non-affiliated investments – United States
Non-control/non-affiliated investments – Brazil
Velum Global Credit Management, LLC
Financial Services
First Lien Debt (15.0% PIK,
Due 12/31/17)
(7)(8)(12)
Sub Total Non-control/non-affiliated investments – Brazil
Sub Total Non-control/non-affiliated investments
Affiliate Investments – 48.8%
Affiliate investments – United States
Burgaflex Holdings, LLC
Burgaflex Holdings, LLC
Burgaflex Holdings, LLC
Automobile
Part Manufacturer
Automobile
Part Manufacturer
Automobile
Part Manufacturer
City Gear, LLC
Footwear Retail
Eastport Holdings, LLC
Business Services
Eastport Holdings, LLC
Business Services
First Lien Debt (12.0% Cash, 1.0%
PIK, Due 3/23/21)
Common Stock Class A (1,253,198
shares)
Common Stock Class B (900,000
shares)
Membership Unit Warrants (11.4%
fully diluted)
(14)
Subordinated Debt (15.8% Cash
(3 month LIBOR + 13.0%, 0.5%
Floor), Due 4/29/20)
Membership Units (22.9% ownership)
GA Communications, Inc.
Advertising &
Marketing Services
Series A-1 Preferred Stock (1,998
shares, 8.0% PIK Dividend)
(5)
16,350
268,298
16,587
283,965
8.7
148.9
%
%
14,277
11,816
11,816
11,816
2,878
2,878
2,878
$280,114 $286,843
1.5
1.5
1.5
150.4
%
%
%
%
$ 14,801 $ 14,801 $ 14,384
1,504
—
300
16,605
—
14,384
—
—
3,184
3,184
7.5
%
0.0
%
0.0
7.5
%
%
1.7
1.7
%
%
16,500
15,496
3,263
18,759
16,500
17,610
34,110
8.7
9.2
17.9
%
%
%
3,179
3,482
1.8
%
See accompanying notes to consolidated financial statements.
F-14
TABLE OF CONTENTS
Capitala Finance Corp.
Consolidated Schedule of Investments – (continued)
(in thousands, except for units/shares)
December 31, 2018
Portfolio Company, Country
GA Communications, Inc.
(1),(2),(3),(4),(19)
Industry
Type of Investment
Advertising &
Marketing Services
Series B-1 Common Stock (200,000
shares)
J&J Produce Holdings, Inc.
Produce Distribution
J&J Produce Holdings, Inc.
J&J Produce Holdings, Inc.
Produce Distribution
Produce Distribution
(12)
Subordinated Debt (13.0% Cash,
Due 6/16/19)
Common Stock (8,182 shares)
Common Stock Warrants (6,369
shares)
$ 6,406
LJS Partners, LLC
QSR Franchisor
Common Stock (1,587,848 shares)
MMI Holdings, LLC
MMI Holdings, LLC
MMI Holdings, LLC
MMI Holdings, LLC
Medical Device
Distributor
Medical Device
Distributor
Medical Device
Distributor
Medical Device
Distributor
First Lien Debt (12.0% Cash,
(12)
Due 1/31/20)
Subordinated Debt (6.0% Cash,
Due 1/31/20)
Preferred Units (1,000 units, 6.0% PIK
Dividend)
Common Membership Units (45 units)
(12)
(5)
Sierra Hamilton Holdings Corporation
Oil & Gas Engineering
and Consulting
Services
Common Stock (15,068,000 shares)
US Bath Group, LLC
Building Products
US Bath Group, LLC
Building Products
First Lien Debt (11.4% Cash (1 month
LIBOR + 9.0%, 1.0% Floor),
Due 1/2/23)
Membership Units (500,000 units)
V12 Holdings, Inc.
Data Processing &
Digital Marketing
Subordinated Debt
(15)
Principal
Amount
Cost
Fair Value
% of
Net Assets
$
2
3,181
$ 1,325
4,807
6,406
818
—
7,224
1,188
1,188
6,210
—
—
6,210
3,018
3,018
0.7
2.5
%
%
3.3
0.0
%
%
0.0
3.3
1.6
1.6
%
%
%
%
2,600
2,600
2,600
1.4
%
400
388
400
0.2
%
1,474
—
4,462
6,958
1,612
185
4,797
6,854
0.8
0.1
%
%
2.5
3.6
%
%
6,958
6,854
3.6
%
12,750
—
12,750
500
13,250
673
12,750
2,083
14,833
742
6.7
1.1
7.8
0.4
%
%
%
%
673
$72,300
742
$92,939
0.4
48.8
%
%
Sub Total Affiliate investments – United States
Control Investments – 36.3%
Control investments – United States
AAE Acquisition, LLC
AAE Acquisition, LLC
AAE Acquisition, LLC
CableOrganizer Acquisition, LLC
CableOrganizer Acquisition, LLC
CableOrganizer Acquisition, LLC
CableOrganizer Acquisition, LLC
CableOrganizer Acquisition, LLC
Industrial Equipment
Rental
Industrial Equipment
Rental
Industrial Equipment
Rental
Second Lien Debt (6.0% Cash,
(12)
Due 8/24/19)
Membership Units (2.2% fully diluted)
$ 16,327 $16,327
17
$16,327
—
Warrants (37.8% fully diluted)
—
—
8.6
0.0
%
%
0.0
%
Computer Supply
Retail
Computer Supply
Retail
Computer Supply
Retail
Computer Supply
Retail
Computer Supply
Retail
First Lien Debt (10.0% Cash,
(16)
Due 5/24/19)
First Lien Debt (12.0% Cash, 4.0%
PIK, Due 6/30/19)
Preferred Units (4,000,000 units)
(12)
Common Stock (21.3% fully diluted)
Common Stock Warrants (10.0% fully
diluted)
See accompanying notes to consolidated financial statements.
F-15
16,344
16,327
8.6
%
1,708
1,708
1,708
0.9
%
8,889
8,889
2,354
1,394
8,889
—
—
—
14,345
—
10,597
4.6
0.0
%
%
0.0
%
0.0
5.5
%
%
TABLE OF CONTENTS
Capitala Finance Corp.
Consolidated Schedule of Investments – (continued)
(in thousands, except for units/shares)
December 31, 2018
Portfolio Company, Country
Capitala Senior Loan Fund II, LLC
(1),(2),(3),(4),(19)
Industry
Investment Funds
Type of Investment
Membership Units (80.0%
(8)(17)
ownership)
Micro Precision, LLC
Micro Precision, LLC
Micro Precision, LLC
Navis Holdings, Inc.
Navis Holdings, Inc.
Navis Holdings, Inc.
Portrait Studio, LLC
Portrait Studio, LLC
Portrait Studio, LLC
Portrait Studio, LLC
Conglomerate
Conglomerate
Conglomerate
(12)
Subordinated Debt (10.0% Cash,
Due 1/1/19)
Subordinated Debt (14.0% Cash, 4.0%
(12)
PIK, Due 1/1/19)
Series A Preferred Units (47 units)
First Lien Debt (15.0% Cash,
(12)
Due 10/30/20)
Class A Preferred Stock (1,000 shares,
10.0% Cash Dividend)
Common Stock (300,000 shares)
(5)
(18)
First Lien Debt (9.0% Cash (1 month
LIBOR + 7.0%, 1.0% Floor, 2.0%
Ceiling), Due 12/31/22)
First Lien Debt (9.4% Cash (1 month
LIBOR + 7.0%, 1.0% Floor, 5.0%
Ceiling), Due 12/31/22)
Preferred Units (4,350,000 Units)
Textile Equipment
Manufacturer
Textile Equipment
Manufacturer
Textile Equipment
Manufacturer
Professional and
Personal Digital
Imaging
Professional and
Personal Digital
Imaging
Professional and
Personal Digital
Imaging
Professional and
Personal Digital
Imaging
Principal
Amount
Cost
Fair Value
% of
Net Assets
$ 13,600 $ 13,695
13,695
13,600
7.2
7.2
%
%
$ 1,862
1,862
1,862
1.0
%
4,325
4,325
1,629
7,816
4,325
2,817
9,004
2.3
1.5
4.8
%
%
%
7,500
7,500
7,500
3.9
%
1,000
1
1,000
4,348
0.5
2.3
%
%
8,501
12,848
6.7
%
—
—
—
0.0
%
4,500
4,500
2,450
4,500
2,174
2.4
1.1
%
%
Membership Units (150,000 Units)
—
—
0.0
%
Sub Total Control investments – United States
TOTAL INVESTMENTS – 235.5%
6,950
6,674
$ 67,556 $ 69,145
3.5
36.3
%
%
$419,970 $448,927
235.5
%
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
All investments valued using unobservable inputs (Level 3).
All investments valued by the Board of Directors.
All debt investments are income producing, unless otherwise noted. Equity and warrant investments are non-
income producing, unless otherwise noted.
Percentages are based on net assets of $190,644 as of December 31, 2018.
The equity investment is income producing, based on rate disclosed.
The cash rate equals the approximate current yield on our last-out portion of the unitranche facility.
Non-accrual investment.
Indicates assets that the Company believes do not represent “qualifying assets” under Section 55(a) of the
Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of the
Company’s total assets at the time of acquisition of any additional non-qualifying assets. As of
December 31, 2018, 9.2% of the Company’s total assets were non-qualifying assets.
(9)
The investment has a $0.8 million unfunded commitment.
(10)
The investment has a $0.5 million unfunded commitment.
(11)
The investment has a $0.6 million unfunded commitment.
(12)
The maturity date of the original investment has been extended.
See accompanying notes to consolidated financial statements.
F-16
TABLE OF CONTENTS
Capitala Finance Corp.
Consolidated Schedule of Investments – (continued)
(in thousands, except for units/shares)
December 31, 2018
(13)
The investment has a $1.0 million unfunded commitment.
(14)
The investment has been exited. The residual value reflects estimated earnout to be settled post-closing.
(15)
The investment has been exited. The residual value reflects estimated escrow and earnout to be settled post-
closing.
(16)
The investment has a $0.3 million unfunded commitment.
(17)
The investment has a $6.4 million unfunded commitment.
(18)
The investment has a $5.0 million unfunded commitment.
(19)
Capitala Finance Corp. generally acquires its investments in private transactions exempt from registration
under the Securities Act of 1933, as amended (the “Securities Act”). These investments are generally subject
to certain limitations on resale, and may be deemed to be “restricted securities” under the Securities Act.
See accompanying notes to consolidated financial statements.
F-17
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 1. Organization
Capitala Finance Corp. (the “Company”, “we”, “us”, and “our”) is an externally managed non-diversified
closed-end management investment company incorporated in Maryland that has elected to be regulated as a
business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940
Act”). The Company commenced operations on May 24, 2013 and completed its initial public offering (“IPO”)
on September 30, 2013. The Company is managed by Capitala Investment Advisors, LLC (the “Investment
Advisor”), an investment adviser that is registered as an investment adviser under the Investment Advisers Act of
1940, as amended, and Capitala Advisors Corp. (the “Administrator”) provides the administrative services
necessary for the Company to operate. For United States (“U.S.”) federal income tax purposes, the Company has
elected to be treated, and intends to comply with the requirements to continue to qualify annually, as a regulated
investment company (“RIC”) under subchapter M of the Internal Revenue Code of 1986, as amended (the
“Code”).
The Company’s investment objective is to generate both current income and capital appreciation through
debt and equity investments. Both directly and through our subsidiary that is licensed by the U.S. Small Business
Administration (“SBA”) under the Small Business Investment Company (“SBIC”) Act, the Company offers
customized financing to business owners, management teams, and financial sponsors for change of ownership
transactions, recapitalizations, strategic acquisitions, business expansion, and other growth initiatives. The
Company invests in first lien loans, second lien loans, subordinated loans, and, to a lesser extent, equity securities
issued by lower middle-market companies and traditional middle-market companies.
The Company was formed for the purpose of: (i) acquiring, through a series of transactions, an investment
portfolio from the following entities: CapitalSouth Partners Fund I Limited Partnership (“Fund I”); CapitalSouth
Partners Fund II Limited Partnership (“Fund II”); CapitalSouth Partners Fund III, L.P. (“Fund III Parent”);
CapitalSouth Partners SBIC Fund III, L.P. (“Fund III”) and CapitalSouth Partners Florida Sidecar Fund I, L.P.
(“Florida Sidecar” and, collectively with Fund I, Fund II, Fund III, and Fund III Parent, the “Legacy Funds”); (ii)
raising capital in the IPO and (iii) continuing and expanding the business of the Legacy Funds by making
additional debt and equity investments in lower middle-market and traditional middle-market companies.
On September 24, 2013, the Company acquired 100% of the limited partnership interests in Fund II,
Fund III, and Florida Sidecar and each of their respective general partners, as well as certain assets from Fund I
and Fund III Parent, in exchange for an aggregate of 8,974,420 shares of the Company’s common stock (the
“Formation Transactions”). Fund II, Fund III and Florida Sidecar became the Company’s wholly owned
subsidiaries. Fund II and Fund III retained their SBIC licenses, continued to hold their existing investments at the
time of the IPO and have continued to make new investments. The IPO consisted of the sale of 4,000,000 shares
of the Company’s common stock at a price of $20.00 per share, resulting in net proceeds to the Company of
$74.25 million, after deducting underwriting fees and commissions totaling $4.0 million and offering expenses
totaling $1.75 million. The other costs of the IPO were borne by the limited partners of the Legacy Funds. During
the fourth quarter of 2017, Florida Sidecar transferred all of its assets to the Company and was legally dissolved
as a standalone partnership. On March 1, 2019, Fund II repaid its outstanding SBA debentures and relinquished
its SBIC license.
The Company has formed, and expects to continue to form, certain consolidated taxable subsidiaries (the
“Taxable Subsidiaries”), which are taxed as corporations for income tax purposes. The Taxable Subsidiaries
allow the Company to make equity investments in companies organized as pass-through entities while continuing
to satisfy the requirements of a RIC under the Code.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation
The Company is considered an investment company as defined in Accounting Standards Codification
(“ASC”) Topic 946 — Financial Services — Investment Companies (“ASC 946”). The accompanying
F-18
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 2. Summary of Significant Accounting Policies – (continued)
consolidated financial statements have been prepared on the accrual basis of accounting in conformity with U.S.
generally accepted accounting principles (“U.S. GAAP”) and pursuant to the requirements for reporting on Form
10-K and Article 6 of Regulation S-X. The consolidated financial statements of the Company include the
accounts of the Company and its wholly owned subsidiaries, including Fund II, Fund III, and the Taxable
Subsidiaries.
The Company’s financial statements as of December 31, 2019 and 2018 and for the years ended
December 31, 2019, 2018 and 2017 are presented on a consolidated basis. The effects of all intercompany
transactions between the Company and its subsidiaries (Fund II, Fund III, and the Taxable Subsidiaries) have
been eliminated in consolidation. All financial data and information included in these consolidated financial
statements have been presented on the basis described above. In the opinion of management, the consolidated
financial statements reflect all adjustments that are necessary for the fair presentation of financial results as of
and for the periods presented.
Use of Estimates in the Preparation of Financial Statements
The preparation of the consolidated financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those estimates under different assumptions
and conditions. The most significant estimates in the preparation of the consolidated financial statements are
investment valuation, revenue recognition, and income taxes.
Consolidation
As provided under ASC 946, the Company will generally not consolidate its investment in a company other
than a substantially wholly owned investment company subsidiary or a controlled operating company whose
business consists of providing services to the Company. Accordingly, the Company consolidated the results of the
Company’s wholly owned investment company subsidiaries (Fund II, Fund III, and the Taxable Subsidiaries) in
its consolidated financial statements. The Company does not consolidate its interest in Capitala Senior Loan
Fund II, LLC (“CSLF II”) because the investment is not considered a substantially wholly owned investment
company subsidiary. Further, CSLF II is a joint venture for which shared power exists relating to the decisions
that most significantly impact the economic performance of the entity. See Note 4 to the consolidated financial
statements for a description of the Company’s investment in CSLF II.
Segments
In accordance with ASC Topic 280 — Segment Reporting (“ASC 280”), the Company has determined that it
has a single reporting segment and operating unit structure. While the Company invests in several industries and
geographic locations, all investments share similar business and economic risks. As such, all investment activities
have been aggregated into a single segment.
Cash and Cash Equivalents
The Company considers cash equivalents to be highly liquid investments with original maturities of
three months or less at the date of purchase. The Company deposits its cash in financial institutions and, at times,
such balances may be in excess of the Federal Deposit Insurance Corporation insurance limits.
Investment Classification
In accordance with the provisions of the 1940 Act, the Company classifies its investments by level of
control. As defined in the 1940 Act, “Control Investments” are investments in those companies that the Company
is deemed to “Control.” “Affiliate Investments” are investments in those companies that are
F-19
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 2. Summary of Significant Accounting Policies – (continued)
“Affiliated Companies” of the Company, as defined in the 1940 Act, other than Control Investments. “Non-
Control/Non-Affiliate Investments” are those investments that are neither Control Investments nor Affiliate
Investments. Generally, under the 1940 Act, the Company is deemed to control a company in which it has
invested if the Company owns more than 25% of the voting securities of such company and/or has greater than
50% representation on its board or has the power to exercise control over management or policies of such
portfolio company. The Company is deemed to be an affiliate of a company in which the Company has invested
if it owns between 5% and 25% of the voting securities of such company.
Valuation of Investments
The Company applies fair value accounting to all of its financial instruments in accordance with the 1940
Act and ASC Topic 820 — Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 defines fair value,
establishes a framework used to measure fair value, and requires disclosures for fair value measurements. In
accordance with ASC 820, the Company has categorized its financial instruments carried at fair value, based on
the priority of the valuation technique, into a three-level fair value hierarchy, as discussed in Note 4.
In determining fair value, the Company’s board of directors (the “Board”) uses various valuation
approaches, and engages a third-party valuation firm, which provides an independent valuation of certain
investments it reviews. In accordance with U.S. GAAP, a fair value hierarchy for inputs is used in measuring fair
value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that
the most observable inputs be used when available.
Observable inputs are those that market participants would use in pricing the asset or liability based on
market data obtained from sources independent of the Board. Unobservable inputs reflect the Board’s
assumptions about the inputs market participants would use in pricing the asset or liability developed based upon
the best information available in the circumstances.
The availability of valuation techniques and observable inputs can vary from security to security and is
affected by a wide variety of factors including the type of security, whether the security is new and not yet
established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation
is based on models or inputs that are less observable or unobservable in the market, the determination of fair
value requires more judgment. Those estimated values do not necessarily represent the amounts that may be
ultimately realized due to the occurrence of future circumstances that cannot be reasonably determined. Because
of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values
that would have been used had a market for the securities existed. Accordingly, the degree of judgment exercised
by the Board in determining fair value is greatest for securities categorized in Level 3. In certain cases, the inputs
used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure
purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is
determined based on the lowest level input that is significant to the fair value measurement.
Fair value is a market-based measure considered from the perspective of a market participant rather than an
entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own
assumptions are set to reflect those that market participants would use in pricing the asset or liability at the
measurement date. The Company uses prices and inputs that are current as of the measurement date, including
periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be
reduced for many securities. This condition could cause a security to be reclassified to a lower level within the
fair value hierarchy.
In estimating the fair value of portfolio investments, the Company starts with the cost basis of the
investment, which includes original issue discount and payment-in-kind (“PIK”) income, if any. The
F-20
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 2. Summary of Significant Accounting Policies – (continued)
transaction price is typically the best estimate of fair value at inception. When evidence supports a subsequent
change to the carrying value from the original transaction price, adjustments are made to reflect the expected fair
values.
As a practical expedient, the Company uses net asset value (“NAV”) as the fair value for its equity
investment in CSLF II. CSLF II records its underlying investments at fair value on a quarterly basis in
accordance with the 1940 Act and ASC 820.
The valuation methodologies summarized below are utilized by the Company in estimating fair value.
Enterprise Value Waterfall Approach
The enterprise value waterfall approach determines an enterprise value based on earnings before interest,
tax, depreciation and amortization (“EBITDA”) multiples of publicly traded companies that are considered
similar to the subject portfolio company. The Company considers a variety of items in determining a reasonable
pricing multiple, including, but not limited to, operating results, budgeted projections, growth, size, risk,
profitability, leverage, management depth, diversification, market position, supplier or customer dependence,
asset utilization, liquidity metrics, and access to capital markets. EBITDA of the portfolio company is adjusted
for non-recurring items in order to reflect a normalized level of earnings that is representative of future earnings.
In certain instances, the Company may also utilize revenue multiples to determine enterprise value. When
available, the Company may assign a pricing multiple or value its investments based on the value of recent
investment transactions in the subject portfolio company or offers to purchase the portfolio company. The
enterprise value is adjusted for financial instruments with seniority to the Company’s ownership and for the effect
of any instrument which may dilute the Company’s investment in the portfolio company. The adjusted enterprise
value is then apportioned based on the seniority and privileges of the Company’s investments within the portfolio
company.
Income Approach
The income approach utilizes a discounted cash flow methodology in which the Company estimates fair
value based on the present value of expected cash flows discounted at a market rate of interest. The determination
of a discount rate, or required rate of return, takes into account the portfolio company’s fundamentals and
perceived credit risk. Because the majority of the Company’s portfolio companies do not have a public credit
rating, determining a discount rate often involves assigning an implied credit rating based on the portfolio
company’s operating metrics compared to average metrics of similar publicly rated debt. Operating metrics
include, but are not limited to, EBITDA, interest coverage, leverage ratios, return on capital, and debt to equity
ratios. The implied credit rating is used to assign a base discount rate range based on publicly available yields on
similarly rated debt securities. The Company may apply a premium to the discount rate utilized in determining
fair value when performance metrics and other qualitative information indicate that there is an additional level of
uncertainty about collectability of cash flows.
Asset Approach
The asset approach values an investment based on the value of the underlying collateral securing the
investment.
Revenue Recognition
The Company’s revenue recognition policies are as follows:
Interest income and paid-in-kind interest income: Interest income is recorded on the accrual basis to the
extent that such amounts are expected to be collected. The Company has loans in the portfolio that contain a
F-21
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 2. Summary of Significant Accounting Policies – (continued)
PIK interest provision. The PIK interest, which represents contractually deferred interest added to the loan
balance that is generally due at maturity, is recorded on an accrual basis to the extent that such amounts are
expected to be collected. PIK interest is not accrued if the Company does not expect the issuer to be able to pay
all principal and interest when due.
Non-accrual investments: Management reviews all loans that become 90 days or more past due, or when
there is reasonable doubt that principal or interest will be collected, for possible placement on non-accrual status.
When the Company otherwise does not expect the borrower to be able to service its debt and other obligations,
the Company will place the loan on non-accrual status and will generally cease recognizing interest income and
PIK interest on that loan for financial reporting purposes. Interest payments received on non-accrual loans may
be recognized as income or applied to principal depending upon management’s judgment. The Company writes
off any previously accrued and uncollected interest when it is determined that interest is no longer considered
collectible. The Company may elect to cease accruing PIK interest and continue accruing interest income in cases
where a loan is currently paying its interest but, in management’s judgment, there is a reasonable likelihood of
principal loss on the loan. Non-accrual loans are returned to accrual status when the borrower’s financial
condition improves such that management believes current interest and principal payments are expected to be
collected.
Gains and losses on investment sales and paydowns: Realized gains and losses on investments are
recognized using the specific identification method.
Dividend income and paid-in-kind dividends: Dividend income is recognized on the date dividends are
declared. The Company holds preferred equity investments in the portfolio that contain a PIK dividend provision.
PIK dividends, which represent contractually deferred dividends added to the equity balance, are recorded on the
accrual basis to the extent that such amounts are expected to be collected. The Company will typically cease
accrual of PIK dividends when the fair value of the equity investment is less than the cost basis of the investment
or when it is otherwise determined by management that PIK dividends are unlikely to be collected. If
management determines that a decline in fair value is temporary in nature and the PIK dividends are more likely
than not to be collected, management may elect to continue accruing PIK dividends.
Original issue discount: Discounts received to par on loans purchased are capitalized and accreted into
income over the life of the loan. Any remaining discount is accreted into income upon prepayment of the loan.
Other income: Origination fees (to the extent services are performed to earn such income), amendment
fees, consent fees, and other fees associated with investments in portfolio companies are recognized as income
when the investment transaction closes. Prepayment penalties received by the Company for debt instruments
repaid prior to maturity date are recorded as income upon receipt.
Loan Sales
The Company follows the guidance in ASC Topic 860 — Transfers and Servicing (“ASC 860”) when
accounting for loan participations and partial loan sales as it relates to concluding on sales accounting treatment
for such transactions. Based on the Company’s analysis of all loan participations and partial sales completed, the
Company believes that all such transactions meet the criterion required by ASC 860 to qualify for sales
accounting treatment.
Guarantees
The Company follows the guidance of ASC Topic 460 — Guarantees (“ASC 460”). ASC 460 elaborates on
the disclosure requirements of a guarantor in its interim and annual consolidated financial statements about its
obligations under certain guarantees that it has issued. It also requires a guarantor to recognize, at
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CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 2. Summary of Significant Accounting Policies – (continued)
the inception of a guarantee, for those guarantees that are covered by ASC 460, the fair value of the obligation
undertaken in issuing certain guarantees.
General and Administrative Expenses
General and administrative expenses are accrued as incurred. The Company’s administrative expenses
include personnel and overhead expenses allocable to the Company paid by and reimbursed to the Administrator
under an administration agreement between the Company and the Administrator (the “Administration
Agreement”). Other operating expenses such as legal and audit fees, director fees, and director and officer
insurance are generally paid directly by the Company.
Deferred Financing Fees
Costs incurred to issue the Company’s debt obligations are capitalized and are amortized over the term of
the debt agreements under the effective interest method.
Earnings per share
The Company’s earnings per share (“EPS”) amounts have been computed based on the weighted-average
number of shares of common stock outstanding for the period. Basic EPS is computed by dividing net increase
(decrease) in net assets resulting from operations by the weighted average number of shares of common stock
outstanding during the period of computation. Diluted EPS is computed by dividing net increase (decrease) in net
assets resulting from operations, adjusted for the change in net assets resulting from the exercise of the dilutive
shares, by the weighted average number of shares of common stock assuming all potentially dilutive shares had
been issued. Diluted EPS reflects the potential dilution using the as-if-converted method for convertible debt,
which could occur if all potentially dilutive securities were exercised.
Commitments and Contingencies
As of December 31, 2019, the Company had outstanding unfunded commitments related to debt and equity
investments in existing portfolio companies of $11.4 million (CSLF II), $4.5 million (Rapid Fire Protection, Inc),
$3.5 million (J5 Infrastructure Partners, LLC), $2.6 million (BigMouth, Inc.), $1.0 million (Freedom Electronics,
LLC), $1.0 million (U.S. BioTek Laboratories, LLC), and $0.5 million (Jurassic Quest Holdings, LLC). As of
December 31, 2018, the Company had outstanding unfunded commitments related to debt and equity investments
in existing portfolio companies of $6.4 million (CSLF II), $5.0 million (Portrait Studio, LLC), $1.1 million (MC
Sign Lessor, Corp), $1.0 million (U.S. BioTek Laboratories, LLC), $0.8 million (Freedom Electronics, LLC), and
$0.3 million (CableOrganizer Acquisition, LLC).
The Company may invest in the same unitranche facility as CSLF II whereby CSLF II provides the first-out
portion of the unitranche facility and the Company and other lenders provide the last-out portion of the
unitranche facility. Under a guarantee agreement, the Company may be required to purchase its pro-rata portion
of first-out loans from CSLF II upon certain triggering events, including acceleration upon payment default of the
underlying borrower. As of December 31, 2019, the Company has evaluated the fair value of the guarantee under
the guidance of ASC Topic 460 — Guarantees and determined that the fair value of the guarantee is immaterial
as the risk of payment default for first-out loans in CSLF II is considered remote. The maximum exposure to
credit risk as of December 31, 2019 and 2018, was $10.3 million and $4.3 million, respectively, and extends to
the stated maturity of the underlying loans in CSLF II.
In the ordinary course of business, the Company may enter into contracts or agreements that contain
indemnifications or warranties. Future events could occur that could lead to the execution of these provisions
against the Company. Based on its history and experience, management believes that the likelihood of such an
event is remote.
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CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 2. Summary of Significant Accounting Policies – (continued)
In the ordinary course of business, the Company may directly or indirectly be a defendant or plaintiff in
legal actions with respect to bankruptcy, insolvency or other types of proceedings. Such lawsuits may involve
claims that could adversely affect the value of certain financial instruments owned by the Company or result in
direct losses to the Company. The nature of litigation can make it difficult to predict the impact a particular
lawsuit will have on the Company. There are many reasons that the Company cannot make these assessments,
including, among others, one or more of the following: the proceeding is in its early stages; the damages sought
are unspecified, unsupportable, unexplained or uncertain; discovery has not started or is not complete; there are
significant facts in dispute; and there are other parties who may share in any ultimate liability.
In management’s opinion, no direct losses with respect to litigation contingencies were probable as of
December 31, 2019 and 2018. Management is of the opinion that the ultimate resolution of such claims, if any,
will not materially affect the Company’s business, financial position, results of operations or liquidity.
Furthermore, in management’s opinion, it is not possible to estimate a range of reasonably possible losses with
respect to litigation contingencies.
Income Taxes
The Company has elected to be treated for U.S. federal income tax purposes and intends to comply with the
requirements to qualify annually as a RIC under subchapter M of the Code and, among other things, intends to
make the requisite distributions to its stockholders which will relieve the Company from U.S. federal income
taxes.
In order to qualify as a RIC, among other requirements, the Company is required to timely distribute to its
stockholders at least 90.0% of its investment company taxable income, as defined by the Code, for each fiscal tax
year. The Company will be subject to a nondeductible U.S. federal excise tax of 4.0% on undistributed income if
it does not distribute at least 98.0% of its ordinary income in any calendar year and 98.2% of its capital gain net
income for each one-year period ending on October 31.
Depending on the level of taxable income earned in an excise tax year, the Company may choose to carry
forward taxable income in excess of current year dividend distributions into the next excise tax year and pay a
4.0% excise tax on such income, as required. To the extent that the Company determines that its estimated current
year annual taxable income will be in excess of estimated current year dividend distributions for excise tax
purposes, the Company accrues excise tax, if any, on estimated excess taxable income as taxable income is
earned. Since the Company’s IPO, the Company has not accrued or paid excise tax.
In 2017, the Company elected to amend its tax year end from August 31 to December 31 and filed a tax
return for the four months ended December 31, 2017. The tax periods ended December 31, 2019, December 31,
2018, December 31, 2017, and August 31, 2017 remain subject to examination by U.S. federal, state, and local
tax authorities. No interest expense or penalties have been assessed for the years ended December 31, 2019, 2018
and 2017. If the Company was required to recognize interest and penalties, if any, related to unrecognized tax
benefits this would be recognized as income tax expense in the consolidated statements of operations.
The Company’s Taxable Subsidiaries record deferred tax assets or liabilities related to temporary book
versus tax differences on the income or loss generated by the underlying equity investments held by the Taxable
Subsidiaries. As of December 31, 2019 and 2018, the Company recorded a net deferred tax asset of $0.0 and
$0.6 million, respectively. For the years ended December 31, 2019, 2018, and 2017, the Company recorded a
deferred tax benefit (provision) of $(0.6) million, $1.9 million, and $(1.3) million, respectively. As of
December 31, 2019 and 2018, the valuation allowance on the Company’s deferred tax asset was $3.2 million and
$0.4 million, respectively. For the years ended December 31, 2019, 2018, and 2017, the Company recognized an
increase in the valuation allowance of $2.8 million, $0.0 million, and $0.4 million, respectively.
F-24
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CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 2. Summary of Significant Accounting Policies – (continued)
In accordance with certain applicable U.S. Treasury regulations and guidance issued by the Internal Revenue
Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each
stockholder may elect to receive its entire distribution in either cash or stock of the RIC, subject to a limitation on
the aggregate amount of cash to be distributed to all stockholders, which limitation must be at least 20.0% of the
aggregate declared distribution. If too many stockholders elect to receive cash, the cash available for distribution
must be allocated among the stockholders electing to receive cash (with the balance of the distribution paid in
stock). In no event will any stockholder, electing to receive cash, receive the lesser of (a) the portion of the
distribution such stockholder has elected to receive in cash or (b) an amount equal to his or her entire distribution
times the percentage limitation on cash available for distribution. If these and certain other requirements are met,
for U.S. federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash
that could have been received instead of stock. For income tax purposes, the Company has paid distributions on
its common stock from ordinary income in the amount of $13.4 million, $16.0 million, $6.1 million, and
$25.2 million during the tax periods ended December 31, 2019, December 31, 2018, December 31, 2017, and
August 31, 2017, respectively. For income tax purposes, the Company has paid distributions on its common stock
that were accounted for as a return of capital in the amount of $2.7 million for the tax year ended December 31,
2019. For the tax periods ended December 31, 2018, December 31, 2017, and August 31, 2017, there was no
return of capital.
ASC Topic 740 — Income Taxes (“ASC 740”), provides guidance for how uncertain tax positions should be
recognized, measured, presented and disclosed in the financial statements. ASC 740 requires the evaluation of tax
positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether
the tax positions are “more-likely-than-not” to be sustained by the applicable tax authority. Tax positions deemed
to meet a “more-likely-than-not” threshold would be recorded as a tax benefit or expense in the current period.
The Company recognizes interest and penalties, if any, related to unrecognized tax benefits as income tax
expense in the consolidated statements of operations. As of December 31, 2019 and 2018, there were no
uncertain tax positions.
The Company is required to determine whether a tax position of the Company is more likely-than-not to be
sustained upon examination by the applicable taxing authority, including resolution of any related appeals or
litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as
the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement.
De-recognition of a tax benefit previously recognized could result in the Company recording a tax liability that
could negatively impact the Company’s net assets.
U.S. GAAP provides guidance on thresholds, measurement, de-recognition, classification, interest and
penalties, accounting in interim periods, disclosure, and transition that is intended to provide better financial
statement comparability among different entities.
Distributions
Distributions to common stockholders are recorded on the record date. The amount to be paid out as a
dividend is determined by the Board. Net capital gains, if any, are generally distributed at least annually, although
we may decide to retain such capital gains for reinvestment.
The Company has adopted an “opt out” dividend reinvestment plan (“DRIP”) for the Company’s common
stockholders. As a result, if the Company declares a distribution, then stockholders’ cash distributions will be
automatically reinvested in additional shares of the Company’s common stock unless a stockholder specifically
“opts out” of our DRIP. If a stockholder opts out, that stockholder will receive cash distributions. Although
distributions paid in the form of additional shares of our common stock will generally be subject to U.S. federal,
state and local taxes in the same manner as cash distributions, stockholders
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TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 2. Summary of Significant Accounting Policies – (continued)
participating in the Company’s DRIP will not receive any corresponding cash distributions with which to pay any
such applicable taxes.
Company Investment Risk, Concentration of Credit Risk, and Liquidity Risk
The Investment Advisor has broad discretion in making investments for the Company. Investments will
generally consist of debt and equity instruments that may be affected by business, financial market or legal
uncertainties. Prices of investments may be volatile, and a variety of factors that are inherently difficult to predict,
such as domestic or international economic and political developments, may significantly affect the results of the
Company’s activities and the value of its investments. In addition, the value of the Company’s portfolio may
fluctuate as the general level of interest rates fluctuate.
The value of the Company’s investments may be detrimentally affected to the extent, among other things,
that a borrower defaults on its obligations, there is insufficient collateral and/or there are extensive legal and other
costs incurred in collecting on a defaulted loan, observable secondary or primary market yields for similar
instruments issued by comparable companies increase materially or risk premiums required in the market
between smaller companies, such as our borrowers, and those for which market yields are observable increase
materially.
The Investment Advisor may attempt to minimize this risk by maintaining low debt-to-liquidation values
with each debt investment and the collateral underlying the debt investment.
The Company’s assets may, at any time, include securities and other financial instruments or obligations that
are illiquid or thinly traded, making purchase or sale of such securities and financial instruments at desired prices
or in desired quantities difficult. Furthermore, the sale of any such investments may be possible only at
substantial discounts, and it may be extremely difficult to value any such investments accurately.
Note 3. Recent Accounting Pronouncements
In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update
2018-13, Disclosure Framework — Changes to the Disclosure Requirement for Fair Value Measurement. The
FASB issued the amendments as part of the disclosure framework project which is intended to improve the
effectiveness of fair value disclosures in the notes to the financial statements by facilitating clear communication
of the information required by U.S. GAAP that is most important to users of the financial statements. The
standard is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2019.
Management has evaluated the impact of adoption of ASU 2018-13 and determined that these changes will not
have a significant impact on the Company’s consolidated financial statements and disclosures.
In October 2018, the SEC adopted amendments (the “Amendments”) to certain disclosure requirements that
have become redundant, duplicative, overlapping, outdated, or superseded, in light of other SEC disclosure
requirements, U.S. GAAP requirements, or changes in the information environment. In part, the Amendments
require an investment company to present distributable earnings in total, rather than showing the three
components of distributable earnings. The compliance date for the Amendments is for all filings on or after
November 5, 2018. Management has adopted the Amendments and included the required disclosures in the
Company’s consolidated financial statements.
In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with
Customers (ASC Topic 606) (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements
under ASC Topic 605, Revenue Recognition, and most industry-specific guidance throughout the ASC. The core
principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or
services to customers in an amount that reflects the consideration to which an entity expects to be
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CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Recent Accounting Pronouncements – (continued)
entitled in exchange for those goods or services. The new guidance significantly enhances comparability of
revenue recognition practices across entities, industries, jurisdictions and capital markets. Additionally, the
guidance requires improved disclosures as to the nature, amount, timing and uncertainty of revenue that is
recognized. The new guidance became effective for the annual reporting period beginning January 1, 2018,
including interim periods within that reporting period. The Company completed its assessment in evaluating the
potential impact on its consolidated financial statements and based on its assessment, determined that its financial
contracts are excluded from the scope of ASU 2014-09. As a result of the scope exception for financial contracts,
the Company’s management has determined that there were no material changes to the recognition, timing, and
classification of revenues and expenses; additionally, the Company’s management determined that the adoption
of ASU 2014-09 did not have a significant impact on its consolidated financial statement disclosures.
Note 4. Investments and Fair Value Measurements
The Company’s investment objective is to generate both current income and capital appreciation through
debt and equity investments. The Company offers customized financing to business owners, management teams
and financial sponsors for change of ownership transactions, recapitalizations, strategic acquisitions, business
expansion and other growth initiatives. The Company invests in first lien loans, second lien loans, subordinated
loans and, to a lesser extent, equity securities issued by lower middle-market companies and traditional middle-
market companies. As of December 31, 2019, our portfolio consisted of investments in 43 portfolio companies
with a fair value of approximately $362.5 million.
Most of the Company’s debt investments are structured as first lien loans. First lien loans may contain some
minimum amount of principal amortization, excess cash flow sweep feature, prepayment penalties, or any
combination of the foregoing. First lien loans are secured by a first priority lien in existing and future assets of
the borrower and may take the form of term loans, delayed draw facilities, or revolving credit facilities.
Unitranche debt, a form of first lien loan, typically involves issuing one debt security that blends the risk and
return profiles of both senior secured and subordinated debt in one debt security, bifurcating the loan into a first-
out tranche and last-out tranche. As of December 31, 2019, 18.1% of the fair value of our first lien loans
consisted of last-out loans. As of December 31, 2018, 13.7% of the fair value of our first lien loans consisted of
last-out loans. In some cases, first lien loans may be subordinated, solely with respect to the payment of cash
interest, to an asset based revolving credit facility.
The Company also invests in debt instruments structured as second lien loans. Second lien loans are loans
which have a second priority security interest in all or substantially all of the borrower’s assets, and which are not
subject to the blockage of cash interest payments to the Company at the first lien lender’s discretion.
In addition to first and second lien loans, the Company may also invest in subordinated loans. Subordinated
loans typically have a second lien on all or substantially all of the borrower’s assets, but unlike second lien loans,
may be subject to the interruption of cash interest payments upon certain events of default, at the discretion of the
first lien lender.
During the year ended December 31, 2019, the Company made approximately $77.8 million of investments
and had approximately $128.1 million in repayments and sales resulting in net repayments and sales of
approximately $50.3 million for the year. During the year ended December 31, 2018, the Company made
approximately $107.8 million of investments and had approximately $123.5 million in repayments and sales
resulting in net repayments and sales of approximately $15.7 million for the year. During the year ended
December 31, 2017, the Company made approximately $82.8 million of investments and had approximately
$115.8 million in repayments and sales resulting in net repayments and sales of approximately $33.0 million for
the year.
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TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Investments and Fair Value Measurements – (continued)
During the year ended December 31, 2019, the Company funded $6.7 million of previously committed
capital to existing portfolio companies. During the year ended December 31, 2019, the Company funded
$71.1 million of investments in portfolio companies for which it was not previously committed to fund. During
the year ended December 31, 2018, the Company funded $6.5 million of previously committed capital to existing
portfolio companies. During the year ended December 31, 2018, the Company funded $101.3 million of
investments in portfolio companies for which it was not previously committed to fund. During the year ended
December 31, 2017, the Company funded $5.9 million of previously committed capital to existing portfolio
companies. During the year ended December 31, 2017, the Company funded $76.9 million of investments in
portfolio companies for which it was not previously committed to fund. During the years ended December 31,
2019 and 2018, the Company did not assist any portfolio companies in obtaining indirect financing. During the
year ended December 31, 2017, the Company assisted one portfolio company in obtaining indirect financing by
providing a limited guarantee. During the years ended December 31, 2019, 2018, and 2017, the Company did not
lead any syndicates.
On August 31, 2016, the Company sold a portion of 14 securities across 10 portfolio companies to
CapitalSouth Partners Florida Sidecar Fund II, L.P. (“FSC II”), including granting an option to acquire a portion
of the Company’s equity investment in Eastport Holdings, LLC (the “Written Call Option”), in exchange for
100% of the partnership interests in FSC II. Concurrent with the sale of these assets to FSC II, the Company
received cash consideration of $47.6 million from an affiliated third-party purchaser in exchange for 100% of the
partnership interests of FSC II. These assets were sold to FSC II at their June 30, 2016 fair market values,
resulting in a net realized gain of $0.1 million. The Company’s Board pre-approved this transaction pursuant to
Section 57(f) of the 1940 Act. On August 27, 2018, FSC II exercised its option at the agreed upon strike price of
$1.5 million.
The Company collected and will periodically collect principal and interest payments related to certain of the
securities purchased by FSC II. Such principal and interest payments will be remitted timely to FSC II based on
its proportionate share of the security. FSC II does not have any recourse to the Company related to the non-
payment of principal or interest by the underlying issuers of the securities.
The composition of our investments as of December 31, 2019, at amortized cost and fair value was as
follows (dollars in thousands):
Investments
at Amortized Cost
Amortized Cost
Percentage of
Total Portfolio
Investments
at Fair Value
Fair Value
Percentage of
Total Portfolio
First Lien Debt
Second Lien Debt
Subordinated Debt
Equity and Warrants
Capitala Senior Loan Fund II, LLC
Total
%
66.6
5.0
10.3
14.3
3.8
100.0
%
$231,203
17,287
36,570
63,841
13,631
$362,532
%
63.8
4.7
10.1
17.6
3.8
100.0
%
$235,646
17,553
36,526
50,556
13,600
$353,881
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TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Investments and Fair Value Measurements – (continued)
The composition of our investments as of December 31, 2018, at amortized cost and fair value was as
follows (dollars in thousands):
First Lien Debt
Second Lien Debt
Subordinated Debt
Equity and Warrants
Capitala Senior Loan Fund II, LLC
Total
Investments
at Amortized Cost
Amortized Cost
Percentage of
Total Portfolio
Investments
at Fair Value
Fair Value
Percentage of
Total Portfolio
$252,174
33,040
72,562
48,594
13,600
$419,970
%
60.0
7.9
17.3
11.6
3.2
100.0
%
$237,570
32,495
73,113
92,054
13,695
$448,927
%
52.9
7.2
16.3
20.5
3.1
100.0
%
As noted above, the Company values all investments in accordance with ASC 820. ASC 820 requires
enhanced disclosures about assets and liabilities that are measured and reported at fair value. As defined in ASC
820, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
ASC 820 establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price
observability of inputs used in measuring investments at fair value. Market price observability is affected by a
number of factors, including the type of investment and the characteristics specific to the investment. Investments
with readily available active quoted prices or for which fair value can be measured from actively quoted prices
generally will have a higher degree of market price observability and a lesser degree of judgment used in
measuring fair value.
Based on the observability of the inputs used in the valuation techniques, the Company is required to
provide disclosures on fair value measurements according to the fair value hierarchy. The fair value hierarchy
ranks the observability of the inputs used to determine fair values. Investments carried at fair value are classified
and disclosed in one of the following three categories:
•
•
•
Level 1 — Valuations based on quoted prices in active markets for identical assets or liabilities that the
Company has the ability to access.
Level 2 — Valuations based on inputs other than quoted prices in active markets, which are either directly
or indirectly observable.
Level 3 — Valuations based on inputs that are unobservable and significant to the overall fair value
measurement.
In addition to using the above inputs in investment valuations, the Company continues to employ the
valuation policy approved by the Board that is consistent with ASC 820 (see Note 2). Consistent with the
Company’s valuation policy, the Company evaluates the source of inputs, including any markets in which its
investments are trading, in determining fair value.
In estimating fair value of portfolio investments, the Company starts with the cost basis of the investment,
which includes amortized original issue discount and PIK income, if any. The transaction price is typically the
best estimate of fair value at inception. When evidence supports a subsequent change to the carrying value from
the original transaction price, adjustments are made to reflect the expected fair values.
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TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Investments and Fair Value Measurements – (continued)
The following table presents the fair value measurements of investments, by major class, as of December 31,
2019 (dollars in thousands), according to the fair value hierarchy:
First Lien Debt
Second Lien Debt
Subordinated Debt
Equity and Warrants
Total
Fair Value Measurements
(1)
Level 1
Level 2
Level 3
Total
$ — $ — $231,203
17,287
—
36,570
—
61,568
—
—
—
2,273
$ 231,203
17,287
36,570
63,841
$2,273
$ — $346,628
$ 348,901
(1)
Excludes our $13.6 million investment in CSLF II, measured at NAV.
The following table presents the fair value measurements of investments, by major class, as of December 31,
2018 (dollars in thousands), according to the fair value hierarchy:
Fair Value Measurements
(1)
Level 1
Level 2
Level 3
Total
First Lien Debt
Second Lien Debt
Subordinated Debt
Equity and Warrants
Total
$ — $ — $ 237,570
32,495
73,113
92,054
—
—
—
—
—
—
$ 237,570
32,495
73,113
92,054
$ — $ — $ 435,232
$ 435,232
(1)
Excludes our $13.7 million investment in CSLF II, measured at NAV.
The following table provides a reconciliation of the beginning and ending balances for investments that use
Level 3 inputs for the year ended December 31, 2019 (dollars in thousands):
Balance as of January 1, 2019
Reclassifications
Repayments/sales
Purchases
Payment in-kind interest and dividends
accrued
Accretion of original issue discount
Realized gain (loss) from investments
Net unrealized appreciation (depreciation) on
investments
Transfers out of Level 3
Balance as of December 31, 2019
First Lien
Debt
Second Lien
Debt
Subordinated
Debt
Equity
and Warrants
$237,570
(2,773
(65,495
70,184
)
)
$ 32,495
—
—
4,511
$ 73,113
(5,215
(27,843
—
)
)
$ 92,054
7,988
(34,784
3,136
)
1,173
241
(19,859
)
317
96
(20,411
)
652
659
(4,288
10,162
—
$231,203
279
—
$ 17,287
(508
—
$ 36,570
)
)
820
—
24,802
)
)
(22,587
(9,861
$ 61,568
)
)
(12,654
(9,861
$ 346,628
Total
$ 435,232
—
(128,122
77,831
)
2,962
996
(19,756
)
(1)
Excludes our $13.6 million investment in CSLF II, measured at NAV.
F-30
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Investments and Fair Value Measurements – (continued)
(2)
The Company’s investment in U.S. Well Services, Inc. is traded on the NASDAQ Capital Market under the
ticker “USWS”. Because the Company’s investment is now traded in an active market, the Company has
reclassified its investment in U.S. Well Services, Inc. from Level 3 to Level 1 of the fair value hierarchy.
Transfers between levels, if any, are recognized at the beginning of the period in which transfers occur. The
unrealized depreciation on the Company’s investment in U.S. Well Services, Inc. for the year ended
December 31, 2019 was $(7.6) million.
The following table provides a reconciliation of the beginning and ending balances for investments that use
Level 3 inputs for the year ended December 31, 2018 (dollars in thousands):
Balance as of January 1, 2018
Reclassifications
Repayments/sales
Purchases
Payment in-kind interest and dividends
accrued
Accretion of original issue discount
Realized gain (loss) from investments
Net unrealized appreciation (depreciation) on
First Lien
Debt
Second Lien
Debt
Subordinated
Debt
Equity
and Warrants
$243,489
16,723
(95,294
92,421
)
$30,794
—
—
—
$ 103,385
(20,806
(8,463
—
)
)
$ 122,271
4,083
(19,760
1,781
)
1,712
264
(20,799
)
482
93
—
1,337
757
(20,499
)
817
—
6,494
Total
(1)
$ 499,939
—
(123,517
94,202
)
4,348
1,114
(34,804
)
investments
(946
)
1,126
17,402
(23,632
)
(6,050
)
Balance as of December 31, 2018
$237,570
$32,495
$ 73,113
$ 92,054
$ 435,232
(1)
Excludes our $13.7 million investment in CSLF II, measured at NAV.
The following table provides a reconciliation of the beginning and ending balances for the Written Call
Option that use Level 3 inputs for the year ended December 31, 2018 (dollars in thousands):
Balance as of January 1, 2018
Payment from Written Call Option
Net unrealized appreciation on Written Call Option
Balance as of December 31, 2018
Written Call
Option
)
$(6,815
20
6,795
$ —
The net change in unrealized depreciation on investments held as of December 31, 2019 and 2018, was
$(13.5) million and $(32.7) million, respectively, and is included in net unrealized depreciation on investments on
the consolidated statements of operations.
F-31
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Investments and Fair Value Measurements – (continued)
The valuation techniques and significant unobservable inputs used in recurring Level 3 fair value
measurements of assets as of December 31, 2019 were as follows:
Fair Value
(in millions)
(2)
Valuation
Approach
First lien debt
$211.2
Income
First lien debt
$ 20.0
Enterprise Value
Waterfall and
(1)
Asset
Unobservable Input
Range (Weighted Average)
Required Rate of Return
Leverage Ratio
Adjusted EBITDA
7.0% – 20.0% (12.0%)
1.5x – 7.9x (3.8x)
$0.8 million – $114.0 million ($13.6 million)
EBITDA Multiple
Adjusted EBITDA
6.0x – 6.0x (6.0x)
$2.9 million – $2.9 million ($2.9 million)
Revenue Multiple
Revenue
1.0x – 1.1x (1.1x)
$13.3 million – $21.6 million ($19.5 million)
Second lien debt
$ 17.3
Income
Subordinated debt
$ 36.6
Income and Asset
(1)
Equity and warrants
$ 61.6
Enterprise Value
Waterfall and
(1)
Asset
Required Rate of Return
Leverage Ratio
Adjusted EBITDA
Required Rate of Return
Leverage Ratio
Adjusted EBITDA
Revenue Multiple
Revenue
EBITDA Multiple
Adjusted EBITDA
13.5% – 15.0% (13.7%)
4.6x – 5.5x (4.9x)
$2.7 million – $74.5 million ($68.3 million)
6.0% – 14.9% (13.4%)
3.0x – 7.0x (5.5x)
$1.8 million – $22.3 million ($15.5 million)
0.4x – 4.7x (0.8x)
$17.1 million – $566.2 million ($406.6 million)
3.9x – 10.0x (7.3x)
$1.8 million – $25.1 million ($11.7 million)
(1)
$2.0 million in first lien debt, $0.7 million in subordinated debt, and $4.9 million in equity and warrants
were valued using the asset approach.
(2)
Excludes our $13.6 million investment in CSLF II, measured at NAV.
F-32
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Investments and Fair Value Measurements – (continued)
The valuation techniques and significant unobservable inputs used in recurring Level 3 fair value
measurements of assets as of December 31, 2018 were as follows:
(2)
Fair Value
(in millions)
Valuation
Approach
First lien debt
$195.1
Income
First lien debt
$ 42.5
Enterprise Value
Waterfall and
(1)
Asset
Second lien debt
$ 16.2
Income
Second lien debt
$ 16.3
Subordinated debt
$ 49.3
Subordinated debt
$ 23.8
Equity and warrants
$ 92.1
Enterprise Value
Waterfall and
Asset
Income
Enterprise Value
Waterfall and
(1)
Asset
Enterprise Value
Waterfall
Unobservable Input
Range (Weighted Average)
Required Rate of Return
Leverage Ratio
Adjusted EBITDA
EBITDA Multiple
Adjusted EBITDA
Revenue Multiple
Revenue
Required Rate of Return
Leverage Ratio
Adjusted EBITDA
EBITDA Multiple
Adjusted EBITDA
9.2% – 16.0% (12.1%)
1.0x – 13.5x (4.3x)
$1.7 million – $118.7 million ($17.6 million)
4.0x – 6.0x (5.3x)
$0.6 million – $3.7 million
($2.3 million)
0.9x – 0.9x (0.9x)
$13.0 million – $13.0 million ($13.0 million)
12.5% – 15.5% (14.6%)
4.6x – 5.0x (4.8x)
$67.0 million – $79.2 million
($75.5 million)
5.6x – 5.6x (5.6x)
$9.2 million – $9.2 million ($9.2 million)
Required Rate of Return
Leverage Ratio
Adjusted EBITDA
EBITDA Multiple
Adjusted EBITDA
Revenue Multiple
Revenue
11.5% – 20.0% (14.1%)
3.1x – 9.1x (5.7x)
$1.7 million – $15.8 million ($10.5 million)
6.0x – 8.0x (7.9x)
$1.7 million – $3.1 million ($3.0 million)
0.4x – 0.4x (0.4x)
$568.2 million – $568.2 million ($568.2 million)
EBITDA Multiple
Adjusted EBITDA
Revenue Multiple
Revenue
3.3x – 14.0x (6.5x)
$1.7 million – $112.3 million ($27.8 million)
0.4x – 0.4x (0.4x)
$164.6 million – $568.2 million ($455.1 million)
(1)
(2)
$0.7 million in subordinated debt and $2.9 million in first lien debt were valued using the asset approach.
Excludes our $13.7 million investment in CSLF II, measured at NAV.
The significant unobservable inputs used in the valuation of the Company’s investments are required rate of
return, adjusted EBITDA, EBITDA multiples, revenue, revenue multiples, and leverage ratios. Changes in any of
these unobservable inputs could have a significant impact on the Company’s estimate of fair value. An increase
(decrease) in the required rate of return or leverage will result in a lower (higher) estimate of fair value while an
increase (decrease) in adjusted EBITDA, EBITDA multiples, revenue, or revenue multiples will result in a higher
(lower) estimate of fair value.
Capitala Senior Loan Fund II, LLC
On December 20, 2018, Capitala and Trinity Universal Insurance Company (“Trinity”), a subsidiary of
Kemper Corporation, entered into a limited liability company agreement (the “LLC Agreement”) to co-manage
CSLF II. The purpose and design of the joint venture is to invest primarily in senior secured first-out loans.
Capitala and Trinity have committed to provide $25.0 million of equity to CSLF II, with
F-33
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Investments and Fair Value Measurements – (continued)
Capitala providing $20.0 million and Trinity providing $5.0 million. Capitala and Trinity each appointed two
members to CSLF II’s four-person board of directors and investment committee. All material decisions with
respect to CSLF II, including those involving its investment portfolio, require approval of a member on the board
of directors and investment committee of at least one member representing Capitala and Trinity, respectively.
As of December 31, 2019 and 2018, $13.6 million and $3.4 million in equity capital had been contributed by
Capitala and Trinity, respectively. As of December 31, 2019 and 2018, the Company and Trinity had $6.4 million
and $1.6 million of unfunded equity capital commitments outstanding, respectively. The Company’s equity
investment in CSLF II is not redeemable.
For the years ended December 31, 2019 and 2018, the Company received $1.0 million and $0.0,
respectively, in dividend income from its equity interest in CSLF II.
On September 3, 2019, CSLF II entered into a senior secured revolving credit facility (the “CSLF II Credit
Facility”) with KeyBank Specialty Finance Lending, an affiliate of KeyCorp. The CSLF II Credit Facility
currently provides for borrowings up to $60.0 million, subject to certain borrowing base restrictions. Borrowings
under the CSLF II Credit Facility bear interest at a rate of 1-month LIBOR + 2.25%. Beginning the quarter ended
March 31, 2020, CSLF II will incur unused fees of .35% when utilization of the CSLF II Credit Facility exceeds
50% and .65% when utilization of the CSLF II Credit Facility is less than 50%. The CSLF II Credit Facility
matures on September 2, 2024.
As of December 31, 2019, $12.7 million was outstanding under the CSLF II Credit Facility. For the year
ended December 31, 2019, CSLF II incurred $0.2 million of interest and financing expenses.
On September 3, 2019, Capitala and Trinity committed to provide $25.0 million of subordinated debt (the
“Subordinated Notes”) to CSLF II, with Capitala providing $5.0 million and Trinity providing $20.0 million. The
Subordinated Notes currently bear interest at a rate of 1-month LIBOR + 5.00%. Beginning the quarter ended
June 30, 2020, the Subordinated Notes will bear interest at a rate of 1-month LIBOR + 6.00%. The Subordinated
Notes mature on September 3, 2024.
As of December 31, 2019, $0.0 was outstanding on the Subordinated Notes. As of December 31, 2019, the
Company and Trinity had $5.0 million and $20.0 million of unfunded commitments related to the Subordinated
Notes, respectively. For the year ended December 31, 2019, the Company did not incur any interest and financing
expenses related to the Subordinated Notes.
Below is a summary of CSLF II’s portfolio as of December 31, 2019 and 2018 (dollars in thousands):
First lien loans
(1)
Weighted average current interest rate on first lien loans
Number of portfolio companies
Largest portfolio company investment
(1)
Total of five largest portfolio company investments
(1)(2)
(1)
(2)
Based on principal amount outstanding at year end.
Only two investments held as of December 31, 2018.
F-34
December 31, 2019
December 31, 2018
%
$28,396
6.4
5
$ 7,443
$28,396
%
$10,000
7.6
2
$ 5,550
$10,000
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Investments and Fair Value Measurements – (continued)
Below is CSLF II’s schedule of investments as of December 31, 2019 (dollars in thousands):
Portfolio Company
Industry
Type of Investment
Principal
Amount
Cost
Fair Value
Investments at Fair Value
Freedom Electronics, LLC
Electronics
Installs, LLC
Logistics
RAM Payment, LLC
Rapid Fire Protection, Inc.
(1)
U.S. BioTek Laboratories, LLC
TOTAL INVESTMENTS
Financial
Services
Security
System
Services
Testing
Laboratories
First Lien Debt (7.0% Cash
(1 month LIBOR + 5.0%,
2.0% Floor), Due 12/20/23)
First Lien Debt (5.8% Cash
(1 month LIBOR + 4.0%,
1.8% Floor), Due 6/20/23)
First Lien Debt (6.7% Cash
(1 month LIBOR + 5.0%,
1.5% Floor), Due 1/4/24)
First Lien Debt (5.5% Cash
(1 month LIBOR + 3.8%,
1.8% Floor), Due 11/22/24)
First Lien Debt (7.0% Cash
(3 month LIBOR + 5.0%,
2.0% Floor), Due 12/14/23)
$ 5,445 $ 5,445 $ 5,445
7,443
7,443
7,443
6,653
6,653
6,653
4,400
4,400
4,400
4,455
4,455
4,455
$28,396 $28,396 $28,396
(1)
The investment has a $3.0 million unfunded commitment.
Below is CSLF II’s schedule of investments as of December 31, 2018 (dollars in thousands):
Portfolio Company
Industry
Type of Investment
Principal
Amount
Cost
Fair Value
Investments at Fair Value
Freedom Electronics, LLC
U.S. BioTek Laboratories, LLC
TOTAL INVESTMENTS
Electronics
Testing
Laboratories
First Lien Debt (7.5% Cash
(1 month LIBOR + 5.0%,
2.0% Floor), Due 12/20/23)
First Lien Debt (7.8% Cash
(3 month LIBOR + 5.0%,
2.0% Floor), Due 12/14/23)
$ 5,500 $ 5,500 $ 5,500
4,500
4,500
4,500
$10,000 $10,000 $10,000
F-35
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Investments and Fair Value Measurements – (continued)
Below are the statements of assets and liabilities for CSLF II as of December 31, 2019 and 2018 (dollars in
thousands):
December 31, 2019
December 31, 2018
ASSETS
Investments at fair value (amortized cost of $28,396 and $10,000,
respectively)
Cash and cash equivalents
Interest receivable
Other assets
Total assets
LIABILITIES
Credit facility (net of deferred financing costs of $621 and $0,
respectively)
Interest and financing fees payable
Accounts payable
Total liabilities
NET ASSETS
Members’ capital
Total net assets
$28,396
$10,000
704
151
7
7,100
31
—
$29,258
$17,131
$12,079
$ —
113
27
$12,219
$
—
12
12
$17,039
$17,039
$17,119
$17,119
Below are the statements of operations for CSLF II (dollars in thousands):
INVESTMENT INCOME
Interest income
Fee income
Total investment income
EXPENSES
Interest and financing expenses
General and administrative expenses
Total expenses
NET INVESTMENT INCOME
NET INCREASE IN NET ASSETS RESULTING FROM
OPERATIONS
F-36
For the period from
December 20, 2018
(commencement of
operations) to
December 31, 2018
For the Year Ended
December 31, 2019
$1,372
175
$1,547
$ 151
176
$ 327
$1,220
$1,220
$ 31
100
$ 131
$ —
12
$ 12
$ 119
$ 119
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Transactions With Affiliated Companies
During the year ended December 31, 2019, the Company had investments in portfolio companies designated
as affiliates under the 1940 Act. Transactions with affiliates were as follows (dollars in thousands):
Type of Investment
Principal
Amount
Amount of
Interest, Fees
or Dividends
Credited to
Income
(1)
December 31,
2018
Fair Value
Gross
Additions
(2)
Gross
Reductions
(3)
Realized
Gain/(Loss)
Unrealized
Appreciation
(Depreciation)
December 31,
2019
Fair Value
$ 14,421
$ 1,837
$ 14,384
$ 370
$
(750
)
$
(4)
Company
Affiliate investments
Burgaflex
Holdings, LLC
Burgaflex
Holdings, LLC
Burgaflex
Holdings, LLC
First Lien Debt (12.0%
Cash, 3.0% PIK, Due
3/23/21)
Common Stock Class B
(1,085,073 shares)
Common Stock Class A
(1,253,198 shares)
City Gear, LLC
Membership Unit
Warrants
Eastport
Holdings, LLC
Eastport
Holdings, LLC
Subordinated Debt
(14.9% Cash (3 month
LIBOR + 13.0%, 0.5%
Floor), Due 12/29/21)
Membership Units
(22.9% ownership)
16,500
GA
Communications,
Inc.
(5)
GA
Communications,
Inc.
Series A-1 Preferred
Stock (1,998 shares,
8.0% PIK Dividend)
Series B-1 Common
Stock (200,000 shares)
J&J Produce
Holdings, Inc.
J&J Produce
Holdings, Inc.
J&J Produce
Holdings, Inc.
Subordinated Debt
(13.0% Cash, Due
6/16/19)
Common Stock (8,182
shares)
Common Stock
Warrants (6,369 shares)
LJS Partners, LLC Preferred Units
(92,924 units)
LJS Partners, LLC Common Membership
Units (2,593,234 units)
MMI Holdings,
LLC
MMI Holdings,
LLC
MMI Holdings,
(5)
LLC
MMI Holdings,
LLC
First Lien Debt (12.0%
Cash, Due 1/31/21)
Subordinated Debt
(6.0% Cash, Due
1/31/21)
Preferred Units
(1,000 units, 6.0% PIK
Dividend)
Common Membership
Units (45 units)
—
—
1,837
—
—
3,230
—
3,230
—
—
—
485
—
—
485
—
—
—
—
2,600
316
400
24
—
—
340
—
—
(750
)
—
—
—
—
—
—
—
—
(5,788
)
—
—
(5,788
)
—
(293
(293
)
)
—
—
—
—
—
—
—
14,384
3,184
3,184
16,500
17,610
34,110
3,482
1,325
62
—
432
111
111
659
—
659
299
—
4,807
299
—
—
—
—
293
327
620
—
—
98
—
98
6,210
—
—
6,210
—
3,018
3,018
2,600
400
1,612
185
4,797
F-37
—
—
—
—
(111
(111
)
)
—
—
—
—
—
—
(618
)
(818
)
—
(1,436
)
—
—
—
—
—
—
—
—
$
417
$ 14,421
573
—
990
142
142
(659
)
212
(447
)
(20
(824
)
)
635
—
15,056
3,326
3,326
16,500
17,822
34,322
3,761
501
(844
)
4,262
196
818
—
1,014
79
(1,543
(1,464
)
)
—
—
—
9
9
—
—
—
—
372
1,509
1,881
2,600
400
1,710
194
4,904
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Transactions With Affiliated Companies – (continued)
(4)
Company
Navis Holdings,
Inc.
Navis Holdings,
(5)
Inc.
Navis Holdings,
Inc.
Nth Degree
Investment
Group, LLC
Type of Investment
First Lien Debt (11.0%
Cash, Due 6/30/23)
Class A Preferred Stock
(1,000 shares, 10.0%
Cash Dividend)
Common Stock (60,000
shares)
Membership Units
(6,088,000 Units)
RAM Payment,
LLC
RAM Payment,
(5)
LLC
First Lien Debt (10.0%
Cash, Due 1/4/24)
Preferred Units
(86,000 Units, 8.0% PIK
Dividend)
Sierra Hamilton
Holdings
Corporation
Sierra Hamilton
Holdings
Corporation
Second Lien Debt (15.0%
PIK, Due 9/12/23)
782
Common Stock
(15,068,000 shares)
US Bath Group,
LLC
US Bath Group,
LLC
First Lien Debt (11.5%
Cash (1 month LIBOR
+ 9.0%, 1.0% Floor),
Due 1/2/23)
Membership Units
(500,000 units)
V12 Holdings, Inc. Subordinated Debt
Total Affiliate investments
Control investments
AAE Acquisition,
LLC
AAE Acquisition,
LLC
AAE Acquisition,
LLC
CableOrganizer
Acquisition,
LLC
CableOrganizer
Acquisition,
LLC
CableOrganizer
Acquisition,
LLC
Second Lien Debt (6.0%
PIK, Due 8/24/19)
Membership Units
(2.2% fully diluted)
Warrants (58.9% fully
diluted)
First Lien Debt (8.0%
Cash, Due 6/30/21)
First Lien Debt (8.0%
Cash, Due 6/30/21)
Preferred
Units – Series A1
(7,200,000 units)
—
—
Amount of
Interest, Fees
or Dividends
Credited to
Income
(1)
December 31,
2018
Fair Value
Principal
Amount
Gross
Additions
(2)
Gross
Reductions
(3)
Realized
Gain/(Loss)
Unrealized
Appreciation
(Depreciation)
December 31,
2019
Fair Value
$ 10,100
$ 568
$
—
$10,100
$
— $
—
$ —
$ 10,100
50
—
618
—
—
9,019
1,212
—
1,212
3
—
3
—
—
—
—
—
—
—
—
—
1,000
—
11,100
6,088
6,088
9,489
928
10,417
748
6,854
—
6,854
748
—
—
—
—
—
(470
)
—
(470
—
)
—
—
—
—
—
—
—
—
—
—
—
—
—
464
464
—
—
—
797
797
—
1,000
464
11,564
6,088
6,088
9,019
1,725
10,744
748
(1,694
)
5,160
—
(1,694
)
5,908
—
676
12,750
—
(12,750
)
—
—
—
—
676
—
—
$ 8,401
2,083
14,833
742
742
$ 92,939
—
—
—
—
$30,572
(4,323
(17,073
(30
(30
$(24,404
)
)
)
)
)
3,823
3,823
12
12
$ 2,288
(1,583
(1,583
(16
(16
$(2,632
)
)
)
)
)
—
—
708
708
$ 98,763
$
— $ —
$ 16,327
$ 4,084
$
— $(20,411
)
$ —
$
—
—
—
72
148
—
—
—
16,327
—
—
4,084
—
—
—
(17
)
—
(20,428
)
1,708
1,842
(3,550
)
—
8,889
—
(3,424
)
(5,465
)
—
5,373
—
(5,373
)
17
—
17
—
—
—
F-38
—
—
—
—
—
—
—
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Transactions With Affiliated Companies – (continued)
(4)
Company
CableOrganizer
Acquisition,
LLC
CableOrganizer
Acquisition,
LLC
CableOrganizer
Acquisition,
LLC
Capitala Senior
Loan Fund II,
LLC
Capitala Senior
Loan Fund II,
LLC
Type of Investment
Preferred
Units – Series A
(4,000,000 units)
Common Stock (14.9%
fully diluted)
Common Stock
Warrants (40.0% fully
diluted)
Subordinated Debt
(6.7% Cash (1 month
LIBOR + 5.0)%, Due
9/3/24)
Membership Units
(80.0% ownership)
Micro Precision,
LLC
Micro Precision,
LLC
Micro Precision,
LLC
Subordinated Debt
(10.0% Cash, Due
3/31/20)
Subordinated Debt
(14.0% Cash, 4.0% PIK,
Due 3/31/20)
Series A Preferred Units
(47 units)
Navis Holdings,
Inc.
Navis Holdings,
(5)
Inc.
Navis Holdings,
Inc.
First Lien Debt (11.0%
Cash, Due 6/30/23)
Class A Preferred Stock
(1,000 shares, 10.0%
Cash Dividend)
Common Stock (60,000
shares)
Portrait Studio,
LLC
Portrait Studio,
LLC
Portrait Studio,
LLC
Portrait Studio,
LLC
Vology, Inc.
First Lien Debt (9.0%
Cash (1 month LIBOR
+ 7.0%, 1.0% Floor,
2.0% Ceiling), Due
12/31/22)
First Lien Debt (9.1%
Cash (1 month LIBOR
+ 7.0%, 1.0% Floor,
5.0% Ceiling), Due
12/31/22)
Preferred Units
(4,350,000 Units)
Membership Units
(150,000 Units)
First Lien Debt (10.5%
Cash (1 month LIBOR
+ 8.5%, 2.0% Floor),
Due 12/31/21)
Amount of
Interest, Fees
or Dividends
Credited to
Income
(1)
December 31,
2018
Fair Value
Principal
Amount
Gross
Additions
(2)
Gross
Reductions
(3)
Realized
Gain/(Loss)
Unrealized
Appreciation
(Depreciation)
December 31,
2019
Fair Value
$ —
$
—
$ —
$
— $ (2,354
)
$ 2,354
$
—
—
—
220
—
—
—
(1,394
)
1,394
—
10,597
—
7,215
—
(6,974
)
—
(14,586
)
—
3,748
—
—
—
—
(64
)
—
13,631
(64
)
13,631
$ —
—
1,040
—
13,695
1,040
13,695
—
—
—
106
350
814
1,270
566
50
—
616
1,862
4,325
2,817
9,004
7,500
1,000
4,348
12,848
—
—
—
—
88
—
88
—
—
—
—
—
—
—
(1,862
)
(4,413
)
(1,629
(7,904
)
)
(7,500
)
(1,000
)
(2,600
(11,100
)
)
—
—
—
—
—
—
—
—
—
—
—
(1,188
(1,188
)
)
—
—
2,599
2,599
(4,347
(4,347
)
)
—
98
—
3,540
(3,540
)
—
—
—
107
—
—
205
4,500
2,174
—
6,674
—
—
—
3,540
(792
)
(3,708
)
—
(2,450
)
—
(4,332
)
—
(6,158
)
—
276
—
276
3,877
119
—
3,877
—
—
—
3,877
F-39
—
—
—
—
—
—
—
—
—
—
—
—
—
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Transactions With Affiliated Companies – (continued)
(4)
Company
Vology, Inc.
Vology, Inc.
Type of Investment
Class A Preferred Units
(9,041,810 Units)
Membership Units
(5,363,982 Units)
Total Control investments
Amount of
Interest, Fees
or Dividends
Credited to
Income
(1)
Principal
Amount
December 31,
2018
Fair Value
Gross
Additions
(2)
Gross
Reductions
(3)
Realized
Gain/(Loss)
Unrealized
Appreciation
(Depreciation)
December 31,
2019
Fair Value
$ —
$
—
$ 5,215
$
— $
—
$ —
$ 5,215
—
119
$ 3,470
—
—
$ 69,145
—
9,092
$24,019
—
—
$(30,310
)
—
—
$(38,573
)
—
—
$(1,558
)
—
9,092
$ 22,723
(1)
(2)
(3)
(4)
Represents the total amount of interest, original issue discount, fees and dividends credited to income for the
portion of the year an investment was included in Affiliate or Control categories, respectively.
Gross additions include increases in the cost basis of investments resulting from new portfolio investments,
follow-on investments, accrued PIK and accretion of original issue discount. Gross additions also include
transfers into Affiliate or Control classification.
Gross reductions include decreases in the cost basis of investments resulting from principal repayments and
sales. Gross reductions also includes transfers out of Affiliate or Control classification.
All debt investments are income producing. Equity and warrant investments are non-income producing,
unless otherwise noted.
(5)
The equity investment is income producing, based on rate disclosed.
F-40
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Transactions With Affiliated Companies – (continued)
During the year ended December 31, 2018, the Company had investments in portfolio companies designated
as affiliates under the 1940 Act. Transactions with affiliates were as follows (dollars in thousands):
Type of Investment
Principal
Amount
Amount of
Interest, Fees
or Dividends
Credited
to Income
(1)
December 31,
2017
Fair Value
Gross
Additions
(2)
Gross
Reductions
(3)
Realized
Gain/(Loss)
Unrealized
Appreciation
(Depreciation)
December 31,
2018
Fair Value
$
— $ 479
$ 15,603
$
320
$(16,165
)
$ —
$
242
$
Company
(4)
Affiliate investments
AAE Acquisition,
LLC
AAE Acquisition,
LLC
AAE Acquisition,
LLC
Second Lien Debt (6.0%
Cash, Due 8/24/19)
Membership Units
(2.2% fully diluted)
Warrants (37.8% fully
diluted)
Burgaflex Holdings,
LLC
Burgaflex Holdings,
LLC
Burgaflex Holdings,
LLC
Burgaflex Holdings,
LLC
Burgaflex Holdings,
LLC
First Lien Debt (12.0%
Cash, 1.0% PIK, Due
3/23/21)
Subordinated Debt
(14.0% Cash, Due
8/9/19)
Subordinated Debt
(12.0% Cash, Due
8/9/19)
Common Stock Class A
(1,253,198 shares)
Common Stock Class B
(900,000 shares)
Chef’n Corporation Series A Preferred Stock
(1,000,000 shares)
City Gear, LLC
City Gear, LLC
(5)
City Gear, LLC
Subordinated Debt
(13.0% Cash, Due
10/20/19)
Preferred Membership
Units (2.8% fully
diluted, 9.0% Cash
Dividend)
Membership Unit
Warrants (11.4% fully
diluted)
Eastport Holdings,
LLC
Eastport Holdings,
LLC
Subordinated Debt
(15.8% Cash (3 month
LIBOR + 13.0%, 0.5%
Floor), Due 4/29/20)
Membership Units
(22.9% ownership)
—
—
479
—
—
15,603
—
—
320
(17
)
—
(16,182
)
14,801
1,390
—
14,801
—
—
—
116
199
—
—
1,705
—
—
3,000
5,828
457
—
9,285
—
—
—
918
8,231
117
1,269
—
1,035
8,248
17,748
—
—
—
300
15,101
—
—
—
—
—
—
(3,000
)
(5,828
)
—
—
(8,828
)
(644
)
(644
)
(8,231
)
(1,269
)
—
—
—
—
17
—
259
(417
)
14,384
—
—
(457
)
(300
)
(1,174
)
—
—
—
—
—
—
—
—
14,384
—
—
—
—
—
—
—
—
—
—
—
—
—
644
644
—
—
(1,908
)
(11,408
)
1,908
1,908
(5,064
)
(5,064
)
3,184
3,184
16,500
1,168
—
1,168
—
—
—
15,496
4,733
20,229
—
(1,470
)
(1,470
)
—
—
—
1,004
16,500
14,347
15,351
17,610
34,110
F-41
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Transactions With Affiliated Companies – (continued)
Amount of
Interest, Fees
or Dividends
Credited
to Income
(1)
December 31,
2017
Fair Value
Principal
Amount
Gross
Additions
(2)
Gross
Reductions
(3)
Realized
Gain/(Loss)
Unrealized
Appreciation
(Depreciation)
December 31,
2018
Fair Value
$ —
—
$ —
—
$
(19
(607
)
)
$ 3,482
1,325
Company
(4)
GA
Communications,
Inc.
(5)
GA
Communications,
Inc.
Type of Investment
Series A-1 Preferred
Stock (1,998 shares,
8.0% PIK Dividend)
Series B-1 Common
Stock (200,000 shares)
J&J Produce
Holdings, Inc.
J&J Produce
Holdings, Inc.
J&J Produce
Holdings, Inc.
Subordinated Debt
(13.0% Cash, Due
6/16/19)
Common Stock (8,182
shares)
Common Stock
Warrants (6,369 shares)
$ 6,406
LJS Partners, LLC Common Stock
(1,587,848 shares)
MJC Holdings, LLC Series A Preferred Units
(2,000,000 units)
MMI Holdings,
LLC
MMI Holdings,
LLC
MMI Holdings,
(5)
LLC
MMI Holdings,
LLC
First Lien Debt (12.0%
Cash, Due 1/31/20)
Subordinated Debt
(6.0% Cash, Due
1/31/20)
Preferred Units
(1,000 units, 6.0% PIK
Dividend)
Common Membership
Units (45 units)
MTI Holdings, LLC Membership Units
(2,000,000 units)
Sierra Hamilton
Holdings
Corporation
Common Stock
(15,068,000 shares)
Source Capital
Penray, LLC
Membership Units
(11.3% ownership)
STX Healthcare
Management
Services, Inc.
Common Stock
(1,200,000 shares)
US Bath Group,
LLC
First Lien Debt (11.4%
Cash (1 month
LIBOR + 9.0%, 1.0%
Floor), Due 1/2/23)
$ —
—
$ 3,225
1,932
$
—
5,157
805
—
—
805
—
—
—
—
6,170
—
—
6,170
7,650
7,650
—
—
2,600
317
2,600
400
24
—
—
341
—
—
—
—
121
121
—
—
400
1,520
193
4,713
100
100
8,528
8,528
101
101
93
93
276
—
276
38
—
—
38
293
293
—
—
—
—
92
—
92
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(28
)
(28
)
—
—
—
—
—
(139
)
(139
)
—
—
—
—
—
—
—
—
—
—
—
28
28
—
—
—
—
—
139
139
—
—
—
—
(108
)
108
(626
)
4,807
2
—
—
2
(4,925
)
(4,925
)
—
—
—
—
—
(8
)
(8
)
(100
)
(100
)
(1,674
)
6,210
—
—
6,210
3,018
3,018
—
—
2,600
400
1,612
185
4,797
—
—
6,854
(1,674
)
6,854
(101
)
(101
)
(93
)
—
—
—
—
(108
)
108
(93
)
12,750
1,806
—
15,000
(2,250
)
—
—
12,750
F-42
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Transactions With Affiliated Companies – (continued)
Total Affiliate investments
$ 8,183
$ 103,957
$52,258
$(60,214
)
$ 2,920
$(5,982
)
$ 92,939
Company
(4)
Type of Investment
US Bath Group,
LLC
Membership Units
(500,000 units)
U.S. Well Services,
LLC
U.S. Well Services,
LLC
U.S. Well Services,
LLC
U.S. Well Services,
LLC
First Lien Debt (8.3%
Cash (1 month
LIBOR + 6.0%, 1.0%
Floor), Due 2/2/22)
First Lien Debt (13.3%
PIK (1 month
LIBOR + 11.0%, 1.0%
Floor), Due 2/2/22)
Class A Units
(5,680,688 Units)
Class B Units
(2,076,298 Units)
V12 Holdings, Inc. Subordinated Debt
—
Control investments
AAE Acquisition,
LLC
AAE Acquisition,
LLC
AAE Acquisition,
LLC
Second Lien Debt (6.0%
Cash, Due 8/24/19)
Membership Units
(2.2% fully diluted)
Warrants (37.8% fully
diluted)
CableOrganizer
Acquisition, LLC
First Lien Debt (10.0%
Cash, Due 5/24/19)
1,708
CableOrganizer
Acquisition, LLC
CableOrganizer
Acquisition, LLC
First Lien Debt (12.0%
Cash, 4.0% PIK, Due
6/30/19)
Preferred Units
(4,000,000 units)
CableOrganizer
Acquisition, LLC
Common Stock (21.3%
fully diluted)
CableOrganizer
Acquisition, LLC
Common Stock
Warrants (10.0% fully
diluted)
Capitala Senior
Loan Fund II,
LLC
Membership Units
(80.0% ownership)
Eastport Holdings,
LLC
Subordinated Debt
(15.8% Cash (3 month
LIBOR + 13.0%, 0.5%
Floor), Due 4/29/20)
Amount of
Interest, Fees
or Dividends
Credited
to Income
(1)
December 31,
2017
Fair Value
Principal
Amount
$ —
1,806
$
—
—
Gross
Additions
(2)
Gross
Reductions
(3)
Realized
Gain/(Loss)
Unrealized
Appreciation
(Depreciation)
December 31,
2018
Fair Value
$
500
$
—
$ —
15,500
(2,250
)
$
—
156
2,299
—
(2,299
)
—
567
—
—
723
—
—
9,516
15,004
955
27,774
1,035
1,035
409
—
—
409
—
—
(9,925
)
(6,260
)
(441
)
(18,925
)
(232
)
(232
)
—
—
—
—
—
—
93
93
—
—
—
—
$ 1,583
1,583
$ 2,083
14,833
—
—
(8,744
)
(514
)
(9,258
)
(154
)
(154
)
—
—
—
—
—
742
742
(17
)
—
(17
)
—
1
(2,354
)
(118
)
(60
)
(2,531
)
95
95
—
—
16,327
1,708
8,889
—
—
—
10,597
13,695
13,695
$ 16,327
$ 488
$
$ —
$ —
$ 16,327
—
—
488
121
—
—
—
—
—
$16,327
$
17
—
16,344
1,708
—
—
—
—
—
8,889
1,173
12,373
—
515
2,354
)
(2,354
—
)
(1,646
—
—
118
—
—
1,294
—
60
12,551
—
—
4,577
13,600
—
—
13,600
—
—
—
—
(2,354
)
(1,646
)
—
—
—
—
—
2,144
16,500
493
(15,231
)
—
(1,762
)
—
F-43
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Transactions With Affiliated Companies – (continued)
Company
(4)
Type of Investment
Eastport Holdings,
LLC
Membership Units
(22.9% ownership)
Kelle’s Transport
Service, LLC
Kelle’s Transport
Service, LLC
Kelle’s Transport
Service, LLC
First Lien Debt (4.0%
Cash, Due 2/15/20)
First Lien Debt (2.2%
Cash, Due 2/15/20)
Membership Units
(27.5% fully diluted)
Micro Precision,
LLC
Micro Precision,
LLC
Micro Precision,
LLC
Subordinated Debt
(10.0% Cash, Due
1/1/19)
Subordinated Debt
(14.0% Cash, 4.0% PIK,
Due 1/1/19)
Series A Preferred Units
(47 units)
Navis Holdings, Inc. First Lien Debt (15.0%
Navis Holdings,
(5)
Inc.
Cash, Due 10/30/20)
Class A Preferred Stock
(1,000 shares, 10.0%
Cash Dividend)
Navis Holdings, Inc. Common Stock (300,000
shares)
On-Site Fuel
Service, Inc.
On-Site Fuel
Service, Inc.
On-Site Fuel
Service, Inc.
On-Site Fuel
Service, Inc.
On-Site Fuel
Service, Inc.
Portrait Studio,
LLC
Portrait Studio,
LLC
Portrait Studio,
LLC
First Lien Debt (18.0%
Cash, Due 12/19/18)
Subordinated Debt
(18.0% Cash, Due
12/19/18)
Series A Preferred Stock
(32,782 shares)
Series B Preferred Stock
(23,648 shares)
Common Stock (33,058
shares)
First Lien Debt (9.0%
Cash (1 month LIBOR
+ 7.0%, 1.0% Floor,
2.0% Ceiling), Due
12/31/22)
First Lien Debt (9.4%
Cash (1 month LIBOR
+ 7.0%, 1.0% Floor,
5.0% Ceiling), Due
12/31/22)
Preferred Units
(4,350,000 Units)
Amount of
Interest, Fees
or Dividends
Credited
to Income
(1)
December 31,
2017
Fair Value
Principal
Amount
Gross
Additions
(2)
Gross
Reductions
(3)
Realized
Gain/(Loss)
Unrealized
Appreciation
(Depreciation)
December 31,
2018
Fair Value
$ —
2,144
$ 26,449
$ — $ (4,733
)
$
42,949
493
(19,964
)
1,300
(3,300
)
—
—
(10,000
)
(3,669
)
—
—
1,300
(13,300
)
(3,669
)
—
—
—
—
—
—
—
—
—
—
—
$(21,716
)
$
(23,478
)
—
4,109
—
4,109
—
—
1,188
1,188
—
—
(657
)
(657
)
—
—
—
—
—
—
—
—
—
(11,020
)
—
(11,020
)
—
(568
)
—
—
—
(3,278
)
(2,364
)
(33
)
3,278
2,364
33
5,107
11,588
11,020
(11,020
)
(16,695
)
$ —
—
1,862
4,325
82
126
—
208
186
601
—
787
2,000
9,560
—
11,560
1,862
4,154
1,629
7,645
—
171
—
171
7,500
1,149
6,500
1,000
—
—
100
—
1,249
30
—
—
—
—
30
1,000
5,005
12,505
—
—
1,000
—
11,020
11,588
—
—
—
—
—
—
—
—
—
—
—
—
—
1,862
4,325
2,817
9,004
7,500
1,000
4,348
12,848
—
—
—
—
—
—
—
—
167
1,860
2,400
(4,260
)
—
—
4,500
435
—
4,500
2,450
—
—
—
—
—
—
—
(276
)
4,500
2,174
F-44
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Transactions With Affiliated Companies – (continued)
Company
(4)
Type of Investment
Portrait Studio,
LLC
Membership Units
(150,000 Units)
Amount of
Interest, Fees
or Dividends
Credited
to Income
(1)
Principal
Amount
December 31,
2017
Fair Value
Gross
Additions
(2)
Gross
Reductions
(3)
Realized
Gain/(Loss)
Unrealized
Appreciation
(Depreciation)
December 31,
2018
Fair Value
$ —
$
—
$ —
$
— $
602
8,810
2,400
(4,260
)
—
—
$
—
$
—
(276
)
6,674
Total Control investments
$ 6,802
$ 107,608
$50,905
$(50,898
)
$(22,010
)
$(16,460
)
$ 69,145
(1)
(2)
(3)
(4)
Represents the total amount of interest, original issue discount, fees and dividends credited to income for the
portion of the year an investment was included in Affiliate or Control categories, respectively.
Gross additions include increases in the cost basis of investments resulting from new portfolio investments,
follow-on investments, accrued PIK and accretion of original issue discount. Gross additions also include
transfers into Affiliate or Control classification.
Gross reductions include decreases in the cost basis of investments resulting from principal repayments and
sales. Gross reductions also includes transfers out of Affiliate or Control classification.
All debt investments are income producing. Equity and warrant investments are non-income producing,
unless otherwise noted.
(5)
The equity investment is income producing, based on rate disclosed.
Note 6. Agreements
On September 24, 2013, the Company entered into an investment advisory agreement (the “Investment
Advisory Agreement”) with our Investment Advisor, which was initially approved by the Board on June 10,
2013. Unless earlier terminated in accordance with its terms, the Investment Advisory Agreement will remain in
effect if approved annually by the Board or by a majority of our outstanding voting securities, including, in either
case, by a majority of our non-interested directors. The Investment Advisory Agreement was most recently re-
approved by the Board, including a majority of our non-interested directors, at an in-person meeting on August 1,
2019. Subject to the overall supervision of the Board, the Investment Advisor manages our day-to-day operations,
and provides investment advisory and management services to us. Under the terms of the Investment Advisory
Agreement, the Investment Advisor:
•
•
•
•
determines the composition of our portfolio, the nature and timing of the changes to our portfolio and the
manner of implementing such changes;
identifies, evaluates and negotiates the structure of the investments we make (including performing due
diligence on our prospective portfolio companies);
closes and monitors the investments we make; and
provides us with other investment advisory, research and related services as we may from time to time
require.
The Investment Advisor’s services under the Investment Advisory Agreement are not exclusive, and it is
free to furnish similar services to other entities so long as its services to us are not impaired.
The Investment Advisory Agreement provides that, absent willful misfeasance, bad faith or negligence in
the performance of its duties or by reason of the reckless disregard of its duties and obligations, the Investment
Advisor and its officers, managers, partners, agents, employees, controlling persons, members and any other
person or entity affiliated with it are entitled to indemnification from the Company for any damages, liabilities,
F-45
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 6. Agreements – (continued)
costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from
the rendering of our Investment Advisor’s services under the Investment Advisory Agreement or otherwise as
Investment Advisor for the Company.
Pursuant to the Investment Advisory Agreement, the Company has agreed to pay the Investment Advisor a
fee for investment advisory and management services consisting of two components — a base management fee
and an incentive fee.
The base management fee is calculated at an annual rate of 1.75% of the gross assets, which are the total
assets reflected on the consolidated statements of assets and liabilities and includes any borrowings for
investment purposes. Although the Company does not anticipate making significant investments in derivative
financial instruments, the fair value of any such investments, which will not necessarily equal their notional
value, will be included in the calculation of gross assets. For services rendered under the Investment Advisory
Agreement, the base management fee is payable quarterly in arrears. The base management fee is calculated
based on the average value of the gross assets at the end of the two most recently completed calendar quarters,
and appropriately adjusted for any share issuances or repurchases during the current calendar quarter.
The incentive fee consists of the following two parts:
The first part of the incentive fee is calculated and payable quarterly in arrears based on the pre-incentive fee
net investment income for the immediately preceding calendar quarter. For this purpose, pre-incentive fee net
investment income means interest income, dividend income and any other income (including any other fees
(other than fees for providing managerial assistance), such as commitment, origination, diligence and consulting
fees or other fees that we receive from portfolio companies) accrued during the calendar quarter, minus our
operating expenses for the quarter (including the base management fee, expenses payable under the
Administration Agreement to our Administrator, and any interest expense and dividends paid on any issued and
outstanding preferred stock, but excluding the incentive fee). Pre-incentive fee net investment income includes, in
the case of investments with a deferred interest feature (such as original issue discount, debt instruments with PIK
interest and zero coupon securities), accrued income that we have not yet received in cash. Pre-incentive fee net
investment income does not include any realized capital gains, computed net of all realized capital losses or
unrealized capital appreciation or depreciation. Pre-incentive fee net investment income, expressed as a rate of
return on the value of our net assets at the end of the immediately preceding calendar quarter, is compared to a
hurdle of 2.0% per quarter (8.0% annualized). The net investment income used to calculate this part of the
incentive fee is also included in the amount of the gross assets used to calculate the 1.75% base management fee.
The Company pays the Investment Advisor an incentive fee with respect to the pre-incentive fee net investment
income in each calendar quarter as follows:
•
•
•
no incentive fee in any calendar quarter in which the pre-incentive fee net investment income does not
exceed the hurdle of 2.0%;
100% of the pre-incentive fee net investment income with respect to that portion of such pre-incentive fee
net investment income, if any, that exceeds the hurdle but is less than 2.5% in any calendar quarter (10.0%
annualized). The Company refers to this portion of the pre-incentive fee net investment income (which
exceeds the hurdle but is less than 2.5%) as the “catch-up.” The “catch-up” is meant to provide the
Investment Advisor with 20% of the pre-incentive fee net investment income as if a hurdle did not apply
if this net investment income exceeds 2.5% in any calendar quarter; and
20% of the amount of the pre-incentive fee net investment income, if any, that exceeds 2.5% in any
calendar quarter (10.0% annualized) is payable to the Investment Advisor (once the hurdle is reached and
the catch-up is achieved, 20% of all pre-incentive fee investment income thereafter is allocated to the
Investment Advisor).
F-46
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 6. Agreements – (continued)
The Investment Advisor has voluntarily agreed to waive all or such portion of the quarterly incentive fees
earned by the Investment Advisor that would otherwise cause the Company’s quarterly net investment income to
be less than the distribution payments declared by the Board. Quarterly incentive fees are earned by the
Investment Advisor pursuant to the Investment Advisory Agreement. Incentive fees subject to the waiver cannot
exceed the amount of incentive fees earned during the period, as calculated on a quarterly basis. The Investment
Advisor will not be entitled to recoup any amount of incentive fees that it waives. The waiver was effective in the
fourth quarter of 2015 and will continue unless otherwise publicly disclosed by the Company.
The second part of the incentive fee is determined and payable in arrears as of the end of each calendar year
(or upon termination of the Investment Advisory Agreement, as of the termination date), and will equal 20% of
our realized capital gains, if any, on a cumulative basis from inception through the end of each calendar year,
computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the
aggregate amount of any previously paid capital gain incentive fees with respect to each of the investments in our
portfolio.
The Company will defer cash payment of the portion of any incentive fee otherwise earned by the
Investment Advisor that would, when taken together with all other incentive fees paid to the Investment Advisor
during the most recent 12 full calendar month period ending on or prior to the date such payment is to be made,
exceed 20% of the sum of (a) the pre-incentive fee net investment income during such period, (b) the net
unrealized appreciation or depreciation during such period and (c) the net realized capital gains or losses during
such period. Any deferred incentive fees will be carried over for payment in subsequent calculation periods to the
extent such payment is payable under the Investment Advisory Agreement. As of December 31, 2019 and 2018,
the Company had incentive fees payable to the Investment Advisor of $3.7 million and $2.5 million, respectively.
For the years ended December 31, 2019, 2018 and 2017, the Company incurred $8.0 million, $9.0 million
and $9.8 million in base management fees, respectively. The Company incurred $1.5 million, $0.2 million and
$1.3 million in incentive fees related to pre-incentive fee net investment income for the years ended
December 31, 2019, 2018 and 2017, respectively. For the years ended December 31, 2019, 2018 and 2017, our
Investment Advisor waived incentive fees of $0.3 million, $0.0 and $1.0 million, respectively.
On September 24, 2013, the Company entered into the Administration Agreement, pursuant to which the
Administrator has agreed to furnish the Company with office facilities, equipment and clerical, bookkeeping and
record keeping services at such facilities. The Administrator also performs, or oversees the performance of the
required administrative services, which include, among other things, being responsible for the financial records
that the Company is required to maintain and preparing reports to our stockholders. In addition, the Administrator
assists in determining and publishing the net asset value, oversees the preparation and filing of the tax returns and
the printing and dissemination of reports to the stockholders, and generally oversees the payment of the expenses
and the performance of administrative and professional services rendered to the Company by others.
Payments under the Administration Agreement are equal to an amount based upon the allocable portion of
the Administrator’s overhead in performing its obligations under the Administration Agreement, including rent,
the fees and expenses associated with performing compliance functions and the allocable portion of the
compensation of the chief financial officer, the chief compliance officer, and their respective administrative
support staff. Under the Administration Agreement, the Administrator will also provide, on the Company’s
behalf, managerial assistance to those portfolio companies that request such assistance. Unless terminated earlier
in accordance with its terms, the Administration Agreement will remain in effect if approved annually by the
Board. The Board most recently approved the renewal of the Administration Agreement on August 1, 2019. To
the extent that the Administrator outsources any of its functions, the Company will pay the fees
F-47
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 6. Agreements – (continued)
associated with such functions on a direct basis without any incremental profit to our Administrator. Stockholder
approval is not required to amend the Administration Agreement.
For the years ended December 31, 2019, 2018 and 2017 the Company paid the Administrator $1.4 million,
$1.4 million and $1.1 million, respectively, for the Company’s allocable portion of the Administrator’s overhead.
The Administration Agreement provides that, absent willful misfeasance, bad faith or negligence in the
performance of its duties or by reason of the reckless disregard of its duties and obligations, our Administrator
and its officers, managers, partners, agents, employees, controlling persons, members and any other person or
entity affiliated with it are entitled to indemnification from the Company for any damages, liabilities, costs and
expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the
rendering of our Administrator’s services under the Administration Agreement or otherwise as Administrator for
the Company.
Note 7. Related Party Transactions
As of December 31, 2019 and 2018, the Company had $3.7 million and $2.5 million, respectively, of
management and incentive fees payable to the Investment Advisor. These amounts are reflected in the
accompanying consolidated statements of assets and liabilities under the caption “Management and incentive fees
payable.”
The Company may invest in the same unitranche facility as CSLF II whereby CSLF II provides the first-out
portion of the unitranche facility and the Company and other lenders provide the last-out portion of the
unitranche facility. Under a guarantee agreement, the Company may be required to purchase its pro-rata portion
of first-out loans from CSLF II upon certain triggering events, including acceleration upon payment default of the
underlying borrower. As of December 31, 2019, the Company has evaluated the fair value of the guarantee under
the guidance of ASC Topic 460 — Guarantees and determined that the fair value of the guarantee is immaterial
as the risk of payment default for first-out loans in CSLF II is considered remote. The maximum exposure to
credit risk as of December 31, 2019 and 2018, was $10.3 million and $4.3 million, respectively, and extends to
the stated maturity of the underlying loans in CSLF II.
Note 8. Borrowings
SBA Debentures
The Company, through its wholly owned subsidiary, uses debenture leverage provided through the SBA to
fund a portion of its investment portfolio. As of December 31, 2019 and 2018, the Company had $150.0 million
and $165.7 million, respectively, of SBA-guaranteed debentures outstanding. The Company has issued all SBA-
guaranteed debentures that were permitted under each of the Legacy Funds’ respective SBIC licenses (as
applicable), and there are no unused SBA debenture commitments remaining. On March 1, 2019, Fund II repaid
its outstanding SBA debentures and relinquished its SBIC license. SBA-guaranteed debentures are secured by a
lien on all assets of Fund III and were secured by a lien on all assets of Fund II prior to March 1, 2019. As of
December 31, 2019, Fund III had total assets of $266.3 million. As of December 31, 2018, Fund II and Fund III
had total assets of $332.7 million. On June 10, 2014, the Company received an exemptive order from the SEC
exempting the Company, Fund II, and Fund III from certain provisions of the 1940 Act (including an exemptive
order granting relief from the asset coverage requirements for certain indebtedness issued by Fund II and Fund III
as SBICs) and from certain reporting requirements mandated by the Securities Exchange Act of 1934, as
amended, with respect to Fund II and Fund III. The Company intends to comply with the conditions of the order.
F-48
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 8. Borrowings – (continued)
The following table summarizes the interest expense and annual charges, deferred financing costs, average
outstanding balance, and average stated interest and annual charge rate on the SBA-guaranteed debentures for
the years ended December 31, 2019, 2018 and 2017 (dollars in thousands):
Interest expense and annual charges
Deferred financing costs
Total interest and financing expenses
For the years ended
December 31,
2019
December 31,
2018
December 31,
2017
$
$
5,454
682
6,136
$
$
6,244
612
6,856
$
$
6,336
611
6,947
Average outstanding balance
Average stated interest and annual charge rate
$152,537
3.57
%
$169,028
3.69
%
$170,700
3.71
%
As of December 31, 2019 and 2018, the Company’s issued and outstanding SBA-guaranteed debentures
mature as follows (dollars in thousands):
Fixed Maturity Date
September 1, 2020
March 1, 2021
March 1, 2021
March 1, 2022
March 1, 2022
March 1, 2023
2021 Notes
Interest
Rate
SBA Annual
Charge
December 31,
2019
December 31,
2018
3.215
4.084
4.084
2.766
2.766
2.351
%
%
%
%
%
%
0.285
0.515
0.285
0.285
0.515
0.515
%
%
%
%
%
%
$ 19,000
—
46,000
10,000
50,000
25,000
$ 19,000
15,700
46,000
10,000
50,000
25,000
$150,000
$165,700
On June 16, 2014, the Company issued $113.4 million in aggregate principal amount of 7.125% fixed-rate
notes due 2021 (the “2021 Notes”). On May 26, 2017, the Company caused notices to be issued to the holders of
its 2021 Notes regarding the Company’s exercise of its option to redeem all of the issued and outstanding 2021
Notes. The Company redeemed all $113.4 million in aggregate principal amount of the 2021 Notes on June 25,
2017. The Notes were redeemed at 100% of their principal amount ($25 per Note), plus the accrued and unpaid
interest thereon from June 16, 2017, through, but excluding, June 25, 2017. As a result of the redemption, the
Company recognized a loss on the extinguishment of debt of $2.7 million for the year ended December 31, 2017,
due to the amortization of the deferred financing costs remaining on the 2021 Notes.
F-49
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 8. Borrowings – (continued)
The following table summarizes the interest expense, deferred financing costs, average outstanding balance
and average stated interest rate on the 2021 Notes for the years ended December 31, 2019, 2018, and 2017
(dollars in thousands):
Interest expense
Deferred financing costs
Total interest and financing expenses
Average outstanding balance
Average stated interest rate
2022 Notes
For the years ended
December 31,
2019
December 31,
2018
December 31,
2017
$ —
—
$ —
$ —
—
$ —
$ 3,908
293
$ 4,201
$ —
—
%
$ —
—
%
$53,766
7.13
%
On May 16, 2017, the Company issued $70.0 million in aggregate principal amount of 6.0% fixed-rate notes
due May 31, 2022 (the “2022 Notes”). On May 25, 2017, the Company issued an additional $5.0 million in
aggregate principal amount of the 2022 Notes pursuant to a partial exercise of the underwriters’ overallotment
option. The 2022 Notes will mature on May 31, 2022 and may be redeemed in whole or in part at any time or
from time to time at the Company’s option on or after May 31, 2019 at a redemption price equal to 100% of the
outstanding principal, plus accrued and unpaid interest.
The following table summarizes the interest expense, deferred financing costs, average outstanding balance,
and average stated interest rate on the 2022 Notes for the years ended December 31, 2019, 2018, and 2017
(dollars in thousands):
Interest expense
Deferred financing costs
Total interest and financing expenses
Average outstanding balance
Average stated interest rate
2022 Convertible Notes
For the years ended
December 31,
2019
December 31,
2018
December 31,
2017
$ 4,500
540
$ 5,040
$ 4,500
509
$ 5,009
$ 2,812
303
$ 3,115
$75,000
6.0
%
$75,000
6.0
%
$47,137
6.0
%
On May 26, 2017, the Company issued $50.0 million in aggregate principal amount of 5.75% fixed-rate
convertible notes due May 31, 2022 (the “2022 Convertible Notes”). On June 26, 2017, the Company issued an
additional $2.1 million in aggregate principal amount of the 2022 Convertible Notes pursuant to a partial exercise
of the underwriters’ overallotment option.
The 2022 Convertible Notes are convertible, at the holder’s option, into shares of the Company’s common
stock at any time on or prior to the close of business on the business day immediately preceding the maturity
date. The conversion rate for the 2022 Convertible Notes is initially 1.5913 shares per $25.00 principal amount of
2022 Convertible Notes (equivalent to an initial conversion price of approximately $15.71 per share of common
stock). The initial conversion premium is approximately 14.0%. Upon conversion, the Company will deliver
shares of its common stock (and cash in lieu of fractional shares). The conversion rate is subject to
F-50
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 8. Borrowings – (continued)
adjustment if certain events occur as outlined in the supplemental indenture relating to the 2022 Convertible
Notes. The Company has determined that the embedded conversion option in the 2022 Convertible Notes is not
required to be separately accounted for as a derivative under U.S. GAAP.
In addition, pursuant to a “fundamental change”, as defined in the supplemental indenture relating to the
2022 Convertible Notes, holders of the 2022 Convertible Notes may require the Company to repurchase for cash
all or part of their 2022 Convertible Notes at a repurchase price equal to 100.0% of the principal amount of the
2022 Convertible Notes to be repurchased, plus accrued and unpaid interest through, but excluding, the
repurchase date. The 2022 Convertible Notes are not redeemable prior to maturity and no “sinking fund” is
provided for the 2022 Convertible Notes.
The following table summarizes the interest expense, deferred financing costs, average outstanding balance,
and average stated interest rate on the 2022 Convertible Notes for the years ended December 31, 2019, 2018, and
2017 (dollars in thousands):
Interest expense
Deferred financing costs
Total interest and financing expenses
Average outstanding balance
Average stated interest rate
Credit Facility
For the years ended
December 31,
2019
December 31,
2018
December 31,
2017
$ 2,995
342
$ 3,337
$ 2,995
324
$ 3,319
$ 1,789
180
$ 1,969
$52,088
5.75
%
$52,088
5.75
%
$31,218
5.75
%
On October 17, 2014, the Company entered into a senior secured revolving credit agreement (as amended,
the “Credit Facility”) with ING Capital, LLC, as administrative agent, arranger, and bookrunner, and the lenders
party thereto. The Credit Facility was amended on May 22, 2015, June 16, 2017, July 19, 2018, February 22,
2019, and December 23, 2019 (the “Amendments”). The Amendments were affected, among other things, in
order to increase the total borrowings allowed under the Credit Facility, allow for stock repurchases, extend the
maturity date, reduce the minimum required interest coverage ratio, reduce the minimum required net asset value,
and reduce the minimum required asset coverage ratio. The Credit Facility currently provides for borrowings up
to $60.0 million and may be increased up to $150.0 million pursuant to its “accordion” feature. The Credit
Facility matures on April 30, 2022.
Borrowings under the Credit Facility bear interest, at the Company’s election, at a rate per annum equal to
(i) the one, two, three or six month LIBOR, as applicable, plus 3.50% or (ii) 2.00% plus the highest of (A) a
prime rate, (B) the Federal Funds rate plus 0.5%, and (C) three month LIBOR plus 1.0%. The Company’s ability
to elect LIBOR indices with various tenors (e.g., one, two, three or six month LIBOR) on which the interest rates
for borrowings under the Credit Facility are based, provides the company with increased flexibility to manage
interest rate risks as compared to a borrowing arrangement that does not provide for such optionality. Once a
particular LIBOR has been selected, the interest rate on the applicable amount borrowed will reset after the
applicable tenor period and be based on the then applicable selected LIBOR (e.g., borrowings for which the
Company has elected the one month LIBOR will reset on the one month anniversary of the period based on the
then selected LIBOR). For any given borrowing under the Credit Facility, the Company intends to elect what it
believes to be an appropriate LIBOR taking into account the Company’s needs at the time as well as the
Company’s view of future interest rate movements. The Credit Facility provides for the ability to step-down the
pricing of the Credit Facility from LIBOR plus 3.50% to LIBOR plus 3.00% when certain conditions are met.
The Company will also pay an unused commitment fee at a rate of 0.75% per
F-51
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 8. Borrowings – (continued)
annum on the unutilized portion of the aggregate commitments under the Credit Facility on each day when the
utilized portion of the aggregate commitments is less than 35% for such day and 0.50% per annum on the
unutilized portion of the aggregate commitments under the Credit Facility when the utilized portion is greater
than 35% for such day.
The following table summarizes the interest expense, deferred financing costs, unused commitment fees,
average outstanding balance, and average stated interest rate on the Credit Facility for the years ended
December 31, 2019, 2018, and 2017 (dollars in thousands):
Interest expense
Deferred financing costs
Unused commitment fees
Total interest and financing expenses
Average outstanding balance
Average stated interest rate
For the years ended
December 31,
2019
December 31,
2018
December 31,
2017
$
580
806
1,222
$ 2,608
$10,448
$ 305
441
1,353
$2,099
$6,304
$
908
713
972
$ 2,593
$22,493
5.41
%
4.89
%
4.08
%
As of December 31, 2019 and 2018, the Company had $0.0 and $10.0 million, respectively, outstanding
under the Credit Facility. The Credit Facility is secured by investments and cash held by the Company, exclusive
of assets pledged as collateral for the Company’s SBA debentures. Assets pledged to secure the Credit Facility
had a carrying value of $159.8 million and $158.9 million, respectively, at December 31, 2019 and December 31,
2018. As part of the terms of the Credit Facility, the Company may not make cash distributions with respect to
any taxable year that exceed 110% (125% if the Company is not in default and our covered debt does not exceed
85% of the borrowing base) of the amounts required to be distributed to maintain eligibility as a RIC and to
reduce our tax liability to zero for taxes imposed on our investment company taxable income and net capital
gains.
Financial Instruments Disclosed, But Not Carried, At Fair Value
The following table presents the carrying value and fair value of the Company’s financial liabilities
disclosed, but not carried, at fair value as of December 31, 2019, and the level of each financial liability within
the fair value hierarchy (dollars in thousands):
SBA debentures
2022 Notes
2022 Convertible Notes
Credit Facility
Total
Carrying
(1)
Value
$150,000
75,000
52,088
—
Fair Value
Level 1
Level 2
Level 3
$151,167
74,970
51,498
—
$
— $ — $151,167
—
—
—
—
—
—
74,970
51,498
—
$277,088
$277,635
$126,468
$ — $151,167
(1)
Carrying value equals the gross principal outstanding at period end.
F-52
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 8. Borrowings – (continued)
The following table presents the carrying value and fair value of the Company’s financial liabilities
disclosed, but not carried, at fair value as of December 31, 2018, and the level of each financial liability within
the fair value hierarchy (dollars in thousands):
SBA debentures
2022 Notes
2022 Convertible Notes
Credit Facility
Total
Carrying
(1)
Value
$165,700
75,000
52,088
10,000
Fair Value
Level 1
Level 2
Level 3
$165,436
74,700
49,546
10,030
$
— $
74,700
49,546
—
— $165,436
—
—
—
—
10,030
—
$302,788
$299,712
$124,246
$
— $175,466
(1)
Carrying value equals the gross principal outstanding at period end.
The estimated fair value of the Company’s SBA debentures was based on future contractual cash payments
discounted at market interest rates to borrow from the SBA as of the measurement date.
The estimated fair value of the 2022 Notes and 2022 Convertible Notes was based on their respective
closing prices as of the measurement date as they are traded on the NASDAQ Global Select Market under the
ticker “CPTAL” (2022 Notes) and on the NASDAQ Capital Market under the ticker “CPTAG” (2022 Convertible
Notes).
The estimated fair value of the Credit Facility was based on future contractual cash payments discounted at
estimated market interest rates for similar debt.
Note 9. Income Taxes
The Company has elected to be treated as a RIC under subchapter M of the Code. As a RIC, the Company is
not taxed on any investment company taxable income or capital gains which it distributes to stockholders. The
Company intends to make the requisite distributions to its stockholders which will relieve the Company from
U.S. federal income taxes. In 2017, the Company elected to amend its tax year end from August 31 to
December 31 and has filed a tax return for the four months ended December 31, 2017.
Distributions from net investment income, distributions from net realized capital gains, and distributions
classified as return of capital are determined in accordance with U.S. federal tax regulations, which may differ
from amounts in accordance with U.S. GAAP and those differences could be material.
Permanent differences between taxable income and net investment income for financial reporting purposes
are reclassified among the capital accounts in the financial statements to reflect their tax character. During the
periods ended December 31, 2019, December 31, 2018, December 31, 2017, and August 31, 2017, the Company
reclassified for book purposes amounts arising from permanent differences in the book and tax basis of
partnership investments sold, sales relating to defaulted bond accruals, deconsolidating book income from a
wholly owned subsidiary, and book and tax character of distributions paid. Such reclassifications are reported in
“Tax reclassifications of stockholders’ equity in accordance with generally accepted accounting principles” in the
statements of changes in net assets for the years ended December 31, 2019, 2018 and 2017, respectively.
F-53
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 9. Income Taxes – (continued)
The following permanent differences due to adjustments for the realized gains (losses) upon disposition of
partnership interests, deconsolidating book income from a wholly owned subsidiary, and for the transfer of
distributions between accumulated capital gains, accumulated net investment income, and return of capital were
reclassified for tax purposes for the tax periods ended December 31, 2019, December 31, 2018, December 31,
2017, and August 31, 2017 (dollars in thousands):
Tax year
ended
December 31,
2019
Tax year
ended
December 31,
2018
Tax period
ended
December 31,
2017
Tax year
ended
August 31,
2017
Increase (decrease) in accumulated net investment
income
)
$ (13
$ 38
$ —
$ (67
)
Increase (decrease) in accumulated net realized gains on
investments
Increase (decrease) in capital in excess of par value
2,450
)
(2,437
—
(38
)
—
—
88
(21
)
For the tax periods ended December 31, 2019, December 31, 2018, December 31, 2017, and August 31,
2017, the tax basis components of distributable earnings were as follows (dollars in thousands):
Undistributed ordinary income
Accumulated capital losses
Unrealized appreciation (depreciation)
Other temporary differences
Total
Tax year
ended
December 31,
2019
Tax year
ended
December 31,
2018
Tax period
ended
December 31,
2017
Tax year
ended
August 31,
2017
$
— $ 1,016
(79,063
6,519
(610
(95,186
)
)
(9,190
)
(6,423
)
)
$ 9,851
(44,078
34,065
(9,426
)
)
$ 8,999
(43,618
25,994
(8,276
)
)
)
$(110,799
$(72,138
)
$ (9,588
)
$(16,901
)
Capital losses in excess of capital gains earned in a tax year may generally be carried forward and used to
offset capital gains, subject to certain limitations. Under the Regulated Investment Company Modernization Act
of 2010, capital losses incurred after September 30, 2011 will not be subject to expiration. As of December 31,
2019, the Company has a short-term capital loss carry forward of $15.1 million and a long-term capital loss carry
forward of $80.1 million.
Taxable income generally differs from net increase (decrease) in net assets resulting from operations for
financial reporting purposes due to temporary and permanent differences in the recognition of income and
expenses and generally excludes unrealized appreciation (depreciation) on investments as investment gains and
losses are not included in taxable income until they are realized.
F-54
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 9. Income Taxes – (continued)
The following table reconciles net increase (decrease) in net assets resulting from operations to taxable
income for the tax periods ended December 31, 2019, December 31, 2018, December 31, 2017, and August 31,
2017 (dollars in thousands):
Tax year
ended
December 31,
2019
Tax year
ended
December 31,
2018
Tax period
ended
December 31,
2017
Tax year
ended
August 31,
2017
Net increase (decrease) in net assets resulting from
operations
$(27,647
)
$(16,026
)
$(17,150
)
$ 1,647
Net change in unrealized (appreciation) depreciation on
investments
Capital loss carryforward (utilization)
Tax provision (benefit)
Other deductions for book in excess of deductions for tax
Total taxable income
20,306
16,246
628
2,903
(840
)
34,985
(1,916
(9,051
)
)
(1,698
)
18,518
460
1,289
24,981
)
(679
—
9,053
$ 12,436
$ 7,152
$ 7,882
$28,539
For income tax purposes, distributions paid to stockholders are reported as ordinary income, return of
capital, long term capital gains or a combination thereof. The estimated tax character of distributions paid for the
tax periods ended December 31, 2019, December 31, 2018, December 31, 2017, and August 31, 2017 were as
follows (dollars in thousands):
Ordinary income
Return of capital
Total
Tax year
ended
December 31,
2019
Tax year
ended
December 31,
2018
Tax period
ended
December 31,
2017
Tax year
ended
August 31,
2016
$13,451
2,659
$16,110
$15,986
—
$15,986
$6,052
—
$6,052
$25,187
—
$25,187
For U.S. federal income tax purposes, as of December 31, 2019, the aggregate net unrealized depreciation
for all securities was $(9.2) million. As of December 31, 2019, gross unrealized appreciation was $7.7 million
and gross unrealized depreciation was $(16.9) million. The aggregate cost of securities for U.S. federal income
tax purposes was $371.7 million as of December 31, 2019. For U.S. federal income tax purposes, as of
December 31, 2018, the aggregate net unrealized appreciation for all securities was $6.5 million. As of
December 31, 2018, gross unrealized appreciation was $31.9 million and gross unrealized depreciation was
$(25.4) million. The aggregate cost of securities for U.S. federal income tax purposes was $442.4 million as of
December 31, 2018.
The Company has formed and expects to continue to form certain Taxable Subsidiaries, which are taxed as
corporations for income tax purposes. These Taxable Subsidiaries allow the Company to make equity investments
in companies organized as pass-through entities while continuing to satisfy the requirements of a RIC under the
Code. The Taxable Subsidiaries are wholly owned consolidated subsidiaries of the Company.
The Company acquired the non-controlling interest in Print Direction, Inc. on December 1, 2017 and
converted the entity to CPTA Master Blocker, Inc. (Georgia), retaining its net operating losses in the transaction
pursuant to Section 382 of the Code. As of December 31, 2019, the Taxable Subsidiaries had net operating losses
for U.S. federal income tax purposes of approximately $16.4 million. If not utilized, $6.1 million of these net
operating losses will expire in the year ended December 31, 2037, $2.4 million of these net operating losses will
expire in the year ended December 31, 2036, and $7.9 million of these net
F-55
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 9. Income Taxes – (continued)
operating losses have no expiration. As of December 31, 2019, the Taxable Subsidiaries had net operating loss for
state income tax purposes of approximately $14.8 million. If not utilized, $0.4 million of these net operating
losses will expire in the year ended December 31, 2037, $1.0 million of these net operating losses will expire in
the year ended December 31, 2036, and $13.4 million of these net operating losses have no expiration.
On December 22, 2017, the United States enacted tax reform legislation through the Tax Cuts and Jobs Act,
which significantly changes the existing U.S. tax laws, including a reduction in the corporate tax rate from 35%
to 21%, a move from a worldwide tax system toward a territorial system, as well as other changes. The Taxable
Subsidiaries’ provisional tax is based on the new lower blended federal and state corporate tax rate of 24.62%,
24.86%, and 25.00% as of December 31, 2019, 2018 and 2017, respectively. The implementation of the Tax Act
did not have a material impact on the Company’s financial position and results of operations.
Deferred U.S. federal income taxes reflect the net tax effect of temporary differences between the carrying
amount of assets and liabilities for financial reporting and U.S. federal income tax purposes. Components of
deferred tax assets (liabilities) as of December 31, 2019 and 2018 are as follows (dollars in thousands):
Deferred tax assets:
Net operating loss carryforwards
Capital loss carryforwards
Other deferred tax assets
Less valuation allowance
Total deferred tax assets
Deferred tax liabilities:
Net unrealized appreciation on investments
Total deferred tax liabilities
Net deferred tax asset (liability)
December 31,
2019
December 31,
2018
$ 4,033
243
5
(3,166
1,115
)
)
)
(1,115
(1,115
$ —
$ 2,963
—
58
(364
2,657
)
)
)
(2,029
(2,029
628
$
At December 31, 2019 and December 31, 2018, the valuation allowance on deferred tax assets was $3.2 and
$0.4 million, respectively, which represents the tax effect of net operating losses that we do not believe we will
realize through future taxable income. Any adjustments to the Company’s valuation allowance will depend on
estimates of future taxable income and will be made in the period such determination is made.
F-56
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 9. Income Taxes – (continued)
Total income tax expense (benefit) differs from the amount computed by applying the federal statutory
income tax rate of 21% to net investment loss and net realized and unrealized appreciation (depreciation) on
investments for the years ended December 31, 2019, 2018, and 2017, are as follows (dollars in thousands):
For the years ended
Tax expense (benefit) at statutory rates
State income tax expense (benefit), net of federal benefit
Tax benefit on net operating losses
Adjustment to unrealized appreciation
Other adjustments
Tax expense on permanent items
Revaluation for federal rate change
Revaluation for state rate change
Change in valuation allowance
)
)
December 31,
2019
$(1,742
(300
—
(359
218
—
—
10
2,801
)
)
)
December 31,
2018
$(1,447
(266
—
(159
(40
—
—
(5
1
)
)
)
)
December 31,
2017
$1,998
188
(908
—
—
140
(492
—
363
)
Total tax provision (benefit), net
$
628
$(1,916
)
$1,289
For the years ended December 31, 2019, 2018 and 2017, the components of the Company’s tax provision
include the following (dollars in thousands):
Deferred tax provision (benefit)
Federal
State
Less change in valuation allowance
Total tax provision (benefit), net
Note 10. Directors’ Fees
For the years ended
December 31,
2019
December 31,
2018
December 31,
2017
)
)
$(1,862
(311
2,801
$
628
)
)
$(1,615
(302
1
$(1,916
)
$ 778
148
363
$1,289
Our independent directors receive an annual fee of $50,000. They also receive $5,000 plus reimbursement
of reasonable out-of-pocket expenses incurred in connection with attending each board meeting and $5,000 plus
reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each committee
meeting. In addition, the chairman of the audit committee receives an annual fee of $10,000 and each chairman
of any other committee receives an annual fee of $5,000 for their additional services, if any, in these capacities.
For the years ended December 31, 2019, 2018 and 2017, the Company recognized directors’ fees expense of
$0.4 million. No compensation is expected to be paid to directors who are “interested persons” of the Company,
as such term is defined in Section 2(a)(19) of the 1940 Act.
Note 11. Stockholders’ Equity
On September 24, 2013, we issued 8,974,420 shares of common stock to the limited partners of the Legacy
Funds, in exchange for 100% of their membership interests or certain investment assets of such Legacy Funds, as
the case may be. On September 30, 2013, we issued 4,000,000 shares of common stock in connection with the
closing of our IPO. The shares issued in the IPO were priced at $20.00 per share. We received proceeds of
$74.25 million in the IPO, net of underwriters’ discounts and commissions of $5.75 million.
F-57
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 11. Stockholders’ Equity – (continued)
On April 13, 2015, the Company completed an underwritten offering of 3,500,000 shares of its common
stock at a public offering price of $18.32 per share. The total proceeds received in the offering net of
underwriting discounts and offering costs were approximately $61.7 million. As of December 31, 2019, the
Company had 16,203,769 shares of common stock outstanding.
Note 12. Summarized Financial Information of Our Unconsolidated Subsidiaries
During the year ended December 31, 2019, the Company sold or exited four portfolio companies that were
considered significant subsidiaries under the guidance in Regulation S-X. During the year ended December 31,
2019, the Company wrote off its investment in AAE Acquisition, LLC and realized a loss of $(20.4) million.
During the year ended December 31, 2019, the Company sold its investments in Portrait Studio, LLC,
CableOrganizer Acquisition, LLC, and Micro Precision, LLC and realized a gain/(loss) of $(6.2) million, $(14.6)
million, and $0.0, respectively.
Note 13. Earnings Per Share
In accordance with the provisions of ASC Topic 260 — Earnings per Share (“ASC 260”), basic earnings per
share is computed by dividing earnings available to common stockholders by the weighted average number of
shares outstanding during the period. Other potentially dilutive common shares, and the related impact to
earnings, are considered when calculating earnings per share. For the years ended December 31, 2019, 2018, and
2017, 3.3 million in convertible shares related to the 2022 Convertible Notes were considered anti-dilutive.
The following information sets forth the computation of the weighted average basic and diluted net decrease
in net assets per share resulting from operations for the years ended December 31, 2019, 2018 and 2017 (dollars
in thousands, except share and per share data):
Basic and diluted
Net decrease in net assets resulting from operations
Weighted average common stock outstanding – basic
For the years ended
December 31,
2019
December 31,
2018
December 31,
2017
$
(27,647
)
$
(16,026
)
$
(6,984
)
and diluted
16,117,719
15,993,436
15,903,167
Net decrease in net assets per share resulting from
operations – basic and diluted
$
(1.72
)
$
(1.00
)
$
(0.44
)
Note 14. Distributions
The Company’s distributions are recorded on the record date. Stockholders have the option to receive
payment of the distribution in cash, shares of common stock, or a combination of cash and common stock.
Tax characteristics of all distributions paid are reported to stockholders on Form 1099 after the end of the
calendar year. For the years ended December 31, 2018 and 2017, total distributions of $16.0 million and
$22.6 million, respectively, were comprised 100% of ordinary income. For the year ended December 31, 2019,
we estimate that total distributions of $16.1 million were comprised of approximately $13.4 million from
ordinary income and $2.7 million from return of capital.
F-58
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 14. Distributions – (continued)
The following tables summarize the Company’s distribution declarations for the years ended December 31,
2019, 2018 and 2017 (in thousands, except share and per share data):
Date Declared
January 2, 2019
January 2, 2019
January 2, 2019
April 1, 2019
April 1, 2019
April 1, 2019
July 1, 2019
July 1, 2019
July 1, 2019
October 1, 2019
October 1, 2019
October 1, 2019
Date Declared
January 2, 2018
January 2, 2018
January 2, 2018
April 2, 2018
April 2, 2018
April 2, 2018
July 2, 2018
July 2, 2018
July 2, 2018
October 1, 2018
October 1, 2018
October 1, 2018
Record Date
Payment Date
Amount
Per Share
Cash
Distribution
January 24, 2019
February 20, 2019
March 21, 2019
April 22, 2019
May 23, 2019
June 20, 2019
July 23, 2019
August 22, 2019
September 20, 2019
October 22, 2019
November 22, 2019
December 23, 2019
January 30, 2019
February 27, 2019
March 28, 2019
April 29, 2019
May 30, 2019
June 27, 2019
July 30, 2019
August 29, 2019
September 27, 2019
October 29, 2019
November 29, 2019
December 30, 2019
$0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
$ 1,256
1,253
1,250
1,246
1,243
1,238
1,237
1,231
1,231
1,231
1,234
1,234
DRIP
Shares
Issued
10,270
10,570
11,756
11,479
11,579
11,747
11,721
16,079
14,327
14,482
14,079
14,133
DRIP
Share
Value
$
81
85
89
94
97
104
106
113
114
115
113
115
Total Distributions Declared and Distributed for 2019
$ 1.00
$14,884
152,222
$1,226
Record Date
Payment Date
Amount
Per Share
Cash
Distribution
January 22, 2018
February 20, 2018
March 23, 2018
April 19, 2018
May 22, 2018
June 20, 2018
July 23, 2018
August 23, 2018
January 30, 2018
February 27, 2018
March 29, 2018
April 27, 2018
May 30, 2018
June 28, 2018
July 30, 2018
August 30, 2018
September 20, 2018
October 23, 2018
November 21, 2018
December 20, 2018
September 27, 2018
October 30, 2018
November 29, 2018
December 28, 2018
$0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
0.0833
$ 1,275
1,275
1,274
1,278
1,277
1,280
1,279
1,277
1,249
1,249
1,249
1,255
DRIP
Shares
Issued
7,280
8,076
7,631
7,006
6,875
6,591
6,515
6,699
10,066
10,918
11,342
11,317
DRIP
Share
Value
$ 54
54
56
53
54
52
53
56
84
85
86
82
Total Distributions Declared and Distributed for 2018
$ 1.00
$15,217
100,316
$769
F-59
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 14. Distributions – (continued)
Date Declared
January 3, 2017
January 3, 2017
January 3, 2017
April 3, 2017
April 3, 2017
April 3, 2017
July 3, 2017
July 3, 2017
July 3, 2017
October 2, 2017
October 2, 2017
October 2, 2017
Record Date
Payment Date
Amount
Per Share
Cash
Distribution
January 20, 2017
February 20, 2017
March 23, 2017
April 19, 2017
May 23, 2017
June 21, 2017
July 21, 2017
August 23, 2017
September 20, 2017
October 23, 2017
November 21, 2017
December 20, 2017
January 30, 2017
February 27, 2017
March 30, 2017
April 27, 2017
May 29, 2017
June 29, 2017
July 28, 2017
August 30, 2017
September 28, 2017
October 30, 2017
November 29, 2017
December 28, 2017
$0.1300
0.1300
0.1300
0.1300
0.1300
0.1300
0.1300
0.1300
0.1300
0.0833
0.0833
0.0833
$ 1,993
1,993
1,998
1,996
1,990
1,969
1,995
1,957
1,989
1,280
1,278
1,273
DRIP
Shares
Issued
5,304
5,195
4,948
5,164
5,880
7,959
5,889
13,162
9,085
5,876
6,856
7,868
DRIP
Share
Value
$ 70
70
67
69
76
97
73
111
80
48
49
55
Total Distributions Declared and Distributed for 2017
$ 1.42
$21,711
83,186
$865
F-60
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 15. Financial Highlights and Senior Securities
The following is a schedule of financial highlights and senior securities for the years ended December 31,
2019, 2018, 2017, 2016, and 2015 (dollars in thousands, except share and per share data):
Per share data:
Net asset value at beginning of year
Net investment income
Net realized gain (loss) on
(1)
investments
(1)
Net unrealized appreciation (depreciation)
on investments
(1)
2019
For the years ended December 31,
2017
2018
2016
$
$
11.88
0.81
$
13.91
1.00
$
15.79
0.98
$
17.04
1.84
(1.23
)
(1.26
)
(2.18
)
(0.37
)
(1.52
)
0.44
(1.44
)
0.35
2015
18.56
1.67
0.35
(1.11
)
Net unrealized appreciation (depreciation)
on Written Call Option
(1)
(1)
Tax benefit (provision)
Distributions – net investment income
Distributions – return of capital
Distributions – net realized gains
Issuance of common stock
Accretive impact of stock repurchase
Other
Net asset value at end of year
Net assets at end of year
Shares outstanding at end of year
Per share market value at end of year
(2)
Total return based on market value
(6)
Ratio/Supplemental data:
Ratio of net investment income to average
net assets
Ratio of incentive fee, net of incentive fee
waiver, to average net assets
(5)
Ratio of interest and financing expenses
to average net assets
Ratio of loss on extinguishment of debt
to average net assets
Ratio of tax (benefit) provision to average
net assets
Ratio of other operating expenses to
average net assets
Ratio of total expenses including tax
provision, net of incentive fee waiver to
(5)
average net assets
Portfolio turnover rate
Average debt outstanding
Average debt outstanding per common
(3)
(4)
share
$
$
$
$
$
—
(0.04
(0.83
(0.17
—
—
—
(0.02
9.14
148,113
16,203,769
8.73
37.75
)
)
)
)
%
0.43
0.12
(1.00
—
—
—
—
(0.03
11.88
190,644
16,051,547
7.17
12.14
$
$
$
)
)
%
(0.26
(0.08
(1.42
—
—
—
—
(0.02
13.91
221,887
15,951,231
7.28
(35.68
$
$
$
)
)
)
)
)%
(0.17
—
(1.80
—
—
—
—
(0.03
15.79
250,582
15,868,045
12.93
24.07
$
$
$
)
)
)
%
—
—
(1.88
—
(0.50
(0.15
0.13
(0.03
17.04
$
$
268,802
15,777,345
12.08
$
(20.43
)
)
)
)
)%
7.85
%
0.73
%
10.30
%
—
%
0.38
%
7.62
%
7.60
%
0.12
%
8.20
%
—
%
(0.91
)%
6.52
%
6.54
%
11.32
%
2.01
%
7.68
%
—
%
—
%
0.15
%
7.94
%
1.15
%
0.54
%
5.75
%
9.55
%
1.88
%
7.17
%
—
%
—
%
5.61
%
5.52
%
%
%
19.03
19.18
290,073
17.90
$
$
%
%
13.93
22.69
302,420
18.84
$
$
%
%
15.53
16.34
325,314
20.39
$
$
%
%
15.30
21.33
356,758
22.48
$
$
%
%
14.57
25.99
324,824
20.59
Total Debt Outstanding Exclusive of Treasury Securities:
Credit Facility
SBA Debentures
2021 Notes
2022 Notes
2022 Convertible Notes
75,000
52,088
— $
$
— $
$
$
150,000
$
$
$
$
$
F-61
10,000
165,700
$
$
— $
$
$
75,000
52,088
9,000
170,700
$
$
— $
$
$
75,000
52,088
44,000
170,700
113,438
$
$
$
— $
— $
70,000
184,200
113,438
—
—
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 15. Financial Highlights and Senior Securities – (continued)
(7)
Asset coverage per unit:
Credit Facility
SBA Debentures
2021 Notes
2022 Notes
2022 Convertible Notes
2019
$
$
$
2,165
N/A
N/A
2,165
2,165
(8)
Involuntary liquidation preference per unit:
Credit Facility
SBA Debentures
2021 Notes
2022 Notes
2022 Convertible Notes
(9)
:
Average market value per unit
Credit Facility
SBA Debentures
2021 Notes
2022 Notes
2022 Convertible Notes
$
$
—
—
—
—
—
N/A
N/A
N/A
1,000
994
For the years ended December 31,
2017
2016
2018
$
$
$
$
$
2,391
N/A
N/A
2,391
2,391
—
—
—
—
—
N/A
N/A
N/A
996
984
$
$
$
$
$
2,630
N/A
N/A
2,630
2,630
—
—
—
—
—
N/A
N/A
N/A
1,014
1,001
$
$
$
2,592
N/A
2,592
N/A
N/A
—
—
—
—
—
N/A
N/A
1,006
N/A
N/A
$
$
$
2015
2,465
N/A
2,465
N/A
N/A
—
—
—
—
—
N/A
N/A
1,020
N/A
N/A
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
Based on daily weighted average balance of shares outstanding during the period.
Total investment return is calculated assuming a purchase of common shares at the current market value on
the first day and a sale at the current market value on the last day of the period reported. Dividends and
distributions, if any, are assumed for purposes of this calculation to be reinvested at prices obtained under
the Company’s DRIP. Total investment return does not reflect brokerage commissions.
Portfolio turnover rate is calculated using the lesser of year-to-date sales or year-to-date purchases over the
average of the invested assets at fair value.
Based on daily weighted average balance of debt outstanding during the period.
The ratio of waived incentive fees to average net assets was 0.17%, 0.00%, 0.40%, 0.65%, and 0.40% for
the years ended December 31, 2019, 2018, 2017, 2016, and 2015, respectively.
Includes the impact of different share amounts used in calculating per share data as a result of calculating
certain per share data based on weighted average shares outstanding during the period and certain per share
data based on shares outstanding as of a period end or transaction date.
Asset coverage per unit is the ratio of the carrying value of our total consolidated assets, less all liabilities
and indebtedness not represented by senior securities, to the aggregate amount of senior securities
representing indebtedness. We have excluded our SBA-guaranteed debentures from the asset coverage
calculation as of December 31, 2019, 2018, 2017, 2016, and 2015 pursuant to the exemptive relief granted
by the SEC in June 2014 that permits us to exclude such debentures from the definition of senior securities
in the 200% asset coverage ratio (150% after November 1, 2019) we are required to maintain under the 1940
Act. Asset coverage per unit is expressed in terms of dollar amounts per $1,000 of indebtedness.
The amount to which such class of senior security would be entitled upon the involuntary liquidation of the
issuer in preference to any security junior to it. The “—” indicates information that the SEC expressly does
not require to be disclosed for certain types of senior securities.
Not applicable except for the 2021 Notes, the 2022 Notes and the 2022 Convertible Notes which are
publicly traded. The Average Market Value Per Unit is calculated by taking the daily average closing price
during the period and dividing it by $25 per share and multiplying the result by $1,000 to determine a unit
price per thousand consistent with Asset Coverage Per Unit.
F-62
TABLE OF CONTENTS
CAPITALA FINANCE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 16. Selected Quarterly Financial Data (Unaudited)
(Dollars in thousands, except per share data)
Total investment income
Net investment income
Net increase (decrease) in net assets resulting from
operations
Net investment income per share
(1)
Net increase (decrease) in net assets resulting from
operations per share
(1)
Net asset value per share at end of period
(Dollars in thousands, except per share data)
Total investment income
Net investment income
Net increase (decrease) in net assets resulting from
operations
Net investment income per share
(1)
Net increase (decrease) in net assets resulting from
operations per share
(1)
$9,634
$1,902
$ (69
)
$ 0.12
)
$ (0.00
$ 9.14
For the quarter ended
December 31,
2019
September 30,
2019
June 30,
2019
$10,126
$ 2,984
$ 11,590
$ 4,022
March 31,
2019
$12,684
$ 4,135
$ 1,717
$(29,144
)
$ (151
)
$
$
$
0.18
0.11
9.40
$
$
$
0.25
$
0.26
(1.81
)
$ (0.01
)
9.55
$ 11.61
For the quarter ended
December 31,
2018
September 30,
2018
June 30,
2018
March 31,
2018
$11,308
$ 3,501
$ 11,530
$ 3,851
$11,882
$ 4,231
$12,572
$ 4,438
$ (9,201
)
$(11,916
)
$ 4,948
$
0.22
$
0.24
$ (0.57
)
$ (0.74
)
$
$
0.26
0.31
$
$
$
141
0.28
0.01
Net asset value per share at end of period
$ 11.88
$ 12.71
$ 13.71
$ 13.66
(1)
Calculated based on weighted average shares outstanding during the quarter.
Note 17. Subsequent Events
Management has evaluated subsequent events through the date of issuance of the consolidated financial
statements included herein. There have been no subsequent events that occurred during such period that would be
required to be recognized in the consolidated financial statements as of December 31, 2019.
Distributions
On January 2, 2020, the Company’s Board declared normal monthly distributions for January, February, and
March of 2020 as set forth below:
Date Declared
January 2, 2020
January 2, 2020
January 2, 2020
Record Date
Payment Date
January 24, 2020
February 20, 2020
March 23, 2020
January 30, 2020
February 27, 2020
March 30, 2020
Distributions
per Share
$0.0833
$0.0833
$0.0833
F-63
TABLE OF CONTENTS
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
As of December 31, 2019 (the end of the period covered by this report), we, including our Chief Executive
Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended).
Based on that evaluation, our management, including the Chief Executive Officer and Chief Financial Officer,
concluded that our disclosure controls and procedures were effective and provided reasonable assurance that
information required to be disclosed in our periodic SEC filings is recorded, processed, summarized and reported
within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure. However, in evaluating the disclosure
controls and procedures, management recognized that any controls and procedures, no matter how well designed
and operated can provide only reasonable assurance of achieving the desired control objectives, and management
necessarily was required to apply its judgment in evaluating the cost-benefit relationship of such possible controls
and procedures.
(b) Report of Management on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial
reporting, and for performing an assessment of the effectiveness of internal control over financial reporting.
Internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance
with U.S. GAAP. The Company’s internal control over financial reporting includes those policies and procedures
that (i) pertain to assets of the Company; (ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that receipts and
expenditures of the Company are being made only in accordance with authorizations of management and
directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the
financial statements.
Management performed an assessment of the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2019 based upon the criteria in the 2013 Internal Control — Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on management’s
assessment, management determined that the Company’s internal control over financial reporting was effective as
of December 31, 2019.
The Company’s independent registered public accounting firm that audited the financial statements has
issued an audit report on the effectiveness of our internal control over financial reporting as of December 31,
2019. This report appears on page F-2 of this Annual Report on Form 10-K.
(c) Changes in Internal Controls Over Financial Reporting
Management has not identified any change in the Company’s internal control over financing reporting that
occurred during the fourth quarter of 2019 that has materially affected, or is reasonably likely to materially affect,
the Company’s internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
103
TABLE OF CONTENTS
PART III
We will file a definitive Proxy Statement for our 2020 Annual Meeting of Stockholders with the Securities
and Exchange Commission, pursuant to Regulation 14A, not later than 120 days after the end of our fiscal year.
Accordingly, certain information required by Part III has been omitted under General Instruction G(3) to Form
10-K. Only those sections of our definitive Proxy Statement that specifically address the items set forth herein are
incorporated by reference.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 is hereby incorporated by reference from our definitive Proxy
Statement relating to our 2020 Annual Meeting of Stockholders, to be filed with the SEC within 120 days
following the end of our fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is hereby incorporated by reference from our definitive Proxy
Statement relating to our 2020 Annual Meeting of Stockholders, to be filed with the SEC within 120 days
following the end of our fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
The information required by Item 12 is hereby incorporated by reference from our definitive Proxy
Statement relating to our 2020 Annual Meeting of Stockholders, to be filed with the SEC within 120 days
following the end of our fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The information required by Item 13 is hereby incorporated by reference from our definitive Proxy
Statement relating to our 2020 Annual Meeting of Stockholders, to be filed with the SEC within 120 days
following the end of our fiscal year.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is hereby incorporated by reference from our definitive Proxy
Statement relating to our 2020 Annual Meeting of Stockholders, to be filed with the SEC within 120 days
following the end of our fiscal year.
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TABLE OF CONTENTS
PART IV
ITEM 15. EXHIBITS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES
a.
The following documents are filed as part of this Annual Report:
The following consolidated financial statements are set forth in Item 8:
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firms
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial
Reporting
Audited Financial Statements:
Consolidated Statements of Assets and Liabilities as of December 31, 2019 and 2018
Consolidated Statements of Operations for the years ended December 31, 2019, 2018, and
2017
Consolidated Statements of Changes in Net Assets for the years ended December 31, 2019, 2018, and
2017
Consolidated Statements of Cash Flows for the years ended December 31, 2019, 2018, and
2017
Consolidated Schedules of Investments as of December 31, 2019 and 2018
Notes to Consolidated Financial Statements
Page
F-1
F-2
F-3
F-4
F-5
F-6
F-7
F-18
105
TABLE OF CONTENTS
b. Exhibits
Exhibit
Number
3.1
3.2
3.3
3.4
3.5
3.6
4.1
4.2
4.3
4.4
4.5
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
Description of Document
(1)
(2)
(2)
(3)
(3)
(1)
Articles of Amendment and Restatement
Certificate of Limited Partnership of CapitalSouth Partners Fund II Limited Partnership
Certificate of Limited Partnership of CapitalSouth Partners SBIC Fund III, L.P.
Bylaws
Form of Amended and Restated Limited Partnership Agreement of CapitalSouth Partners Fund II
Limited Partnership
Form of Amended and Restated Agreement of Limited Partnership of CapitalSouth Partners SBIC
Fund III, L.P.
Form of Common Stock Certificate
Form of Base Indenture
Form of Second Supplemental Indenture relating to the 6.00% notes due 2022, by and between the
Registrant and U.S. Bank National Association, as trustee, including the form of Global Note
Form of the Third Supplemental Indenture relating to the 5.75% convertible notes due 2022, by and
between the Registrant and U.S. Bank National Association, as trustee, including the form of Global
Note
Description of Securities (filed herewith)
Form of Dividend Reinvestment Plan
Form of Investment Advisory Agreement by and between Registrant and Capitala Investment
Advisors, LLC
(1)
(1)
(9)
(4)
(1)
(8)
(1)
(1)
(1)
(1)
(5)
Form of Custodian Agreement
Form of Administration Agreement by and between Registrant and Capitala Advisors Corp.
Form of Indemnification Agreement by and between Registrant and each of its directors
Form of Trademark License Agreement by and between Registrant and Capitala Investment
Advisors, LLC
Form of Senior Secured Revolving Credit Agreement dated October 17, 2014, among Capitala
Finance Corp., as Borrower, the lenders party thereto, and ING Capital LLC, as Administrative
Agent, Arranger and Bookrunner
Form of Guarantee, Pledge and Security Agreement dated October 17, 2014, among Capitala Finance
Corp., as Borrower, the subsidiary guarantors party thereto, ING Capital LLC, as Revolving
Administrative Agent for the Revolving Lenders and as Collateral Agent, and each Financing Agent
(5)
and Designated Indebtedness Holder party thereto
Form of Incremental Assumption Agreement, dated January 6, 2015, relating to the Senior Secured
Revolving Credit Agreement, dated as of October 17, 2014, among Capitala Finance Corp., as
borrower, the lenders from time to time party thereto, and ING Capital LLC, as administrative agent,
arranger and bookrunner
Form of Incremental Assumption Agreement, dated August 19, 2015, relating to the Senior Secured
Revolving Credit Agreement, dated as of October 17, 2014, among Capitala Finance Corp., as
borrower, the lenders from time to time party thereto, and ING Capital LLC, as administrative agent,
arranger and bookrunner
Form of Amendment No. 2 to Senior Secured Revolving Credit Agreement dated June 16, 2017,
among Capitala Finance Corp., as Borrower, the lenders party thereto, and ING Capital LLC, as
administrative agent, arranger, and bookrunner
Form of Amendment No. 1 to Guarantee, Pledge and Security Agreement dated June 16, 2017,
among Capitala Finance Corp., as Borrower, the subsidiary guarantors party thereto, ING Capital
LLC, as Revolving Administrative Agent for the Revolving Lenders and as Collateral Agent, and
each Financing Agent and Designated Indebtedness Holder party thereto
Form of Amendment No. 3, dated as of July 19, 2018, to the Senior Secured Revolving Credit
Agreement, dated as of October 17, 2014, among Capitala Finance Corp., as borrower, the lenders
from time to time party thereto, and ING Capital LLC, as administrative agent, arranger and
bookrunner, and First National Bank of Pennsylvania, as documentation agent
(10)
(10)
(12)
(8)
(6)
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TABLE OF CONTENTS
Exhibit
Number
10.14
10.15
10.16
10.17
14.1
14.2
21.1
23.1
31.1
31.2
32.1
32.2
SM
(13)
(15)
(14)
Description of Document
Form of Amendment No. 4, dated as of February 22, 2019, to the Senior Secured Revolving Credit
Agreement, dated as of October 17, 2014, among Capitala Finance Corp., as borrower, the lenders
from time to time party thereto, and ING Capital LLC, as administrative agent, arranger and
bookrunner, and First National Bank of Pennsylvania, as documentation agent
Form of Amendment No. 6, to Senior Secured Revolving Credit Agreement, dated as of
December 23, 2019, among Capitala Finance Corp., as borrower, the lenders from time to time party
thereto, and ING Capital LLC, as administrative agent
Second Amended and Restated Limited Liability Company Agreement of Capitala Senior Loan
Fund II, LLC
Open Market Sale Agreement
Corp., Capitala Investment Advisors, LLC, Capitala Advisors Corp. and Jefferies LLC
Code of Business Conduct
Code of Ethics
List of Subsidiaries (filed herewith)
Consent of Independent Registered Public Accounting Firm (filed herewith)
Certification of Chief Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act of
1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
Certification of Chief Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act of
1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
Certification of Chief Executive Officer 18 U.S.C. Section 1350, as adopted pursuant to section 906
of the Sarbanes-Oxley Act of 2002 (filed herewith)
Certification of Chief Financial Officer 18 U.S.C. Section 1350, as adopted pursuant to section 906 of
the Sarbanes-Oxley Act of 2002 (filed herewith)
, dated as of December 31, 2019, by and among Capitala Finance
(16)
(11)
(1)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
Previously filed in connection with the Pre-Effective Amendment No. 1 to Capitala Finance Corp.’s
registration statement on Form N-2 (File No. 333-188956) filed on September 9, 2013.
Previously filed in connection with Pre-Effective Amendment No. 2 to Capitala Finance Corp.’s registration
statement on Form N-2 (File No. 333-188956) filed on September 16, 2013.
Previously filed in connection with Pre-Effective Amendment No. 5 to Capitala Finance Corp.’s registration
statement on Form N-2 (File No. 333-188956) filed on September 24, 2013.
Previously filed in connection with Pre-Effective Amendment No. 2 to Capitala Finance Corp.’s registration
statement on Form N-2 (File No. 333-193374) filed on May 21, 2014.
Previously filed in connection with Capitala Finance Corp.’s report on Form 8-K filed on October 21, 2014.
Previously filed in connection with Capitala Finance Corp.’s report on Form 8-K filed on January 8, 2015.
Previously filed in connection with Capitala Finance Corp.’s report on Form 8-K filed on August 25, 2015.
Previously filed in connection with Post-Effective Amendment No. 5 to Capitala Finance Corp.’s
registration statement on Form N-2 (File No. 333-204582) filed on May 16, 2017.
Previously filed in connection with Post-Effective Amendment No. 6 to Capitala Finance Corp.’s
registration statement on Form N-2 (File No. 333-204582) filed on May 26, 2017.
(10)
Previously filed in connection with Capitala Finance Corp.’s report on Form 8-K filed on June 21, 2017.
(11)
Previously filed in connection with Capitala Finance Corp.’s report on Form 10-K filed on February 27,
2018.
(12)
Previously filed in connection with Capitala Finance Corp.’s report on Form 8-K filed on July 20, 2018.
(13)
Previously filed in connection with Capitala Finance Corp.’s report on Form 8-K filed on February 28, 2019.
(14)
Previously filed in connection with Capitala Finance Corp’s report on Form 10-K filed on March 4, 2019.
107
TABLE OF CONTENTS
(15)
Previously filed in connection with Capitala Finance Corp.’s report on Form 8-K filed on December 23,
2019.
(16)
Previously filed in connection with Capitala Finance Corp.’s report on Form 8-K filed on December 31,
2019.
c. Consolidated Financial Statement Schedules
No consolidated financial statement schedules are filed herewith because (1) such schedules are not required
or (2) the information has been presented in the aforementioned consolidated financial statements.
ITEM 16. FORM 10-K SUMMARY
None.
108
TABLE OF CONTENTS
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly
authorized.
SIGNATURES
Date: March 2, 2020
Capitala Finance Corp.
By
/s/ Joseph B. Alala III
Joseph B. Alala III
Chief Executive Officer
(Principal Executive Officer)
Capitala Finance Corp.
Date: March 2, 2020
By
/s/ Stephen A. Arnall
Stephen A. Arnall
Chief Financial Officer
(Principal Financial Officer)
Capitala Finance Corp.
Date: March 2, 2020
By
/s/ Kevin A. Koonts
Kevin A. Koonts
Chief Accounting Officer
(Principal Accounting Officer)
Capitala Finance Corp.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
/s/ Joseph B. Alala III
Joseph B. Alala III
Title
Chief Executive Officer, President and Chairman of the Board
of Directors
(Principal Executive Officer)
/s/ M. Hunt Broyhill
Director
M. Hunt Broyhill
/s/ R. Charles Moyer
Director
R. Charles Moyer
/s/ Larry W. Carroll
Director
Larry W. Carroll
/s/ H. Paul Chapman
Director
H. Paul Chapman
Date
March 2, 2020
March 2, 2020
March 2, 2020
March 2, 2020
March 2, 2020
109
Exhibit 4.5
A.
Common Stock, $0.01 par value per share
DESCRIPTION OF SECURITIES
As of December 31, 2019, the authorized common stock of Capitala Finance Corp. (the “Company,” “we,” “our” or “us”) consisted of 100,000,000 shares of
stock, par value $0.01 per share. Our common stock is quoted on The Nasdaq Global Select Market under the ticker symbol “CPTA.” There are no
outstanding options or warrants to purchase our stock. No stock has been authorized for issuance under any equity compensation plans. Under Maryland law,
our stockholders generally are not personally liable for our debts or obligations.
Under our charter, our board of directors is authorized to classify and reclassify any unissued shares of stock into other classes or series of stock without
obtaining stockholder approval. As permitted by the Maryland General Corporation Law, our charter provides that the board of directors, without any action
by our stockholders, may amend the charter from time to time to increase or decrease the aggregate number of shares of stock or the number of shares of
stock of any class or series that we have authority to issue.
All shares of our common stock have equal rights as to earnings, assets, voting and distributions and, when they are issued, will be duly authorized, validly
issued, fully paid and nonassessable. Distributions may be paid to the holders of our common stock if, as and when authorized by our board of directors and
declared by us out of assets legally available therefor. Shares of our common stock have no preemptive, conversion or redemption rights and are freely
transferable, except where their transfer is restricted by federal and state securities laws or by contract. In the event of our liquidation, dissolution or winding
up, each share of our common stock would be entitled to share ratably in all of our assets that are legally available for distribution after we pay all debts and
other liabilities and subject to any preferential rights of holders of our preferred stock, if any preferred stock is outstanding at such time. Each share of our
common stock is entitled to one vote on all matters submitted to a vote of stockholders, including the election of directors. Except as provided with respect to
any other class or series of stock, the holders of our common stock will possess exclusive voting power. There is no cumulative voting in the election of
directors, which means that holders of a majority of the outstanding shares of common stock can elect all of our directors, and holders of less than a majority
of such shares will be unable to elect any director.
Certain Provisions of the Maryland General Corporation Law and Our Charter and Bylaws
The Maryland General Corporation Law and our charter and bylaws contain provisions that could make it more difficult for a potential acquirer to acquire us
by means of a tender offer, proxy contest or otherwise. These provisions are expected to discourage certain coercive takeover practices and inadequate
takeover bids and to encourage persons seeking to acquire control of us to negotiate first with our board of directors. We believe that the benefits of these
provisions outweigh the potential disadvantages of discouraging any such acquisition proposals because, among other things, the negotiation of such
proposals may improve their terms.
Classified Board of Directors
Our board of directors is divided into three classes of directors serving staggered three-year terms. The terms of the first, second and third classes will expire
at the annual meeting of stockholders held in 2020, 2021 and 2022, respectively, and in each case, those directors will serve until their successors are duly
elected and qualify. Upon expiration of their current terms, directors of each class will be elected to serve for three-year terms until their successors are duly
elected and qualify and each year one class of directors will be elected by the stockholders. A classified board may render a change in control of us or
removal of our incumbent management more difficult. We believe, however, that the longer time required to elect a majority of a classified board of directors
will help to ensure the continuity and stability of our management and policies.
Election of Directors
Our bylaws provide that the affirmative vote of the holders of a plurality of the outstanding shares of stock, entitled to vote in the election of directors cast at a
meeting of stockholders duly called and at which a quorum is present, will be required to elect a director. Pursuant to our charter, our board of directors may
amend the bylaws to alter the vote required to elect directors.
Number of Directors; Vacancies; Removal
Our charter provides that the number of directors will be set only by the board of directors in accordance with our bylaws. Our bylaws provide that a majority
of our entire board of directors may at any time increase or decrease the number of directors. However, unless our bylaws are amended, the number of
directors may never be less than one nor more than nine. Our charter provides that, at such time as we have at least three independent directors and our
common stock is registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), we elect to be subject to the provision of Subtitle 8
of Title 3 of the Maryland General Corporation Law regarding the filling of vacancies on the board of directors. Accordingly, at such time, except as may be
provided by the board of directors in setting the terms of any class or series of preferred stock, any and all vacancies on the board of directors may be filled
only by the affirmative vote of a majority of the remaining directors in office, even if the remaining directors do not constitute a quorum, and any director
elected to fill a vacancy will serve for the remainder of the full term of the directorship in which the vacancy occurred and until a successor is elected and
qualifies, subject to any applicable requirements of the Investment Company Act of 1940, as amended (the “1940 Act”).
Our charter provides that a director may be removed only for cause, as defined in our charter, and then only by the affirmative vote of at least two-thirds of
the votes entitled to be cast in the election of directors.
Action by Stockholders
Under the Maryland General Corporation Law, stockholder action can be taken only at an annual or special meeting of stockholders or by unanimous written
consent in lieu of a meeting (unless the charter provides for stockholder action by less than unanimous written consent, which our charter does not). These
provisions, combined with the requirements of our bylaws regarding the calling of a stockholder-requested special meeting of stockholders discussed below,
may have the effect of delaying consideration of a stockholder proposal until the next annual meeting.
Advance Notice Provisions for Stockholder Nominations and Stockholder Proposals
Our bylaws provide that with respect to an annual meeting of stockholders, nominations of persons for election to the board of directors and the proposal of
business to be considered by stockholders may be made only (1) pursuant to our notice of the meeting, (2) by the board of directors or (3) by a stockholder
who is entitled to vote at the meeting and who has complied with the advance notice procedures of our bylaws. With respect to special meetings of
stockholders, only the business specified in our notice of the meeting may be brought before the meeting. Nominations of persons for election to the board of
directors at a special meeting may be made only (1) pursuant to our notice of the meeting, (2) by the board of directors or (3) provided that the board of
directors has determined that directors will be elected at the meeting, by a stockholder who is entitled to vote at the meeting and who has complied with the
advance notice provisions of the bylaws.
The purpose of requiring stockholders to give us advance notice of nominations and other business is to afford our board of directors a meaningful
opportunity to consider the qualifications of the proposed nominees and the advisability of any other proposed business and, to the extent deemed necessary
or desirable by our board of directors, to inform stockholders and make recommendations about such qualifications or business, as well as to provide a more
orderly procedure for conducting meetings of stockholders. Although our bylaws do not give our board of directors any power to disapprove stockholder
nominations for the election of directors or proposals recommending certain action, they may have the effect of precluding a contest for the election of
directors or the consideration of stockholder proposals if proper procedures are not followed and of discouraging or deterring a third party from conducting a
solicitation of proxies to elect its own slate of directors or to approve its own proposal without regard to whether consideration of such nominees or proposals
might be harmful or beneficial to us and our stockholders.
- 2 -
Calling of Special Meetings of Stockholders
Our bylaws provide that special meetings of stockholders may be called by our board of directors and certain of our officers. Additionally, our bylaws provide
that, subject to the satisfaction of certain procedural and informational requirements by the stockholders requesting the meeting, a special meeting of
stockholders will be called by the secretary of the corporation upon the written request of stockholders entitled to cast not less than a majority of all the votes
entitled to be cast at such meeting.
Approval of Extraordinary Corporate Action; Amendment of Charter and Bylaws
Under Maryland law, a Maryland corporation generally cannot dissolve, amend its charter, merge, sell all or substantially all of its assets, engage in a share
exchange or engage in similar transactions outside the ordinary course of business, unless approved by the affirmative vote of stockholders entitled to cast at
least two-thirds of the votes entitled to be cast on the matter. However, a Maryland corporation may provide in its charter for approval of these matters by a
lesser percentage, but not less than a majority of all of the votes entitled to be cast on the matter. Our charter generally provides for approval of charter
amendments and extraordinary transactions by the stockholders entitled to cast at least a majority of the votes entitled to be cast on the matter. Our charter
also provides that certain charter amendments, any proposal for our conversion, whether by charter amendment, merger or otherwise, from a closed-end
company to an open-end company or any proposal for our liquidation or dissolution requires the approval of the stockholders entitled to cast at least 80% of
the votes entitled to be cast on such matter. However, if such amendment or proposal is approved by a majority of our continuing directors (in addition to
approval by our board of directors), such amendment or proposal may be approved by a majority of the votes entitled to be cast on such a matter. The
“continuing directors” are defined in our charter as (1) our current directors, (2) those directors whose nomination for election by the stockholders or whose
election by the directors to fill vacancies is approved by a majority of our current directors then on the board of directors or (3) any successor directors whose
nomination for election by the stockholders or whose election by the directors to fill vacancies is approved by a majority of continuing directors or the
successor continuing directors then in office. In any event, in accordance with the requirements of the 1940 Act, any amendment or proposal that would have
the effect of changing the nature of our business so as to cause us to cease to be, or to withdraw our election as, a business development company would be
required to be approved by a majority of our outstanding voting securities, as defined under the 1940 Act.
Our charter and bylaws provide that the board of directors will have the exclusive power to adopt, alter, amend or repeal any provision of our bylaws.
No Appraisal Rights
Except with respect to appraisal rights arising in connection with the Control Share Act discussed below, as permitted by the Maryland General Corporation
Law, our charter provides that stockholders will not be entitled to exercise appraisal rights unless a majority of the board of directors shall determine such
rights apply.
Control Share Acquisitions
The Maryland General Corporation Law provides that control shares of a Maryland corporation acquired in a control share acquisition have no voting rights
except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the matter (the “Control Share Act”). Shares owned by the acquirer, by
officers or by directors who are employees of the corporation are excluded from shares entitled to vote on the matter. Control shares are voting shares of stock
which, if aggregated with all other shares of stock owned by the acquirer or in respect of which the acquirer is able to exercise or direct the exercise of voting
power (except solely by virtue of a revocable proxy), would entitle the acquirer to exercise voting power in electing directors within one of the following
ranges of voting power:
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•
one-tenth or more but less than one-third;
one-third or more but less than a majority; or
a majority or more of all voting power.
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The requisite stockholder approval must be obtained each time an acquirer crosses one of the thresholds of voting power set forth above. Control shares do
not include shares the acquiring person is then entitled to vote as a result of having previously obtained stockholder approval or shares acquired directly from
the corporation. A control share acquisition means the acquisition of control shares, subject to certain exceptions.
A person who has made or proposes to make a control share acquisition may compel the board of directors of the corporation to call a special meeting of
stockholders to be held within 50 days of demand to consider the voting rights of the shares. The right to compel the calling of a special meeting is subject to
the satisfaction of certain conditions, including an undertaking to pay the expenses of the meeting. If no request for a meeting is made, the corporation may
itself present the question at any stockholders meeting.
If voting rights are not approved at the meeting or if the acquiring person does not deliver an acquiring person statement as required by the statute, then the
corporation may redeem for fair value any or all of the control shares, except those for which voting rights have previously been approved. The right of the
corporation to redeem control shares is subject to certain conditions and limitations, including compliance with the 1940 Act. Fair value is determined,
without regard to the absence of voting rights for the control shares, as of the date of the last control share acquisition by the acquirer or of any meeting of
stockholders at which the voting rights of the shares are considered and not approved. If voting rights for control shares are approved at a stockholders
meeting and the acquirer becomes entitled to vote a majority of the shares entitled to vote, all other stockholders may exercise appraisal rights. The fair value
of the shares as determined for purposes of appraisal rights may not be less than the highest price per share paid by the acquirer in the control share
acquisition.
The Control Share Act does not apply (a) to shares acquired in a merger, consolidation or share exchange if the corporation is a party to the transaction or (b)
to acquisitions approved or exempted by the charter or bylaws of the corporation. Our bylaws contain a provision exempting from the Control Share Act any
and all acquisitions by any person of our shares of stock. There can be no assurance that such provision will not be amended or eliminated at any time in the
future. However, the SEC staff has taken the position that, under the 1940 Act, an investment company may not avail itself of the Control Share Act. As a
result, we will amend our bylaws to be subject to the Control Share Act only if the Board of Directors determines that it would be in our best interests and if
the SEC staff does not object to our determination that our being subject to the Control Share Act does not conflict with the 1940 Act.
Business Combinations
Under Maryland law, “business combinations” between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are
prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder (the “Business Combination Act”).
These business combinations include a merger, consolidation, share exchange or, in circumstances specified in the statute, an asset transfer or issuance or
reclassification of equity securities. An interested stockholder is defined as:
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any person who beneficially owns 10% or more of the voting power of the corporation’s outstanding voting stock; or
an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner
of 10% or more of the voting power of the then outstanding voting stock of the corporation.
A person is not an interested stockholder under this statute if the board of directors approved in advance the transaction by which the stockholder otherwise
would have become an interested stockholder. However, in approving a transaction, the board of directors may provide that its approval is subject to
compliance, at or after the time of approval, with any terms and conditions determined by the board.
After the five-year prohibition, any business combination between the Maryland corporation and an interested stockholder generally must be recommended
by the board of directors of the corporation and approved by the affirmative vote of at least:
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80% of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation; and
two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder
with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested
stockholder.
These super-majority vote requirements do not apply if the corporation’s common stockholders receive a minimum price, as defined under Maryland law, for
their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares. The statute permits
various exemptions from its provisions, including business combinations that are exempted by the board of directors before the time that the interested
stockholder becomes an interested stockholder. Our board of directors has adopted a resolution that any business combination between us and any other
person is exempted from the provisions of the Business Combination Act, provided that the business combination is first approved by the board of directors,
including a majority of the directors who are not interested persons as defined in the 1940 Act. This resolution may be altered or repealed in whole or in part
at any time; however, our board of directors will adopt resolutions so as to make us subject to the provisions of the Business Combination Act only if the
board of directors determines that it would be in our best interests and if the SEC staff does not object to our determination that our being subject to the
Business Combination Act does not conflict with the 1940 Act. If this resolution is repealed, or the board of directors does not otherwise approve a business
combination, the statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer.
Conflict with 1940 Act
Our bylaws provide that, if and to the extent that any provision of the Maryland General Corporation Law, including the Control Share Act (if we amend our
bylaws to be subject to such Act) and the Business Combination Act, or any provision of our charter or bylaws conflicts with any provision of the 1940 Act,
the applicable provision of the 1940 Act will control.
B.
Debt Securities –6.00% Notes due 2022
On May 16, 2017, we issued $70.0 million in aggregate principal amount of 6.0% fixed-rate notes due May 31, 2022 (the “2022 Notes”). On May 25, 2017,
we issued an additional $5.0 million in aggregate principal amount of the 2022 Notes pursuant to a partial exercise of the underwriters’ overallotment option.
The 2022 Notes will mature on May 31, 2022, and may be redeemed in whole or in part at any time or from time to time at our option on or after May 31,
2019 at a redemption price equal to 100% of the outstanding principal, plus accrued and unpaid interest. Interest is payable quarterly. The 2022 Notes are
listed on the NASDAQ Global Select Market under the trading symbol “CPTAL” with a par value $25.00 per share.
The 2022 Notes were issued under that certain indenture, dated June 16, 2014 (the “Base Indenture”), by and between the Company and U.S. Bank National
Association (the “Trustee”), as supplemented by the second supplemental indenture dated as of May 16, 2017 (the “Second Supplemental Indenture” and,
together with the Base Indenture, the “2022 Notes Indenture”), between the Company and the Trustee.
The 2022 Notes Indenture provides that debt securities may be issued thereunder from time to time in one or more series. The 2022 Notes Indenture and the
2022 Notes are governed by, and construed in accordance with, the laws of the State of New York. The 2022 Notes Indenture does not limit the amount of
debt securities that we may issue under the 2022 Notes Indenture. We may, without the consent of the holders of the debt securities of any series, issue
additional debt securities ranking equally with, and otherwise similar in all respects to, the debt securities of the series so that those additional debt securities
will be consolidated and form a single series with the debt securities of the series previously offered and sold.
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The 2022 Notes are the Company’s direct unsecured obligations and rank:
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pari passu in right of payment with the Company’s future unsecured unsubordinated indebtedness, including the 2022 Convertible Notes (as
defined below);
senior to any of the Company’s future indebtedness that expressly states it is subordinated in right of payment to the 2022 Notes,
effectively subordinated in right of payment to all of the Company’s existing and future secured indebtedness (including indebtedness that is
initially unsecured, but to which the Company subsequently grant security) to the extent of the value of the assets securing such
indebtedness; and
structurally subordinated to all existing and future indebtedness and other obligations of any of the Company’s subsidiaries, financing
vehicles, or similar facilities.
The 2022 Notes may be redeemed in whole or in part at any time or from time to time at our option on or after May 31, 2019, upon not less than 30 days’ nor
more than 60 days’ written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount
thereof plus accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to but not including the date fixed
for redemption. A holder may be prevented from exchanging or transferring the 2022 Notes when they are subject to redemption. In case any 2022 Notes are
to be redeemed in part only, the redemption notice will provide that, upon surrender of such 2022 Note, a holder will receive, without a charge, a new 2022
Note or 2022 Notes of authorized denominations representing the principal amount of such holders remaining unredeemed Notes. Any exercise of our option
to redeem the 2022 Notes will be done in compliance with the 1940 Act and the related rules, regulations and interpretations, to the extent applicable. If we
redeem only some of the 2022 Notes, the Trustee or the Depositary Trust Company (“DTC”), as applicable, will determine the method for selection of the
particular Notes to be redeemed, in accordance with the indenture and the 1940 Act and in accordance with the rules of any national securities exchange or
quotation system on which the Notes are listed. Unless we default in payment of the redemption price, on and after the date of redemption, interest will cease
to accrue on the 2022 Notes called for redemption.
As required by federal law for all bonds and notes of companies that are publicly offered in the United States, the debt securities are governed by a document
called an “indenture.” An indenture is a contract between us and a financial institution acting as trustee on a holders behalf, and is subject to and governed by
the Trust Indenture Act of 1939, as amended. The Trustee with respect to the 2022 Notes has two main roles. First, the Trustee can enforce a holder’s rights
against us if we default under the applicable Notes. There are some limitations on the extent to which the Trustee acts on a holder’s behalf, see “Events of
Default” for more information. Second, the Trustee performs certain administrative duties for us, such as sending interest and principal payments to holders of
the 2022 Notes.
General
For purposes of this description, any reference to the payment of principal of, or premium or interest, if any, on, the 2022 Notes will include additional
amounts if required by the terms of the 2022 Notes.
The 2022 Notes Indenture does not limit the amount of debt securities that may be issued thereunder from time to time. Debt securities issued under the 2022
Notes Indenture, when a single trustee is acting for all debt securities issued thereunder, are called the “indenture securities.” The 2022 Notes Indenture also
provides that there may be more than one trustee thereunder, each with respect to one or more different series of indenture securities. See “Resignation of
Trustee” below. At a time when two or more trustees are acting under the 2022 Notes Indenture, each with respect to only certain series, the term “indenture
securities” means the one or more series of debt securities with respect to which each respective trustee is acting. In the event that there is more than one
trustee under the 2022 Notes Indenture, the powers and trust obligations of each trustee described in this description will extend only to the one or more series
of indenture securities for which it is trustee. If two or more trustees are acting under the 2022 Notes Indenture, then the indenture securities for which each
trustee is acting would be treated as if issued under separate indentures.
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The 2022 Notes Indenture does not contain any provisions that give a holder protection in the event we issue a large amount of debt or we are acquired by
another entity.
Global Securities
The 2022 Notes were issued as registered securities in book-entry form only. A global security represents one or any other number of individual debt
securities. Generally, all debt securities represented by the same global securities will have the same terms.
Each debt security issued in book-entry form is represented by a global security that we deposit with and register in the name of a financial institution or its
nominee that we select. The financial institution that we select for this purpose is called the depositary. DTC is the depositary for all debt securities issued in
book-entry form.
A global security may not be transferred to or registered in the name of anyone other than the depositary or its nominee, unless special termination situations
arise. We describe those situations below under “Special Situations when a Global Security Will Be Terminated.” As a result of these arrangements, the
depositary, or its nominee, will be the sole registered owner and holder of all debt securities represented by a global security, and investors will be permitted
to own only beneficial interests in a global security. Beneficial interests must be held by means of an account with a broker, bank or other financial institution
that in turn has an account with the depositary or with another institution that has an account with the depositary. Thus, an investor whose security is
represented by a global security will not be a holder of the debt security, but only an indirect holder of a beneficial interest in the global security.
Special Considerations for Global Securities
As an indirect holder, an investor’s rights relating to a global security will be governed by the account rules of the investor’s financial institution and of the
depositary, as well as general laws relating to securities transfers. The depositary that holds the global security will be considered the holder of the debt
securities represented by the global security.
If debt securities are issued only in the form of a global security, an investor should be aware of the following:
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an investor cannot cause the debt securities to be registered in its name and cannot obtain certificates for its interest in the debt securities,
except in the special situations we describe below;
an investor will be an indirect holder and must look to its own bank or broker for payments on the debt securities and protection of its legal
rights relating to the debt securities, as we describe under “Issuance of Securities in Registered Form” above;
an investor may not be able to sell interests in the debt securities to some insurance companies and other institutions that are required by
law to own their securities in non-book-entry form;
an investor may not be able to pledge its interest in a global security in circumstances where certificates representing the debt securities
must be delivered to the lender or other beneficiary of the pledge in order for the pledge to be effective;
the depositary’s policies, which may change from time to time, will govern payments, transfers, exchanges and other matters relating to an
investor’s interest in a global security. We and the Trustee have no responsibility for any aspect of the depositary’s actions or for its records
of ownership interests in a global security. We and the Trustee also do not supervise the depositary in any way;
if we redeem less than all the debt securities of a particular series being redeemed, DTC’s practice is to determine by lot the amount to be
redeemed from each of its participants holding that series;
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an investor is required to give notice of exercise of any option to elect repayment of its debt securities, through its participant, to the
applicable trustee and to deliver the related debt securities by causing its participant to transfer its interest in those debt securities, on DTC’s
records, to the applicable trustee;
DTC requires that those who purchase and sell interests in a global security deposited in its book-entry system use immediately available
funds. A holder’s broker or bank may also require a holder to use immediately available funds when purchasing or selling interests in a
global security; and
financial institutions that participate in the depositary’s book-entry system, and through which an investor holds its interest in a global
security, may also have their own policies affecting payments, notices and other matters relating to the debt securities. There may be more
than one financial intermediary in the chain of ownership for an investor. We do not monitor and are not responsible for the actions of any
of those intermediaries.
Special Situations when a Global Security Will Be Terminated
In a few special situations, a global security will be terminated and interests in it will be exchanged for certificates in non-book-entry form (certificated
securities). After that exchange, the choice of whether to hold the certificated debt securities directly or in street name will be up to the investor. Investors
must consult their own banks or brokers to find out how to have their interests in a global security transferred on termination to their own names, so that they
will be holders.
If a global security is terminated, only the depositary, and not we or the applicable trustee, is responsible for deciding the names of the institutions in whose
names the debt securities represented by the global security will be registered and, therefore, who will be the holders of those debt securities.
Payment and Paying Agents
We will pay interest to the person listed in the applicable trustee’s records as the owner of the debt security at the close of business on a particular day in
advance of each due date for interest, even if that person no longer owns the debt security on the interest due date. That day, usually about two weeks in
advance of the interest due date, is called the “record date.” Because we will pay all the interest for an interest period to the holders on the record date, holders
buying and selling debt securities must work out between themselves the appropriate purchase price. The most common manner is to adjust the sales price of
the debt securities to prorate interest fairly between buyer and seller based on their respective ownership periods within the particular interest period. This
prorated interest amount is called “accrued interest.”
Payments on Global Securities
We will make payments on the 2022 Notes so long as they are represented by a global security in accordance with the applicable policies of the depositary as
in effect from time to time. Under those policies, we will make payments directly to the depositary, or its nominee, and not to any indirect holders who own
beneficial interests in the global security. An indirect holder’s right to those payments will be governed by the rules and practices of the depositary and its
participants, as described under “Global Securities.”
Payment When Offices Are Closed
If any payment is due on the 2022 Notes on a day that is not a business day, we will make the payment on the next day that is a business day. Payments made
on the next business day in this situation will be treated under the 2022 Notes Indenture as if they were made on the original due date, except as otherwise
indicated in this description. Such payment will not result in a default under the 2022 Notes or the 2022 Notes Indenture, and no interest will accrue on the
payment amount from the original due date to the next day that is a business day.
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Events of Default under the 2022 Notes
A holder will have rights if an Event of Default occurs in respect of the 2022 Notes and is not cured, as described later in this subsection.
The term “Event of Default” in respect of the 2022 Notes means any of the following:
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we do not pay the principal of, or any premium on, any 2022 Notes when due and payable;
we do not pay interest on any 2022 Notes when due and such default is not cured within 30 days;
we remain in breach of any other covenant with respect to the 2022 Notes for 60 days after we receive a written notice of default stating we
are in breach. The notice must be sent by either the Trustee or holders of at least 25% of the principal amount of the 2022 Notes;
we file for bankruptcy or certain other events of bankruptcy, insolvency or reorganization occur and in the case of certain orders or decrees
entered against us under bankruptcy law, such order or decree remains undischarged or unstayed for a period of 60 days; and
on the last business day of each of twenty-four consecutive calendar months, the 2022 Notes have the asset coverage, as defined in the 1940
Act, of less than 100% after giving effect to any exemptive relief granted to us by the SEC;
An Event of Default for the 2022 Notes does not necessarily constitute an Event of Default for any other series of debt securities issued under the same or any
other indenture. The Trustee may withhold notice to the holders of the 2022 Notes of any default, except in the payment of principal or interest, if it in good
faith considers the withholding of notice to be in the best interests of the holders.
Remedies if an Event of Default Occurs
If an Event of Default has occurred and is continuing, the Trustee or the holders of not less than 25% in principal amount of the 2022 Notes may declare the
entire principal amount of all the 2022 Notes to be due and immediately payable. This is called a declaration of acceleration of maturity. In certain
circumstances, a declaration of acceleration of maturity may be canceled by the holders of a majority in principal amount of the 2022 Notes if (1) we have
deposited with the Trustee all amounts due and owing with respect to the 2022 Notes (other than principal that has become due solely by reason of such
acceleration) and certain other amounts, and (2) any other Events of Default have been cured or waived.
The Trustee is not required to take any action under the 2022 Notes Indenture at the request of any holders unless the holders offer the Trustee protection from
expenses and liability reasonably satisfactory to it (called an “indemnity”). If indemnity reasonably satisfactory to the Trustee is provided, the holders of a
majority in principal amount of the 2022 Notes may direct the time, method and place of conducting any lawsuit or other formal legal action seeking any
remedy available to the Trustee. The Trustee may refuse to follow those directions in certain circumstances. No delay or omission in exercising any right or
remedy will be treated as a waiver of that right, remedy or Event of Default.
Before a holder is allowed to bypass the Trustee and bring its own lawsuit or other formal legal action or take other steps to enforce its rights or protect its
interests relating to the 2022 Notes, the following must occur:
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it must give the Trustee written notice that an Event of Default has occurred and remains uncured;
the holders of at least 25% in principal amount of all the 2022 Notes must make a written request that the Trustee take action because of the
default and must offer the Trustee indemnity, security, or both reasonably satisfactory to it the Trustee against the cost, expenses, and other
liabilities of taking that action;
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the Trustee must not have taken action for 60 days after receipt of the above notice and offer of indemnity and/or security; and
the holders of a majority in principal amount of the 2022 Notes must not have given the Trustee a direction inconsistent with the above
notice during that 60-day period.
However, a holder is entitled at any time to bring a lawsuit for the payment of money due on its 2022 Notes on or after the due date.
Book-entry and other indirect holders should consult their banks or brokers for information on how to give notice or direction to or make a request
of the Trustee and how to declare or cancel an acceleration of maturity.
Each year, we will furnish to the Trustee a written statement of certain of our officers certifying that to their knowledge we are in compliance with the 2022
Notes Indenture and the 2022 Notes, or else specifying any default.
Waiver of Default
The holders of a majority in principal amount of the 2022 Notes may waive any past defaults other than a default than:
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in the payment of principal or interest; or
in respect of a covenant that cannot be modified or amended without the consent of each holder.
Merger or Consolidation
Under the terms of the 2022 Notes Indenture, we are generally permitted to consolidate or merge with another entity. We are also permitted to sell all or
substantially all of our assets to another entity. However, we may not take any of these actions unless all the following conditions are met:
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where we merge out of existence or convey or transfer our assets substantially as an entirety, the resulting entity must agree to be legally
responsible for our obligations under the 2022 Notes;
the merger or sale of assets must not cause a default on the 2022 Notes and we must not already be in default (unless the merger or sale
would cure the default). For purposes of this no-default test, a default would include an Event of Default that has occurred and has not been
cured, as described under “Events of Default” above. A default for this purpose would also include any event that would be an Event of
Default if the requirements for giving us a notice of default or our default having to exist for a specific period of time were disregarded;
we must deliver certain certificates and documents to the Trustee; and
Modification or Waiver
There are three types of changes we can make to the 2022 Notes Indenture and the 2022 Notes issued thereunder.
Changes Requiring Approval
First, there are changes that we cannot make to the 2022 Notes without specific approval. The following is a list of those types of changes:
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change the stated maturity of the principal of or interest on the 2022 Notes;
reduce any amounts due on the 2022 Notes;
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reduce the amount of principal payable upon acceleration of the maturity of a 2022 Note following a default;
change the place or currency of payment on a Note;
impair the right to sue for payment;
reduce the percentage of holders of 2022 Notes whose consent is needed to modify or amend the 2022 Notes Indenture; and
reduce the percentage of holders of 2022 Notes whose consent is needed to waive compliance with certain provisions of the 2022 Notes
Indenture or to waive certain defaults.
Changes Not Requiring Approval
The second type of change does not require any vote by the holders of the 2022 Notes. This type is limited to clarifications and certain other changes that
would not adversely affect holders of the 2022 Notes in any material respect.
Changes Requiring Majority Approval
Any other change to the 2022 Notes Indenture and the 2022 Notes would require the following approval:
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if the change affects only the 2022 Notes, it must be approved by the holders of a majority in principal amount of the 2022 Notes; and
if the change affects more than one series of debt securities issued under the same 2022 Notes Indenture, it must be approved by the holders
of a majority in principal amount of all of the series affected by the change, with all affected series voting together as one class for this
purpose.
In each case, the required approval must be given by written consent.
The holders of a majority in principal amount of all of the series of debt securities issued under the 2022 Notes Indenture, voting together as one class for this
purpose, may waive our compliance with some of our covenants in the 2022 Notes Indenture. However, we cannot obtain a waiver of a payment default or of
any of the matters covered by the bullet points included above under “— Changes Requiring Approval.”
Further Details Concerning Voting
When taking a vote, we will use the following rules to decide how much principal to attribute to the 2022 Notes:
The 2022 Notes will not be considered outstanding, and therefore not eligible to vote, if we have deposited or set aside in trust money for their payment or
redemption. The 2022 Notes will also not be eligible to vote if they have been fully defeased as described later under “— Defeasance — Full Defeasance.”
We will generally be entitled to set any day as a record date for the purpose of determining the holders of the 2022 Notes that are entitled to vote or take other
action under the 2022 Notes Indenture. However, the record date may not be more than 30 days before the date of the first solicitation of holders to vote on or
take such action. If we set a record date for a vote or other action to be taken by holders of the 2022 Notes, that vote or action may be taken only by persons
who are holders of the 2022 Notes on the record date and must be taken within eleven months following the record date.
Book-entry and other indirect holders should consult their banks or brokers for information on how approval may be granted or denied if we seek to
change the 2022 Notes Indenture or the 2022 Notes or request a waiver.
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Defeasance
The following defeasance provisions will be applicable to the 2022 Notes. “Defeasance” means that, by depositing with a trustee an amount of cash and/or
government securities sufficient to pay all principal and interest, if any, on the 2022 Notes when due and satisfying any additional conditions noted below, we
will be deemed to have been discharged from our obligations under the 2022 Notes. In the event of a “covenant defeasance,” upon depositing such funds and
satisfying similar conditions discussed below we would be released from certain of the restrictive covenants under the 2022 Notes Indenture relating to the
2022 Notes. The consequences to the holders of the 2022 Notes is that, while they no longer benefit from those restrictive covenants under the 2022 Notes
Indenture, and while the 2022 Notes may not be accelerated for any reason, the holders of 2022 Notes nonetheless are guaranteed to receive the principal and
interest owed to them.
Covenant Defeasance
Under current U.S. federal tax law and the 2022 Notes Indenture, we can make the deposit described below and be released from some of the restrictive
covenants in the 2022 Notes Indenture under which the 2022 Notes were issued. This is called “covenant defeasance.” In that event, a holder would lose the
protection of those restrictive covenants but would gain the protection of having money and government securities set aside in trust to repay the 2022 Notes.
In order to achieve covenant defeasance, we must do the following:
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Since the 2022 Notes are denominated in U.S. dollars, we must deposit in trust for the benefit of all holders of the 2022 Notes a
combination of cash and U.S. government or U.S. government agency notes or bonds that will generate enough cash to make interest,
principal and any other payments on the 2022 Notes on their various due dates;
we must deliver to the trustee a legal opinion of our counsel confirming that, under current U.S. federal income tax law, we may make the
above deposit without causing a holder to be taxed on the 2022 Notes any differently than if we did not make the deposit;
we must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the 1940
Act, and a legal opinion and officers’ certificate stating that all conditions precedent to covenant defeasance have been complied with;
defeasance must not result in a breach or violation of, or result in a default under, the 2022 Notes Indenture or any of our other material
agreements or instruments; and
no default or event of default with respect to the 2022 Notes shall have occurred and be continuing and no defaults or events of default
related to bankruptcy, insolvency or reorganization shall occur during the next 90 days.
If we accomplish covenant defeasance, a holder can still look to us for repayment of the 2022 Notes if there were a shortfall in the trust deposit or the trustee
is prevented from making payment. In fact, if one of the remaining Events of Default occurred (such as our bankruptcy) and the 2022 Notes became
immediately due and payable, there might be a shortfall. Depending on the event causing the default, a holder may not be able to obtain payment of the
shortfall.
Full Defeasance
If there is a change in U.S. federal tax law, as described below, we can legally release ourselves from all payment and other obligations on the 2022 Notes
(called “full defeasance”) if we put in place the following other arrangements for a holder to be repaid:
•
Since the 2022 Notes are denominated in U.S. dollars, we must deposit in trust for the benefit of all holders of the 2022 Notes a
combination of money and U.S. government or U.S. government agency notes or bonds that will generate enough cash to make interest,
principal and any other payments on the 2022 Notes on their various due dates;
- 12 -
•
•
•
•
we must deliver to the trustee a legal opinion confirming that there has been a change in current U.S. federal tax law or a U.S. Internal
Revenue Service ruling that allows us to make the above deposit without causing a holder to be taxed on the 2022 Notes any differently
than if we did not make the deposit. Under current U.S. federal tax law the deposit and our legal release from the 2022 Notes would be
treated as though we paid the appropriate share of the cash and notes or bonds at the time the cash and notes or bonds were deposited in
trust in exchange for the 2022 Notes and a holder would recognize gain or loss on the 2022 Notes at the time of the deposit;
we must deliver to the trustee a legal opinion of our counsel stating that the above deposit does not require registration by us under the 1940
Act, and a legal opinion and officers’ certificate stating that all conditions precedent to defeasance have been complied with;
defeasance must not result in a breach or violation of, or constitute a default under, of the 2022 Notes Indenture or any of our other material
agreements or instruments; and
no default or event of default with respect to the 2022 Notes shall have occurred and be continuing and no defaults or events of default
related to bankruptcy, insolvency or reorganization shall occur during the next 90 days.
If we ever did accomplish full defeasance, as described above, a holder would have to rely solely on the trust deposit for repayment of the 2022 Notes. A
holder could not look to us for repayment in the unlikely event of any shortfall. Conversely, the trust deposit would most likely be protected from claims of
our lenders and other creditors if we ever became bankrupt or insolvent.
Form, Exchange and Transfer of Certificated Registered Securities
If registered 2022 Notes cease to be issued in book-entry form, they will be issued:
•
•
•
only in fully registered certificated form;
without interest coupons; and
unless we indicate otherwise, in denominations of $25 and amounts that are multiples of $25.
Holders may exchange their certificated securities for 2022 Notes of smaller denominations or combined into fewer 2022 Notes of larger denominations, as
long as the total principal amount is not changed and as long as the denomination is equal to or greater than $25.
Holders may exchange or transfer their certificated securities at the office of the trustee. We have appointed the trustee to act as our agent for registering 2022
Notes in the names of holders transferring 2022 Notes. We may appoint another entity to perform these functions or perform them ourselves.
Holders will not be required to pay a service charge to transfer or exchange their certificated securities, but they may be required to pay any tax or other
governmental charge associated with the transfer or exchange. The transfer or exchange will be made only if our transfer agent is satisfied with the holder’s
proof of legal ownership.
We may appoint additional transfer agents or cancel the appointment of any particular transfer agent. We may also approve a change in the office through
which any transfer agent acts.
If we redeem any of the 2022 Notes, we may block the transfer or exchange of those 2022 Notes selected for redemption during the period beginning 15 days
before the day we mail the notice of redemption and ending on the day of that mailing, in order to freeze the list of holders to prepare the mailing. We may
also refuse to register transfers or exchanges of any certificated 2022 Notes selected for redemption, except that we will continue to permit transfers and
exchanges of the unredeemed portion of any 2022 Notes that will be partially redeemed.
- 13 -
If a registered Note is issued in book-entry form, only the depositary will be entitled to transfer and exchange the Note as described in this subsection, since it
will be the sole holder of the Note.
Resignation of Trustee
The trustee may resign or be removed with respect to the 2022 Notes provided that a successor trustee is appointed to act with respect to the 2022 Notes. In
the event that two or more persons are acting as trustee with respect to different series of indenture securities under the 2022 Notes Indenture, each of the
trustees will be a trustee of a trust separate and apart from the trust administered by any other trustee.
Indenture Provisions — Subordination
Upon any distribution of our assets upon our dissolution, winding up, liquidation or reorganization, the payment of the principal of (and premium, if any) and
interest, if any, on any indenture securities denominated as subordinated debt securities is to be subordinated to the extent provided in the indenture in right of
payment to the prior payment in full of all Senior Indebtedness (as defined below), but our obligation to a holder to make payment of the principal of (and
premium, if any) and interest, if any, on such subordinated debt securities will not otherwise be affected. In addition, no payment on account of principal (or
premium, if any), sinking fund or interest, if any, may be made on such subordinated debt securities at any time unless full payment of all amounts due in
respect of the principal (and premium, if any), sinking fund and interest on Senior Indebtedness has been made or duly provided for in money or money’s
worth.
In the event that, notwithstanding the foregoing, any payment by us is received by the trustee in respect of subordinated debt securities or by the holders of
any of such subordinated debt securities, upon our dissolution, winding up, liquidation or reorganization before all Senior Indebtedness is paid in full, the
payment or distribution received by the trustee in respect of such subordinated debt securities or by the holders of any of such subordinated debt securities
must be paid over to the holders of the Senior Indebtedness or on their behalf for application to the payment of all the Senior Indebtedness remaining unpaid
until all the Senior Indebtedness has been paid in full, after giving effect to any concurrent payment or distribution to the holders of the Senior Indebtedness.
Subject to the payment in full of all Senior Indebtedness upon this distribution by us, the holders of such subordinated debt securities will be subrogated to the
rights of the holders of the Senior Indebtedness to the extent of payments made to the holders of the Senior Indebtedness out of the distributive share of such
subordinated debt securities.
By reason of this subordination, in the event of a distribution of our assets upon our insolvency, certain of our senior creditors may recover more, ratably, than
holders of any subordinated debt securities or the holders of any indenture securities that are not Senior Indebtedness. The indenture provides that these
subordination provisions will not apply to money and securities held in trust under the defeasance provisions of the indenture.
Senior Indebtedness is defined in the indenture as the principal of (and premium, if any) and unpaid interest on:
•
•
our indebtedness (including indebtedness of others guaranteed by us), whenever created, incurred, assumed or guaranteed, for money
borrowed, that we have designated as “Senior Indebtedness” for purposes of the indenture and in accordance with the terms of the indenture
(including any indenture securities designated as Senior Indebtedness), and
renewals, extensions, modifications and refinancings of any of this indebtedness.
If this prospectus is being delivered in connection with the offering of a series of indenture securities denominated as subordinated debt securities, the
accompanying prospectus supplement will set forth the approximate amount of our Senior Indebtedness and of our other Indebtedness outstanding as of a
recent date.
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C.
Debt Securities –5.75% Convertible Notes due 2022
On May 26, 2017, we issued $50.0 million in aggregate principal amount of 5.75% fixed-rate convertible notes due on May 31, 2022 (the “2022 Convertible
Notes”). On June 26, 2017, we issued an additional $2.1 million in aggregate principal amount of the 2022 Convertible Notes pursuant to a partial exercise of
the underwriters’ overallotment option. Interest is payable quarterly. The 2022 Convertible Notes are listed on the NASDAQ Capital Market under the trading
symbol “CPTAG” with a par value $25.00 per share.
The 2022 Convertible Notes were issued under the Base Indenture, as supplemented by the third supplemental indenture dated as of May 26, 2017 (the “Third
Supplemental Indenture” and, together the Base Indenture, the “2022 Convertible Notes Indenture”), between the Company and the Trustee.
The 2022 Convertible Notes Indenture provides that the 2022 Convertible Notes may be issued thereunder from time to time in one or more series. The 2022
Convertible Notes Indenture and the 2022 Convertible Notes are governed by, and construed in accordance with, the laws of the State of New York. The 2022
Convertible Notes Indenture does not limit the amount of 2022 Convertible Notes that we may issue under the 2022 Convertible Notes Indenture. We may,
without the consent of the holders of the debt securities of any series, issue additional debt securities ranking equally with, and otherwise similar in all
respects to, the debt securities of the series so that those additional debt securities will be consolidated and form a single series with the debt securities of the
series previously offered and sold.
The Convertible 2022 Notes are the Company’s direct unsecured obligations and rank:
•
•
•
•
pari passu in right of payment with the Company’s future unsecured unsubordinated indebtedness, including the 2022 Notes;
senior to any of the Company’s future indebtedness that expressly states it is subordinated in right of payment to the 2022 Notes,
effectively subordinated in right of payment to all of the Company’s existing and future secured indebtedness (including indebtedness that is
initially unsecured, but to which the Company subsequently grant security) to the extent of the value of the assets securing such
indebtedness; and
structurally subordinated to all existing and future indebtedness and other obligations of any of the Company’s subsidiaries, financing
vehicles, or similar facilities.
As required by federal law for all bonds and notes of companies that are publicly offered in the United States, the debt securities are governed by a document
called an “indenture.” An indenture is a contract between us and a financial institution acting as trustee on a holder’s behalf, and is subject to and governed by
the Trust Indenture Act of 1939, as amended. The Trustee with respect to the 2022 Convertible Notes has two main roles. First, the Trustee can enforce a
holder’s rights against us if we default under the 2022 Convertible Notes. There are some limitations on the extent to which the Trustee acts on a holder’s
behalf, see “Events of Default” for more information. Second, the Trustee performs certain administrative duties for us, such as sending interest and principal
payments to holders of the 2022 Convertible Notes.
General
For purposes of this description, any reference to the payment of principal of, or premium or interest, if any, on, the 2022 Convertible Notes will include
additional amounts if required by the terms of the 2022 Convertible Notes.
- 15 -
The 2022 Convertible Notes Indenture does not limit the amount of debt securities that may be issued thereunder from time to time. Debt securities issued
under the 2022 Convertible Notes Indenture, when a single trustee is acting for all debt securities issued thereunder, are called the “indenture securities.” The
2022 Convertible Notes also provides that there may be more than one trustee thereunder, each with respect to one or more different series of indenture
securities. At a time when two or more trustees are acting under the 2022 Convertible Notes Indenture, each with respect to only certain series, the term
“indenture securities” means the one or more series of debt securities with respect to which each respective trustee is acting. In the event that there is more
than one trustee under the 2022 Convertible Notes Indenture, the powers and trust obligations of each trustee described in this description will extend only to
the one or more series of indenture securities for which it is trustee. If two or more trustees are acting under the 2022 Convertible Notes Indenture, then the
indenture securities for which each trustee is acting would be treated as if issued under separate indentures.
The 2022 Convertible Notes Indenture does not contain any provisions that give a holder protection in the event we issue a large amount of debt or we are
acquired by another entity.
Cancellation and Repurchase
We will cause all 2022 Convertible Notes surrendered for payment, registration of transfer or exchange or conversion, if surrendered to any person other than
the Trustee (including any of our agents, subsidiaries or affiliates), to be delivered to the Trustee for cancellation. All 2022 Convertible Notes delivered to the
Trustee will be cancelled by the Trustee in accordance with its customary procedures. No 2022 Convertible Notes will be authenticated in exchange for any
2022 Convertible Notes cancelled as provided in the indenture. Any 2022 Convertible Notes surrendered for cancellation may not be reissued or resold and
will be promptly cancelled.
We may, to the extent permitted by law, and directly or indirectly (regardless of whether such 2022 Convertible Notes are surrendered to us), repurchase the
2022 Convertible Notes in the open market or otherwise, whether by us or our subsidiaries or through a private or public tender or exchange offer or through
counterparties to private agreements, including by cash-settled swaps or other derivatives. Any 2022 Convertible Notes repurchased by us may, at our option,
be surrendered to the Trustee for cancellation.
Payments on the 2022 Convertible Notes; Paying Agent and Registrar; Transfer and Exchange
We will pay the principal of, and interest on, the 2022 Convertible Notes in global form registered in the name of or held by DTC or its nominee in
immediately available funds to DTC or its nominee, as the case may be, as the registered holder of such global note.
We will pay the principal of any certificated 2022 Convertible Notes at the office or agency designated by us for that purpose. We have initially designated the
Trustee as our paying agent and registrar and its agency in New York, New York as a place where 2022 Convertible Notes may be presented for payment or
for registration of transfer. We may, however, change the paying agent or registrar without prior notice to the holders of the 2022 Convertible Notes, and we
may act as paying agent or registrar. Interest on certificated 2022 Convertible Notes will be payable (i) to holders having an aggregate principal amount of
$5,000,000 or less, by check mailed to the holders of these 2022 Convertible Notes and (ii) to holders having an aggregate principal amount of more than
$5,000,000, either by check mailed to each holder or, upon application by a holder to the registrar not later than the relevant regular record date (as defined
below), by wire transfer in immediately available funds to that holder’s account within the United States, which application will remain in effect until the
holder notifies, in writing, the registrar to the contrary.
A holder of 2022 Convertible Notes may transfer or exchange 2022 Convertible Notes at the office of the registrar in accordance with the 2022 Convertible
Notes Indenture and the applicable procedures of DTC. The registrar and the Trustee may require a holder, among other things, to furnish appropriate
endorsements and transfer documents. No service charge will be imposed by us, the Trustee or the registrar for any registration of transfer or exchange of
2022 Convertible Notes, but we may require a holder to pay a sum sufficient to cover any transfer tax or other similar governmental charge required by law or
permitted by the indenture. We are not required to transfer or exchange any Note surrendered for conversion or required repurchase.
The registered holder of a Note will be treated as its owner for all purposes.
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Conversion Rights
General
Holders may convert their 2022 Convertible Notes at the conversion rate at any time prior to the close of business on the scheduled trading day immediately
preceding the maturity date. The conversion rate is initially 1.5913 shares of our common stock per $25.00 principal amount of 2022 Convertible Notes
(equivalent to an initial conversion price of approximately $15.71 per share of our common stock). The conversion rate is subject to adjustment as described
below. The Trustee will initially act as the conversion agent, but any shares of our common stock issuable upon conversion will be issued by us directly to the
relevant converting holder in accordance with the indenture.
A holder may convert fewer than all of such holder’s 2022 Convertible Notes so long as the 2022 Convertible Notes converted are a multiple of $25.00
principal amount.
If a holder of 2022 Convertible Notes has submitted 2022 Convertible Notes for repurchase upon a fundamental change, the holder may convert those 2022
Convertible Notes only if that holder first withdraws its repurchase notice.
Upon conversion, a holder will not receive any cash payment for accrued and unpaid interest, if any, except as described below. We will not issue fractional
shares of our common stock upon conversion of 2022 Convertible Notes. Instead we will pay cash in lieu of any fractional share based on the last reported
sale price of our common stock on the conversion date. Our payment and delivery to a holder of shares of our common stock (and any cash in lieu of
fractional shares) into which a 2022 Convertible Note is convertible will be deemed to satisfy in full our obligation to pay:
•
•
the principal amount of the note; and
accrued and unpaid interest, if any, to, but not including, the conversion date.
As a result, accrued and unpaid interest, if any, to, but not including, the conversion date will be deemed to be paid in full rather than cancelled, extinguished
or forfeited.
Notwithstanding the immediately preceding paragraph, if 2022 Convertible Notes are converted after the close of business on a regular record date for the
payment of interest, holders of such 2022 Convertible Notes at the close of business on such regular record date will receive the full amount of interest
payable on such 2022 Convertible Notes on the corresponding interest payment date notwithstanding the conversion. 2022 Convertible Notes surrendered for
conversion during the period from the close of business on any regular record date to 9:00 a.m. New York City time (the “open of business”) on the
immediately following interest payment date must be accompanied by funds equal to the amount of interest payable on the 2022 Convertible Notes so
converted; provided that no such payment need be made:
•
•
•
for conversions following the regular record date immediately preceding the maturity date;
if we have specified a fundamental change repurchase date that is after a regular record date and on or prior to the corresponding interest
payment date; or
to the extent of any overdue interest, if any overdue interest exists at the time of conversion with respect to such note.
If a holder converts 2022 Convertible Notes, we will pay any documentary, stamp or similar issue or transfer tax due on the issue of shares of our common
stock upon the conversion, unless the tax is due because the holder requests any shares to be issued in a name other than the holder’s name, in which case the
holder will pay that tax.
- 17 -
Conversion Procedures
If a holder holds a beneficial interest in a global note, to convert, it must comply with DTC’s procedures for converting a beneficial interest in a global note
and, if required, pay funds equal to interest payable on the next interest payment date to which such holder is not entitled and, if required, pay all taxes or
duties, if any.
If a holder hold a certificated note, to convert it must:
•
•
•
•
complete and manually sign the conversion notice on the back of the note, or a facsimile of the conversion notice;
deliver the conversion notice, which is irrevocable, and the note to the conversion agent;
if required, furnish appropriate endorsements and transfer documents and, if required, pay all taxes or duties, if any; and
if required, pay funds equal to interest payable on the next interest payment date.
We refer to the date a holder complies with the relevant procedures for conversion described above as the “conversion date.”
If a holder has already delivered a repurchase notice as described under “— Fundamental Change Permits Holders to Require Us to Repurchase 2022
Convertible Notes” with respect to a 2022 Convertible Note, the holder may not surrender that 2022 Convertible Note for conversion until the holder has
withdrawn the repurchase notice in accordance with the relevant provisions of the 2022 Convertible Note Indenture. If a holder submits its 2022 Convertible
Notes for required repurchase, the holder’s right to withdraw the repurchase notice and convert the 2022 Convertible Notes that are subject to repurchase will
terminate at the close of business on the business day immediately preceding the relevant fundamental change repurchase date.
Limitation on Beneficial Ownership
Notwithstanding the foregoing, no holder of 2022 Convertible Notes is entitled to receive shares of our common stock upon conversion to the extent (but only
to the extent) that such receipt would cause such converting holder to become, directly or indirectly, a “beneficial owner” (within the meaning of Section
13(d) of the Exchange Act and the rules and regulations promulgated thereunder) of more than 5.0% of the shares of our common stock outstanding at such
time (the “limitation”). Any purported delivery of shares of our common stock upon conversion of 2022 Convertible Notes will be void and have no effect to
the extent (but only to the extent) that such delivery would result in the converting holder becoming the beneficial owner of more than the limitation. If any
delivery of shares of our common stock owed to a holder upon conversion of 2022 Convertible Notes is not made, in whole or in part, as a result of the
limitation, our obligation to make such delivery will not be extinguished and we will deliver such shares as promptly as practicable after any such converting
holder gives notice to us that such delivery would not result in it being the beneficial owner of more than 5.0% of the shares of common stock outstanding at
such time. The limitation will no longer apply following the effective date of any fundamental change, as defined in “— Fundamental Change Permits
Holders to Require Us to Repurchase 2022 Convertible Notes.”
Settlement Upon Conversion
We will deliver to the converting holder in respect of each $25.00 principal amount of 2022 Convertible Notes being converted a number of shares of
common stock equal to the conversion rate (plus cash in lieu of fractional shares).
Except as described under “— Adjustment to Shares Delivered Upon Conversion Upon a Make-Whole Fundamental Change” and “— Recapitalizations,
Reclassifications and Changes of Our Common Stock,” we will deliver the consideration due in respect of conversion on the third business day immediately
following the relevant conversion date.
- 18 -
Each conversion will be deemed to have been effected as to any 2022 Convertible Notes surrendered for conversion on the conversion date. The person in
whose name any shares of our common stock will be issuable upon such conversion will become the holder of record of such shares as of the close of
business on the conversion date solely for the purpose of receiving or participating in any dividend, distribution, issuance, share split or combination, tender
or exchange offer or any other event that would lead to a conversion rate adjustment as described under “— Conversion Rate Adjustments” below.
Conversion Rate Adjustments
The conversion rate will be adjusted as described below, except that we will not make any adjustments to the conversion rate if holders of the 2022
Convertible Notes participate (other than in the case of a share split or share combination), at the same time and upon the same terms as holders of our
common stock and solely as a result of holding the 2022 Convertible Notes, in any of the transactions described below without having to convert their 2022
Convertible Notes as if they held a number of shares of common stock equal to the conversion rate, multiplied by the principal amount of 2022 Convertible
Notes held by such holder.
(1)
If we exclusively issue shares of our common stock as a dividend or distribution on shares of our common stock, or if we effect a share split
or share combination, the conversion rate will be adjusted based on the following formula:
CR1 = CR0 ×
OS1
OS0
where,
CR0 = the conversion rate in effect immediately prior to the open of business on the ex-dividend date of such dividend or distribution, or
immediately prior to the effectiveness of such share split or combination, as applicable;
CR1 = the conversion rate in effect immediately after the open of business on such ex-dividend date or immediately after such effectiveness;
OS0 = the number of shares of our common stock outstanding immediately prior to the open of business on such ex-dividend date or immediately
prior to such effectiveness; and
OS1 = the number of shares of our common stock outstanding immediately after giving effect to such dividend, distribution, share split or share
combination.
Any adjustment made under this clause (1) will become effective immediately after the open of business on the ex-dividend date for such dividend or
distribution, or immediately after the effectiveness of such share split or share combination, as applicable. If any dividend or distribution of the type
described in this clause (1) is declared but not so paid or made, the conversion rate will be immediately readjusted, effective as of the date our board
of directors or a committee thereof determines not to pay such dividend or distribution, to the conversion rate that would then be in effect if such
dividend or distribution had not been declared.
(2)
If we issue to all or substantially all holders of our common stock any rights, options or warrants entitling them, for a period of not more
than 45 calendar days after the issuance date for such distribution, to subscribe for or purchase shares of our common stock at a price per
share that is less than the average of the last reported sale prices of our common stock for the 10 consecutive trading day period ending on,
and including, the trading day immediately preceding the date of announcement of such issuance, the conversion rate will be adjusted based
on the following formula:
- 19 -
CR1 = CR0 ×
OS0 + X
OS0 + Y
where,
CR0 = the conversion rate in effect immediately prior to the open of business on the ex-dividend date for such issuance;
CR1 = the conversion rate in effect immediately after the open of business on such ex-dividend date;
OS0 = the number of shares of our common stock outstanding immediately prior to the open of business on such ex-dividend date;
X = the total number of shares of our common stock issuable pursuant to such rights, options or warrants; and
Y = the number of shares of our common stock equal to the aggregate price payable to exercise such rights, options or warrants, divided by the
average of the last reported sale prices of our common stock over the 10 consecutive trading day period ending on, and including, the
trading day immediately preceding the date of announcement of the issuance of such rights, options or warrants.
Any increase made under this clause (2) will be made successively whenever any such rights, options or warrants are issued and will become
effective immediately after the open of business on the ex-dividend date for such issuance. To the extent that shares of common stock are not
delivered after the expiration of such rights, options or warrants, the conversion rate will be decreased to the conversion rate that would then be in
effect had the increase with respect to the issuance of such rights, options or warrants been made on the basis of delivery of only the number of
shares of common stock actually delivered. If such rights, options or warrants are not so issued, the conversion rate will be decreased to the
conversion rate that would then be in effect if such ex-dividend date for such issuance had not occurred.
For the purpose of this clause (2), in determining whether any rights, options or warrants entitle the holders to subscribe for or purchase shares of the
common stock at less than such average of the last reported sale prices for the 10 consecutive trading day period ending on, and including, the
trading day immediately preceding the date of announcement of such issuance, and in determining the aggregate offering price of such shares of
common stock, there will be taken into account any consideration received by us for such rights, options or warrants and any amount payable on
exercise or conversion thereof, the value of such consideration, if other than cash, to be determined by our board of directors or a committee thereof.
(3)
If we distribute shares of our capital stock, evidences of our indebtedness, other assets or property of ours or rights, options or warrants to
acquire our capital stock or other securities, to all or substantially all holders of our common stock, excluding:
•
•
•
dividends, distributions or issuances as to which an adjustment was effected pursuant to clause (1) or (2) above;
dividends or distributions paid exclusively in cash; and
spin-offs to which the provisions set forth below in this clause (3) will apply;
then the conversion rate will be adjusted based on the following formula:
CR1 = CR0 ×
SP0
SP0 - FMV
- 20 -
where,
CR0 = the conversion rate in effect immediately prior to the open of business on the ex-dividend date for such distribution;
CR1 = the conversion rate in effect immediately after the open of business on such ex-dividend date;
SP0 = the average of the last reported sale prices of our common stock over the 10 consecutive trading day period ending on, and including, the
trading day immediately preceding the ex-dividend date for such distribution; and
FMV = the fair market value (as determined by our board of directors or a committee thereof) of the shares of capital stock, evidences of
indebtedness, assets, property, rights, options or warrants distributed with respect to each outstanding share of our common stock on the ex-
dividend date for such distribution.
Any increase made under this clause (3) above will become effective immediately after the open of business on the ex-dividend date for such
distribution. If such distribution is not so paid or made, the conversion rate will be decreased to be the conversion rate that would then be in effect if
such dividend or distribution had not been declared. Notwithstanding the foregoing, if “FMV” (as defined above) is equal to or greater than “SP0”
(as defined above), in lieu of the foregoing increase, each holder of a Note will receive, in respect of each $25.00 principal amount thereof, at the
same time and upon the same terms as holders of our common stock, the amount and kind of our capital stock, evidences of our indebtedness, other
assets or property of ours or rights, options or warrants to acquire our capital stock or other securities that such holder would have received if such
holder owned a number of shares of common stock equal to the conversion rate in effect on the ex-dividend date for the distribution.
With respect to an adjustment pursuant to this clause (3) where there has been a payment of a dividend or other distribution on our common stock of
shares of capital stock of any class or series, or similar equity interest, of or relating to a subsidiary or other business unit, that are, or, when issued,
will be, listed or admitted for trading on a U.S. national securities exchange, which we refer to as a “spin-off,” the conversion rate will be adjusted
based on the following formula:
CR1 = CR0 ×
FMV + MP0
MP0
where,
CR0 = the conversion rate in effect immediately prior to the open of business on the ex-dividend date for the spin-off;
CR1 = the conversion rate in effect immediately after the open of business on the ex-dividend date for the spin-off;
FMV = the average of the last reported sale prices of the capital stock or similar equity interest distributed to holders of our common stock
applicable to one share of our common stock (determined by reference to the definition of “last reported sale price” set forth below as if
references therein to our common stock were to such capital stock or similar equity interest) over the first 10 consecutive trading day period
after, and including, the ex-dividend date of the spin-off (the “valuation period”); and
MP0 = the average of the last reported sale prices of our common stock over the valuation period.
The adjustment to the conversion rate under the preceding paragraph will occur on the last trading day of the valuation period but will be given effect
as of the open of business on the ex-dividend date for the spin-off; provided that in respect of any conversion during the valuation period, references
in the preceding paragraph with respect to 10 trading days shall be deemed to be replaced with such lesser number of trading days as have elapsed
between the ex-dividend date of such spin-off and the conversion date in determining the conversion rate.
- 21 -
(4)
If any cash dividend or distribution is made by us to all or substantially all holders of our common stock, other than a regular, monthly cash
dividend that does not exceed the DTA, the conversion rate will be adjusted based on the following formula:
where,
CR1 = CR0 ×
SP0 - DTA
SP0 - C
CR0 = the conversion rate in effect immediately prior to the open of business on the ex-dividend date for such dividend or distribution;
CR1 = the conversion rate in effect immediately after the open of business on the ex-dividend date for such dividend or distribution;
SP0 = the last reported sale price of our common stock on the trading day immediately preceding the ex-dividend date for such dividend or
distribution;
DTA = the dividend threshold amount, which will initially be equal to $0.13 per month; provided that if there is not an ex-dividend date for a
dividend in any month, the dividend threshold amount may be carried forward by the Company to the next subsequent month and to the
extent the aggregate amount of any dividends with an ex-dividend date in such subsequent month is less than $0.26 such difference may be
carried forward to the second subsequent month, subject to a maximum dividend threshold amount at any time of $0.39; and
C =
the amount in cash per share we distribute to holders of our common stock.
The initial dividend threshold amount (DTA) is subject to adjustment in a manner inversely proportional to adjustments to the conversion rate;
provided that no adjustment will be made to the dividend threshold amount (DTA) for any adjustment to the conversion rate under this clause (4). If
an adjustment is required to be made as set forth in this clause (4) as a result of a distribution that is not a regular monthly dividend, the dividend
threshold amount (DTA) will be deemed to be zero. Notwithstanding the foregoing, if at any time regular dividends are distributed other than on a
monthly basis, the dividend threshold amount (DTA) shall be appropriately adjusted as set forth in an Officers’ Certificate delivered to the Trustee
and shall apply to such regular dividends.
Any increase made under this clause (4) will become effective immediately after the open of business on the ex-dividend date for such dividend or
distribution. If such dividend or distribution is not so paid, the conversion rate will be decreased, effective as of the date our board of directors or a
committee thereof determines not to make or pay such dividend or distribution, to be the conversion rate that would then be in effect if such dividend
or distribution had not been declared. Notwithstanding the foregoing, if “C” (as defined above) is equal to or greater than “SP0” (as defined above),
in lieu of the foregoing increase, each holder of a Note will receive, for each $25.00 principal amount of 2022 Convertible Notes, at the same time
and upon the same terms as holders of shares of our common stock, the amount of cash that such holder would have received if such holder owned a
number of shares of our common stock equal to the conversion rate on the ex-dividend date for such cash dividend or distribution.
(5)
If we or any of our subsidiaries make a payment in respect of a tender or exchange offer for our common stock, to the extent that the cash
and value of any other consideration included in the payment per share of common stock exceeds the last reported sale price of our common
stock on the trading day next succeeding the last date on which tenders or exchanges may be made pursuant to such tender or exchange
offer, the conversion rate will be adjusted based on the following formula:
- 22 -
CR1 = CR0 × AC + (SP1 × OS1)
OS0 × SP1
where,
CR0 = the conversion rate in effect immediately prior to the open of business on the trading day immediately following the date such tender or
exchange offer expires;
CR1 = the conversion rate in effect immediately after the open of business on the trading day immediately following the date such tender or
exchange offer expires;
AC =
the aggregate value of all cash and any other consideration (as determined by our board of directors or a committee thereof) paid or payable
for shares purchased in such tender or exchange offer;
0S0 =
the number of shares of our common stock outstanding immediately prior to the date such tender or exchange offer expires (prior to giving
effect to the purchase of all shares accepted for purchase or exchange in such tender or exchange offer);
0S1 =
the number of shares of our common stock outstanding immediately after the date such tender or exchange offer expires (after giving effect
to the purchase of all shares accepted for purchase or exchange in such tender or exchange offer); and
SP1 =
the average of the last reported sale prices of our common stock over the 10 consecutive trading day period commencing on, and including,
the trading day next succeeding the date such tender or exchange offer expires.
The adjustment to the conversion rate under the preceding paragraph will occur at the close of business on the 10th trading day immediately following, and
including, the trading day next succeeding the date such tender or exchange offer expires but will be given effect as of the open of business on the trading day
next succeeding the date such tender or exchange offer expires; provided that in respect of any conversion within the 10 trading days immediately following,
and including, the expiration date of any tender or exchange offer, references with respect to 10 trading days shall be deemed replaced with such lesser
number of trading days as have elapsed between the expiration date of such tender or exchange offer and the conversion date in determining the conversion
rate.
Notwithstanding the foregoing, if a conversion rate adjustment becomes effective on any ex-dividend date as described above, and a holder that has converted
its 2022 Convertible Notes on or after such ex-dividend date and on or prior to the related record date would be treated as the record holder of shares of our
common stock as of the related conversion date as described under “— Settlement Upon Conversion” based on an adjusted conversion rate for such ex-
dividend date, then, notwithstanding the foregoing conversion rate adjustment provisions, the conversion rate adjustment relating to such ex-dividend date
will not be made for such converting holder. Instead, such holder will be treated as if such holder were the record owner of the shares of our common stock on
an unadjusted basis and participate in the related dividend, distribution or other event giving rise to such adjustment.
Except as stated herein, we will not adjust the conversion rate for the issuance of shares of our common stock or any securities convertible into or
exchangeable for shares of our common stock or the right to purchase shares of our common stock or such convertible or exchangeable securities.
As used in this section, “ex-dividend date” means the first date on which the shares of our common stock trade on the applicable exchange or in the applicable
market, regular way, without the right to receive the issuance, dividend or distribution in question, from us or, if applicable, from the seller of our common
stock on such exchange or market (in the form of due bills or otherwise) as determined by such exchange or market.
- 23 -
We are permitted to increase the conversion rate of the 2022 Convertible Notes by any amount for a period of at least 20 business days if our board of
directors or a committee thereof determines that such increase would be in our best interest. We may also (but are not required to) increase the conversion rate
to avoid or diminish income tax to holders of our common stock or rights to purchase shares of our common stock in connection with a dividend or
distribution of shares (or rights to acquire shares) or similar event. We will not take any action that would result in an adjustment of the conversion rate,
pursuant to the provisions described above, in such a manner as to result in the reduction of the conversion price to less than the par value per share of our
common stock.
A holder may, in some circumstances, including a distribution of cash dividends to holders of our shares of common stock, be deemed to have received a
distribution subject to U.S. federal income tax as a result of an adjustment or the nonoccurrence of an adjustment to the conversion rate.
To the extent that we have a rights plan in effect upon conversion of the 2022 Convertible Notes, a holder will receive, in addition to the shares of common
stock received in connection with such conversion, the rights under the rights plan, unless prior to any conversion, the rights have separated from the common
stock, in which case, and only in such case, the conversion rate will be adjusted at the time of separation as if we distributed to all holders of our common
stock, shares of our capital stock, evidences of indebtedness, assets, property, rights, options or warrants as described in clause (3) above, subject to
readjustment in the event of the expiration, termination or redemption of such rights.
Notwithstanding any of the foregoing, the conversion rate will not be adjusted:
•
•
•
•
•
upon the issuance of any shares of our common stock pursuant to any present or future plan providing for the reinvestment of dividends or
interest payable on our securities and the investment of additional optional amounts in shares of our common stock under any plan;
upon the issuance of any shares of our common stock or options or rights to purchase those shares pursuant to any present or future
employee, director or consultant benefit plan or program of or assumed by us or any of our subsidiaries;
upon the issuance of any shares of our common stock pursuant to any option, warrant, right or exercisable, exchangeable or convertible
security not described in the preceding bullet and outstanding as of the date the 2022 Convertible Notes were first issued;
solely for a change in the par value of the common stock or a change in our jurisdiction of incorporation; or
for accrued and unpaid interest, if any.
Adjustments to the conversion rate will be calculated to the nearest 1/10,000th of a share. We are no required to make an adjustment in the conversion rate
unless the adjustment would require a change of at least 1% in the conversion rate. However, we will carry forward any adjustments that are less than 1% of
the conversion rate and make such carried forward adjustment, regardless of whether the aggregate adjustment is less than 1%, on the conversion date for any
2022 Convertible Notes.
The “last reported sale price” of our common stock on any date means the closing sale price per share (or if no closing sale price is reported, the average of
the bid and ask prices or, if more than one in either case, the average of the average bid and the average ask prices) on that date as reported in composite
transactions for the principal U.S. national or regional securities exchange on which our common stock is traded. The last reported sale price will be
determined without reference to after-hours trading or extended market trading. If our common stock is not listed for trading on a U.S. national or regional
securities exchange on the relevant date, the “last reported sale price” will be the last quoted bid price for our common stock in the over-the-counter market
on the relevant date as reported by OTC Markets Group Inc. or a similar organization. If our common stock is not so quoted, the “last reported sale price” will
be the average of the mid-point of the last bid and ask prices for our common stock on the relevant date from each of at least three nationally recognized
independent investment banking firms selected by us for this purpose.
- 24 -
“Scheduled trading day” means a day that is scheduled to be a trading day on the principal U.S. national or regional securities exchange or market on which
our common stock is listed or admitted for trading. If our common stock is not so listed or admitted for trading, “scheduled trading day” means a “business
day.”
“Trading day” means a day on which (i) trading in our common stock generally occurs on The NASDAQ Global Select Market or, if our common stock is not
then listed on The NASDAQ Global Select Market, on the principal other U.S. national or regional securities exchange on which our common stock is then
listed or, if our common stock is not then listed on a U.S. national or regional securities exchange, on the principal other market on which our common stock
is then traded, and (ii) a last reported sale price for our common stock is available on such securities exchange or market. If our common stock is not so listed
or traded, “trading day” means a “business day.”
Recapitalizations, Reclassifications and Changes of Our Common Stock
In the case of:
•
•
•
•
any recapitalization, reclassification or change of our common stock (other than changes resulting from a subdivision or combination or a
change solely in par value),
any consolidation, merger or combination involving us,
any sale, lease or other transfer to a third party of all or substantially all of our and our subsidiaries’ consolidated assets, or
any statutory share exchange,
in each case, as a result of which our common stock would be converted into, or exchanged for, stock, other securities, other property or assets (including
cash or any combination thereof), then, at and after the effective time of the transaction, the right to convert each $25.00 principal amount of 2022
Convertible Notes will be changed into a right to convert such principal amount of 2022 Convertible Notes into the kind and amount of shares of stock, other
securities or other property or assets (including cash or any combination thereof) that a holder of a number of shares of common stock equal to the conversion
rate immediately prior to such transaction would have owned or been entitled to receive (the “reference property”) upon such transaction. However, at and
after the effective time of the transaction, any shares of our common stock that we would have been required to deliver upon conversion of the 2022
Convertible Notes will instead be deliverable in the amount and type of reference property that a holder of that number of shares of our common stock would
have received in such transaction. If the transaction causes our common stock to be converted into the right to receive more than a single type of consideration
(determined based in part upon any form of stockholder election), the reference property into which the 2022 Convertible Notes will become convertible will
be deemed to be the kind and amount of consideration elected to be received by a majority of our common stock voted for such an election (if electing
between two types of consideration) or a plurality of our common stock voted for such an election (if electing between more than two types of consideration),
as the case may be. If the holders receive only cash in such transaction, then for all conversions that occur after the effective date of such transaction (i) the
consideration due upon conversion of each $25.00 principal amount of 2022 Convertible Notes shall be solely cash in an amount equal to the conversion rate
in effect on the conversion date (as may be increased by any additional shares as described under “— Adjustment to Shares Due Upon Conversion Upon a
Make-Whole Fundamental Change”), multiplied by the price paid per share of common stock in such transaction and (ii) we will satisfy our conversion
obligation by paying cash to converting holders on the third business day immediately following the relevant conversion date. We are not permitted to
become a party to any such transaction unless its terms are consistent with the foregoing in all material respects.
In connection with any adjustment to the conversion rate described above, we will also adjust the initial dividend threshold (as defined under “— Conversion
Rate Adjustments”) based on the relative value of shares of common stock comprising the reference property as compared to the value of any non-stock
consideration comprising the reference property. If the reference property is composed solely of non-stock consideration, the initial dividend threshold will be
zero.
- 25 -
Adjustments of Prices
Whenever any provision of the 2022 Convertible Notes Indenture requires us to calculate the last reported sale prices over a span of multiple days (including
the “stock price” (as defined below) for purposes of a make-whole fundamental change), our board of directors or a committee thereof will make appropriate
adjustments to each to account for any adjustment to the conversion rate that becomes effective, or any event requiring an adjustment to the conversion rate
where the ex-dividend date of the event occurs, at any time during the period when the last reported sale prices are to be calculated.
Adjustment to Shares Delivered Upon Conversion Upon a Make-Whole Fundamental Change
If a “fundamental change” as defined in clauses (1), (2) or (4) below and determined after giving effect to any exceptions to or exclusions from such
definition, but without regard to the proviso in clause (2) of the definition thereof (a “make-whole fundamental change”) occurs and a holder elects to convert
its 2022 Convertible Notes in connection with such make-whole fundamental change, we will, under certain circumstances, increase the conversion rate for
the 2022 Convertible Notes so surrendered for conversion by a number of additional shares of common stock (the “additional shares”), as described below. A
conversion of 2022 Convertible Notes will be deemed for these purposes to be “in connection with” such make-whole fundamental change if the notice of
conversion of the 2022 Convertible Notes is received by the conversion agent from, and including, the effective date of the make-whole fundamental change
up to, and including, the business day immediately prior to the related fundamental change repurchase date (or, in the case of a make-whole fundamental
change that would have been a fundamental change but for the proviso in clause (2) of the definition thereof, the 35th calendar day immediately following the
effective date of such make-whole fundamental change).
We will notify holders of the effective date of any make-whole fundamental change and issue a press release announcing such effective date no later than five
business days after such effective date.
The number of additional shares, if any, by which the conversion rate will be increased will be determined by reference to the table below, based on the date
on which the make-whole fundamental change occurs or becomes effective (the “effective date”) and the price (the “stock price”) paid (or deemed to be paid)
per share of our common stock in the make-whole fundamental change. If the holders of our common stock receive only cash in a make-whole fundamental
change described in clause (2) of the definition of fundamental change, the stock price will be the cash amount paid per share. Otherwise, the stock price will
be the average of the last reported sale prices of our common stock over the five trading day period ending on, and including, the trading day immediately
preceding the effective date of the make-whole fundamental change.
The stock prices set forth in the column headings of the table below will be adjusted as of any date on which the conversion rate of the 2022 Convertible
Notes is otherwise adjusted. The adjusted stock prices will equal the stock prices immediately prior to such adjustment, multiplied by a fraction, the
numerator of which is the conversion rate immediately prior to the adjustment giving rise to the stock price adjustment and the denominator of which is the
conversion rate as so adjusted. The number of additional shares will be adjusted in the same manner and at the same time as the conversion rate as set forth
under “— Conversion Rate Adjustments.”
The following table sets forth the number of additional shares to be received per $25.00 principal amount of 2022 Convertible Notes for each stock price and
effective date set forth below:
Effective Stock Price
Effective Date
$13.78
$14.00
$14.50
$15.00
$15.50
$15.71
$16.00
$16.50
$17.00
$17.50
$18.00
$18.50
May 26, 2017
0.2228
0.2040
0.1647
0.1303
0.1003
0.0890
0.0747
0.0532
0.0355
0.0216
0.0113
0.0046
May 31, 2018
0.2228
0.2040
0.1647
0.1303
0.1003
0.0890
0.0747
0.0532
0.0355
0.0216
0.0113
0.0046
May 31, 2019
0.2228
0.2040
0.1647
0.1303
0.1003
0.0890
0.0747
0.0526
0.0347
0.0210
0.0111
0.0046
May 31, 2020
0.2228
0.2040
0.1647
0.1303
0.0981
0.0859
0.0706
0.0483
0.0308
0.0177
0.0088
0.0035
May 31, 2021
0.2228
0.2040
0.1605
0.1194
0.0852
0.0729
0.0577
0.363
0.0207
0.0101
0.0040
0.0013
May 31, 2022
0.2228
0.1934
0.1327
0.0753
0.0215
0.0000
0.0000
0.0000
0.0000
0.0000
0.0000
0.0000
- 26 -
The exact stock prices and effective dates may not be set forth in the table above, in which case
•
•
•
If the stock price is between two stock prices in the table or the effective date is between two effective dates in the table, the number of
additional shares will be determined by a straight-line interpolation between the number of additional shares set forth for the higher and
lower stock prices and the earlier and later effective dates, as applicable, based on a 365-day year.
If the stock price is greater than $18.50 per share (subject to adjustment in the same manner as the stock prices set forth in the column
headings of the table above), no additional shares will be added to the conversion rate.
If the stock price is less than $13.78 per share (subject to adjustment in the same manner as the stock prices set forth in the column headings
of the table above), no additional shares will be added to the conversion rate.
Notwithstanding the foregoing, in no event will the conversion rate per $25.00 principal amount of 2022 Convertible Notes exceed 1.8142, subject to
adjustment in the same manner as the conversion rate as set forth under “— Conversion Rate Adjustments.”
Our obligation to satisfy the additional shares requirement could be considered a penalty, in which case the enforceability thereof would be subject to general
principles of reasonableness and equitable remedies.
Fundamental Change Permits Holders to Require Us to Repurchase 2022 Convertible Notes
If a “fundamental change” (as defined below in this section) occurs at any time, holders have the right, at their option, to require us to repurchase for cash any
or all of their 2022 Convertible Notes, or any portion of the principal amount thereof that is equal to $25.00 or a multiple of $25.00. The price we are required
to pay is equal to 100% of the principal amount of the 2022 Convertible Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the
fundamental change repurchase date (unless the fundamental change repurchase date falls after a regular record date but on or prior to the interest payment
date to which such regular record date relates, in which case we will instead pay the full amount of accrued and unpaid interest to the holder of record on such
regular record date, and the fundamental change repurchase price will be equal to 100% of the principal amount of the 2022 Convertible Notes to be
repurchased). The fundamental change repurchase date will be a date specified by us that is not less than 20 or more than 35 business days following the date
of our fundamental change notice as described below (and will be subject to postponement by a number of days by which our notice of the fundamental
change is delivered to holders beyond the deadline set forth in the fourth immediately succeeding paragraph).
A “fundamental change” will be deemed to have occurred at the time after the 2022 Convertible Notes are originally issued if any of the following occurs:
(1)
a “person or group” within the meaning of Section 13(d) of the Exchange Act, other than us, our subsidiaries and our and their employee
benefit plans, has become the direct or indirect beneficial owner of our common equity representing more than 50% of the voting power of
our common equity and files a Schedule 13D or Schedule TO or any other schedule, form or report under the Exchange Act disclosing such
beneficial ownership;
- 27 -
(2)
(3)
(4)
the consummation of (A) any recapitalization, reclassification or change of our common stock (other than changes resulting from a
subdivision or combination or a change solely in par value) as a result of which our common stock would be converted into, or exchanged
for, stock, other securities, other property or assets; (B) any share exchange, consolidation or merger of us pursuant to which our common
stock will be converted into cash, securities or other property; or (C) any sale, lease or other transfer in one transaction or a series of
transactions of all or substantially all of the consolidated assets of us and our subsidiaries, taken as a whole, to any person other than one of
our subsidiaries; provided, however, that a transaction described in clause (A) or (B) in which the holders of all classes of our common
equity immediately prior to such transaction own, directly or indirectly, more than 50% of all classes of common equity of the continuing or
surviving corporation or transferee or the parent thereof immediately after such transaction in substantially the same proportions as such
ownership immediately prior to such transaction will not be a fundamental change pursuant to this clause (2);
our stockholders approve any plan or proposal for the liquidation or dissolution of us; or
our common stock (or other common stock underlying the 2022 Convertible Notes) ceases to be listed or quoted on any of The New York
Stock Exchange, The NASDAQ Global Select Market or The NASDAQ Global Market (or any of their respective successors).
A transaction or transactions described in clause (2) above will not constitute a fundamental change (even if that transaction is, or those transactions are, also
described under another clause above) if at least 90% of the consideration received or to be received by our common stockholders, excluding cash payments
for fractional shares, in connection with such transaction or transactions consists of shares of common stock that are listed or quoted on any of The New York
Stock Exchange, The NASDAQ Global Select Market or The NASDAQ Global Market (or any of their respective successors) or will be so listed or quoted
when issued or exchanged in connection with such transaction or transactions and as a result of such transaction or transactions the 2022 Convertible Notes
become convertible into such consideration, excluding cash payments for fractional shares.
After any transaction in which our common stock is replaced by the securities of another entity, should one occur, following completion of any related make-
whole fundamental change period and any related fundamental change purchase date, references to us in the definition of “fundamental change” above will
apply to such other entity instead. In addition, a filing that would otherwise constitute a fundamental change under clause (1) above will not constitute a
fundamental change if (x) the filing occurs in connection with a transaction in which we become a wholly-owned subsidiary of an SEC-reporting entity, and
for purposes of the conversion provisions herein, our common stock is replaced by the publicly-traded and listed securities of such SEC-reporting company,
and (y) no such filing is made or is in effect with respect to common equity representing more than 50% of the voting power of such other company.
On or before the 20th day after the date the fundamental change occurred, we will provide to all holders of the 2022 Convertible Notes and the Trustee and
paying agent a written notice of the occurrence of the fundamental change and of the resulting repurchase right. Such notice will state, among other things:
•
•
•
•
•
•
•
•
•
the events causing a fundamental change;
the date of the fundamental change;
the last date on which a holder may exercise the repurchase right;
the fundamental change repurchase price;
the fundamental change repurchase date;
the name and address of the paying agent and the conversion agent, if applicable;
if applicable, the conversion rate and any adjustments to the conversion rate;
if applicable, that the 2022 Convertible Notes with respect to which a fundamental change repurchase notice has been delivered by a holder
may be converted only if the holder withdraws the fundamental change repurchase notice in accordance with the terms of the indenture; and
the procedures that holders must follow to require us to repurchase their 2022 Convertible Notes.
- 28 -
Simultaneously with providing such notice, we will publish a notice containing this information in a newspaper of general circulation in The City of New
York or publish the information on our website or through such other public medium as we may use at that time.
To exercise the fundamental change repurchase right, a holder must deliver, on or before the business day immediately preceding the fundamental change
repurchase date, the 2022 Convertible Notes to be repurchased, duly endorsed for transfer, together with a written repurchase notice and the form entitled
“Form of Fundamental Change Repurchase Notice” on the reverse side of the 2022 Convertible Notes duly completed, to the paying agent. Each repurchase
notice must state:
•
•
•
if certificated, the certificate numbers of a holder’s 2022 Convertible Notes to be delivered for repurchase or if not certificated, the notice
must comply with appropriate DTC procedures;
the portion of the principal amount of 2022 Convertible Notes to be repurchased, which must be $25.00 or an integral multiple thereof; and
that the 2022 Convertible Notes are to be repurchased by us pursuant to the applicable provisions of the 2022 Convertible Notes and the
indenture.
If the 2022 Convertible Notes are not in certificated form, the notice given by each holder must comply with appropriate DTC procedures.
Holders may withdraw any repurchase notice (in whole or in part) by a written notice of withdrawal delivered to the paying agent prior to the close of
business on the business day immediately preceding the fundamental change repurchase date. The notice of withdrawal will state:
•
•
•
the principal amount of the withdrawn 2022 Convertible Notes;
if certificated 2022 Convertible Notes have been issued, the certificate numbers of the withdrawn 2022 Convertible Notes or, if not
certificated, the notice must comply with appropriate DTC procedures; and
the principal amount, if any, which remains subject to the repurchase notice, which must be $25.00 or an integral multiple thereof.
If the 2022 Convertible Notes are not in certificated form, the notice given by each holder must comply with appropriate DTC procedures.
We are required to repurchase the 2022 Convertible Notes surrendered for repurchase in accordance with the 2022 Convertible Notes Indenture on the
fundamental change repurchase date, subject to extension if necessary to comply with the provisions of the 1940 Act. Holders will receive payment of the
fundamental change repurchase price on the later of (i) the fundamental change repurchase date and (ii) the time of book-entry transfer or the delivery of the
2022 Convertible Notes to the paying agent. If on the fundamental change repurchase date the paying agent holds money sufficient to pay the fundamental
change repurchase price of the 2022 Convertible Notes for which holders have surrendered and not withdrawn repurchase notices on the fundamental change
repurchase date, then:
- 29 -
•
•
the 2022 Convertible Notes will cease to be outstanding and interest will cease to accrue (whether or not book-entry transfer of the 2022
Convertible Notes is made or whether or not the 2022 Convertible Notes are delivered to the paying agent); and
all other rights of the holder will terminate (other than the right to receive the fundamental change repurchase price upon delivery or transfer
of the 2022 Convertible Notes).
In connection with any repurchase offer pursuant to a fundamental change repurchase notice, we will, if required:
•
•
•
comply with the provisions of Rule 13e-4, Rule 14e-1 and any other tender offer rules under the Exchange Act that may then be applicable;
file a Schedule TO or any other required schedule under the Exchange Act; and
otherwise comply with all federal and state securities laws in connection with any offer by us to repurchase the 2022 Convertible Notes;
in each case, so as to permit the rights and obligations under this “— Fundamental Change Permits Holders to Require Us to Repurchase 2022 Convertible
Notes” to be exercised in the time and in the manner specified in the indenture.
No 2022 Convertible Notes may be repurchased on any date at the option of holders upon a fundamental change if the principal amount of the 2022
Convertible Notes has been accelerated, and such acceleration has not been rescinded, on or prior to such date (except in the case of an acceleration resulting
from a default by us in the payment of the fundamental change repurchase price with respect to such 2022 Convertible Notes).
The repurchase rights of the holders could discourage a potential acquirer of us. The fundamental change repurchase feature, however, is not the result of
management’s knowledge of any specific effort to obtain control of us by any means or part of a plan by management to adopt a series of anti-takeover
provisions.
The term fundamental change is limited to specified transactions and may not include other events that might adversely affect our financial condition. In
addition, the requirement that we offer to repurchase the 2022 Convertible Notes upon a fundamental change may not protect holders in the event of a highly
leveraged transaction, reorganization, merger or similar transaction involving us.
The definition of fundamental change includes a phrase relating to the conveyance, transfer, sale, lease or disposition of “all or substantially all” of our
consolidated assets. There is no precise, established definition of the phrase “substantially all” under applicable law. Accordingly, the ability of a holder of the
2022 Convertible Notes to require us to repurchase its 2022 Convertible Notes as a result of the conveyance, transfer, sale, lease or other disposition of less
than all of our assets may be uncertain.
If a fundamental change were to occur, we may not have enough funds to pay the fundamental change repurchase price. Our ability to repurchase the 2022
Convertible Notes for cash may be limited by restrictions on our ability to obtain funds for such repurchase through dividends from our subsidiaries, the terms
of our then existing borrowing arrangements or otherwise. Under our existing credit facility, we would be prohibited from making any such repurchase
without consent from the lenders thereunder or a waiver or modification of such requirements. If we fail to repurchase the 2022 Convertible Notes when
required following a fundamental change, we will be in default under the 2022 Convertible Notes Indenture. In addition, we have, and may in the future incur,
other indebtedness with similar change in control provisions permitting our holders to accelerate or to require us to repurchase our indebtedness upon the
occurrence of similar events or on some specific dates.
Events of Default under the 2022 Convertible Notes
A holder has rights if an Event of Default occurs in respect of the 2022 Convertible Notes and is not cured, as described later in this subsection.
(1)
default in any payment of interest on any 2022 Convertible Note when due and payable and the default continues for a period of 30 days;
- 30 -
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
default in the payment of principal of any 2022 Convertible Note when due and payable at its stated maturity, upon any required repurchase,
upon declaration of acceleration or otherwise;
our failure to comply with our obligation to convert the 2022 Convertible Notes in accordance with the 2022 Convertible Notes Indenture
upon exercise of a holder’s conversion right;
our failure to give a fundamental change notice as described under “— Fundamental Change Permits Holders to Require Us to Repurchase
2022 Convertible Notes”;
we remain in breach of a covenant in respect of the 2022 Convertible Notes for 60 days after we receive a written notice of default stating
we are in breach (the notice must be sent by either the Trustee or holders of at least 25% of the principal amount of the 2022 Convertible
Notes);
our failure to comply with the obligation set forth under “Investment Company Act — Section 18(a)(1)(A) as Modified by Section 61(a)
(1)”;
default by us or any of our significant subsidiaries, as defined in Article 1, Rule 1-02 of Regulation S-X under the Exchange Act, with
respect to any mortgage, agreement or other instrument under which there may be outstanding, or by which there may be secured or
evidenced, any indebtedness for money borrowed in excess of $25 million in the aggregate of us and/or any such subsidiary, whether such
indebtedness now exists or will hereafter be created (i) resulting in such indebtedness becoming or being declared due and payable or (ii)
constituting a failure to pay the principal or interest of any such debt when due and payable at its stated maturity, upon required repurchase,
upon declaration of acceleration or otherwise unless such indebtedness is discharged, or such acceleration is rescinded, stayed or annulled,
within a period of 30 calendar days after written notice of such failure is given to us by the Trustee or to us and the Trustee by the holders of
at least 25.0% in aggregate principal amount of the 2022 Convertible Notes then outstanding;
(a) we or any of our significant subsidiaries, as defined in Article 1, Rule 1-02 of Regulation S-X under the Exchange Act, file for
bankruptcy or (b) certain events of bankruptcy, insolvency, or reorganization of us or any of our significant subsidiaries, as defined in Article
1, Rule 1-02 of Regulation S-X under the Exchange Act occur and remain undischarged or unstayed for a period of 60 days; or
a final judgment for the payment of $25 million or more (excluding any amounts covered by insurance) rendered against us or any of our
significant subsidiaries, as defined in Article 1, Rule 1-02 of Regulation S-X under the Exchange Act, which judgment is not discharged or
stayed within 60 days after (i) the date on which the right to appeal thereof has expired if no such appeal has commenced, or (ii) the date on
which all rights to appeal have been extinguished.
Remedies if an Event of Default Occurs
If an Event of Default occurs and is continuing, the Trustee by notice to the Company, or the holders of at least 25% in principal amount of the outstanding
2022 Convertible Notes by notice to the Company and the Trustee, may, and the Trustee at the request of such holders will, declare 100% of the principal of
and accrued and unpaid interest, if any, on all the 2022 Convertible Notes to be due and payable. In case of certain events of bankruptcy, insolvency or
reorganization involving the Company, but not any of its subsidiaries, 100% of the principal of and accrued and unpaid interest on the 2022 Convertible Notes
will automatically become due and payable. Upon such a declaration of acceleration, such principal and accrued and unpaid interest, if any, will be due and
payable immediately.
If an event of default occurs and is continuing, the Trustee by notice to us, or the holders of at least 25% in principal amount of the outstanding 2022
Convertible Notes by notice to us and the Trustee, may, and the Trustee at the request of such holders will, declare 100% of the principal of and accrued and
unpaid interest, if any, on all the 2022 Convertible Notes to be due and payable. In case of certain events of bankruptcy, insolvency or reorganization
involving us, but not any of our subsidiaries, 100% of the principal of and accrued and unpaid interest on the 2022 Convertible Notes will automatically
become due and payable. Upon such a declaration of acceleration, such principal and accrued and unpaid interest, if any, will be due and payable
immediately.
- 31 -
The provisions described in the paragraph above, however, are subject to the condition that if, at any time after the principal of the 2022 Convertible Notes
will have been so declared due and payable, and before any judgment or decree for the payment of the moneys due will have been obtained as provided in the
2022 Convertible Note Indenture, we will pay or deliver, as the case may be, or will deposit with the Trustee an amount of cash and/or shares of common
stock sufficient to pay all matured installments of interest upon all the 2022 Convertible Notes, all amounts of consideration due upon the conversion of any
and all converted 2022 Convertible Notes, and the principal of any and all 2022 Convertible Notes which will have become due otherwise than by
acceleration (with interest upon such principal and, to the extent that payment of such interest is enforceable under applicable law, on overdue installments of
interest, at the rate or rates, if any, specified in the 2022 Convertible Notes to the date of such payment or deposit) and such amount as will be sufficient to
cover all amounts owing to the Trustee and its agents and counsel, and if any and all events of default under the 2022 Convertible Note Indenture, other than
the non-payment of the principal of 2022 Convertible Notes which will have become due by acceleration, will have been cured, waived or otherwise remedied
as provided in the 2022 Convertible Note Indenture, then and in every such case the holders of a majority in aggregate principal amount of all the 2022
Convertible Notes then outstanding, by written notice to us and to the Trustee, may rescind and annul such declaration and its consequences, but no such
rescission and annulment will extend to or will affect any subsequent default or will impair any right consequent on such default.
Notwithstanding the foregoing, the 2022 Convertible Notes Indenture provides that, to the extent we elect, the sole remedy for an event of default relating to
our failure to comply with our obligations as set forth under “— Reports” below and for any failure to comply with the requirements of Section 314(a)(1) of
the Trust Indenture Act (which also relate to the provision of reports) will, after the occurrence of such an event of default, consist exclusively of the right to
receive additional interest on the 2022 Convertible Notes at a rate equal to:
•
•
0.25% per annum of the principal amount of the 2022 Convertible Notes outstanding for each day during the 90-day period beginning on,
and including, the date on which such an event of default first occurs; and
0.50% per annum of the principal amount of the 2022 Convertible Notes outstanding for each day during the 90-day period beginning on,
and including, the 91st day following, and including, the occurrence of such an event of default during which such event of default is
continuing.
If we so elect, such additional interest will be payable in the same manner and on the same dates as the stated interest payable on the 2022 Convertible Notes.
On the 181st day after such event of default (if the event of default relating to the reporting obligations is not cured or waived prior to such 181st day), the
2022 Convertible Notes will be subject to acceleration as provided above. The provisions of the 2022 Convertible Notes Indenture described in this paragraph
will not affect the rights of holders of 2022 Convertible Notes in the event of the occurrence of any other event of default. In the event we do not elect to pay
the additional interest following an event of default in accordance with this paragraph or we elected to make such payment but do not pay the additional
interest when due, the 2022 Convertible Notes will be immediately subject to acceleration as provided above.
In order to elect to pay the additional interest as the sole remedy during the first 180 days after the occurrence of an event of default relating to the failure to
comply with the reporting obligations in accordance with the immediately preceding paragraph, we must notify in writing all holders of record of 2022
Convertible Notes, the Trustee and the paying agent of such election prior to the fifth business day of such 180-day period. Upon our failure to timely give
such notice, the 2022 Convertible Notes will be immediately subject to acceleration as provided above.
If any portion of the amount payable on the 2022 Convertible Notes upon acceleration is considered by a court to be unearned interest (through the allocation
of the value of the instrument to the embedded warrant or otherwise), the court could disallow recovery of any such portion.
The holders of a majority in principal amount of the outstanding 2022 Convertible Notes may waive all past defaults, except with respect to nonpayment of
principal or interest, with respect to the failure to deliver the consideration due upon conversion or with respect to a covenant that cannot be modified or
amended without the consent of each holder.
- 32 -
Each holder will have the right to receive payment or delivery, as the case may be, of:
•
•
•
the principal (including the fundamental change repurchase price, if applicable) of;
accrued and unpaid interest, if any, on; and
the consideration due upon conversion of,
its 2022 Convertible Notes, on or after the respective due dates expressed or provided for in the indenture, or to institute suit for the enforcement of any such
payment or delivery, as the case may be, and such right to receive such payment or delivery, as the case may be, on or after such respective dates will not be
impaired or affected without the consent of such holder.
Subject to the provisions of the 2022 Convertible Notes Indenture relating to the duties of the Trustee, if an event of default occurs and is continuing, the
Trustee will be under no obligation to exercise any of the rights or powers under the 2022 Convertible Notes Indenture at the request or direction of any of the
holders unless such holders have offered to the Trustee indemnity or security satisfactory to it against any loss, liability or expense (including fees and
expenses of its counsel). Except to enforce the right to receive payment of principal or interest when due, or the right to receive payment or delivery of the
consideration due upon conversion, no holder may pursue any remedy with respect to the 2022 Convertible Notes Indenture or the 2022 Convertible Notes
unless:
(1)
(2)
(3)
(4)
(5)
such holder has previously given the Trustee written notice that an event of default is continuing;
holders of at least 25% in principal amount of the outstanding 2022 Convertible Notes have requested the Trustee in writing to institute
proceedings to remedy such event of default;
such holders have offered to the Trustee indemnity, security, or both, reasonably satisfactory to the Trustee, against the costs, expenses and
liabilities to be incurred in compliance with such request;
the Trustee for 60 days after its receipt of such notice, request and offer of indemnity and/or security has failed to institute any such
proceeding; and
the holders of a majority in principal amount of the outstanding 2022 Convertible Notes have not given the Trustee a direction that, in the
opinion of the Trustee, is inconsistent with such request during that 60-day period.
Subject to certain restrictions and the Trustee’s right to demand security or indemnity satisfactory to it in accordance with the indenture, the holders of a
majority in principal amount of the outstanding 2022 Convertible Notes are given the right to direct the time, method and place of conducting any proceeding
for any remedy available to the Trustee or of exercising any trust or power conferred on the Trustee.
The 2022 Convertible Notes Indenture provides that in the event an event of default has occurred and is continuing, the Trustee will be required in the
exercise of its powers to use the degree of care that a prudent person would use in the conduct of its own affairs under the circumstances. The Trustee,
however, may refuse to follow any direction that conflicts with law or the 2022 Convertible Notes Indenture or that the Trustee determines is unduly
prejudicial to the rights of any other holder or that would involve the Trustee in personal liability. Prior to taking any action under the indenture, the Trustee
will be entitled to indemnification satisfactory to it in its sole discretion against all losses and expenses caused by taking or not taking such action.
The 2022 Convertible Notes Indenture provides that if a default occurs and is continuing and is known to the Trustee, the Trustee must deliver to each holder
notice of the default within 90 days after it occurs. Except in the case of a default in the payment of principal of or interest on any 2022 Convertible Note or a
default in the payment or delivery of the consideration due upon conversion, the Trustee may withhold notice if and so long as the Trustee in good faith
determines that withholding notice is in the interests of the holders.
- 33 -
The Trustee shall not be charged with knowledge of any fact, notice of default or event of default with respect to the 2022 Convertible Notes unless either (i)
a responsible officer of the Trustee shall have actual knowledge of such default or event of default or (ii) written notice of such fact, default or event or default
shall have been given by us or by the holders of at least 25% of the aggregate principal amount of the 2022 Convertible Notes and received by a responsible
officer of the Trustee and references the 2022 Convertible Notes Indenture and the 2022 Convertible Notes.
Merger or Consolidation
The 2022 Convertible Notes Indenture provides that we will not consolidate with or merge with or into, or sell, convey, or transfer all or substantially all of
our properties and assets to, another person, unless all the following conditions are met:
•
•
•
where we merge out of existence or convey or transfer our assets substantially as an entirety, the resulting entity must agree to be legally
responsible for our obligations under the 2022 Convertible Notes;
immediately after giving effect to such transaction, no default or event of default has occurred and is continuing under the indenture. For
purposes of this no-default test, a default would include an event of default that has occurred and has not been cured, as described under
“Events of Default” below. A default for this purpose would also include any event that would be an event of default if the requirements for
giving us a notice of default or our default having to exist for a specific period of time were disregarded; and
we must deliver certain certificates and documents to the Trustee.
Upon any such consolidation, merger or sale, conveyance, or transfer, the resulting, surviving or transferee person (if not us) will succeed to us, and may
exercise every right and power of, ours under the 2022 Convertible Note Indenture, and we will be discharged from our obligations under the 2022
Convertible Notes and the 2022 Convertible Note Indenture.
Although these types of transactions are permitted under the 2022 Convertible Note Indenture, certain of the foregoing transactions could constitute a
fundamental change permitting each holder to require us to repurchase the 2022 Convertible Notes of such holder as described above.
An assumption by any person of obligations under the 2022 Convertible Notes and the 2022 Convertible Notes Indenture might be deemed for U.S. federal
income tax purposes to be an exchange of the 2022 Convertible Notes for new 2022 Convertible Notes by the holders thereof, resulting in recognition of gain
or loss for such purposes and possibly other adverse tax consequences to the holders. Holders should consult their own tax advisors regarding the tax
consequences of such an assumption.
Modification and Amendment
Subject to certain exceptions, the 2022 Convertible Notes Indenture or the 2022 Convertible Notes may be amended with the consent of the holders of at least
a majority in principal amount of the 2022 Convertible Notes then outstanding (including without limitation, consents obtained in connection with a
repurchase of, or tender or exchange offer for, 2022 Convertible Notes) and, subject to certain exceptions, any past default or compliance with any provisions
may be waived with the consent of the holders of a majority in principal amount of the 2022 Convertible Notes then outstanding (including, without
limitation, consents obtained in connection with a repurchase of, or tender or exchange offer for, 2022 Convertible Notes). However, without the consent of
each holder of an outstanding 2022 Convertible Note affected, no amendment may, among other things:
(1)
(2)
reduce the amount of 2022 Convertible Notes whose holders must consent to an amendment;
reduce the rate of or extend the stated time for payment of interest on any note;
- 34 -
(3)
(4)
(5)
(6)
(7)
(8)
reduce the principal of or extend the stated maturity of any note;
make any change that adversely affects the conversion rights of any 2022 Convertible Notes;
reduce the fundamental change repurchase price of any 2022 Convertible Note or amend or modify in any manner adverse to the holders of
2022 Convertible Notes our obligation to make such payments, whether through an amendment or waiver of provisions in the covenants,
definitions or otherwise;
make any 2022 Convertible Note payable in money other than that stated in the note;
impair the right of any holder to receive payment of principal and interest on such holder’s 2022 Convertible Notes on or after the due dates
therefor or to institute suit for the enforcement of any payment on or with respect to such holder’s 2022 Convertible Notes; or
make any change in the amendment provisions that require each holder’s consent or in the waiver provisions, except to increase any such
percentage or to provide that other provisions of the 2022 Convertible Notes Indenture cannot be modified or waived without the consent of
the holder of each outstanding 2022 Convertible Note affected thereby.
Without the consent of any holder, we and the Trustee may amend the 2022 Convertible Notes Indenture without notice to:
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
cure or supplement any ambiguity, omission, defect or inconsistency in a manner that does not adversely affect the interests of any holder of
the 2022 Convertible Notes in any material respect;
provide for the assumption by a successor entity of our obligations under the 2022 Convertible Note Indenture;
secure the 2022 Convertible Notes;
add to our covenants or events of default for the benefit of the holders or surrender any right or power conferred upon us;
make any change that does not adversely affect the interests of any holder of 2022 Convertible Notes in any material respect;
conform the provisions of the 2022 Convertible Notes Indenture to the “Description of 2022 Convertible Notes” section in the prospectus
supplement related thereto as determined in good faith by us;
comply with any requirement of the SEC in connection with the qualification of the 2022 Convertible Notes Indenture under the Trust
Indenture Act;
reflect the replacement of our common stock by reference property as described under “— Recapitalizations, Reclassifications and Changes
of Our Common Stock”; or
(9)
evidence and provide for the appointment under the 2022 Convertible Notes Indenture of a successor Trustee.
Holders do not need to approve the particular form of any proposed amendment. It will be sufficient if such holders approve the substance of the proposed
amendment. After an amendment under the 2022 Convertible Notes Indenture becomes effective, we are required to mail to the holders a notice briefly
describing such amendment. However, the failure to give such notice to all the holders, or any defect in the notice, will not impair or affect the validity of the
amendment.
- 35 -
Discharge
We may satisfy and discharge our obligations under the 2022 Convertible Notes Indenture by delivering to the securities registrar for cancellation all
outstanding 2022 Convertible Notes or by depositing with the Trustee or delivering to the holders, as applicable, after the 2022 Convertible Notes have
become due and payable, whether at maturity, any fundamental change repurchase date, upon conversion or otherwise, shares of common stock (and cash in
lieu of fractional shares) solely to satisfy outstanding conversions, as applicable, and cash sufficient to pay all of the outstanding 2022 Convertible Notes and
all other sums payable under the 2022 Convertible Notes Indenture by us. Such discharge is subject to terms contained in the indenture.
Calculations in Respect of 2022 Convertible Notes
We are responsible for making all calculations called for under the 2022 Convertible Notes. These calculations include, but are not limited to, determinations
of the last reported sale prices of our common stock, accrued interest payable on the 2022 Convertible Notes and the conversion rate of the 2022 Convertible
Notes. We will make all these calculations in good faith and, absent manifest error, our calculations will be final and binding on holders of 2022 Convertible
Notes. We will provide a schedule of our calculations to each of the Trustee and the conversion agent, and each of the Trustee and conversion agent is entitled
to rely conclusively upon the accuracy of our calculations without independent verification. The Trustee will forward our calculations to any holder of 2022
Convertible Notes upon the request of that holder.
Reports
The 2022 Convertible Notes Indenture provides that any documents or reports that we are required to file with the SEC pursuant to Section 13 or 15(d) of the
Exchange Act must be filed by us with the Trustee within 15 days after the same are required to be filed with the SEC (giving effect to any grace period
provided by Rule 12b-25 under the Exchange Act). Documents filed by us with the SEC via the EDGAR system will be deemed to be filed with the Trustee
as of the time such documents are filed via EDGAR.
Delivery of such reports, information and documents to the Trustee is for informational purposes only and the Trustee’s receipt of such shall not constitute
constructive notice of any information contained therein or determinable from information contained therein, including our compliance with any of its
covenants under the 2022 Convertible Notes Indenture (as to which the Trustee is entitled to rely exclusively on officers’ certificates). The Trustee shall not
be obligated to monitor or confirm, on a continuing basis or otherwise, our compliance with the covenants or with respect to any reports or other documents
filed with the SEC or website under the indenture, or participate in any conference calls. Delivery of reports to the Trustee shall not constitute knowledge of,
or notice to, the Trustee of the information contained therein.
1940 Act — Section 18(a)(1)(A) as Modified by Section 61(a)(1)
We agree that for the period of time during which 2022 Convertible Notes are outstanding, we will not violate Section 18(a)(1)(A) as modified by Section
61(a)(1) of the 1940 Act or any successor provisions thereto of the 1940Act, whether or not we continue to be subject to such provisions of the 1940 Act, but
giving effect to any exemptive relief that may be granted to us by the SEC.
Trustee
U.S. Bank National Association is the Trustee, security registrar, paying agent and conversion agent. U.S. Bank National Association, in each of its capacities,
including without limitation as Trustee, security registrar, paying agent and conversion agent, assumes no responsibility for the accuracy or completeness of
the information concerning us or our affiliates or any other party contained in this document or the related documents or for any failure by us or any other
party to disclose events that may have occurred and may affect the significance or accuracy of such information, or for any information provided to it by us,
including but not limited to last reported sale prices of our stock, settlement amounts and any other information.
- 36 -
We may maintain banking relationships in the ordinary course of business with the Trustee and its affiliates.
Governing Law
The 2022 Convertible Notes Indenture provides that it and the 2022 Convertible Notes will be governed by and construed in accordance with the laws of the
State of New York.
Book-Entry, Settlement and Clearance
Global Notes
The 2022 Convertible Notes were initially issued in the form of one or more registered notes in global form, without interest coupons (the “global notes”).
Upon issuance, each of the global notes was deposited with the Trustee as custodian for DTC and registered in the name of Cede & Co., as nominee of DTC.
Ownership of beneficial interests in a global note are limited to persons who have accounts with DTC (“DTC participants”) or persons who hold interests
through DTC participants. Under procedures established by DTC:
•
•
upon deposit of a global note with DTC’s custodian, DTC credited portions of the principal amount of the global note to the accounts of the
DTC participants designated by the underwriters; and
ownership of beneficial interests in a global note are shown on, and transfer of ownership of those interests will be effected only through,
records maintained by DTC (with respect to interests of DTC participants) and the records of DTC participants (with respect to other owners
of beneficial interests in the global note).
Beneficial interests in global notes may not be exchanged for 2022 Convertible Notes in physical, certificated form except in the limited circumstances
described below.
Book-Entry Procedures for Global Notes
All interests in the global notes will be subject to the operations and procedures of DTC. We provide the following summary of those operations and
procedures solely for the convenience of investors. The operations and procedures of DTC are controlled by that settlement system and may be changed at
any time. Neither we nor the underwriters are responsible for those operations or procedures.
So long as DTC’s nominee is the registered owner of a global note, that nominee will be considered the sole owner or holder of the 2022 Convertible Notes
represented by that global note for all purposes under the indenture. Except as provided below, owners of beneficial interests in a global note:
•
•
•
will not be entitled to have 2022 Convertible Notes represented by the global note registered in their names;
will not receive or be entitled to receive physical, certificated 2022 Convertible Notes; and
will not be considered the owners or holders of the 2022 Convertible Notes under the 2022 Convertible Notes Indenture for any purpose,
including with respect to the giving of any direction, instruction or approval to the Trustee under the 2022 Convertible Note Indenture.
As a result, each investor who owns a beneficial interest in a global note must rely on the procedures of DTC to exercise any rights of a holder of 2022
Convertible Notes under the 2022 Convertible Notes Indenture (and, if the investor is not a participant or an indirect participant in DTC, on the procedures of
the DTC participant through which the investor owns its interest).
- 37 -
Payments of principal and interest and of amounts due upon conversion with respect to the 2022 Convertible Notes represented by a global note will be made
by the Trustee to DTC’s nominee as the registered holder of the global note. Neither we nor the Trustee will have any responsibility or liability for the
payment of amounts to owners of beneficial interests in a global note, for any aspect of the records relating to or payments made on account of those interests
by DTC, or for maintaining, supervising or reviewing any records of DTC relating to those interests.
Payments by participants and indirect participants in DTC to the owners of beneficial interests in a global note will be governed by standing instructions and
customary industry practice and will be the responsibility of those participants or indirect participants and DTC.
Transfers between participants in DTC will be effected under DTC’s procedures and will be settled in same-day funds.
Certificated Notes
2022 Convertible Notes in physical, certificated form will be issued and delivered to each person that DTC identifies as a beneficial owner of the related 2022
Convertible Notes only if:
•
•
•
DTC notifies us at any time that it is unwilling or unable to continue as depositary for the global notes and a successor depositary is not
appointed within 90 days;
DTC ceases to be registered as a clearing agency under the Exchange Act and a successor depositary is not appointed within 90 days; or
an event of default with respect to the 2022 Convertible Notes has occurred and is continuing and such beneficial owner requests that its
2022 Convertible Notes be issued in physical, certificated form.
- 38 -
List of Subsidiaries
CapitalSouth Partners Fund II Limited Partnership (North Carolina)
CapitalSouth Partners F-II, LLC (North Carolina)
CapitalSouth Partners SBIC Fund III, L.P. (Delaware)
CapitalSouth Partners SBIC F-III, LLC (North Carolina)
CPTA Master Blocker, Inc. (Georgia)
Exhibit 21.1
Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in the Registration Statement (Form N-2 No. 333-230336) of Capitala Finance Corp. and in the related
Prospectus of our reports dated March 2, 2020, with respect to the consolidated financial statements of Capitala Finance Corp. and the effectiveness of
internal control over financial reporting of Capitala Finance Corp. included in this Annual Report (Form 10-K) for the year ended December 31, 2019.
Exhibit 23.1
/s/ Ernst & Young LLP
Charlotte, North Carolina
March 2, 2020
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO RULE 13a-14 OF THE SECURITIES EXCHANGE ACT OF 1934,
AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Joseph B. Alala III, certify that:
Exhibit 31.1
1.
2.
3.
4.
I have reviewed this Annual Report on Form 10-K of Capitala Finance Corp.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the consolidated financial statements, and other financial information
included in this report, fairly present in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for
the registrant and have:
(a)
(b)
(c)
(d)
Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to the
registrant, is made known to us by others within those entities, particularly during the period in
which this report is being prepared;
Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such evaluation;
Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in
the case of an annual report) that has materially affected, or is reasonably likely to materially
affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the
registrant’s Board of Directors (or persons performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 2, 2020
/s/ Joseph B. Alala III
Joseph B. Alala III
Chief Executive Officer
(Principal Executive Officer)
Capitala Finance Corp.
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO RULE 13a-14 OF THE SECURITIES EXCHANGE ACT OF 1934,
AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Stephen A. Arnall, certify that:
Exhibit 31.2
1.
2.
3.
4.
I have reviewed this Annual Report on Form 10-K of Capitala Finance Corp.;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the consolidated financial statements, and other financial information
included in this report, fairly present in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for
the registrant and have:
(a)
(b)
(c)
(d)
Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to the
registrant, is made known to us by others within those entities, particularly during the period in
which this report is being prepared;
Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such evaluation;
Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in
the case of an annual report) that has materially affected, or is reasonably likely to materially
affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the
registrant’s Board of Directors (or persons performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 2, 2020
/s/ Stephen A. Arnall
Stephen A. Arnall
Chief Financial Officer
(Principal Financial Officer)
Capitala Finance Corp.
Exhibit 32.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K of Capitala Finance Corp. (the “Company”) for the
annual period ended December 31, 2019, as filed with the Securities and Exchange Commission on the date
hereof (the “Report”), I, Joseph B. Alala III, Chief Executive Officer of the Company, certify, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that:
1.
2.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange
Act of 1934, as amended; and
The information contained in the Report fairly presents, in all material respects, the financial condition
and results of operations of the Company.
Date: March 2, 2020
/s/ Joseph B. Alala III
Joseph B. Alala III
Chief Executive Officer
(Principal Executive Officer)
Capitala Finance Corp.
Exhibit 32.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K of Capitala Finance Corp. (the “Company”) for the
annual period ended December 31, 2019, as filed with the Securities and Exchange Commission on the date
hereof (the “Report”), I, Stephen A. Arnall, Chief Financial Officer of the Company, certify, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that:
1.
2.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange
Act of 1934, as amended; and
The information contained in the Report fairly presents, in all material respects, the financial condition
and results of operations of the Company.
Date: March 2, 2020
/s/ Stephen A. Arnall
Stephen A. Arnall
Chief Financial Officer
(Principal Financial Officer)
Capitala Finance Corp.