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EX-32.2 - EXHIBIT 32.2 - VII Peaks Co-Optivist Income BDC II, Inc.v368115_ex32-2.htm
EX-4.1 - FORM OF SUBSCRIPTION AGREEMENT - VII Peaks Co-Optivist Income BDC II, Inc.v368115_ex4-1.htm
EX-32.1 - EXHIBIT 32.1 - VII Peaks Co-Optivist Income BDC II, Inc.v368115_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - VII Peaks Co-Optivist Income BDC II, Inc.v368115_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - VII Peaks Co-Optivist Income BDC II, Inc.v368115_ex31-1.htm
EX-10.5 - ADMINISTRATION AGREEMENT - VII Peaks Co-Optivist Income BDC II, Inc.v368115_ex10-5.htm
EX-4.2 - FORM OF ADDITIONAL SUBSCRIPTION AGREEMENT - VII Peaks Co-Optivist Income BDC II, Inc.v368115_ex4-2.htm

 

 

 

 

 

  

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

 

  x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2013

 

  ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from             to

 

Commission File No. 0-54615

 

 

 

VII Peaks Co-Optivist Income BDC II, Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

Maryland   45-2918121
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification Number)

 

100 Pine Street, Suite 500

San Francisco, California 94111

(Address of principal executive offices)

 

(855) 889-1778

(Registrant’s telephone number, including area code)

 

Not applicable

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, par value

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value

$0.001 per share

  

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933.  Yes ¨ No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934. Yes ¨ No x

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No ¨

  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x Smaller reporting company ¨
    (Do not check if a smaller reporting company)  

 

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

 

There is no established market for the Registrant’s shares of common stock. The Registrant is currently conducting an ongoing public offering of its shares of common stock pursuant to a Registration Statement on Form N-2 (File No. 333-166636), which shares are being sold at $10.15 per share as of December 31, 2013, with discounts available for certain categories of purchasers, or at a price necessary to ensure that shares are not sold at a price below net asset value per share.

  

The number of shares of the Registrant’s common stock, par value $0.001 per share, outstanding as of March 10, 2014 was 3,619,692.

 

Documents Incorporated by Reference

 

Portions of the registrant’s definitive Proxy Statement relating to the registrant’s 2014 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.

 

 
 

  

  

Forward Looking Statements

 

The following information contains statements that constitute forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements generally are characterized by the use of terms such as “may,” “should,” “plan,” “anticipate,” “estimate,” “intend,” “predict,” “believe,” and “expect” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, our actual results could differ materially from those set forth in the forward-looking statements.

 

Forward-looking statements contained in this Annual Report are subject to a number of risks and uncertainties, some of which are beyond our control, including statements as to:

 

  our ability to invest in discounted corporate debt and equity-linked debt securities of our target companies;
  our ability to successfully employ our Co-OptivistTM approach in executing our investment strategy;
  a limited pool of prospective target businesses;
  our ability to pay distributions on our shares of common stock;
  an economic downturn which could impair our target companies’ abilities to continue to operate, which could lead to the loss of some or all of our assets;
  changes in general economic or business conditions or economic or demographic trends in the United States; and

 

For a discussion of factors that could cause our actual results to differ from forward-looking statements contained in this Annual Report, please see the discussion under Part I, Item 1A “Risk Factors”. You should not place undue reliance on these forward-looking statements. The forward-looking statements made in this Annual Report relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date of this Annual Report.

 

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VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2013

 

TABLE OF CONTENTS

 

 

  Page
PART I  
   
Item 1. Business 4
Item 1A. Risk Factors 15
Item 1B. Unresolved Staff Comments 29
Item 2. Properties 29
Item 3. Legal Proceedings 29
Item 4. Mine Safety Disclosures 29
PART II  
   
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 29
Item 6. Selected Financial Data 31
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 32
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 39
Item 8. Financial Statements and Supplementary Data F-1
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 40
Item 9A. Controls and Procedures 40
Item 9B. Other Information 40

PART III

 
   
Item 10. Directors, Executive Officers and Corporate Governance 41
Item 11. Executive Compensation 41
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 41
Item 13. Certain Relationships and Related Transactions, and Director Independence 41
Item 14. Principal Accountant Fees and Services 41
PART IV  
   
Item 15. Exhibits and Financial Statement Schedules 42
Signatures 43

 

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Part I

 

Except as otherwise specified in this annual report on Form 10-K (“Annual Report”), the terms:

 

  “we”, “us”, “our” and the “Fund” refer to VII Peaks Co-Optivist Income BDC II, Inc., a Maryland Corporation.

 

ITEM 1. BUSINESS

 

General

 

We are a specialty finance company incorporated in Maryland on August 3, 2011. We are an externally managed, non-diversified closed-end management investment company that has elected to be treated as a business development company ("BDC"), under the Investment Company Act of 1940, as amended (the “1940 Act”). In addition, we have elected to be treated for federal income tax purpose, and intend to qualify annually, as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code of 1986, as amended, or the Code.

 

As of August 20, 2013, we are managed by VII Peaks Capital, LLC (the “Manager”), a registered investment adviser under the Investment Advisers Act of 1940, as amended, (the “Advisers Act”). Our Manager is responsible for sourcing and conducting research on prospective investments, analyzing opportunities, structuring our portfolio, and monitoring our investments and portfolio companies on an ongoing basis. Prior to August 20, 2013 the Fund was managed by VII Peaks-KBR BDC Advisor II, LLC who was wholly-owned by VII Peaks-KBR, LLC which was a joint venture between VII Peaks Capital, LLC and KBR Capital Advisors, LLC (“KBR”).

 

On August 9, 2011, we filed a registration statement on Form N-2 to sell up to 75,000,000 shares of common stock, $0.001 par value per share, at an initial public offering price of $10.00 per share. The registration statement was declared effective by the Securities Exchange Commission (the “SEC”) on March 1, 2012. We commenced operations when we raised gross offering proceeds of over $1.0 million, all of which was from persons who were not affiliated with us or our manager by one year from the date the registration statement was declared effective by the SEC. Prior to the successful satisfaction of that condition, all subscription payments were placed in an account held by the escrow agent, UMB Bank, N.A., in trust for the benefit of our subscribers, pending release to us. We achieved the minimum offering requirement on July 10, 2012 and commenced operations on such date. As of December 31, 2013, we issued 3.2 million shares of common stock for gross proceeds of $31.6 million, including $0.7 million under our distribution reinvestment plan (“DRIP”).

 

We invest in discounted corporate debt and equity-linked debt securities of public and private companies that trade on the secondary loan market for institutional investors and provide distributions to investors. The debt is generally high-yield and non-investment grade. At the same time, we actively work with the target company’s management to restructure the underlying securities and improve the liquidity position of the target company’s balance sheet. We employ a proprietary “Co-Optivist” TM approach (“cooperative activism”, Co-Optivist TM is a registered trademark of VII Peaks Capital, LLC, or (“VII Peaks”), and is being used with their permission) in executing our investment strategy, which entails proactively engaging the target company management on average 24 months prior to a redemption event (typically a put or maturity event) to create an opportunity for growth in the investments. Our strategy is not dependent on restructuring to generate distributions. Capital appreciation on securities is generally not realized evenly over the holding period. In some instances market prices for securities may continue to reflect a discount until a relatively short time period prior to a redemption event. The potential capital gain typically occurs during the end of the holding period of a bond in our portfolio when securities are either called by the company or exchanged to new securities during refinance. We have tendered certain debt securities well above the market-traded deep discount.

 

Our investment objectives are to generate current income and capital appreciation. We meet our investment objectives by: (i) realizing income and capital appreciation through the acquisition, management and orderly liquidation of corporate debt securities, (ii) making distributions of available distributable cash to our shareholders, and (iii) preserving the capital investments of our shareholders.

 

Our proprietary “Co-Optivist” TM approach entails investment in the corporate debt and equity-linked debt securities of target companies, or Target Investments, in conjunction with proactively engaging the target companies’ management. We acquire Target Investments whose debt securities trade on the over-the-counter market for institutional loans at a discount to their par redemption value, and will be subject to a “redemption event” within (on average) 24 months. We define a “redemption event” as a maturity event or a put event (where investors in the target companies’ debt security can have a redemption right at a pre-determined price). We hold such debt an average of 12 – 18 months, during which time we anticipate working actively with the target companies’ management to effect and/or participate in a restructuring or exchange of the invested securities for new securities.

 

We make target companies that meet our investment criteria. The size of an individual investment will vary based on numerous factors. However, assuming we raise the maximum offering amount of $750 million we expect to hold at least 50 investments, and we anticipate that the minimum investment size will be approximately $250,000. We do not anticipate being heavily invested in any one industry, and generally, we do not expect to invest in more than two different classes of debt of the same target company. We invest in debt and equity-linked debt of target company with a minimum enterprise value of $200 million and whose debt and equity-linked debt is actively traded in the secondary loan market. Our portfolio is predominantly composed of fixed-rate high-yield and equity-linked corporate debt securities. However, we may also purchase senior secured corporate debt securities which may have variable interest rates. We currently anticipate that the portion of our portfolio composed of variable rate corporate debt securities, if any, will not exceed 20%, but we may increase that to 33% of our aggregate portfolio at the time of any purchase depending on market opportunities.

 

We offer our stockholders the ability to receive distributions as well as the potential capital appreciation resulting from the restructuring of the debt of our Target Investments. To the extent we have distributable income available we anticipate declaring distributions with a record and payment date on a semi-monthly basis. Please see Part II, Item 5. “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for a detailed description of Distributions.

 

 

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Between 2001 and 2008, corporate debt levels and the supply of leverage offered by banks and other investors steadily increased. We believe a significant amount of this debt will be subject to a redemption event prior to 2015. Many of the companies that have outstanding issues of such debt have not been able to proactively refinance, creating a “refinancing wall” that we believe will create a liquidity shortfall for many issuers. The value of the debt securities of these companies as reflected in prices quoted in the secondary loan market, may be at a significant discount to par, and represent a premium yield to maturity reflective of these liquidity concerns, creating the opportunity for us to identify and invest in the debt securities of select companies at attractive current market valuations. We believe that our Co-Optivist TM approach can help our target companies achieve results that are beneficial to the long-term value of their businesses, which will in turn, result in capital gains through capital appreciation, or the exchange of invested securities into a current security or cash at a premium to its acquisition price. Our principals collectively have experience in principal investing, debt securities and general capital markets, and we believe we are well-positioned to capitalize on these opportunities.

 

Our investment activities are managed by our Manager who is registered as an investment adviser under the Advisers Act. Our Manager is responsible for sourcing potential investments, conducting research on prospective investments, analyzing investment opportunities, structuring our investments, and monitoring our investments and portfolio companies on an ongoing basis. Our Manager is led by Gurpreet (Gurprit) S. Chandhoke, who also serves as our Chief Executive Officer, who has extensive experience in underwriting and issuing debt products that include high-yield, bank debt and convertible debt and has acted as financial adviser to private equity funds, venture capital firms and corporations in mergers and acquisitions, recapitalization and corporate finance transactions, and has served as principal investor in private equity and leveraged buyout transactions.

 

Our Manager has an investment committee that is responsible for reviewing, discussing and approving each investment opportunity we seek to pursue. Our investment committee meets routinely to discuss new and existing opportunities and developments on current investments. Our investment committee currently is led by Mr. Chandhoke, our Chief Executive Officer, with Stephen F. Shea, a Managing Partner of VII Peaks Capital, LLC.

 

As a BDC, we are required to comply with certain regulatory requirements. For instance, we have to invest at least 70% of our total assets in “qualifying assets,” including securities of U.S. operating companies whose securities are not listed on a national securities exchange (i.e., New York Stock Exchange, American Stock Exchange and The NASDAQ Global Market), U.S. operating companies with listed securities that have equity market capitalizations of less than $250 million, 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, which, as defined in the 1940 Act, measures the ratio of total assets less total liabilities (excluding borrowings) to total borrowings, equals at least 200% after such borrowing, with certain limited exceptions.

 

Market Opportunity

 

In the upcoming years, we believe many companies will face maturities and redemptions on significant amounts of outstanding debt and will have to find ways to refinance those obligations.

 

While companies have recently taken advantage of the low-interest rate environment to amend and extend their debt maturities, we believe this is only a temporary push-out of the debt maturity wall without a meaningful reduction in overall outstanding debt. For the foreseeable future, we expect continued low demand for collateralized debt and soft economic growth to keep credit markets tight. The amount of speculative-grade debt (“BB+” and lower) coming due will continue to be a large share of overall maturing debt. Corporate borrowers whose debt carries lower ratings have had difficulty obtaining refinancing and face what we call a “refinancing wall”. As a result, many companies with speculative-grade debt have chosen to amend-and-extend their maturities rather than fully refinance their debt.

 

Our strategy is to invest in debt securities that are issued by companies with solid fundamentals and business prospects but who are facing a liquidity shortfall as they approach the “refinancing wall”. We believe that the expertise and experience of the officers of our Manager provide us with the ability to identify debt securities that we believe are currently mispriced in the secondary loan market and thus provide opportunity for returns as their values recover and appreciate.

 

Potential Competitive Strengths  

 

We believe that we have the following potential competitive strengths as compared to investment funds that also invest in discounted corporate debt and equity-linked debt securities:

  

  We Are Not a Traditional Distressed Fund.   Traditional distressed debt investors typically seek to own the debt and engage in a bankruptcy process with the issuing company and eventually become equity holders. Through equity ownership, traditional distressed debt investors then intend to restructure operations of the company. In contrast, we do not invest in debt securities with the intent of undergoing a bankruptcy process. We look to partner with management to pro-actively avoid a default and bankruptcy situation. We are focused on restructuring company balance sheets, not company operations.

 

  Investment Hold Period.   We will not actively trade in and out of positions. Rather, we hold our investments for an average of 12 – 18 months. During this hold period we anticipate working co-operatively with target company management and other debt holders on a debt restructuring or exchange.

 

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  Comprehensive Private Equity Due Diligence Approach.   We employ a comprehensive private equity approach to our investment due diligence process. This approach involves performing comprehensive business and industry due diligence and in-depth, bottoms-up valuation analyses for each investment, comparable to what a private equity firm with a long-term ownership position would conduct prior to investing in a target company. We believe this disciplined approach serves as an effective risk management tool for our investment process.

 

  Relevant Capital Markets and Investment Experience.   Our investment team consists of individuals who collectively have expertise and experience in principal investing, debt securities and general capital markets. The members of our investment team combined have been involved in the issuance of over $20 billion of debt securities, advised on a number of merger and acquisition transactions and invested in a number of private equity and leveraged buyout transactions.

 

Investment Criteria and Strategy

 

We invest in discounted corporate debt and equity-linked debt securities of companies that have a perceived risk of near term liquidity issues but have solid business fundamentals and prospects, including historical revenue growth, positive cash flow, significant and sustainable market presence, and sufficient asset coverage. We take a principal position in discounted debt securities with the primary goal of restructuring the terms of the debt to allow the target company to increase its liquidity and strengthen its balance sheet. Our typical target company has a debt redemption event (typically either a put or maturity event) on average within 24 months of our investment and has experienced a significant decline in its equity value reflective of a highly leverage capital structure or general market conditions. We believe that proactively guiding such companies to restructure their debt will allow them to increase liquidity and free up resources to grow their businesses rather than focusing on managing their debt obligations. We also believe that our involvement can allow the target company more flexibility to explore strategic alternatives, since the terms of the existing debt structure often limits strategic options for the target company.

 

The following is our primary investment criteria for our target company:

  

  minimum enterprise value of $200 million;

 

  solid business fundamentals, such as historic revenue growth, profitability and cash flow generation, and favorable prospects for continued improvement in financial performance;

 

  sufficient asset coverage of at least one and a half times the amount of our potential investment for outstanding liabilities;

 

  debt or equity-linked debt trading at a discount to par or at a premium yield in secondary loan markets due to a perceived risk of near term liquidity issues;

 

  balance sheet with debt to total capitalization of at least 50% or high debt to equity ratios; and

 

  near term redemption (maturity or put) event on its debt creating an upcoming liquidity shortfall.

  

The securities that we target include high-yield debt, bank debt, convertible debt, and collateralized loan obligations (“CLO”), which are high-yield loans securitized into pools containing varying degrees of credit rating. Our portfolio is predominantly composed of fixed-rate high-yield and equity-linked corporate debt securities. However, we may also purchase senior secured corporate debt securities which may have variable interest rates. We currently anticipate that the portion of our portfolio composed of variable rate corporate debt securities, if any, will not exceed 20%, but we may increase that to 33% of our aggregate portfolio at the time of any purchase depending on market opportunities. In addition to the investments noted above, we may invest up to 30% of our portfolio in opportunistic investments, including, but not limited to, high-yield bonds, private equity investments, distressed debt investments and securities of public companies that are not thinly traded. We expect that these public companies generally will have debt securities that are non-investment grade. We also may invest in debt securities of middle-market companies located outside of the United States. All investments by us will be subject to oversight by our board of directors, a majority of whom will be independent directors with no material interests in such transactions.

 

In each of our debt investments, we seek to become an influential investor, typically either through the size of our position or cooperation with other debt holders to pursue the shared goal of a beneficial debt restructuring. We actively work with other debt holders and the target company management to potentially restructure and exchange the existing debt for new securities with amended terms. We believe that a debt restructuring can be a positive outcome for not just the issuer but also its other stakeholders.

 

  For such issuers and their equity holders, a debt restructuring is typically viewed favorably by the equity markets and may result in price appreciation in the target company equity securities.

 

 

For investors in the existing debt, a restructuring is often effected through an exchange of securities at a premium to current trading levels to compel security holders to participate. The commencement of a restructuring and its perceived improvement to the company’s balance sheet represents an opportunity for investors to participate in capital appreciation that may result from a recovery in the value of the debt securities. 

  

  For the issuer, a debt restructuring can potentially improve liquidity and strengthen its balance sheet by allowing the issuer to retire debt at a discount or obtain more favorable repayment terms.

 

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We employ our Co-Optivist TM approach in executing our investment strategy, which entails taking an influential position and proactively engaging the target company management on average 24 months prior to a redemption event (typically a put or maturity event). This approach differs from traditional activist debt holders who typically wait until a company is near or at bankruptcy before beginning formal discussions regarding debt restructuring options. In addition, our strategy does not involve taking an operational role in the target company or changing management or members of the target companies’ board of directors or actively negotiating the terms of the restructuring. Rather, we look to establish a positive working relationship in assisting our target company to achieve shared goals.

 

We apply strict investment criteria to, and perform comprehensive due diligence on, each investment opportunity prior to making an investment decision. We define a base case as a situation where no debt restructuring occurs and the target company management chooses to meet the redemption event. With a successful restructuring, we see a potential for further upside in returns that could potentially exceed our base case. In connection with our investments, we actively pursue various hedging strategies to manage the volatility and risk profile of our overall investment portfolio, which may include purchasing derivatives or other securities. We do not anticipate that such equity exposure including overall hedging costs will exceed 5% of the overall portfolio.

 

Investment Selection Process

 

Our investment committee is responsible for reviewing, discussing and approving each investment idea we seek to pursue. Our investment committee meets routinely, to discuss new and existing ideas and developments on current investments. Our investment committee currently is led by Mr. Chandhoke, who also serves as our Chief Executive Officer, and Mr. Shea, a Managing Partner of VII Peaks Capital, LLC.

 

At the start of the investment selection process, the investment team distributes to the investment committee a preliminary memorandum for each investment opportunity detailing how the investment fits our investment criteria and the associated opportunities and risks of such investment. The investment committee then decides whether to expend resources and proceed with further due diligence on a particular investment opportunity. For the opportunities that are approved for further diligence, the investment team commences detailed due diligence. Upon completion of due diligence, the investment team circulates a final due diligence report to the investment committee, which will include a full investment memorandum detailing the investment opportunities and risks along with all supplemental due diligence materials and exhibits, including industry and market research, due diligence summaries and financial analyses. The investment committee reviews and discusses all materials and conducts a final vote on whether to execute on an investment. We will only make investments that are approved by a majority of the investment committee members, and no investment can be approved without the favorable vote on the investment by our Chief Executive Officer.

 

Below is a summary of our investment and approval process:

 

 

 

In addition to the investments noted above, we may invest up to 30% of our portfolio in opportunistic investments, including, but not limited to, securities of public companies that are not thinly traded and debt securities of companies located outside of the United States.

 

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Investment Exit Strategy

 

We employ a strict sell discipline to our investments. As mentioned in our investment selection process, we look for investment opportunities that provide us with the potential to generate income to support sustainable distributions, even if no restructuring of the debt occurs. If a debt restructuring has not occurred upon an investment reaching this return threshold, we will continue our efforts to drive towards a restructuring. If a successful restructuring of the target company debt occurs, we sell a portion of our holdings upon the next pre-determined sell threshold (which we estimate will be approximately twice the average current yield of high yield bonds), usually within one to two quarters after the restructuring event. At that time, depending on the market response to the proposed restructuring, we may choose to exit the entire investment or maintain a small portion to further augment returns.

 

We anticipate that it will take approximately two weeks to accumulate our position in a target company. Following that, we expect that it will take a minimum of an additional two to four weeks to approach management of the target company with a debt restructuring proposal. Assuming the target company wishes to pursue our debt restructuring proposal, we expect that the restructuring itself will take approximately three to six months to implement. At any time during this process, if we feel the target company is unwilling to pursue our debt restructuring proposal, we will seek to dispose of our position in the target company in an orderly manner. We avoid holding the discounted debt if a redemption event is approaching within six months and there is no existing evidence that this debt will be restructured.

 

Portfolio Monitoring

 

Valuation process.   Each quarter, we value investments in our portfolio, and such values are disclosed in reports filed with the SEC. Investments for which market quotations are readily available are recorded at such market quotations. With respect to investments for which market quotations are not readily available, our board of directors will determine the fair value of such investments in good faith, utilizing the input of our valuation committee, our Manager and any other professionals or materials that our board of directors deems worthy and relevant, including independent third-party valuation firms, if applicable.

 

Managerial assistance.   As a BDC, we must offer, and provide upon request, managerial assistance to certain of our portfolio companies. This assistance could involve, among other things, monitoring the operations of our portfolio companies, participating in board and management meetings, consulting with and advising officers of portfolio companies and providing other organizational and financial guidance. Depending on the nature of the assistance required, our Manager will provide such managerial assistance on our behalf to portfolio companies that request this assistance. To the extent fees are paid for these services, we, rather than our Manager, will retain any fees paid for such assistance.

 

Determination of Net Asset Value

 

We determine the net asset value of our investment portfolio each quarter. Securities that are publicly-traded are valued at the reported closing price on the valuation date. Securities that are not publicly-traded are valued at fair value as determined in good faith by our board of directors. In connection with that determination, our Manager will prepare portfolio company valuations using relevant inputs, including, but not limited to, indicative dealer quotes, values of like securities, the most recent portfolio company financial statements and forecasts, and valuations prepared by third-party valuation services.

 

With respect to investments for which market quotations are not readily available, we undertake a multi-step valuation process each quarter, as described below:

  

  our quarterly valuation process begins with each portfolio company or investment being initially valued by members of our investment committee, with such valuation taking into account information received from our independent valuation firm, if applicable;

 

  preliminary valuation conclusions are then documented and discussed with the members of our board of directors; and

 

  our board of directors discuss valuations and determine the fair value of each investment in our portfolio in good faith based on various statistical and other factors, including the input and recommendation of members of our investment committee and any third-party valuation firm, if applicable.

  

Investments are valued utilizing a market approach, an income approach, or both approaches, as appropriate. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present value amount (discounted) calculated based on an appropriate discount rate. The measurement is based on the net present value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that we take into account in fair value pricing our investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral, the portfolio company’s ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, M&A comparables, the principal market and enterprise values, among other factors.

 

We have adopted Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, Topic 820, Fair Value Measurements and Disclosures (formerly Statement of Financial Accounting Standards No. 157, Fair Value Measurements ), which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements.

 

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ASC Topic 820 clarifies that the exchange price is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. ASC Topic 820 provides a consistent definition of fair value which focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. In addition, ASC Topic 820 provides a framework for measuring fair value and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels of valuation hierarchy established by ASC Topic 820 are defined as follows:

 

Level 1:  Quoted prices in active markets for identical assets or liabilities, accessible by the company at the measurement date.

 

Level 2:  Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or other observable inputs other than quoted prices.

 

Level 3:  Unobservable inputs for the asset or liability.

 

In all cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level of input that is significant to the fair value measurement.

 

Determinations in Connection With Offerings

 

We offer our shares on a continuous basis at a current offering price of $10.15 per share; however, to the extent that our net asset value increases, we will sell at a price necessary to ensure that shares are not sold at a price per share, after deduction of selling commissions and dealer manager fees, that is below the net asset value per share. The closings are typically on a semi-monthly basis. To the extent that the net asset value per share increases subsequent to the last closing, the price per share may increase. Therefore, persons who subscribe for shares of our common stock in our continuous offering must submit subscriptions for a certain dollar amount, rather than a number of shares of common stock and, as a result, may receive fractional shares of our common stock. In connection with each closing on the sale of shares of our common stock offered pursuant to our prospectus on a continuous basis, the board of directors or a committee thereof is required within 48 hours of the time that each closing and sale is made to make the determination that we are not selling shares of our common stock at a price which, after deducting selling commissions and dealer manager fees, is below our then current net asset value per share. The board of directors or a committee thereof will consider the following factors, among others, in making such determination:

  

  the net asset value of our common stock disclosed in the most recent periodic report we filed with the SEC;

 

  our management’s assessment of whether any material change in the net asset value has occurred (including through the realization of net gains on the sale of our portfolio investments) from the period beginning on the date of the most recently disclosed net asset value to the period ending two days prior to the date of the closing on and sale of our common stock; and

 

  the magnitude of the difference between the net asset value disclosed in the most recent periodic report we filed with the SEC and our management’s assessment of any material change in the net asset value since the date of the most recently disclosed net asset value, and the offering price of the shares of our common stock at the date of closing.

  

Importantly, this determination does not require that we calculate net asset value in connection with each closing and sale of shares of our common stock, but instead it involves the determination by the board of directors or a committee thereof that we are not selling shares of our common stock at a price which, after deducting selling commissions and dealer manager fees, is below the then current net asset value at the time at which the closing and sale is made.

 

Moreover, to the extent that there is even a remote possibility that we may (i) issue shares of our common stock at a price which, after deducting selling commissions and dealer manager fees, is below the then current net asset value of our common stock at the time at which the closing and sale is made or (ii) trigger the undertaking (which we provided to the SEC in the registration statement to which our prospectus is a part) to suspend the offering of shares of our common stock pursuant to our prospectus if the net asset value fluctuates by certain amounts in certain circumstances until our prospectus is amended, the board of directors or a committee thereof will elect, in the case of clause (i) above, either to postpone the closing until such time that there is no longer the possibility of the occurrence of such event or to undertake to determine net asset value within two days prior to any such sale to ensure that such sale will not be at a price which, after deducting selling commissions and dealer manager fees, is below our then current net asset value, and, in the case of clause (ii) above, to comply with such undertaking or to undertake to determine net asset value 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 we are required to maintain under the 1940 Act. Promptly following any adjustment to the offering price per share of our common stock, we will update our prospectus by filing a prospectus supplement with the SEC. We will also make updated information available via our website.

 

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Election to be taxed as a Regulated Investment Company (RIC)

 

We have elected to be treated as a RIC under Subchapter M of the Code effective for our taxable year ended December 31, 2013, and to annually qualify as a RIC thereafter. 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 from our tax earnings and profits. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements (as described below). In addition, in order to obtain RIC tax treatment, we must distribute to our stockholders, for each taxable year, at least 90% of our “investment company taxable income,” which is generally our net ordinary income plus the excess, if any, of realized net short-term capital gain over realized net long-term capital loss, or the Annual Distribution Requirement. Even if we qualify as a RIC, we generally will be subject to corporate-level U.S. federal income tax on our undistributed taxable income and could be subject to U.S. federal excise, state, local and foreign taxes.

 

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

  

  elect to be treated as a RIC;

 

  meet the Annual Distribution Requirement;

 

  qualify to be treated as a BDC or be registered as a management investment company 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 certain securities loans, gains from the sale or other disposition of stock or other securities or currencies or other income derived with respect to our business of investing in such stock, securities or currencies and net income derived from an interest in a “qualified publicly traded partnership” (as defined in the Code), or the 90% Income Test; and

 

  diversify our holdings so that at the end of each quarter of the taxable year (i) 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 (which for these purposes includes the equity securities of a “qualified publicly traded partnership”); and (ii) 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, (i) of one issuer (ii) of two or more issuers that are controlled, as determined under applicable tax rules, by us and that are engaged in the same or similar or related trades or businesses or (iii) of one or more “qualified publicly traded partnerships,” or the Diversification Tests.

  

Provided that we qualify as a RIC and satisfy the Annual Distribution Requirement, we will not be subject to U.S. federal income tax on the portion of our investment company taxable income and net capital gain (which we define as net long-term capital gain in excess of net short-term capital loss) that we timely distribute to stockholders. We will be subject to U.S. federal income tax at the regular corporate rates on any income or capital gain not distributed (or deemed distributed) to our stockholders.

 

We will be subject to a 4% nondeductible U.S. Federal excise tax on certain undistributed income of RICs unless we distribute in a timely manner an amount at least equal to the sum of (1) 98% of our 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 U.S. federal income tax. We generally will endeavor in each taxable year to avoid any U.S. Federal excise tax on our earnings.

 

Overview of Our Manager

 

Our investment activities are managed by our Manager who is registered as an investment adviser under the Investment Advisers Act of 1940. Our Manager is responsible for sourcing potential investments, conducting research on prospective investments, analyzing investment opportunities, structuring our investments, and monitoring our investments and portfolio companies on an ongoing basis. Our Manager is led by Mr. Chandhoke, who also serves as our Chief Executive Officer, and Mr. Shea, Managing Partner of VII Peaks Capital, LLC. They are supported by the Manager’s team of employees, including investment professionals who have extensive experience in underwriting and issuing debt products that include high-yield, bank debt and convertible debt and have acted as financial advisers to private equity funds, venture capital firms and corporations in mergers and acquisitions, recapitalization and corporate finance transactions, and have served as principal investors in private equity and leveraged buyout transactions.

 

Our Manager has an investment committee that is responsible for reviewing, discussing and approving each investment opportunity we seek to pursue. Our investment committee routinely meets to discuss new and existing opportunities and developments on current investments. Our investment committee is currently led by Mr. Chandhoke, who also serves as our Chief Executive Officer, and Mr. Shea, a managing Partner of VII Peaks Capital, LLC.

 

Management Services and Responsibilities  

 

Under the terms of the investment advisory agreement, our Manager:

  

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

 

  determines what securities we will purchase, retain or sell;

 

  identifies, evaluates, negotiates and structures the investments we make; and

 

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  executes, monitors and services the investments we make.

 

Under the investment advisory agreement, the Manager has a fiduciary responsibility for the safeguarding and use of our assets. The Manager is also subject to liability under both the 1940 Act and the Advisers Act for a breach of these fiduciary duties.

  

Our Manager’s services under the investment advisory agreement may not be exclusive, and it is free to furnish similar services to other entities so long as its services to us are not impaired. In addition, our Manager performs certain administrative services under the administration agreement. See “Administration Agreement”.

 

Administration Agreement

 

Our Manager serves as our administrator. Pursuant to an administration agreement, our Manager furnishes us with office facilities, equipment, clerical, and record keeping services at such facilities. Under the administration agreement, our Manager also performs, or oversees the performance of, our required administrative services, which include, among other things, being responsible for the financial records which we are required to maintain and preparing reports to our stockholders. In addition, our Manager 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. Under the administration agreement, we are obligated to reimburse our Manager for our allocable portion of our Manager’s overhead 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 and any administrative support staff. Under the administration agreement, our Manager will also provide on our behalf managerial assistance to those portfolio companies that request such assistance. The administration agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party.

 

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 Manager and its officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated with it are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of our Manager’s services under the administration agreement or otherwise as administrator for us.

 

License Agreements

 

We have entered into a license agreement with VII Peaks under which VII Peaks has agreed to grant us a non-exclusive, royalty-free license to use the names “VII Peaks” and “Co-Optivist.” Under these agreements, we will have a right to use the “VII Peaks,” and “Co-Optivist” names for so long as our Manager or one of its affiliates remains our investment adviser. Other than with respect to these limited licenses, we will have no legal right to the “VII Peaks,” and “Co-Optivist” names. These license agreements will remain in effect for so long as the investment advisory agreement with our Manager is in effect.

 

Certain Relationship and Related Party Transactions

 

Conflicts of interest between the operation of the Company and other activities of the Manager and its affiliates and principals are expected to occur from time to time. The Manager, in its sole judgment and discretion, will try to mitigate such potential adversity by the exercise of its business judgment in an attempt to fulfill its obligations. However, the Manager has not developed, and does not expect to develop, any formal process for resolving conflicts of interest. Such conflicts may include:

 

Competing Programs

 

Conflicts of interest between us and the various roles, activities and duties of the Manager and its affiliates may occur from time to time. The Manager, its officers and other affiliates may act as a manager or general partner of other private or public entities, some of whom may have the same or a similar investment objective as the Company. As a result, conflicts of interest between us and the other activities of the Manager and its affiliates may occur from time to time. None of the agreements or arrangements, including those relating to compensation, between the Company, the Manager or their affiliates, is the result of arm’s-length negotiations. As a result, there may be conflicts between us, on the one hand, and our Manager, including members of its management team, on the other, regarding the allocation of resources to the management of our day-to-day activities.

 

Further, the officers of VII Peaks are involved in other ventures, some of which may compete with us for investment opportunities, including certain affiliated funds or managed accounts, and may be incentivized to offer investment opportunities to such other ventures rather than to us which would make it more difficult to achieve our investment objectives 

 

As a BDC, we will be subject to certain regulatory restrictions in making our investments. For example, we generally will not be permitted to co-invest with certain entities affiliated with our Manager in transactions originated by our Manager or its affiliates unless we obtain an exemptive order from the SEC or co-invest alongside our Manager or its affiliates in accordance with existing regulatory guidance and our allocation policy. Under existing regulatory guidance, we will be permitted to, and may co-invest in syndicated deals and secondary loan market transactions where price is the only negotiated point.

 

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We may seek exemptive relief from the SEC to engage in co-investment transactions with our Manager and/or its affiliates. However, there can be no assurance that we will obtain such exemptive relief, if requested. Even if we receive exemptive relief, neither our Manager nor its affiliates are obligated to offer us the right to participate in any transactions originated by them. Prior to obtaining exemptive relief, we may co-invest alongside our Manager or its affiliates only in accordance with existing regulatory guidance and our allocation policy.

 

Compensation Arrangements

 

The compensation we pay to our Manager was not entered into on an arm’s-length basis with unaffiliated third parties. As a result, the form and amount of such compensation may be less favorable to us than they might have been had they been entered into through arm’s-length transactions with unaffiliated parties. See “Investment Advisory Agreement”.

 

Affiliated Dealer Manager

 

Prior to August 20, 2013, the dealer manager for our offering was KBR Capital Markets, LLC, which was an affiliate of us and our Manager. This relationship might have created conflicts in connection with KBR Capital Markets, LLC due diligence obligations under the federal securities laws. As of August 20, 2013, the agreement with KBR was terminated due to KBR’s decision to discontinue operations. Effective September 23, 2013 Axiom Capital Management, Inc. (the “Dealer Manager”) was selected as the new dealer manager for the funds. Axiom Capital Management, Inc. is not an affiliate of the Fund or Manager.

 

Regulation

 

We have elected to be regulated as a BDC under the 1940 Act. The 1940 Act contains prohibitions and restrictions relating to transactions between BDCs and their affiliates (including any investment advisers or sub-advisers), principal underwriters and affiliates of those affiliates or underwriters and requires that a majority of the directors be persons other than “interested persons”, as that term is defined in the 1940 Act. In addition, the 1940 Act provides that we may not change the nature of our business so as to cease to be, or to withdraw our election as, a BDC unless approved by “a majority of our outstanding voting securities” as defined in the 1940 Act.

 

We may invest up to 100% of our assets in securities acquired directly from issuers in privately negotiated transactions. We do not intend to acquire securities issued by any investment company that exceed the limits imposed by the 1940 Act. Under these limits, except for registered money market funds we generally cannot acquire more than 3% of the voting stock of any investment company, invest more than 5% of the value of our total assets in the securities of one investment company or invest more than 10% of the value of our total assets in the securities of more than one investment company. With regard to that portion of our portfolio invested in securities issued by investment companies, it should be noted that such investments might subject our stockholders to additional expenses. None of our investment policies are fundamental and any may be changed without stockholder approval.

 

As a BDC, we may be periodically examined by the SEC for compliance with the 1940 Act. Our Adviser is a registered investment adviser and is also subject to examination by the SEC.

 

We are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a BDC, we are prohibited from protecting any director or officer against any liability to us or our stockholders arising from willful misconduct, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.

 

Qualifying Assets

 

Under the 1940 Act, a BDC may not acquire any asset other than assets of the type listed in section 55(a) of the 1940 Act, which are referred to as qualifying assets, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. The principal categories of qualifying assets relevant to our business are the following:

 

Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. An eligible portfolio company is defined in the 1940 Act as any issuer which:

  

  is organized under the laws of, and has its principal place of business in, the United States;

 

  is not an investment company (other than a small business investment company wholly owned by the Company) or a company that would be an investment company but for certain exclusions under the 1940 Act; and

 

  satisfies either of the following:

 

  has a market capitalization of less than $250 million or does not have any class of securities listed on a national securities exchange; or

 

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  is controlled by a BDC or a group of companies including a BDC, the BDC actually exercises a controlling influence over the management or policies of the eligible portfolio company, and, as a result thereof, the BDC has an affiliated person who is a director of the eligible portfolio company.

 

  Securities of any eligible portfolio company which we control.

 

  Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident thereto, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.

 

  Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own 60% of the outstanding equity of the eligible portfolio company.

 

  Securities received in exchange for or distributed on or with respect to securities described above, or pursuant to the exercise of warrants or rights relating to such securities.

 

  Cash, cash equivalents, U.S. Government securities or high-quality debt securities maturing in one year or less from the time of investment.

   

Managerial Assistance to Portfolio Companies

 

A BDC must have been organized and have its principal place of business in the United States and must be operated for the purpose of making investments in the types of securities described in “Regulation – Qualifying Assets” above. However, in order to count portfolio securities as qualifying assets for the purpose of the 70% test, the BDC must either control the issuer of the securities or must offer to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial assistance. Where the BDC purchases such securities in conjunction with one or more other persons acting together, the BDC will satisfy this test if one of the other persons in the group makes available such managerial assistance. Making available managerial assistance means, among other things, any arrangement whereby the BDC, through its directors, officers or employees, offers to provide, and, if accepted, does so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company.

 

Temporary Investments

 

Pending investment in other types of “qualifying assets,” as described above, our investments may consist of cash, cash equivalents, U.S. Government securities or high-quality debt securities maturing in one year or less from the time of investment, which we refer to, collectively, as temporary investments, so that 70% of our assets are qualifying assets. Typically, we invest in money market funds which invest in highly rated commercial paper, U.S. Government agency notes, U.S. Treasury bills or in repurchase agreements relating to such securities that are fully collateralized by cash or securities issued by the U.S. Government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed-upon future date and at a price which is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, certain diversification tests in order to qualify as a RIC for federal income tax purposes will typically require us to limit the amount we invest with any one counterparty. Our Manager 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 200% immediately after each such issuance. In addition, while any preferred stock or publicly traded debt securities are outstanding, we may be prohibited from making distributions to our stockholders or the repurchasing of such securities or shares unless we meet the applicable asset coverage ratios at the time of the distribution or repurchase. We may also borrow amounts up to 5% of the value of our total assets for temporary or emergency purposes without regard to asset coverage.

 

Code of Ethics

 

We and our Manager have each adopted a code of ethics pursuant to Rule 17j-1 under the 1940 Act that establishes procedures for personal investments and restricts certain personal securities transactions. Personnel subject to each code may invest in securities for their personal investment accounts, including securities that may be purchased or held by us, so long as such investments are made in accordance with the code’s requirements. You may read and copy the code of ethics at the SEC’s Public Reference Room in Washington, D.C. You may obtain information on the operation of the Public Reference Room by calling the SEC at (202) 551-8090. In addition, the code of ethics is attached as an exhibit to the registration statement of which the prospectus is a part, and is available on the EDGAR Database on the SEC’s Internet site at http://www.sec.gov . You may also obtain copies of the code of ethics, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov , or by writing the SEC’s Public Reference Section, 100 F Street, N.E., Washington, D.C. 20549.

 

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Compliance Policies and Procedures

 

We have adopted and implemented written policies and procedures reasonably designed to prevent violation of the federal securities laws. We are required to review these compliance policies and procedures annually for their adequacy and the effectiveness of their implementation. Our Chief Compliance Officer is responsible for administering these policies and procedures.

 

Proxy Voting Policies and Procedures

 

We have delegated our proxy voting responsibility to our Manager. The Proxy Voting Policies and Procedures of our Manager are set forth below. The guidelines are reviewed periodically by our Manager and our independent directors, and, accordingly, are subject to change.

 

Introduction

 

Our Manager is registered with the SEC as an investment adviser registered under the Advisers Act. As an investment advisor registered under the Advisers Act, our Manager has fiduciary duties to us. As part of this duty, our Manager recognizes that it must vote client securities in a timely manner free of conflicts of interest and in our best interests and the best interests of our stockholders. Our Manager’s Proxy Voting Policies and Procedures have been formulated to ensure decision-making consistent with these fiduciary duties.

 

These policies and procedures for voting proxies for our investment advisory clients are intended to comply with Section 206 of, and Rule 206(4)-6 under, the Advisers Act.

 

Proxy Policies

 

Our Manager evaluates routine proxy matters, such as proxy proposals, amendments or resolutions on a case-by-case basis. Routine matters are typically proposed by management and our Manager will normally support such matters so long as they do not measurably change the structure, management control, or operation of the corporation and are consistent with industry standards as well as the corporate laws of the state of incorporation.

 

Our Manager also evaluates non-routine matters on a case-by-case basis. Non-routine proposals concerning social issues are typically proposed by stockholders who believe that the corporation’s internally adopted policies are ill-advised or misguided. If our Manager has determined that management is generally socially responsible, our Manager will generally vote against these types of non-routine proposals. Non-routine proposals concerning financial or corporate issues are usually offered by management and seek to change a corporation’s legal, business or financial structure. Our Manager will generally vote in favor of such proposals provided the position of current stockholders is preserved or enhanced. Non-routine proposals concerning stockholder rights are made regularly by both management and stockholders. They can be generalized as involving issues that transfer or realign board or stockholder voting power. Our Manager typically would oppose any proposal aimed solely at thwarting potential takeovers by requiring, for example, super-majority approval. At the same time, our Manager believes stability and continuity promote profitability. Our Manager’s guidelines in this area seek a middle road and individual proposals will be carefully assessed in the context of their particular circumstances. If a vote may involve a material conflict of interest, prior to approving such vote, our Manager must consult with its Chief Compliance Officer to determine whether the potential conflict is material and if so, the appropriate method to resolve such conflict. If the conflict is determined not to be material, our Manager’s employees shall vote the proxy in accordance with our Manager’s proxy voting policy.

 

Proxy Voting Records

 

You may obtain information about how we voted proxies by making a written request for proxy voting information to:

 

Chief Compliance Officer

VII Peaks Co-Optivist Income BDC II, Inc.

100 Pine Street, Suite 500

San Francisco, California 94111

 

Available Information

 

We have filed a registration statement with the SEC on Form N-2, including amendments, relating to the shares we are offering. We have filed a prospectus with the SEC. The prospectus does not contain all of the information set forth in the registration statement, including any exhibits and schedules it may contain. For further information concerning us or the shares we are offering, please refer to the registration statement and prospectus. Statements contained in the prospectus and this 10-K as to the contents of any contract or other document referred to are not necessarily complete and in each instance reference is made to the copy of any contract or other document filed as an exhibit to the registration statement or prospectus. Each statement is qualified in all respects by this reference. Any stockholder and its designated representative are permitted access to our records to which it is entitled under applicable law by all reasonable times, and may inspect and copy any of them for a reasonable charge. Please see our charter and bylaws for additional information regarding stockholders’ rights to access our records.

 

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We are required to file with or submit to the SEC annual, quarterly and current periodic reports, proxy statements and other information meeting the informational requirements of the Securities Exchange Act of 1934. You may inspect and copy these reports, proxy statements and other information, as well as the registration statement and prospectus with all related exhibits and schedules at the Public Reference Room of the SEC at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Copies of these reports, proxy and information statements and other information may be obtained, after paying a duplicating fee, by electronic request at the following e-mail address: publicinfo@sec.gov, or by writing the SEC’s Public Reference Section, Washington, D.C. 20549-0102. In addition, the SEC maintains an Internet website that contains reports, proxy and information statements and other information filed electronically by us with the SEC at http://www.sec.gov.

 

  Our Manager provides quarterly reports to shareholders within 60 days after the end of each quarter. Our manager shall also provide an annual report to shareholders within 120 days after the end of each fiscal year. These reports will also be available on the SEC’s website at www.sec.gov. These reports should not be considered a part of or as incorporated by reference in the prospectus or registration statement of which the prospectus is a part.

 

ITEM 1A. RISK FACTORS

 

An investment in shares of our common stock involves a high degree of risk and may be considered speculative. The risks set forth below are not the only risks we face. If any of the following risks occur, our business and financial condition could be materially adversely affected. In such case, the net asset value of our common stock could decline, and you may lose all or part of your investment.

  

Risks Related to Our Business and Structure 

 

We are a recently formed entity with limited operating history and revenues, and you have a limited `basis on which to evaluate our ability to achieve our business objectives.

 

We were formed on 2011, and commenced operations in July 2012 when we raised an aggregate of $1.0 million from investors unaffiliated with us or our Manager. Because we lack an extended operating history, there is a limited basis on which to evaluate our ability to achieve our business objectives. We are subject to all of the business risks and uncertainties associated with any new business, including the risk that we will not achieve our investment objectives and that the value of our common shares could decline substantially.

 

We face competition for investment opportunities.

 

We face competition for investment opportunities from a range of competitors, including mutual funds, private equity, hedge funds, and leveraged buyout funds. Many of these entities may have greater financial resources than we do or access to financing on more favorable terms than we will. These entities could make it more difficult or expensive to make investments in the debt securities of our target company at appropriate price levels.

 

We face competition for assets to manage.

 

We face competition from a range of competitors, including mutual funds, private equity, hedge funds, and leveraged buyout funds, for assets to manage. Many of these entities may have greater financial resources than we do or access to financing on more favorable terms than we will. Our operating expenses are relatively fixed, and therefore we will have a higher expense ratio, which will decrease returns to shareholders, to extent we are unable to increase the amount of assets that we manage.

  

Our board of directors has full authority and discretion over the timing and amount of distributions we make, and it may decide to reduce or eliminate distributions at any time, which may have an adverse affect on your investment.

 

To the extent that we have income available, we will continue to authorize and declare distributions with record and payment dates distributions on a semi-monthly basis to our shareholders. Our distributions, if any, will be determined by our board of directors. There can be no assurances that we will be able to make distributions or, to the extent we make distributions, the level of distributions declared and paid to our shareholders or our ability to pay distributions. The target companies in which we invest will generally have near-term liquidity issues that make investments in them highly speculative. If one or more of our investments in our target companies is not successful, it may adversely impact our ability to make distributions to shareholders.

 

If we are unsuccessful in raising significant proceeds in our ongoing, continuous “best efforts” public offering, we will be limited in the number and type of investments we may make, and the value of your investment in us may be reduced in the event our assets under-perform.

 

Our continuous offering is being made on a best efforts basis, whereby the dealer manager and broker-dealers participating in the offering are only required to use their best efforts to sell our shares and have no firm commitment or obligation to purchase any of the shares. To the extent that less than the maximum number of shares is subscribed for, the opportunity for the allocation of our investments among various issuers and industries may be decreased, and the returns achieved on those investments may be reduced as a result of allocating all of our expenses over a smaller capital base.

 

Purchases of debt securities of financially stressed companies create an enhanced risk of substantial loss or loss of entire investment.

 

We may purchase debt securities of companies that are experiencing significant financial or business stress, including companies involved in bankruptcy or other reorganization and liquidation proceedings. Such purchases involve a substantial degree of risk and may not show any return for a considerable period of time. In fact, many of these instruments ordinarily remain unpaid unless and until the company reorganizes and/or emerges from bankruptcy proceedings, and as a result may have to be held for an extended period of time. The level of analytical sophistication, both financial and legal, necessary for successful investment in companies experiencing significant business and financial stress is unusually high. There is no assurance that we will correctly evaluate the nature and magnitude of the various factors that could affect the prospects for a successful reorganization or similar action. In any reorganization or liquidation proceeding relating to a company in which we invest, we may lose our entire investment or may be required to accept cash or securities with a value less than our original investment. Under such circumstances, the returns generated from our investments may not compensate shareholders adequately for the risks assumed.

 

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Resources could be expended in researching investment opportunities that are not consummated, which could materially adversely affect subsequent attempts to locate and invest in other businesses.

 

It is anticipated that the investigation of each specific target company and the negotiation, drafting, and execution of relevant agreements, disclosure documents, and other instruments necessary to restructure and de-lever their balance sheets will require substantial management time and attention and substantial costs for accountants, attorneys, and others. If a decision is made not to complete a specific investment, the costs incurred up to that point for the proposed transaction may not be recoverable. Furthermore, even if an agreement is reached relating to a specific target company, we may fail to consummate the transaction for any number of reasons including those beyond our control. Any such event will result in a loss to us of the related costs incurred which could materially adversely affect subsequent attempts to locate additional investment opportunities.

 

The recovery from the 2008 and 2009 recession remains challenging.

 

Beginning in the third quarter of 2007, global credit and other financial markets suffered substantial stress, volatility, illiquidity and disruption. These forces reached extraordinary levels in late 2008, resulting in the bankruptcy of, the acquisition of, or government intervention in the affairs of several major domestic and international financial institutions. In particular, the financial services sector was negatively impacted by significant write-offs as the value of the assets held by financial firms declined, impairing their capital positions and abilities to lend and invest. We believe that such value declines were exacerbated by widespread forced liquidations as leveraged holders of financial assets, faced with declining prices, were compelled to sell to meet margin requirements and maintain compliance with applicable capital standards. Such forced liquidations also impaired or eliminated many investors and investment vehicles, leading to a decline in the supply of capital for investment and depressed pricing levels for many assets. These events significantly diminished overall confidence in the debt and equity markets, engendered unprecedented declines in the values of certain assets, and caused extreme economic uncertainty.

 

According to a D&B Global Economic Outlook, economic activity following the 2008 – 2009 recession will continue to make slow progress over the next five years. The significant restructuring of the US private sector is a chief driver, resulting in slowing bankruptcies across most sectors and improved payment performance. Furthermore, the boom in unconventional gas and oil in the US is driving down energy prices, boosting business confidence and supporting growth in key sectors. Despite this cautious optimism, a number of risks remain including high levels of debt, particularly in the public sector. The increase in public sector debt since 2008 is concerning, as governments ramped up spending to boost the economic growth. As a result, government spending in many countries will remain constrained and tax levels high over the next few years a governments attempt to balance their books. This will, in turn, constrain growth in economies such as the US, where private sector restructuring has begun. There also may be some longer-term unintended consequences of quantitative easing policies, including excessive risk-taking. Already, yields between high-risk bonds and US treasuries are narrowing, stock markets have boomed in many countries, speculative activity in commodity markets are keeping prices higher than fundamentals would dictate.

 

A potential downgrade in the U.S.’s credit rating by a second rating agency and very slow growth with continued high unemployment in Europe could materially adversely affect our business, financial condition and results of operations.

 

On August 5, 2011, Standard & Poor’s downgraded the U.S.’s credit rating to AA+ from its top rank of AAA, resulting in an immediate drop in the Dow of 2,000 and gold soaring to $1,895 an ounce. Standard & Poor’s downgrading was largely due to lack of political backbone to come together to reduce spending and debt and balance the budget, while keeping the economy growing. The current U.S. debt ceiling and budget deficit concerns have increased the possibility of further credit-rating agency downgrades, such as from Fitch Ratings, warning that the repeated casting of uncertainty over the full faith and credit of the U.S. risks undermines confidence in the U.S. Dollar. On the plus side, Fitch Rating is considering the U.S economy has experienced a 1.9% GDP growth in 2013, according the Bureau of Economic Analysis advance estimates, with projections for a 3% GDP growth in 2014, according to the Congressional Budget Office. Further, the U.S. dollar is still the most liquid in the world. On the minus side for a potential Fitch Rating downgrade, Fitch has indicated that the continued political environment is not a characteristic of an AAA sovereign. Additionally, Fitch Ratings noted that the U.S. is the most heavily indebted AAA rated sovereign, with a gross debt ratio equivalent to double that of the AAA median. The potential downgrade from Fitch Ratings with the current S&P rating of the U.S.’s credit, together with signs of deteriorating sovereign debt and conditions in Europe, could have a material adverse effect on the financial markets and economic conditions in the U.S. and throughout the world. Additionally, austerity measures necessary to reduce the U.S.’s deficit could accelerate an already slowing U.S. economy in the near term.

 

The U.S.’s S&P credit rating downgrade and potential same from Fitch Ratings could negatively impact the trading market for U.S. government securities and would likely impact the credit risk associated with our investments in U.S. Treasury securities. This could reduce the value of the U.S. Treasury securities that we may hold in our portfolio. In addition, adverse market and economic conditions that could occur due to a downgrade of the U.S.’s credit rating on the U.S.’s debt could result in rapidly rising interest rates, a falling dollar, shakier financial markets and slowing or negative economic growth in the near term. These events could adversely affect our business in many ways, including, but not limited to, adversely impacting our portfolio companies’ ability to obtain financing, or obtaining financing but at significantly lower valuations than the preceding financing rounds. If any of these events were to occur, it could materially adversely affect our business, financial condition and results of operations

 

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A substantial portion of our investment portfolio may be recorded at fair value as determined in good faith by our board of directors and, as a result, there will 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 our board of directors. We expect that a substantial portion of our investments will not trade on a national securities exchange or actively trade on a secondary market, but instead will trade on a privately negotiated over-the-counter secondary market for institutional investors. As a result, we will value these securities quarterly at fair value as determined in good faith by our board of directors.

 

Certain factors that may be considered in determining the fair value of our investments include the nature and realizable value of any collateral, the portfolio company’s earnings and its ability to make payments on its indebtedness, the markets in which the portfolio company does business, comparison to comparable publicly-traded companies, discounted cash flow and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these non-traded 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 upon the sale of one or more of our investments.

 

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

 

We and our portfolio companies are subject to regulation at the local, state and federal level. New legislation may be enacted or new interpretations, rulings or regulations could be adopted, including those governing the types of investments we are permitted to make, any of which could harm us and our shareholders, 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 to avail ourselves of new or different opportunities. Such changes could result in material differences to our strategies and plans as set forth in our prospectus and may result in our investment focus shifting from the areas of expertise of our Manager to other types of investments in which our Manager 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.

 

As a public company, we are subject to regulations not applicable to private companies, such as provisions of the Sarbanes-Oxley Act. Efforts to comply with such regulations will involve significant expenditures, and non-compliance with such regulations may adversely affect us. 

 

We are subject to regulations not applicable to private companies, including provisions of the Sarbanes-Oxley Act and the related rules and regulations promulgated by the SEC. Beginning with our fiscal year ending December 31, 2013, our management will be required to report on our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act and rules and regulations of the SEC thereunder. We will be required to review on an annual basis our internal control over financial reporting, and on a quarterly and annual basis, to evaluate and disclose changes in our internal control over financial reporting. As a newly-formed company, developing an effective system of internal controls may require significant expenditures, which may negatively impact our financial performance and our ability to make distributions. This process will also result in a diversion of management’s time and attention. We cannot be certain as to the timing of the completion of our evaluation, testing and remediation actions or the impact of the same on our operations and we may not be able to ensure that the process is effective or that our internal control over financial reporting is or will be effective in a timely manner. In the event that we are unable to develop or maintain an effective system of internal controls and maintain or achieve compliance with the Sarbanes-Oxley Act and related rules, we may be adversely affected.

 

The impact of recent financial reform legislation on us is uncertain.

 

In light of current conditions in the U.S. and global financial markets and the U.S. and global economy, legislators, the presidential administration and regulators have increased their focus on the regulation of the financial services industry. The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, institutes a wide range of reforms that will have an impact on all financial institutions. Many of the requirements called for in the Dodd-Frank Act will be implemented over time, most of which will be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full impact such requirements will have on our business, results of operations or financial condition is unclear. The changes resulting from the Dodd-Frank Act may require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements. Failure to comply with any such laws, regulations or principles, or changes thereto, may negatively impact our business, results of operations and financial condition. While we cannot predict what effect any changes in the laws or regulations or their interpretations would have on us as a result of the Dodd-Frank Act, these changes could be materially adverse to us and our shareholders.

 

We may experience fluctuations in our quarterly results.

 

We could experience fluctuations in our quarterly operating results due to a number of factors, including our ability or inability to make investments in companies that meet our investment criteria, the interest rate payable on the debt securities we acquire, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. As a result of these factors, results for any previous period should not be relied upon as being indicative of performance in future periods.

 

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Your interest in us will be diluted if we issue additional shares, which could reduce the overall value of an investment in us.

 

Potential investors will not have preemptive rights to any shares we issue in the future. Our certificate of incorporation authorizes us to issue 200,000,000 shares of common stock. Pursuant to our certificate of incorporation, a majority of our entire board of directors may amend our certificate of incorporation to increase the number of authorized shares without shareholder approval. To the extent we issue additional equity interests after an investor purchases shares of our common stock, an investor’s percentage ownership interest in us will be diluted. In addition, depending upon the terms and pricing of any additional offerings and the value of our investments, an investor may also experience dilution in the book value and fair value of his/her shares.

 

We may acquire various structured financial instruments for purposes of “hedging” or reducing our risks, which may be costly and ineffective and could reduce our cash available for distribution to our stockholders.

 

We may seek to hedge against interest rate and currency exchange rate fluctuations and credit risk by using structured financial instruments such as futures, options, swaps and forward contracts, subject to the requirements of the 1940 Act. Use of structured financial instruments for hedging purposes may present significant risks, including the risk of loss of the amounts invested. Defaults by the other party to a hedging transaction can result in losses in the hedging transaction. Hedging activities also involve the risk of an imperfect correlation between the hedging instrument and the asset being hedged, which could result in losses both on the hedging transaction and on the instrument being hedged. Use of hedging activities may not prevent significant losses and could increase our losses. Further, hedging transactions may reduce cash available to pay distributions to our stockholders.

 

If we internalize our management functions, your interest in us could be diluted, and we could incur other significant costs associated with being self-managed.

 

Our board of directors may decide in the future to internalize our management functions. If we do so, we may elect to negotiate to acquire our Manager’s assets and personnel. At this time, we cannot anticipate the form or amount of consideration or other terms relating to any such acquisition. Such consideration could take many forms, including cash payments, promissory notes and shares of our common stock. The payment of such consideration could result in dilution of your interests as a stockholder and could reduce the earnings per share attributable to your investment.

 

In addition, while we would no longer bear the costs of the various fees and expenses we expect to pay to our Manager under the investment advisory agreement, we would incur the compensation and benefits costs of our officers and other employees and consultants that are being paid by our Manager or its affiliates. In addition, we may issue equity awards to officers, employees and consultants. These awards would decrease net income and may further dilute your investment. We cannot reasonably estimate the amount of fees we would save or the costs we would incur if we became self-managed. If the expenses we assume as a result of an internalization are higher than the expenses we avoid paying to our Manager, our earnings per share would be lower as a result of the internalization than it otherwise would have been, potentially decreasing the amount of funds available to distribute to our stockholders and the value of our shares. As we are currently organized, we do not have any employees. If we elect to internalize our operations, we would employ personnel and would be subject to potential liabilities commonly faced by employers, such as workers disability and compensation claims and other employee-related liabilities and grievances.

 

If we internalize our management functions, we could have difficulty integrating these functions as a standalone entity. Currently, individuals employed by our Manager and its affiliates perform asset management and general and administrative functions, including accounting and financial reporting, for multiple entities. These personnel have a great deal of know-how and experience. We may fail to properly identify the appropriate mix of personnel and capital needs to operate as a stand-alone entity. An inability to manage an internalization transaction effectively could thus result in our incurring excess costs and/or suffering deficiencies in our disclosure controls and procedures or our internal control over financial reporting. Such deficiencies could cause us to incur additional costs, and our management’s attention could be diverted from effectively managing our investments.

 

In recent years, management internalization transactions have been the subject of shareholder litigation. Shareholder litigation can be costly and time-consuming, and there can be no assurance that any litigation expenses we might incur if we were to internalize our management functions would not be significant or that the outcome of litigation would be favorable to us. Any amounts we are required to expend defending any such litigation will reduce our net investment income.

 

Security breaches and other disruptions could compromise our and our Manager’s information and expose us and our Manager to liability, which would cause our business and reputation to suffer.

 

 In the ordinary course of our business, we and our Manager store sensitive data, including our proprietary business information and that of our portfolio companies, and personally identifiable information of our directors, officers and other employees, in our and our Manager’s data centers and networks. The secure processing, maintenance and transmission of this information is important to our and our Manager’s operations and business strategy. Despite our security measures, our and our Manager’s information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. Any such breach could compromise our and our Manager’s networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, and regulatory penalties, disrupt our operations, and damage our and our Manager’s reputations, and cause a loss of confidence in us and our Manager’s products and services, which could adversely affect our business.

 

Risks Related to our Manager

 

Our Manager has limited prior experience managing a BDC or a RIC.

 

Our Manager is a new entity and has limited prior experience managing a BDC or a RIC. Similarly, members of our Manager’s management team, including our Chief Executive Officer and our Chief Financial Officer, have no prior experience managing a BDC or RIC. Therefore, our Manager and its management team may not be able to successfully operate our business or achieve our investment objectives. As a result, an investment in our shares may entail more risk than the shares of a comparable company with a substantial operating history.

 

The 1940 Act and the Code impose numerous constraints on the operations of BDCs and RICs that do not apply to the other types of investment vehicles. For example, under the 1940 Act, BDCs are required to invest at least 70% of their total assets primarily in securities of qualifying U.S. private or thinly traded companies. Moreover, qualification for RIC tax treatment under subchapter M of the Code requires satisfaction of source-of-income, diversification and other requirements. The failure to comply with these provisions in a timely manner could prevent us from qualifying as a BDC or a RIC or could force us to pay unexpected taxes and penalties, which could be material. Our Manager has no experience managing a BDC or RIC. Its lack of experience in managing a portfolio of assets under such constraints may hinder its ability to take advantage of attractive investment opportunities and, as a result, achieve our investment objectives.

 

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Members of our Manager’s management team may engage in other activities that compete with us.

 

The officers of our Manager anticipate devoting a significant portion of their time to the affairs of our Manager and performing services for other entities. As a result, there may be conflicts between us, on the one hand, and our Manager, including members of its management team, on the other, regarding the allocation of resources to the management of our day-to-day activities.

 

Further, the officers of VII Peaks are involved in other ventures, some of which may compete with us for investment opportunities and may be incentivized to offer investment opportunities to such other ventures rather than to us which would make it more difficult to achieve our investment objectives.

  

In addition, the officers of Axiom may also be involved in other ventures, some of which may compete with us for investment opportunities.

 

Our Manager will receive compensation regardless of profitability.

 

Our Manager is entitled to receive certain fees and other compensation, payments and reimbursements regardless of us being profitable. For example, we will pay our Manager an annualized management fee calculated as follows and payable monthly in arrears:

  

  2.00% if our net assets are below $100 million;

 

  1.75% if our net assets are between $100 million and $250 million; and

 

  1.50% if our net assets are above $250 million.

 

The management fee will be calculated based on the net asset value of our assets under management as of the last business day of each month and paid monthly in arrears.

 

We may be obligated to pay our Manager incentive compensation even if we incur a net loss due to a decline in the value of our portfolio.

 

 Our investment advisory agreement entitles our Manager to receive an incentive fee based on our net investment income regardless of any capital losses. In such case, we may be required to pay our Manager an incentive fee for a fiscal quarter even if there is a decline in the value of our portfolio or if we incur a net loss for that quarter. Any incentive fee payable by us that relates to our net investment income may be computed and paid on income that may include interest that has been accrued but not yet received. If a portfolio company defaults on a loan that is structured to provide accrued interest, it is possible that accrued interest previously included in the calculation of the incentive fee will become uncollectible. Our Manager is not obligated to reimburse us for any part of the incentive fee it received that was based on accrued income that we never received as a result of a subsequent default. Such circumstances would result in us paying an incentive fee on income we never receive captured in one reporting period, with the related reduction in the incentive fee paid in the subsequent period.

 

For federal income tax purposes, we are required to recognize taxable income in some circumstances in which we do not receive a corresponding payment in cash (such as deferred interest that is accrued as original issue discount) and to make distributions with respect to such income to maintain our status as a RIC. Under such circumstances, we may have difficulty meeting the annual distribution requirement necessary to obtain and maintain RIC tax treatment under the Code. This difficulty in making the required distribution may be amplified to the extent that we are required to pay an incentive fee with respect to such accrued income. As a result, 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 for this purpose. If we are not able to obtain cash from other sources, we may fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax.

 

Our incentive fee may induce our Manager to make speculative investments.

 

The incentive fee payable by us to our Manager may create an incentive for it to make investments on our behalf that are risky or more speculative than would be the case in the absence of such compensation arrangement. The way in which the incentive fee payable to our Manager is determined may encourage it to use leverage to increase the return on our investments.

 

Shares of our common stock may be purchased by the Manager or its affiliates.

 

Our Manager and its affiliates may purchase shares of our common stock for any reason deemed appropriate; provided, however, that the Manager and its affiliates will not purchase or hold more than 5% of our outstanding shares of common stock. The Manager and its affiliates will not acquire any shares of our common stock with the intention to resell or re-distribute such shares. The purchase of shares by the Manager or its affiliates could create certain risks, including, but not limited to, the following:

  

  the Manager or its affiliates may have an interest in disposing of our assets at an earlier date so as to recover their investment in our shares; and

 

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  substantial purchases of shares by the Manager or its affiliates may limit the Manager’s ability to fulfill any financial obligations that it may have to or on our behalf.

 

Our Manager relies on key personnel, the loss of any of whom could impair its ability to successfully manage us.

 

Our future success depends, to a significant extent, on the continued services of the employees of our Manager or its affiliates. The loss of services of one or more members of our Manager’s management team, including members of our investment committee, could adversely affect our financial condition, business and results of operations.

 

The compensation we pay to our Manager was determined without independent assessment on our behalf, and these terms may be less advantageous to us than if they had been the subject of arm’s-length negotiations.

 

The compensation we pay to our Manager was not entered into on an arm’s-length basis with an unaffiliated third party. As a result, the form and amount of such compensation may be less favorable to us than they might have been had they been entered into through arm’s-length transactions with an unaffiliated third party. However, we believe that the terms of the base management fee that we pay our Manager is generally more favorable to us than what most or all other externally-managed BDC’s pay their manager, and the terms of the incentive fee on income and capital gains are roughly the same as what other externally-managed BDC’s pay their manager.

 

Our Manager’s influence on conducting our operations, including on our conducting of transactions, gives it the ability to increase its fees, which may reduce the amount of cash flow available for distribution to our shareholders.

 

Our Manager is paid a management fee calculated as a percentage of our net assets and is unrelated to net income or any other performance base or measure. Our Manager may advise us to consummate transactions or conduct our operations in a manner that, in our Manager’s reasonable discretion, are in the best interests of our shareholders. These transactions, however, may increase the amount of fees paid to our Manager. Our Manager’s ability to influence the management fee paid to it by us could reduce the amount of cash flow available for distribution to our shareholders.

 

Risks Related to Business Development Companies

 

The requirement that we invest a sufficient portion of our assets in qualifying assets could preclude us from investing in accordance with our current business strategy; conversely, the failure to invest a sufficient portion of our assets in qualifying assets could result in our failure to maintain our status as a BDC.

 

As a BDC, we may not acquire any assets other than “qualifying assets” unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets are qualifying assets. Therefore, we may be precluded from investing in what we believe are attractive investments if such investments are not qualifying assets. Conversely, if we fail to invest a sufficient portion of our assets in qualifying assets, we could lose our status as a BDC, which would have a material adverse effect on our business, financial condition and result of operations. Similarly, these rules could prevent us from making additional investments in existing portfolio companies, which could result in the dilution of our position, or could require us to dispose of investments at an inopportune time to comply with the 1940 Act. If we were forced to sell non-qualifying investments in the portfolio for compliance purposes, the proceeds from such sale could be significantly less than the current value of such investments.

 

Failure to maintain our status as a BDC would reduce our operating flexibility.

 

If we do not remain a BDC, we might be regulated as a registered closed-end investment company under the 1940 Act, which would subject us to substantially more regulatory restrictions under the 1940 Act and correspondingly decrease our operating flexibility.

 

Regulations governing our operation as a BDC and RIC will affect our ability to raise, and the way in which we raise, additional capital or borrow for investment purposes, which may have a negative effect on our growth.

 

As a result of the annual distribution requirement to qualify as a RIC, we may need to periodically access the capital markets to raise cash to fund new investments. We may issue “senior securities,” including borrowing money from banks or other financial institutions only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after such incurrence or issuance. Our ability to issue different types of securities is also limited. Compliance with these requirements may unfavorably limit our investment opportunities and reduce our ability in comparison to other companies to profit from favorable spreads between the rates at which we can borrow and the rates at which we can lend. As a BDC, therefore, we continuously issue equity at a rate more frequent than our privately owned competitors, which may lead to greater shareholder dilution.

 

Although we do not currently use any leverage, we reserve the right to utilize leverage to generate capital to make additional investments. If the value of our assets declines, we may be unable to satisfy the asset coverage test under the 1940 Act, which could prohibit us from paying distributions and could prevent us from qualifying as a RIC. If we cannot satisfy the asset coverage test, we may be required to sell a portion of our investments and, depending on the nature of our debt financing, repay a portion of our indebtedness at a time when such sales and repayments may be disadvantageous.

 

Under the 1940 Act, we generally are prohibited from issuing or selling our shares at a price below net asset value per share, which may be a disadvantage as compared with other public companies. We may, however, sell our shares, or warrants, options or rights to acquire our shares, at a price below the current net asset value of the shares if our board of directors and independent directors determine that such sale is in our best interests and the best interests of our shareholders, and our shareholders as well as those shareholders that are not affiliated with us 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 of directors, closely approximates the fair value of such securities.

 

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Our ability to enter into transactions with our affiliates will be restricted.

 

We are prohibited under the 1940 Act from participating in certain transactions with certain of our affiliates without the prior approval of a majority of the independent members of our board of directors and, in some cases, the SEC. Any person that owns, directly or indirectly, 5% or more of our outstanding voting securities is considered our affiliate for purposes of the 1940 Act and we are generally prohibited from buying or selling any securities from or to such affiliate, absent the prior approval of our board of directors. The 1940 Act also prohibits certain “joint” transactions with certain of our affiliates, which could include investments in the same portfolio company (whether at the same or different times), without prior approval of our board of directors and, in some cases, the SEC. If a person acquires more than 25% of our voting securities, we will be prohibited from buying or selling any security from or to such person or certain of that person’s affiliates, or entering into prohibited joint transactions with such persons, absent the prior approval of the SEC or adherence to certain interpretive advice from the SEC. Similar restrictions limit our ability to transact business with our officers or directors or their affiliates. As a result of these restrictions, we may be prohibited from buying or selling any security from or to any portfolio company of a private equity fund managed by our Manager 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.

 

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. To the extent that we assume large positions in the securities of a small number of issuers, or within a particular industry, 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. However, we will be subject to the diversification requirements applicable to RICs under Subchapter M of the Code.

 

 Risks Related to our Target Investments

 

Our investments in prospective portfolio companies may be risky, and we could lose all or part of our investment.

 

We intend to invest primarily in senior secured loans, second lien secured loans and subordinated debt of private U.S. companies. We may also invest in equity securities or securities of foreign companies.

 

Senior secured loans and second lien secured loans. There is a risk that any collateral pledged by portfolio companies in which we have taken a security interest may decrease in value over time or lose its entire value, 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. To the extent our debt investment is collateralized by the securities of a portfolio company’s subsidiaries, such securities may lose some or all of their value in the event of the bankruptcy or insolvency of the portfolio company. Also, in some circumstances, our security interest may be contractually or structurally 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. Loans that are under-collateralized involve a greater risk of loss. Consequently, the fact that a loan is secured does not guarantee that we will receive principal and interest payments according to the loan’s terms, or at all, or that we will be able to collect on the loan should we be forced to enforce our remedies.

 

Subordinated debt. Our subordinated debt investments will generally rank junior in priority of payment to senior loans and will generally be unsecured. This may result in a heightened level of risk and volatility or a loss of principal, which could lead to the loss of the entire investment. These investments may involve additional risks that could adversely affect our investment returns. To the extent interest payments associated with such debt are deferred, such debt may be subject to greater fluctuations in valuations, and such debt could subject us and our stockholders to non-cash income. Since we will not receive any principal repayments prior to the maturity of some of our subordinated debt investments, such investments will be of greater risk than amortizing loans.

 

Equity investments. We expect to make select equity investments. In addition, when we invest in senior secured and second lien secured loans or subordinated debt, we may acquire warrants to purchase equity securities. 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.

 

Non-U.S. securities. We may invest in non-U.S. securities, which may include securities denominated in U.S. dollars or in non-U.S. currencies, to the extent permitted by the 1940 Act. Because evidences of ownership of such securities usually are held outside the United States, we would be subject to additional risks if we invested in non-U.S. securities, which include possible adverse political and economic developments, seizure or nationalization of foreign deposits and adoption of governmental restrictions which might adversely affect or restrict the payment of principal and interest on the non-U.S. securities to investors located outside the country of the issuer, whether from currency blockage or otherwise. Since non-U.S. securities may be purchased with and payable in foreign currencies, the value of these assets as measured in U.S. dollars may be affected unfavorably by changes in currency rates and exchange control regulations.

 

In addition, we invest in securities that are rated below investment grade by rating agencies or that would be rated below investment grade if they were rated. Below investment grade securities, which are often referred to as “junk,” have predominantly speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal. They may also be difficult to value and illiquid.

 

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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 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 proceeds. After repaying such senior creditors, such portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of debt ranking equally with debt 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.

 

There may be circumstances where our debt investments could be subordinated to claims of other creditors or we could be subject to lender liability claims.

 

If one of our portfolio companies were to go bankrupt, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might recharacterize our debt investment and subordinate all or a portion of our claim to that of other creditors. In situations where a bankruptcy carries a high degree of political significance, our legal rights may be subordinated to other creditors. We may also be subject to lender liability claims for actions taken by us with respect to a borrower’s business or in instances where we exercise control over the borrower or render significant managerial assistance.

 

Second priority liens on collateral securing debt investments that we own 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 debt investments that we own may be secured on a second priority basis by the same collateral securing first priority debt of such companies. The first priority liens on the collateral will secure the portfolio company’s obligations under any outstanding senior debt and may secure certain other future debt that may be permitted to be incurred by such company under the agreements governing the loans. The holders of obligations secured by the first priority liens on the collateral will generally control the liquidation of and be entitled to receive proceeds from any realization of the collateral to repay their obligations in full before us. In addition, the value of the collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. There can be no assurance that the proceeds, if any, from the sale or sales of all of the collateral would be sufficient to satisfy the debt obligations secured by the second priority liens after payment in full of all obligations secured by the first priority liens on the collateral. If such proceeds are not sufficient to repay amounts outstanding under the debt obligations secured by the second priority liens, then we, to the extent not repaid from the proceeds of the sale of the collateral, will only have an unsecured claim against such company’s remaining assets, if any.

 

The rights we may have with respect to the collateral securing the debt investments we own with senior debt outstanding may also be limited pursuant to the terms of one or more intercreditor agreements that we enter into with the holders of senior debt. Under such an intercreditor agreement, at any time that obligations that have the benefit of the first priority liens are outstanding, any of the following actions that may be taken in respect of the collateral will be at the direction of the holders of the obligations secured by the first priority liens: the ability to cause the commencement of enforcement proceedings against the collateral; the ability to control the conduct of such proceedings; the approval of amendments to collateral documents; releases of liens on the collateral; and waivers of past defaults under collateral documents. We may not have the ability to control or direct such actions, even if our rights are adversely affected.

  

We do not expect to control our portfolio companies.

 

We do not expect to control our portfolio companies. As a result, we are subject to the risk that a portfolio company in which we invest may make business decisions with which we disagree and the management of such company, as representatives of the holders of their common equity, may take risks or otherwise act in ways that do not serve our interests as debt investors. Due to the limited liquidity for our debt investments in our portfolio companies, we may not be able to dispose of our interests in our portfolio companies as readily as we would like or at an appropriate valuation. As a result, a portfolio company may make decisions that could decrease the value of our portfolio holdings.

 

 

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We will be exposed to risks associated with changes in interest rates.

 

We are subject to financial market risks, including changes in interest rates. We expect our portfolio to be predominantly composed of fixed-rate high-yield and equity-linked corporate debt securities, but we may also purchase senior secured corporate debt securities which may have variable interest rates. We currently anticipate that the portion of our portfolio composed of variable rate corporate debt securities, if any, will not exceed 20%, but we may increase that to 33% of our aggregate portfolio at the time of any purchase depending on market opportunities. Accordingly, general interest rate fluctuations may have a substantial negative impact on our investments and investment opportunities and, therefore may have a material adverse effect on our investment objectives and our rate of return on invested capital.

 

We invest a portion of our assets in privately held companies which presents certain challenges, including the lack of available information about these companies.

 

We invest a portion of our assets in privately held companies. Investments in private companies pose certain incremental risks as compared to investments in public companies including that they:

  

  have reduced access to the capital markets, resulting in diminished capital resources and ability to withstand financial distress;

 

  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;

 

  may 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 changing market conditions, as well as general economic downturns;

 

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

 

  generally have less predictable operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position. In addition, our executive officers, directors and members of our Manager’s management team may, in the ordinary course of business, be named as defendants in litigation arising from our investments in the portfolio companies.

  

In addition, investments in private companies tend to be less liquid. The securities of private companies are often not publicly traded or actively traded on the secondary market and are, instead, traded on a privately negotiated over-the-counter secondary market for institutional investors. These privately negotiated over-the-counter secondary markets may be inactive during an economic downturn or a credit crisis. In addition, the securities in these companies will be subject to legal and other restrictions on resale or will otherwise be less liquid than publicly traded securities. Also, under the 1940 Act, if there is no readily available market for these investments, we are required to carry these investments at fair value as determined by our board of directors. As a result 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. We may also face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we, our Manager or any of their respective affiliates have material nonpublic information regarding such portfolio company or where the sale would be an impermissible joint transaction. The reduced liquidity of our investments may make it difficult for us to dispose of them at a favorable price, and, as a result, we may suffer losses.

 

Finally, little public information generally exists about private companies and these companies may not have third-party debt ratings or audited financial statements. We must therefore rely on the ability of our Manager to obtain adequate information through due diligence to evaluate the creditworthiness and potential returns from investing in these companies. Additionally, these companies and their financial information will not generally be subject to the Sarbanes-Oxley Act and other rules that govern public 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.

 

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

 

Many of our portfolio companies may be susceptible to economic slowdowns or recessions and may be unable to repay our debt investments during these periods. Therefore, our non-performing assets are likely to increase, and the value of our portfolio is likely to decrease, during these periods. Adverse economic conditions may also decrease the value of any collateral securing our first lien or second lien secured loans. A prolonged recession may further decrease the value of such collateral and result in losses of value in our portfolio and a decrease in our revenues, net income and net asset 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 on terms we deem acceptable. These events could prevent us from increasing investments and harm our operating results.

 

A covenant breach by our portfolio companies may 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 a portfolio company’s ability to meet its obligations under the debt or equity securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial covenants, with a defaulting portfolio company.

 

An investment strategy focused primarily on privately held companies presents certain challenges, including the lack of available information about these companies.

 

Our investments are primarily in privately-held companies. Investments in private companies pose significantly greater risks than investments in public companies. First, private companies have reduced access to the capital markets, resulting in diminished capital resources and the ability to withstand financial distress. As a result, these companies, which may present greater credit risk than public companies, may be unable to meet their obligations under their debt securities that we hold. Second, the investments themselves often may be less liquid. The securities of many of the companies in which we invest are not publicly-traded or actively traded on the secondary market and are, instead, traded on a privately negotiated over-the-counter secondary market for institutional investors. In addition, such securities may be subject to legal and other restrictions on resale.

  

A lack of liquidity in certain of our investments may adversely affect our business.

 

We invest in certain companies whose securities are not publicly-traded or actively traded on the secondary market and are, instead, traded on a privately negotiated over-the-counter secondary market for institutional investors and whose securities are subject to legal and other restrictions on resale or are otherwise less liquid than publicly-traded securities. The illiquidity of certain of our 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. The reduced liquidity of our investments may make it difficult for us to dispose of them at a favorable price, and, as a result, we may suffer losses.

 

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Certain macro-economic events may adversely affect the value of our bond positions and thus may impair our investment performance.

 

The following risks may adversely affect the value of our bond positions and thus may impair our investment performance:

  

  Recession.  If the U.S. economy slides back into a recession it may cause a correction in bond prices driving them lower and increasing the cost of borrowing for companies.

 

  Correction in U.S. Treasuries or Broader Bond Markets.  U.S. Treasuries and corporate bonds have seen a dramatic increase in prices over the past several quarters, driving down yields. A correction or trade out of these fixed income securities could correct bond prices across the board, from Treasuries to corporate debt.

 

  Increase in Corporate Default Rates.   Corporate debt default rates and bankruptcy rates have remained relatively flat and remain at extremely low levels (less than 2%). Any significant increase in default rates would depress bond prices as corporate borrowing costs increase.

 

  Inflation.  Core inflation in the United States remains under 2%. However, a significant increase in inflation would reduce the real return of debt securities, causing prices to drop.

 

  Monetary Tightening and Rising Interest Rates.   The U.S. Federal Reserve continued its policy of quantitative easing, helping to spur liquidity in the capital markets. The policy has helped keep interest rates near an all-time low in the U.S. In late 2013, the Federal Reserve began tapering its bond purchases. Eventually, as the economy recovers, the Federal Reserve may begin the monetary tightening, causing an increase of interest rates that may drive down bond prices.

 

  Devaluation of the U.S. Dollar.   We invest in the debt securities of issuers domiciled in the United States. As such, the debt securities that we purchase will pay coupons denominated in U.S. dollars. A significant devaluation of the U.S. dollar could lead to lower bond prices as real returns are diminished due to a devalued currency.

  

Risks Related to Our Continuous Offering and Our Shares

 

This is a speculative investment.

 

Our business objectives should be considered highly speculative, and there are no assurances that the Manager will satisfy those objectives. No assurances can be given that the Manager will realize a substantial return, if any, on its investment purchases, or that you will not lose your entire investment in us.

 

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There is no market for the shares of our common stock nor do we expect a market to develop in the foreseeable future, which adversely affects the liquidity and price of our shares.

 

There is no market for the shares of our common stock and no market for our shares is expected to develop in the foreseeable future. Shareholders therefore have no access to information about prior market history on which to base their investment decision. As a result, shareholders may be unable to sell their shares unless a market can be established and sustained.

 

If we are unable to raise substantial funds in our continuous “best efforts” offering, we will be limited in the number and type of investments we may make, and the value of your investment in us may be reduced in the event our assets under-perform.

 

Our continuous offering is being made on a best efforts basis, whereby Axiom Capital Management, Inc. and any selected dealers who enter into agreements with Axiom Capital Management, Inc. are only required to use their best efforts to sell our shares and have no firm commitment or obligation to purchase any of our shares. To the extent that less than the maximum number of shares is sold, the opportunity for diversification of our investments may be decreased and the returns achieved on those investments may be reduced as a result of allocating all of our expenses among a smaller capital base.

 

 Investors will not know the purchase price per share at the time they submit their subscription agreements and could receive fewer shares than anticipated if our board of directors determines to increase the offering price to comply with the requirement that we avoid selling our shares below net asset value per share.

 

The purchase price at which shareholders purchase shares of common stock will be determined at closing date to ensure that the sales price, after deducting selling commissions and dealer manager fees, is equal to or greater than the net asset value of our shares. As a result, in the event of an increase to our net asset value per share, an investor’s purchase price may be higher than the prior closing price per share, and therefore shareholders may receive a smaller number of shares than if shareholders had subscribed at the prior closing price.

 

Investors will not know the purchase price per share at the time they submit their subscription agreements and could pay a premium for their shares of common stock if our board of directors, or delegated committee, does not decrease the offering price in the event of a decline to our net asset value per share.

 

The purchase price at which shareholders purchase shares will be determined at each closing date to ensure that the sales price is equal to or greater than the net asset value of our shares, after deducting selling commissions and dealer manager fees. In the event of a decrease to our net asset value per share, shareholders could pay a premium for their shares of common stock if our board of directors, or delegated committee, does not decrease the offering price. Closing dates are typically semi-annual.

 

The shares sold in our continuous offering will not be listed on an exchange or quoted through a quotation system for the foreseeable future, if ever. Therefore, if an investor purchase shares in our continuous offering, they will have limited liquidity and may not receive a full return of their invested capital if they sell their shares.

 

The shares offered by us are illiquid assets for which there is not expected to be any secondary market nor is it expected that any will develop in the foreseeable future. Within four years following the completion of our public offering or any subsequent follow-on offering, our board of directors is required to recommend that we pursue a liquidity event for our shareholders. However, there can be no assurance that we will complete a liquidity event within such time or at all. A liquidity event could include: (i) a listing of our shares on a national securities exchange; (ii) a merger or another transaction approved by our board of directors in which our shareholders will receive cash or shares of a listed company; or (iii) a sale of all or substantially all of our assets either on a complete portfolio basis or individually followed by a liquidation.

 

Prior to the completion of a liquidity event, our tender offer program may provide a limited opportunity for investors to achieve liquidity, subject to certain restrictions and limitations, at a price which may reflect a discount from the purchase price they paid for their shares being repurchased.

 

In making a determination of what type of liquidity event is in the best interest of our shareholders, our board of directors, including our independent directors, may consider a variety of criteria, including, but not limited to, market conditions, portfolio diversification, portfolio performance, our financial condition, potential access to capital as a listed company, market conditions for the sale of our assets or listing of our shares, internal management requirements to become a perpetual life company and the potential for shareholder liquidity. We can offer no assurance that we will be able to effect a liquidity event. Further, even if we do complete a liquidity event, you may not receive a return of all of your invested capital.

 

We are not obligated to complete a liquidity event by a specified date; therefore, it will be difficult for an investor to sell his or her shares.

 

Within four years following the completion of our public offering or any subsequent follow-on offering, our board of directors is required to recommend that we pursue a liquidity event for our shareholders. A liquidity event could include: (i) a listing of our shares on a national securities exchange; (ii) a merger or another transaction approved by our board of directors in which our shareholders will receive cash or shares of a listed company; or (iii) a sale of all or substantially all of our assets either on a complete portfolio basis or individually followed by a liquidation. We expect that the liquidity event recommended by our board of directors will be completed within twelve months following the recommendation by our board of directors. We do not know at this time what circumstances will exist in the future and therefore we do not know what factors our board of directors will consider in determining what form of liquidity event to pursue. There may be economic or other factors that negatively impact our ability to complete a liquidity event within this timeframe or at all. As a result, it may be difficult for investors to sell their shares.

 

26
 

 

Our ability to successfully conduct our continuous offering is dependent, in part, on the ability of Axiom Capital Management, Inc. to successfully establish, operate and maintain a network of broker-dealers.

 

The success of our public offering, and correspondingly our ability to implement our business strategy, is dependent upon the ability of Axiom Capital Management, Inc. to establish and maintain a network of licensed securities broker-dealers and other agents to sell our shares. If Axiom Capital Management, Inc. fails to perform, we may not be able to raise adequate proceeds through our public offering to implement our investment strategy. If we are unsuccessful in implementing our investment strategy, shareholders could lose all or a part of their investment.

 

Beginning with the fourth calendar quarter of 2013, we began offering a repurchase program for shareholders shares on a quarterly basis. However, we are not required to make repurchases and there can be no assurance we will do so. As a result shareholders may be unable to sell their shares and, to the extent they are able to sell their shares under the tender offer program, they may not be able to recover the amount of their investment in our shares.

 

Beginning with the fourth calendar quarter of 2013, we began offering a repurchase program for shareholders to tender their shares on a quarterly basis at a price equal to 90% of or current offering price as of the date of repurchase. To the extent that we make purchases, the tender offer program will include numerous restrictions that limit their ability to sell their shares. We intend to limit the number of shares repurchased pursuant to our proposed tender offer program as follows: (1) we currently intend to limit the number of shares to be repurchased during any calendar year to 20% of the weighted average number of shares outstanding in the prior calendar year, or 5% in each quarter; (2) unless shareholders tender all of their shares, shareholders must tender at least 25% of the amount of shares they have purchased in the offering and must maintain a minimum balance of $5,000 subsequent to submitting a portion of their shares for repurchase by us; and (3) to the extent that the number of shares put to us for repurchase exceeds the number of shares that we are able to purchase, we will repurchase shares on a pro rata basis, not on a first-come, first-served basis. Further, we will have no obligation to repurchase shares if the repurchase would violate the restrictions on distributions under federal law or Maryland law, which prohibits distributions that would cause a corporation to fail to meet statutory tests of solvency. These limits may prevent us from accommodating all repurchase requests made in any year. Our board of directors may amend, suspend or terminate the tender offer program upon 30 days notice. We will notify shareholders of such developments (1) in our quarterly reports or (2) by means of a separate mailing to shareholders, accompanied by disclosure in a current or periodic report under the Exchange Act. In addition, although we have adopted a tender offer program, we have discretion to not repurchase shareholders shares, to suspend the plan, and to cease repurchases. Further, the plan has many limitations and should not be relied upon as a method to sell shares promptly and at a desired price.

  

The timing of our repurchase offers pursuant to our tender offer program may be at a time that is disadvantageous to our shareholders.

 

When we make quarterly repurchase offers pursuant to our tender offer program, we may offer to repurchase shares at a price that is lower than the price that investors paid for shares in our offering. As a result, to the extent investors have the ability to sell their shares to us as part of our tender offer program, the price at which an investor may sell shares, which will be equal to the net asset value per share on the date of repurchase, may be lower than what an investor paid in connection with the purchase of shares in our offering.

 

In addition, in the event an investor chooses to participate in our tender offer program, the investor will be required to provide us with notice of intent to participate prior to knowing what the net asset value per share will be on the repurchase date. Although an investor will have the ability to withdraw a repurchase request prior to the repurchase date, to the extent an investor seeks to sell shares to us as part of our tender offer program, the investor will be required to do so without knowledge of what the repurchase price of our shares will be on the repurchase date.

 

Various conflicts of interest exist between us and the roles, activities and duties of the Manager and its affiliates.

 

Conflicts of interest between us and the various roles, activities and duties of the Manager and its affiliates may occur from time to time. The Manager, its officers and other affiliates may act as a manager or general partner of other private or public entities, some of whom may have the same or a similar investment objective as the Company. As a result, conflicts of interest between us and the other activities of the Manager and its affiliates may occur from time to time. None of the agreements or arrangements, including those relating to compensation, between us, the Manager or their affiliates, is the result of arm’s-length negotiations. 

 

Certain provisions of the Maryland Corporation Law could deter takeover attempts.

 

Our bylaws exempt us from the Maryland Control Share Acquisition Act, which significantly restricts the voting rights of control shares of a Maryland corporation acquired in a control share acquisition. If our board of directors were to amend our bylaws to repeal this exemption from the Maryland Control Share Acquisition Act, that statute may make it more difficult for a third party to obtain control of us and increase the difficulty of consummating such a transaction. There can be no assurance, however, that we will not amend our bylaws at some time in the future. We will not, however, amend our bylaws to make us subject to the Maryland Control Share Acquisition Act without our board of directors determining that doing so would not conflict with the 1940 Act and obtaining confirmation from the SEC that it does not object to that determination.

 

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Additionally, our board of directors may, without stockholder action, authorize the issuance of shares of stock in one or more classes or series, including preferred stock. Our board of directors may also, without stockholder action, amend our articles of incorporation to increase the number of shares of stock of any class or series that we have authority to issue. These anti-takeover provisions may inhibit a change of control in circumstances that could give the holders of our common stock the opportunity to realize a premium over the value of our common stock.

 

Risks Related to Taxation

 

We will be subject to corporate-level income tax if we are unable to qualify as a RIC under Subchapter M of the Code or to satisfy RIC distribution requirements.

 

To maintain RIC tax treatment under the Code, we must meet the following minimum annual distribution, income source and asset diversification requirements.

 

The minimum 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 taxable income and realized net short-term capital gains in excess of realized net long-term capital losses, if any. We would also be taxed on any retained income and/or gains, including any short-term capital gains or long-term capital gains. We must also satisfy an additional annual distribution requirement during each calendar year in order to avoid a 4% excise tax on the amount of the under-distribution. Because we may use debt financing, we are subject to an asset coverage ratio requirement under the 1940 Act and may in the future become subject to certain financial covenants under loan and credit agreements that could, under certain circumstances, restrict us from making distributions necessary to satisfy the distribution requirements. If we are unable to obtain cash from other sources, we could fail to qualify for RIC tax treatment, or could be required to retain a portion of our income or gains, and thus become subject to corporate-level income tax.

 

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

 

The asset diversification requirement will be satisfied if we meet certain asset diversification requirements at the end of each quarter of our taxable year. To satisfy this requirement, at least 50% of the value of our assets must consist of cash, cash equivalents, U.S. Government securities, securities of other RICs, and other acceptable securities; and no more than 25% of the value of our assets can be invested in the securities, other than U.S. government securities or securities of other RICs, of one issuer, of two or more issuers that are controlled, as determined under applicable Code rules, by us and that are engaged in the same or similar or related trades or businesses or of certain “qualified publicly traded partnerships.” Failure to meet these requirements may result in our having to dispose of certain investments quickly in order to prevent the loss of RIC status. Because a portion of our investments are expected to be in private companies, and therefore will be relatively illiquid, any such dispositions could be made at disadvantageous prices and could result in substantial losses.

 

If we fail to qualify for or maintain RIC tax treatment for any reason and are subject to corporate income tax, the resulting corporate taxes could substantially reduce our net assets, the amount of income available for distribution, and the amount of our distributions.

 

If we do not qualify as a “publicly offered regulated investment company,” as defined in the Code, shareholders will be taxed as though they received a distribution of some of our expenses.

 

A “publicly offered regulated investment company” is a RIC whose shares are either (i) continuously offered pursuant to a public offering, (ii) regularly traded on an established securities market or (iii) held by at least 500 persons at all times during the taxable year. If we are not a publicly offered RIC for any period, a non-corporate stockholder’s allocable portion of our affected expenses, including our management fees, will be treated as an additional distribution to the stockholder and will be deductible by such stockholder only to the extent permitted under the limitations described below. For non-corporate stockholders, including individuals, trusts, and estates, significant limitations generally apply to the deductibility of certain expenses of a non-publicly offered RIC, including advisory fees. In particular, these expenses, referred to as miscellaneous itemized deductions, are deductible to an individual only to the extent they exceed 2% of such a stockholder’s adjusted gross income, and are not deductible for alternative minimum tax purposes.

 

We may have difficulty paying our required distributions if we recognize income before or without receiving cash representing such income.

 

For federal income tax purposes, we may be required to recognize taxable income in circumstances in which we do not receive a corresponding payment in 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 debt instruments that were issued with warrants), we must include in income each year a portion of the original issue discount that accrues over the life of the obligation, regardless of whether cash representing such income is received by us in the same taxable year. We may also have to include in income other amounts that we have not yet received in cash, such as deferred loan origination fees that are paid after origination of the loan or are paid in non-cash compensation such as warrants or stock. Furthermore, we may invest in non-U.S. corporations (or other non-U.S. entities treated as corporations for U.S. federal income tax purposes) that could be treated under the Code and U.S. Treasury regulations as “passive foreign investment companies” and/or “controlled foreign corporations.” The rules relating to investment in these types of non-U.S. entities are designed to ensure that U.S. taxpayers are either, in effect, taxed currently (or on an accelerated basis with respect to corporate level events) or taxed at increased tax rates at distribution or disposition. In certain circumstances this could require us to recognize income where we do not receive a corresponding payment in cash.

 

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We anticipate that a portion of our income may constitute original issue discount or other income required to be included in taxable income prior to receipt of cash. Further, we may elect to amortize market discounts and include such amounts in our taxable income in the current year, instead of upon disposition, as an election not to do so would limit our ability to deduct interest expenses for tax purposes.

 

Because any original issue discount or other amounts accrued will be included in our investment company taxable income for the year of the accrual, we may be required to make a distribution to our stockholders in order to satisfy the annual distribution requirement, even if we will not have received any corresponding cash amount. As a result, we may have difficulty meeting the annual distribution requirement necessary to obtain and maintain RIC tax treatment under the Code. 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, make a partial share distribution, or forgo new investment opportunities for this purpose. If we are not able to obtain cash from other sources, and choose not to make a qualifying share distribution, we may fail to qualify for RIC tax treatment and thus become subject to corporate-level income tax.

  

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

ITEM 2. PROPERTIES

 

We do not own any real estate or other physical properties materially important to our operation. Our executive offices are located at 100 Pine Street, Suite 500, San Francisco, California 94111. We believe that our current office facilities are adequate for our business as we intend to conduct it.

 

ITEM 3. LEGAL PROCEEDINGS

 

Neither we nor our Manager are currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us. From time to time, we 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 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.

 

 

Part II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Our authorized stock consists of 250,000,000 shares of stock, par value $0.001 per share, of which 200,000,000 shares are classified as common stock and 50,000,000 shares are classified as preferred stock. There is currently no market for our common stock, and we do not expect that a market for our shares will develop in the future. No stock has been authorized for issuance under any equity compensation plans. Under Maryland law, our stockholders generally will not be personally liable for our debts or obligations.

 

We are currently selling our shares on a continuous basis at a price of $10.15 per share; however, to the extent that our net asset value per share increases, we will sell at a price necessary to ensure that shares are not sold at a price per share, after deduction of selling commissions and dealer manager fees, that is below net asset value per share. Closings are typically semi-monthly. In connection with each closing on the sale of shares of our common stock pursuant to our prospectus, as amended or supplemented, which relates to our public offering of common stock on a continuous basis, our board of directors or a committee thereof is required to make the determination that we are not selling shares of our common stock at a price per share, after deduction of selling commissions and dealer manager fees, that is below our then current net asset value per share within 48 hours of the time that we price our shares.

 

A decline in our net asset value per share to an amount more than 5.0% below our current offering price, net of selling commissions and dealer manager fees, creates a rebuttable presumption that there has been a material change in the value of our assets such that a reduction in the offering price per share is warranted. This presumption may only be rebutted if our board of directors, in consultation with its management, reasonably and in good faith determines that the decline in net asset value per share is the result of a temporary movement in the credit markets or the value of our assets, rather than a more fundamental shift in the valuation of our portfolio. In the event that (i) net asset value per share decreases to more than 5.0% below our current net offering price and (ii) our board of directors believes that such decrease in net asset value per share is the result of a non-temporary movement in the credit markets or the value of our assets, the board of directors will undertake to establish a new net offering price that is not more than 5.0% above our net asset value per share.

 

Set forth below is a chart describing the classes of our securities outstanding as of December 31, 2013:

 

Title of Class   Amount Authorized   Amount Issued
Common Stock, par value $0.001 per share   $200,000,000   3,151,376

 

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As of December 31, 2013, gross proceeds from the sale of common stock were $31.6 million, including stock issued pursuant to the distribution reinvestment plan (“DRIP”) and the purchase made by our Manager for our initial capitalization. As of December 31, 2013, we had 892 record holders of our common stock.

 

As of December 31, 2012, gross proceeds from the sale of common stock were $9.5 million, including stock issued pursuant to the DRIP and the purchase made by our Manager for our initial capitalization. As of December 31, 2012, we had 263 record holders of our common stock.

 

Distributions

 

Subject to our board of director’s discretion and applicable legal restrictions, we authorized and declare ordinary cash distributions, with a record date and payment date on a semi-monthly basis. Semi-monthly distributions were paid to stockholders since July 10, 2012 when we commenced operations. Our board of director’s intend to continue to authorize and declare distributions and we intend to pay distributions on a semi-monthly basis to our shareholders. Any distributions to our shareholders will be declared out of assets legally available for distribution. We expect to continue making distributions unless our results of operations, our general financial condition, general economic conditions, or other factors prohibit us from doing so. From time to time, but not less than quarterly, we will review our accounts to determine whether distributions to our shareholders are appropriate. There can be no assurance that we will be able to sustain distributions at any particular level. Our distributions may exceed our earnings, which we refer to as a return of capital, especially during the period before we have invested substantially all of the proceeds of the offering. As a result, a portion of the distributions we make may represent a return of capital for tax purposes. A return of capital generally is a return of your investment rather than a return of earnings or gains derived from our investment activities and will be made after deduction of the fees and expenses payable in connection with the offering, including any fees payable to our Manager.

 

Each year a statement on Internal Revenue Service Form 1099-DIV (or such successor form) identifying the source of the distribution ( i.e. , paid from ordinary income, paid from net capital gain on the sale of securities, or a return of capital) will be mailed to our shareholders. There can be no assurance that we will be able to sustain distributions at any particular level. Our distributions may exceed our earnings, which we refer to as a return of capital, especially during the period before we have invested substantially all of the proceeds. As a result, a portion of the distributions we make may represent a return of capital for tax purposes. The tax basis of shares must be reduced by the amount of any return of capital distributions, which will result in an increase in the amount of any taxable gain (or a reduction in any deductible loss) on the sale of shares.

 

We have elected to be treated, beginning with our taxable year ending December 31, 2012, as a RIC under the Code. To obtain and maintain RIC tax treatment, we must, among other things, distribute at least 90% of our net ordinary income and net short-term capital gains in excess of net long-term capital losses, if any, to our shareholders. In order to avoid certain excise taxes imposed on RICs, we currently intend to distribute during each calendar year an amount at least equal to the sum of: (i) 98% of our ordinary income for the calendar year, (ii) 98.2% of our capital gains in excess of capital losses for the one-year period generally ending on October 31 of the calendar year (unless an election is made by us to use our taxable year) and (iii) any ordinary income and net capital gains for preceding years that were not distributed during such years and on which we paid no federal income tax.

 

We declared our first distribution on July 30, 2012. We have adopted an “opt-in” DRIP pursuant to which you may elect to have the full amount of your cash distributions reinvested in additional shares of our common stock.

 

The following table reflects the distributions per share paid or payable in cash or DRIP on our common stock to date (dollars in thousands except per share amounts):  

 

SOURCE OF DISTRIBUTION
Date Declared  Payment Dates  Net Investment Income   Realized Gain from Investments   Return of Capital   Total   Per Share   Paid in Cash   DRIP   TOTAL 
2012                                   
July 31, 2012  August 17, 2012  $4   $-   $-   $4   $0.03   $3   $1   $4 
July 31, 2012  August 31, 2012   4    -    -    4    0.03    3    1    4 
August 29, 2012  September 14, 2012   9    -    -    9    0.03    6    3    9 
August 29, 2012  September 28, 2012   9    -    -    9    0.03    6    3    9 
September 26, 2012  October 15, 2012   6    -    6    12    0.03    8    4    12 
September 26, 2012  October 31, 2012   -    -    12    12    0.03    8    4    12 
October 29, 2012  November 16, 2012   17    -    -    17    0.03    11    6    17 
October 29, 2012  November 30, 2012   17    -    -    17    0.03    11    6    17 
November 29, 2012  December 17, 2012   22    -    -    22    0.03    12    10    22 
November 29, 2012  December 31, 2012   23    -    -    23    0.03    14    11    25 
December 27, 2012  January 17, 2013 (1)   35    -    57    92    0.11                
December 27, 2012  January 31, 2013   4    -    25    29    0.03                
      $150   $-   $100   $250        $82   $49   $131 
                                            
2013                                           
                                            
December 27, 2012  January 17, 2013 (1)                           $57   $35   $92 
December 27, 2012  January 31, 2013                  18    11    29 
January 30, 2013  February 15, 2013  35   -   -   35   $ 0.03    21    14    35 
January 30, 2013  February 28, 2013   38    -    -    38    0.03    23    15    38 
February 27, 2013  March 15, 2013 (1)   72    47    28    147    0.11    87    60    147 
February 27, 2013  March 29, 2013   -    -    47    47    0.03    29    18    47 
February 27, 2013  April 15, 2013   49    -    -    49    0.03    29    20    49 
February 27, 2013  April 30, 2013   53    -    -    53    0.03    32    21    53 
May 9, 2013  May 17, 2013   56    -    -    56    0.03    34    22    56 
May 9, 2013  May 31, 2013   62    -    -    62    0.03    38    24    62 
May 9, 2013  June 14, 2013   62    -    -    62    0.03    38    24    62 
May 9, 2013  June 28, 2013   55    8    -    63    0.03    38    25    63 
July 9, 2013  July 15, 2013   -    35    27    62    0.03    38    24    62 
July 9, 2013  July 30, 2013   22    40    -    62    0.03    38    24    62 
July 9, 2013  August 14, 2013   55    7    -    62    0.03    38    24    62 
July 9, 2013  August 30, 2013   62    -    -    62    0.03    30    32    62 
DRIP financed by VII Peaks Capital, LLC  August 30, 2013 (2)   -    -    24    24         -    24    24 
September 11, 2013  September 16, 2013   17    -    71    88    0.03    56    32    88 
September 11, 2013  September 30, 2013   -    -    88    88    0.03    56    32    88 
September 11, 2013  October 15, 2013   88    -    -    88    0.03    56    32    88 
September 11, 2013  October 29, 2013   20    69    -    89    0.03    56    33    89 
September 11, 2013  November 15, 2013   -    88    -    88    0.03    55    33    88 
September 11, 2013  November 27, 2013   -    88    -    88    0.03    55    33    88 
November 20, 2013  December 16, 2013   -    13    78    91    0.03    57    34    91 
November 20, 2013  December 30, 2013   -    -    92    92    0.03    58    34    92 
Other  January 8, 2014   -    -    5    5         -    -    - 
November 20, 2013  January 16, 2014   -    -    96    96    0.03    -    -    - 
                                            
      $746   $395   $556   $1,697        $1,037   $680   $1,717 
                                            
November 20, 2013  January 16, 2014  $-   $-   $-   $-        $64   $35   $99 
November 20, 2013  January 30, 2014   -    -    95    95   $0.03    59    36    95 
      $-   $-   $95   $95        $123   $71   $194 

 

(1) Includes a special distribution of $0.077 per share.

(2) Does not include $62,000 cash portion financed by VII Peaks Capital, LLC.

 

There were no distributions paid with borrowings, offering proceeds, non-capital gain proceeds from sale of assets, distribution on account of preferred and common equity or expense reimbursement from sponsor.                

 

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ITEM 6. SELECTED FINANCIAL DATA

 

The following selected financial data for the years ended December 31, 2013 and December 31, 2012 and for the period from August 3, 2011 (date of inception) to December 31, 2011 is derived from our financial statements which have been audited by Burr Pilger Mayer, Inc., our independent registered public accounting firm as stated in their report. The data should be read in conjunction with our financial statements and related notes thereto and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report (dollars in thousands except share and per share data):

 

   For the Year Ended
December 31, 2013
   For the Year Ended
December 31, 2012
   For the Period from
August 3, 2011 (Date of
Inception) to
December 31, 2011
 
Statement of operations data:               
Total investment income  $1,659   $146   $- 
Operating expenses               
            Total expenses   1,688    520    4 
            Less: Expense waivers and reimbursements   (776)   (524)   - 
            Net expenses (income)   912    (4)   4 
            Net investment income (loss)   747    150    (4)
Realized and unrealized gain (loss), net   (101)   (119)   - 
Net increase (decrease) in net assets resulting from operations  $646   $31   $(4)
Per share data - basic and diluted:               
Net investment income (loss)  $0.35   $0.61   $(44.44)
Net realized and unrealized gain (loss) on investments  $(0.05)  $(0.48)  $- 
Net increase (decrease) in net assets resulting from operations  $0.30   $0.13   $(44.44)
Distributions declared  $(0.79)  $(1.02)  $- 
Balance sheet data:               
Total investments at fair value  $23,154   $5,823   $- 
Cash and cash equivalents  $1,644   $1,304   $201 
Total assets  $27,713   $8,548   $201 
Total liabilities  $340   $212   $4 
Total net assets  $27,373   $8,336   $197 
Other data:               
Total return   7.51%   10.98%   -% 
Number of portfolio company investments at period end   39    22    - 
Total portfolio investments for the period  $27,685   $7,166   $- 
Investment sales and prepayments for the period  $10,314   $1,250   $- 

  

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

 

The following discussion should be read in conjunction with the accompanying financial statements of VII Peaks Co-Optivist Income BDC II, Inc., and the notes thereto. As used herein, the terms “we,” “our” and “us” refer to VII Peaks Co-Optivist Income BDC II, Inc., a Maryland corporation and, as required by context to VII Peaks Advisor II, LLC (the “Manager”), which serves as our investment adviser and administrator. We are externally managed by our Manager.

 

Overview

 

We invest in discounted corporate debt and equity-linked debt securities of public and private companies whose securities trade on the secondary loan market for institutional investors and provide distributions to investors. At the same time, we actively work with the target company’s management to restructure the underlying securities and improve the liquidity position of the target company’s balance sheet. We employ a proprietary “Co-Optivist TM ” approach (“cooperative activism”, Co-Optivist TM is a registered trademark of VII Peaks Capital, LLC, or VII Peaks, and is being used with their permission) in executing our investment strategy, which entails proactively engaging the target company management on average 24 months prior to a redemption event (typically a put or maturity event) to create an opportunity for growth in the investments. Our strategy is not dependent on restructuring to generate distributions.

 

Our investment objectives are to generate current income and capital appreciation. We meet our investment objectives by: (i) realizing income and capital appreciation through the acquisition, management and orderly liquidation of corporate debt securities, (ii) making distributions of available distributable cash to our shareholders, and (iii) preserving the capital investments of our stockholders.

 

We make investments in target companies that meet our investment criteria. The size of an individual investment will vary based on numerous factors, including the amount of funds raised in our offering. However, assuming we raise the maximum offering amount of $750.0 million, we expect to hold at least 50 investments, and we anticipate that the minimum investment size will be approximately $0.25 million. We do not anticipate being heavily invested in any one industry, and generally, we do not expect to invest in more than two different classes of debt of the same Target Investment. We invest in debt and equity-linked debt of target companies with a minimum enterprise value of $200.0 million and whose debt and equity-linked debt is actively traded in the secondary loan market. We expect our portfolio to be predominantly composed of fixed-rate high-yield and equity-linked corporate debt securities. However, we may also purchase senior secured corporate debt securities which may have variable interest rates. We currently anticipate that the portion of our portfolio composed of variable rate corporate debt securities, if any, will not exceed 20%, but we may increase that to 33% of our aggregate portfolio at the time of any purchase depending on market opportunities.

 

We offer our stockholders the ability to receive distributions as well as the potential capital appreciation resulting from the restructuring of the debt of our target companies. To the extent we have distributable income available we anticipate declaring distributions with a semi-monthly record and payment date basis. We declared and paid distributions beginning in August 2012 at $0.03063 per share each (an annualized rate of 7.35% based on our initial public offering price of $10.00 per share) to stockholders. On December 27, 2012, for shareholders of record on December 27, 2012, and a payable date of January 17, 2013, the board of directors authorized a special distribution of $0.07664 per share, together with the routine distribution of $0.03063 per share for a total one time annualized return of 8.11%.

 

Please see Part II, Item 8. “Financial Statements and Supplementary Data” for a detailed description of Distributions in the Notes to Financial Statements.

 

Our Manager has an investment committee that is responsible for reviewing, discussing and approving each investment opportunity we seek to pursue. Our investment committee meets routinely to discuss new and existing opportunities and developments on current investments. Our investment committee currently is led by Mr. Chandhoke, our Chief Executive Officer, with Mr. Shea, Managing Partner of VII Peaks Capital, LLC.

 

Critical Accounting Policies

 

The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to the valuation of portfolio securities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.

 

Valuation of Portfolio Investments

 

We determine the net asset value of our investment portfolio each quarter. Securities that are publicly-traded are valued at the reported closing price on the valuation date. Securities that are not publicly-traded are valued at fair value as determined in good faith by our board of directors. In connection with that determination, our Manager prepares portfolio company valuations using relevant inputs, including, but not limited to, indicative dealer quotes, values of like securities, the most recent portfolio company financial statements and forecasts, and valuations prepared by third-party valuation services.

 

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With respect to investments for which market quotations are not readily available, we will undertake a multi-step valuation process each quarter, as described below:

 

  · our quarterly valuation process begins with each portfolio company or investment being initially valued by members of our investment committee, with such valuation taking into account information received from our independent valuation firm, if applicable;

 

  · preliminary valuation conclusions are then documented and discussed with the members of our board of directors; and

 

  · the board of directors discusses valuations and determines the fair value of each investment in our portfolio in good faith based on various statistical and other factors, including the input and recommendation of members of our investment committee and any third-party valuation firm, if applicable.

  

Investments are valued utilizing a market approach, an income approach, or both approaches, as appropriate. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present value amount (discounted) calculated based on an appropriate discount rate. The measurement is based on the net present value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that we may take into account in fair value pricing our investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral, the portfolio company’s ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, M&A comparables, the principal market and enterprise values, among other factors.

 

We have adopted Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, Topic 820, Fair Value Measurements and Disclosures (formerly Statement of Financial Accounting Standards No. 157, Fair Value Measurements ), which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements.

 

ASC Topic 820 clarifies that the exchange price is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of market participants. ASC Topic 820 provides a consistent definition of fair value which focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. In addition, ASC Topic 820 provides a framework for measuring fair value and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels of valuation hierarchy established by ASC Topic 820 are defined as follows:

 

Level 1:  Quoted prices in active markets for identical assets or liabilities, accessible by the Fund at the measurement date.

 

Level 2:  Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or other observable inputs other than quoted prices.

 

Level 3:  Unobservable inputs for the asset or liability.

 

In all cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level of input that is significant to the fair value measurement.

 

Revenue Recognition

 

We record interest income on an accrual basis to the extent that we expect to collect such amounts. For loans and debt securities with contractual payment-in-kind (“PIK”) interest, which represents contractual interest accrued and added to the principal balance, we generally will not accrue PIK interest for accounting purposes if the portfolio company valuation indicates that such PIK interest is not collectible. We do not accrue as a receivable interest on loans and debt securities for accounting purposes if we have reason to doubt our ability to collect such interest. Original issue discounts, market discounts or premiums are accreted or amortized using the effective interest method as interest income. We record prepayment premiums on loans and debt securities as interest income. Dividend income, if any, is recognized on an accrual basis to the extent that we expect to collect such amount. Our total interest income was $1.7 million for the fiscal year ended December 31, 2013, as compared to $0.1 million for the fiscal year ended 2012. The increase is due to a larger note portfolio earning interest in 2013 as compared to 2012. At December 31, 2013, the weighted average coupon yield was 10.7%, as compared to 9.8% as of December 31, 2012.

 

 

Expense Reimbursement

 

We entered into an expense reimbursement agreement with our prior manager under which the prior manager agreed to reimburse us for certain GAAP compliant expenses recognized on our quarterly financial statements for 2012, retroactive to the date of formation on August 3, 2011. In 2013, the expense reimbursement agreement was modified to exclude management fees and incentive fees payable to the prior manager effective as of January 1, 2013. We recognized a receivable on our books for the amount due from the prior manager under the expense reimbursement agreement, and the prior manager recognized a liability on its books in the same amount. The expense reimbursement agreement allowed the prior manage and us to offset the related receivables and payables to each other resulting in a net receivable, or payable position.

 

 

33
 

 

On August 20, 2013, we terminated our investment management agreement with our prior manager, and entered into a new investment management agreement with our current Manager. Our current Manager has not entered into an expense reimbursement agreement with us, but has agreed to assume the prior manager’s obligation to pay us the $1.3 million which had accrued under the prior manager’s expense reimbursement agreement. In consideration for such assumption, we have agreed to pay our current Manager any amounts otherwise due our prior manager for organization and offering expenses funded by our prior manager.

 

Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation

 

We measure net realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized, but considering unamortized upfront fees and prepayment penalties. Net change in unrealized appreciation or depreciation will reflect the change in portfolio investment values during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized. Our total net realized gain from investments was $0.4 million for the fiscal year ended December 31, 2013, as compared to no realized gain or loss from investments for the fiscal year ended 2012. The 2013 gains were from notes sold or tendered. No gains in 2012 were due to the first year of operations and a smaller investment portfolio.

 

Our total net unrealized depreciation on investments was a $0.5 million for the fiscal year ended December 31, 2013 as compared to $0.1 million in 2012. The fiscal year 2013 had a larger investment portfolio.

 

Payment-in-Kind Interest

 

We may have investments in our portfolio that contain a PIK interest provision. Any PIK interest will be added to the principal balance of such investments and is recorded as income, if the portfolio company valuation indicates that such PIK interest is collectible. In order to maintain our status as a regulated investment company (“RIC”), substantially all of this income must be paid out to stockholders in the form of distributions, even if we have not collected any cash.

 

Organization and Offering Expenses

 

The Fund is a closed-end fund with a continuous offering period. Under the investment advisory agreement between the fund and the Manager, our Manager fronts the cost of the offering expenses which are reimbursable by the Fund with up to 1.5% of the gross offering proceeds. The Fund expenses organizational and offering costs as they become payable under the investor advisory agreement. Our total offering expense was $0.4 million for the fiscal year ended December 31, 2013, as compared to $0.1 million for the fiscal year ended December 31, 2012. The year 2013 had a higher amount of investor closings as compared to the year 2012.

 

Federal Income Taxes

 

We have elected to be treated for federal income tax purposes as a RIC under Subchapter M of the Code. As a RIC, we generally will not have to pay corporate-level federal income taxes on any ordinary income or capital gains that we distribute to our shareholders from our tax earnings and profits. To obtain and maintain our RIC tax treatment, we must meet, among other things, specified source-of-income and asset diversification requirements and distribute annually at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any.

 

Portfolio and Investment Activity

 

For the year ended December 31, 2013, we made $27.7 million of investments in new portfolio companies and had $10.3 million in aggregate amount of exits and repayments, resulting in net investments of $17.4 million for the period. For the year ended December 31, 2012, we made $7.2 million of investments in new portfolio companies and had $1.2 million in aggregate amount of exits and repayments, resulting in net investments of $6.0 million for the period. We had no investments as of December 31, 2011.

 

The following table presents our portfolio composition based on fair value at December 31, 2013:

 

   At December 31, 2013 
   Percentage of Total
Portfolio
   Weighted Average
Current
Coupon Yield
 
Investments – Money Market   6.6%   %
Senior Secured First Lien Debt   9.2    10.2 
Senior Secured Second Lien Debt   21.3    10.8 
Senior Unsecured Debt   33.8    10.4 
Senior Subordinated Debt   29.1    11.1 
Total   100.0%   10.7%

 

As of December 31, 2013, our investment portfolio had a yield to maturity of 11.16%, and an average duration of 2.36 years.

 

 

 

34
 

 

The following table presents our portfolio composition based on fair value at December 31, 2012:

 

   At December 31, 2012 
   Percentage of Total
Portfolio
   Weighted Average
Current
Coupon Yield
 
Investments – Money Market   18.3%   %
Senior Secured First Lien Debt   11.5    10.4 
Senior Secured Second Lien Debt   12.1    11.0 
Senior Unsecured Debt   43.7    9.5 
Senior Subordinated Debt   14.4    9.4 
Total   100.0%   9.8%

 

As of December 31, 2012, our investment portfolio had a yield to maturity of 12.17%.

 

The following table shows the portfolio composition by industry grouping at fair value at December 31, 2013 (dollars in thousands):

 

   At December 31, 2013 
   Investments at Fair
Value
   Percentage of Total
Portfolio
 
Healthcare & Pharmaceuticals  $3,160    12.7%
Services: Business   3,015    12.2 
Aerospace and Defense   2,616    10.6 
Energy: Oil & Gas   2,604    10.5 
Telecommunications   2,289    9.2 
Investments – Money Market   1,644    6.6 
Media: Advertising, Printing & Publishing   1,541    6.2 
Services: Consumer   1,282    5.2 
Metals & Mining   1,222    4.9 
High Tech Industries   1,158    4.7 
Banking, Finance, Insurance & Real Estate   1,069    4.3 
Retail   968    3.9 
Media: Broadcasting & Subscription   875    3.5 
Hotel, Gaming & Leisure   790    3.2 
Beverage, Food & Tobacco   557    2.2 
Environmental Industries   8    0.1 
Total  $24,798    100.0%

  

The following table shows the portfolio composition by industry grouping at fair value at December 31, 2012 (dollars in thousands):

 

   At December 31, 2012 
   Investments at Fair
Value
   Percentage of Total
Portfolio
 
Investments – Money Market  $1,304    18.3%
Healthcare & Pharmaceuticals   830    11.7 
High Tech Industries   771    10.8 
Beverage, Food & Tobacco   769    10.8 
Telecommunications   764    10.7 
Retail   564    7.9 
Services: Consumer   541    7.6 
Consumer Goods: Non-durable   415    5.8 
Consumer Goods: Durable   401    5.6 
Services: Business   365    5.1 
Banking, Finance, Insurance & Real Estate   358    5.0 
Environmental Industries   45    0.7 
Total  $7,127    100.0%

 

Our fair value of total investments was $24.8 million for the fiscal year ended December 31, 2013 as compared to $7.1 million for the fiscal year ended December 31, 2012. The portfolio increase in 2013 is mainly due to invested proceeds from continuous investor closings in 2013. The additional proceeds from investor closings throughout 2013 also led to a more diverse portfolio by industry, as compared to 2012.

 

35
 

 

Results of Operations

 

We were formed on August 3, 2011, and commenced operations on July 10, 2012, when we raised in excess of $1,000,000 from persons who were not affiliated with us or our Manager. Prior to satisfying the minimum offering requirement, we had no operations except for matters relating to our organization and registration as a non-diversified, closed-end management investment company. As a result, our operating results for 2013 are not necessarily applicable to our results in 2012. The results of operations are based on revenue less expenses, adjusted for the impact of the realized gain/loss and change in unrealized gain/loss on our investment portfolio. Revenue is earned as interest on the high-yield investments. Expenses include professional services, management fees, organizational and offering costs and other general and administrative. Realized gain/loss are from investments sold or called at an advantageous price. The unrealized gain/loss is the change in the market price on investments in the portfolio at period end. Operating results for the years ended December 31, 2013 and 2012 and for the period from August 3, 2011 (date of inception) to December 31, 2011 are as follows (dollars in thousands):

 

   For the Year Ended
December 31,
2013
   For the Year Ended
December 31,
2012
   For the Period
from August 3,
2011 (Date of
Inception) to
December 31,
2011
 
     
Total investment income   $1,659   $146   $- 
Total expenses (income), net      912    (4)   4 
Net investment income (loss)    747    150    (4)
Net realized gains    395    -    - 
Net unrealized depreciation    (496)   (119)   - 
Net increase (decrease) in net assets resulting from operations   $646   $31   $(4)

 

Revenues

 

We generated investment income of $1.7 million for the fiscal year ended December 31, 2013, as compared to $0.1 million for the year ended December 31, 2012, in the form of interest and fees earned on senior secured loans, senior secured bonds, subordinated debt and collateralized securities in our portfolio. The level of income we receive is directly related to the balance of income producing investments multiplied by the weighted average yield of our investments. We expect the dollar amount of interest and any dividend income that we earn to increase as the size of our investment portfolio increases. The average balance of the December 31, 2013 note portfolio was significantly higher than the December 31, 2012 balance.

 

Expenses

 

                Our total operating expenses were $1.7 million for the fiscal year ended December 31, 2013, as compared to $0.5 million for the fiscal year ended December 31, 2012. Our operating expenses were offset by an expense reimbursement from our prior manager of $0.8 million in 2013 and $0.5 million in 2012. Our operating expenses include professional services of $0.4 million in 2013, as compared to $0.1 million in 2012. Professional Services include legal, audit and other service providers of compliance, custody and fund administration. The increase in 2013 is due to legal fees for the prospectus update and a full year of service provider support in 2013 as compared to 2012. Our operating expenses also include base management fees attributed to our Manager and the prior manager of $0.4 million in 2013, as compared to $0.06 million in 2012. The management fees increase in 2013 is due to higher assets under management as compared to 2012. General and administrative expenses include the transfer agent service, printing and mailing, and other back office support. The year 2013 is higher than 2012 due to the portfolio growth and a full year of operations in 2013 as compared to 2012. Our Manager is eligible to receive incentive fees based on performance. We did not pay or accrue any incentive fees in either 2013 or 2012. We generally expect our operating expenses related to our ongoing operations to increase because of the anticipated growth in the size of our asset base, although the increase should be slower than the growth in our assets.

 

The composition of our operating expenses for the years ended December 31, 2013 and 2012 and for the period from August 3, 2011 (date of inception) to December 31, 2011 was as follows (dollars in thousands):

 

   For the Year Ended
December 31,
2013
   For the Year Ended
December 31,
2012
   For the Period
from August 3,
2011 (Date of
Inception) to
December 31,
2011
 
                
Professional fees   $444   $119   $ 
Director fees    42    31     
Insurance    83    49     
Management fees    429    61     
General and administrative expenses    317    118    4 
Organizational and offering expense    373    142     
Operating expenses before expense waivers and reimbursements   1,688    520    4 
Expense reimbursement    (776)   (524)    
Total operating expenses (income) net of expense waivers and reimbursement  $912   $(4)  $4 

 

Expense Reimbursement

 

We entered into an expense reimbursement agreement with our prior manager under which the prior manager agreed to reimburse us for all U.S. GAAP compliant expenses recognized on our quarterly financial statements for 2012, retroactive to the date of formation on August 3, 2011. In 2013, the expense reimbursement agreement was modified to exclude management fees and incentive fees payable to the Manager effective as of January 1, 2013. We recognized a receivable on our books for the amount due from the prior manager under the expense reimbursement agreement, and the prior manager recognized a liability on its books in the same amount. The expense reimbursement agreement allowed the prior manager and us to offset the related receivables from and payables to each other resulting in a net receivable, or payable position. Our prior manager was obligated to reimburse us for $0.8 million in 2013 and $0.5 million in 2012.

 

On August 20, 2013, we terminated our investment management agreement with our prior manager, and entered into a new investment management agreement with our current Manager. Our current Manager has not entered into an expense reimbursement agreement with us, but has agreed to assume the prior manager’s obligation to pay us $1.3 million which had accrued under the prior manager’s expense reimbursement agreement. In consideration for such assumption, we have agreed to pay our current Manager any amounts otherwise due our prior manager for organization and offering expenses funded by our prior manager.

 

36
 

 

 

Net Investment Income

 

Our net investment income totaled $0.7 million and $0.2 million for the periods ended December 31, 2013 and 2012, respectively. Of our net investment income in each period, $0.8 million and $0.5 million for the periods ending December 31, 2013 and 2012, respectively, was attributable to expense reimbursements by our prior manager, and the balance was attributable to investment income less operating expenses for the period. For the fiscal years ended December 31, 2013, and 2012, total investment income was $1.7 million and $0.1 million, respectively. The 2013 increase is due to a higher average balance in the investment portfolio in 2013. For the fiscal year ended December 31, 2013, total expenses before expense waivers and reimbursements was $1.7 million and $0.5 million for the fiscal year ended December 31, 2012. Drivers of the higher expenses in 2013 include larger management fees due to more assets under management and professional services increase due to legal expenses for the prospectus update and service providers in for a full year as compared to 2012.

 

Net Realized Gains or Losses from Investments

 

For the years ended December 31, 2013 and 2012, we had $10.3 million and $1.2 million of principal repayments, resulting in $0.4 million and $233 of realized gains, respectively.

 

Net Change in Unrealized Appreciation or Depreciation on Investments

 

For the years ended December 31, 2013 and 2012, we had $0.5 million and $0.1 million of unrealized depreciation, respectively.

 

Changes in Net Assets from Operations

 

For the years ended December 31, 2013 and 2012, we recorded a net increase in net assets resulting from operations of $0.6 million and $0.03 million, respectively. Based on 2,150,019 and 246,231 weighted average common shares outstanding for the years ended December 31, 2013 and 2012, respectively, our per share net increase and decrease in net assets resulting from operations was $0.30 and $0.13, respectively. For the period from August 3, 2011 (date of inception) to December 31, 2011, we held no investments.

 

Liquidity and Capital Resources

 

We generate cash primarily from the net proceeds of our ongoing continuous public offering and from cash flows from fees, interest and dividends earned from our investments as well as principal repayments and proceeds from sales of our investments. On July 10, 2012, we satisfied our minimum offering requirement of raising gross offering proceeds in excess of $1.0 million from persons who are not affiliated with us or our Manager, and commenced operations on such date. As of December 31, 2013, we issued 3.2 million shares of common stock for gross proceeds of $31.6 million. We currently sell our shares on a continuous basis at a current offering price of $10.15; however, to the extent that our net asset value per share increases, we will sell at a price necessary to ensure that our shares are not sold at a price, after deduction of selling commissions and dealer manager fees, that is below our net asset value per share.

 

37
 

 

Prior to investing in debt securities, we invest the net proceeds from our continuous offering primarily in money market funds that invest in U.S. government securities and high-quality debt instruments maturing in one year or less from the time of investment. As of December 31, 2013, we had $1.6 million invested in money market investments pending investment in debt instruments. As of December 31, 2012, we had $1.3 million invested in money market investments pending investment in debt instruments.

 

For the year ended December 31, 2013, we experienced a net increase in money market investments of $0.3 million. For the year ended December 31, 2013, approximately $18.4 million was generated from our financing activities, which primarily consisted of $19.4 million in net offering proceeds received, offset by $1.0 million in distributions. We used approximately $18.4 million of cash in our operating activities primarily as the result of the purchase of new portfolio debt investments of $27.7 million, offset by the receipt of proceeds from the sale of, repayment of and principal payments on portfolio debt investments of $10.3 million. Cash used in operating activities was also affected by increases in receivables for interest and due from related party.

 

For the year ended December 31, 2012, we experienced a net increase in money market investments of $1.1 million. For the year ended December 31, 2012, approximately $7.5 million was generated from our financing activities, which primarily consisted of $7.6 million in net offering proceeds received, offset by $82,000 in distributions. We used approximately $7.5 million of cash in our operating activities primarily as the result of the purchase of new portfolio debt investments of $7.2 million, offset by the receipt of proceeds from the sale of, repayment of and principal payments on portfolio debt investments of $1.3 million. Cash used in operating activities was also affected by increases in receivables for interest and due from related party.

 

We do not expect to borrow funds during the following twelve months to make investments. In the future, however, if the market for debt financing presents attractively priced debt financing opportunities, or if our board of directors determines that leveraging our portfolio would be in our best interests and the best interests of our shareholders, we may decide to borrow funds to make investments. We do not currently anticipate issuing any preferred shares.

 

Distributions

 

We offer our stockholders the ability to receive distributions as well as the potential capital appreciation resulting from the restructuring of the debt of our target companies. To the extent we have distributable income available the board of directors declares distributions with a record and payment date on a semi-monthly basis.

 

On December 27, 2012, we authorized and declared a special cash distribution equal to $0.077 per share, that was paid to stockholders of record at the close of business on December 27, 2012, payable on January 17, 2013. This special distribution is in addition to the current annualized distribution of 7.35% per share, based on a $10.00 share price. The current and one-time special distributions total an annualized return of 8.11%.

 

Please see Part II, Item 8. “Financial Statements and Supplementary Data” for a detailed description of Distributions in the Notes to Financial Statements.

 

 Any distributions to our shareholders are declared out of assets legally available for distribution. We expect to continue making distributions unless our results of operations, our general financial condition, general economic conditions, or other factors prohibit us from doing so. There can be no assurance that we will be able to sustain distributions at any particular level.

  

Each year a statement on Internal Revenue Service Form 1099-DIV (or such successor form) identifying the source of the distributions (i.e., paid from ordinary income, paid from net capital gain on the sale of securities, or a return of capital) will be mailed to our shareholders. Our distributions may exceed our earnings, especially during the period before we have substantially invested the proceeds from our continuous offering. As a result, a portion of the distributions we make may represent a return of capital for tax purposes. The tax basis of shares must be reduced by the amount of any return of capital distributions, which will result in an increase in the amount of any taxable gain (or a reduction in any deductible loss) on the sale of shares.

 

Distribution Reinvestment Plan

 

We have adopted an “opt-in” distribution reinvestment plan (“DRIP”) pursuant to which shareholders may elect to have the full amount of their cash distributions reinvested in additional shares of our common stock. If shareholders wish to receive their distribution in cash, no action will be required on their part to do so. There will be no selling commissions, dealer manager fees or other sales charges to shareholders if, they elect to participate in the DRIP. We will pay the plan administrator’s fees under the plan. Shareholders distribution amount will purchase shares at 95% of the price that the shares are offered pursuant to the effective registration statement of the public offering. Shares issued pursuant to our DRIP will have the same voting rights as our shares of common stock offered pursuant to our prospectus.

 

38
 

 

Election as a RIC

 

We elected to be treated as a RIC under Subchapter M of the Code for U.S. federal income tax purposes beginning with the taxable year ended December 31, 2012. 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 from our tax earnings and profits. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. In addition, in order to obtain RIC tax treatment, we must distribute to our stockholders, for each taxable year, at least 90% of our “investment company taxable income,” which is generally our net ordinary income plus the excess, if any, of realized net short-term capital gain over realized net long-term capital loss, or the annual distribution requirement. Even if we qualify as a RIC, we generally will be subject to corporate-level U.S. federal income tax on our undistributed taxable income and could be subject to U.S. federal excise, state, local and foreign taxes.

 

Related-Party Transactions and Agreements 

 

We have entered into agreements with the Manager, whereby we pay it certain fees and reimbursements. These include payments to our Manager for reimbursement of organization and offering costs, as well as, payments for certain services that include, but are not limited to, the identification, execution, and management of our investments and also the management of our day-to-day operations provided to us by our Manager. See Note 4 to the financial statements included elsewhere in this annual report on Form 10-K for additional information regarding such contractual obligations.

 

Conflicts of interest between us and the various roles, activities and duties of the Manager and its affiliates may occur from time to time. The Manager, its officers and other affiliates may act as a manager or general partner of other private or public entities, some of whom may have the same or a similar investment objective as us. As a result, conflicts of interest between us and the other activities of the Manager and its affiliates may occur from time to time. None of the agreements or arrangements, including those relating to compensation, between us, the Manager or their affiliates, is the result of arm’s-length negotiations. As a result, there may be conflicts between us, on the one hand, and our Manager, including members of its management team, on the other, regarding the allocation of resources to the management of our day-to-day activities.

 

The compensation we pay to our Manager was not entered into on an arm’s-length basis with unaffiliated third parties. As a result, the form and amount of such compensation may be less favorable to us than they might have been had they been entered into through arm’s-length transactions with unaffiliated parties. See Note 4 to the financial statements included elsewhere in this annual report on Form 10-K for a discussion of the investment advisory agreement we have with the Manager.

 

Further, our officers are involved in other ventures, some of which may compete with us for investment opportunities, including certain affiliated funds or managed accounts, and may be incentivized to offer investment opportunities to such other ventures rather than to us which would make it more difficult to achieve our investment objectives. In addition, the officers of VII Peaks may also be involved in other ventures, some of which may compete with us for investment opportunities.

 

As a BDC, we are subject to certain regulatory restrictions in making our investments. For example, we generally are not permitted to co-invest with certain entities affiliated with our Manager in transactions originated by our Manager or its affiliates unless we obtain an exemptive order from the SEC or co-invest alongside our Manager or its affiliates in accordance with existing regulatory guidance and our allocation policy. Under existing regulatory guidance, we are permitted to, and may co-invest in syndicated deals and secondary loan market transactions where price is the only negotiated point.

 

Contractual Obligations

 

We have entered into agreements with the Manager and the Dealer Manager, whereby we pay certain fees and reimbursements to these entities. These include payments to the Dealer Manager for selling commissions and the Dealer Manager fee and payments to our Manager for reimbursement of organization and offering costs. In addition, we make payments for certain services that include, but are not limited to, the identification, execution, and management of our investments and also the management of our day-to-day operations provided to us by our Manager, pursuant to various agreements that we have entered into.

 

Off-Balance Sheet Arrangements

 

We have no 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.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are subject to financial market risks, including changes in interest rates. Any investments we make that are denominated in a foreign currency will be subject to risks associated with changes in currency exchange rates. These risks include the possibility of significant fluctuations in the foreign currency markets, the imposition or modification of foreign exchange controls and potential illiquidity in the secondary market. These risks will vary depending upon the currency or currencies involved.

 

We may hedge against interest rate and currency exchange rate fluctuations by using standard hedging instruments such as futures, options and forward contracts subject to the requirements of the 1940 Act. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in benefits of lower interest rates with respect to our portfolio of investments with fixed interest rates. During the periods covered by this report, we did not engage in interest rate hedging activities. We would not hold or issue these derivative contracts for trading or speculative purposes. We do not have any foreign operations and thus we are not exposed to foreign currency fluctuations.

 

Assuming that our current balance sheet was to remain constant and no actions were taken to alter our existing interest rate sensitivity, a 100 basis point move in prime interest rates up or down from their December 31, 2013 levels, would increase or decrease our net income by $0.2 million annually. The effect of a 100 basis point increase or decrease in prime interest rates from their December 31, 2013 levels would result in an increase or decrease in net asset value of $0.2 million or 0.92%.  

 

39
 

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Index to Financial Statements

 

    Page
   
Report of Independent Registered Public Accounting Firm F-2
Statements of Assets and Liabilities as of December 31, 2013 and 2012 F-3
Statements of Operations for the Years Ended December 31, 2013 and 2012 and for the Period from August 3, 2011 (Date of Inception) to December 31, 2011 F-4
Statements of Changes in Net Assets for the Years Ended December 31, 2013 and 2012 and for the Period from August 3, 2011 (Date of Inception) to December 31, 2011 F-5
Statements of Cash Flows for the Years Ended December 31, 2013 and 2012 and for the Period from August 3, 2011 (Date of Inception) to December 31, 2011 F-6
Schedule of Investments as of December 31, 2013 and 2012 F-7
Notes to Financial Statements F-9

  

F- 1
 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

VII Peaks Co-Optivist Income BDC II, Inc.

 

We have audited the accompanying statements of assets and liabilities of VII Peaks Co-Optivist Income BDC II, Inc. (the Fund) as of December 31, 2013 and 2012, including the schedules of investments as of December 31, 2013 and 2012, and the related statements of operations, changes in net assets and cash flows for the years ended December 31, 2013 and 2012 and for the period from August 3, 2011 (date of inception) to December 31, 2011. These financial statements are the responsibility of the Fund’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Fund is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2013, by correspondence with the custodian. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of VII Peaks Co-Optivist Income BDC II, Inc. as of December 31, 2013 and 2012, and the results of its operations, changes in its net assets and its cash flows for the years ended December 31, 2013 and 2012 and for the period from August 3, 2011 (date of inception) to December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.

 

/s/ Burr Pilger Mayer, Inc.

 

San Francisco, California

March 11, 2014

 

F- 2
 

  

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

STATEMENTS OF ASSETS AND LIABILITIES

(in thousands, except share and per share data)

 

   As of 
   December 31, 2013   December 31, 2012 
       (Restated) 
ASSETS          
           
Investments, at fair value (amortized cost of $23,769 and $5,942)  $23,154   $5,823 
Investments, money market at fair value (cost of $1,644 and $1,304)   1,644    1,304 
Total investments, at fair value  $24,798   $7,127 
Interest receivable   579    132 
Prepaid expenses   8    5 
Due from related party   1,354    555 
Receivable for common stock purchased   974    729 
Total assets  $27,713   $8,548 
           
LIABILITIES          
Payable for unsettled trades  $104   $- 
Management and incentive fees payable   8    21 
Accounts payable and accrued liabilities   129    71 
Stockholder distributions payable   99    120 
Total liabilities  $340   $212 
           
NET ASSETS          
Preferred stock, par value, $.001 per share, 50,000,000 authorized;          
none issued and outstanding   -    - 
Common stock, par value, $.001 per share, 200,000,000 authorized;          
3,151,376 and 950,733 shares issued and outstanding, respectively   3    1 
Paid-in capital in excess of par value   28,645    8,558 
Accumulated distribution in excess of net investment income   (660)   (104)
Net unrealized depreciation on investments   (615)   (119)
Total net assets   27,373    8,336 
Total liabilities and net assets  $27,713   $8,548 
           
Net asset value per share  $8.69   $8.77 

 

The accompanying notes are an integral part of these financial statements.

  

F- 3
 

  

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

 

   For the Year Ended
Ended December 31, 2013
   For the Year Ended
Ended December 31, 2012
   For the Period from
August 3, 2011 (Date of
Inception) to
December 31, 2011
 
       (Restated)   (Restated) 
Investment income:               
Interest from investments  $1,657   $146   $- 
Interest from cash and cash equivalents   1    -    - 
Total interest income   1,658    146    - 
Other income   1    -    - 
Total investment income  $1,659   $146   $- 
                
Operating expenses:               
Professional fees   444    119    - 
Directors fees   42    31    - 
Insurance   83    49    - 
Management fees   429    61    - 
General and administrative   317    118    4 
Organizational and offering expense   373    142    - 
Expenses before expense waivers and reimbursements   1,688    520    4 
Expense reimbursement   (776)   (524)   - 
Total expenses (income) net of expense waivers and reimbursements   912    (4)   4 
                
Net investment income (loss)   747    150    (4)
                
Realized and unrealized gain (loss) on investments:               
Net realized gain from investments   395    -    - 
Net unrealized depreciation on investments   (496)   (119)   - 
Net realized and unrealized loss on investments   (101)   (119)   - 
                
Net increase (decrease) in net assets resulting from operations  $646   $31   $(4)
                
Per share information - basic and diluted:               
Net investment income (loss)  $0.35   $0.61   $(44.44)
Net increase (decrease) in net assets resulting from operations  $0.30   $0.13   $(44.44)
Weighted average common shares outstanding   2,150,019    246,231    90 

 

The accompanying notes are an integral part of these financial statements.

 

F- 4
 

  

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.
 
STATEMENTS OF CHANGES IN NET ASSETS
(in thousands, except share and per share data)

 

   For the Year Ended
December 31, 2013
   For the Year Ended
December 31, 2012
   For the Period from
August 3, 2011
(Date of Inception) to
December 31, 2011
 
       (Restated)   (Restated) 
Operations:               
Net investment income (loss)  $747   $150   $(4)
Net realized gain from investments   395    -    - 
Net unrealized depreciation on investments   (496)   (119)   - 
Net increase (decrease) in net assets from operations   646    31    (4)
Stockholder distributions:               
Distributions from net investment income   (746)   (150)   - 
Distributions from net realized gain on investments   (395)   -    - 
Distributions from paid in capital   (556)   (100)   - 
Net decrease in net assets from stockholder distributions   (1,697)   (250)   - 
Capital share transactions:               
Issuance of common stock, net of issuance costs   19,407    8,358    201 
Reinvestment of stockholder distributions   681    -    - 
Net increase in net assets from capital share transactions   20,088    8,358    201 
                
Total increase in net assets   19,037    8,139    197 
Net assets at beginning of period   8,336    197    - 
Net assets at end of period  $27,373   $8,336   $197 
                
Net asset value per common share  $8.69   $8.77   $8.82 
Common shares outstanding at end of period   3,151,376    950,733    22,333 
                
Accumulated distribution in excess of net investment income  $(660)  $(104)  $(4)

 

The accompanying notes are an integral part of these financial statements.

  

F- 5
 

  

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

STATEMENTS OF CASH FLOWS
(in thousands)

 

   For the Year Ended
December 31, 2013
   For the Year Ended
December 31, 2012
   For the Period from
August 3, 2011 (Date
of Inception) to
December 31, 2011
 
       (Restated)   (Restated) 
Operating activities:               
Net increase (decrease) in net assets from operations  $646   $31   $(4)
Adjustments to reconcile net increase (decrease) in net assets from               
operations to net cash used in operating activities:               
Net accretion of discount on investments   (61)   (26)   - 
Repayments of investments   10,314    1,250    - 
Purchase of investments   (27,685)   (7,166)   - 
Repayments of investments - money market   29,777    -    - 
Purchase of investments - money market   (30,117)   (1,103)   (201)
Net realized gain from investments   (395)   -    - 
Net unrealized depreciation on investments   496    119    - 
(Increase) decrease in operating assets:               
Interest receivable   (447)   (132)   - 
Prepaid expenses   (3)   (5)   - 
Due from related party   (799)   (555)   - 
Receivable for common stock purchased   (245)   -    - 
Increase (decrease) in operating liabilities:               
Payable for unsettled trades   104    -    - 
Management and incentive fees payable   (13)   21    4 
Accounts payable and accrued liabilities   58    67    - 
Net cash used in operating activities   (18,370)   (7,499)   (201)
                
Financing activities:               
Proceeds from issuance of shares of common stock, net   19,407    7,581    201 
Stockholder distributions   (1,037)   (82)   - 
Net cash provided by financing activities   18,370    7,499    201 
                
Net increase in cash and cash equivalents   -    -    - 
Cash and cash equivalents, beginning of period   -    -    - 
Cash and cash equivalents, end of period  $-   $-   $- 
                
Supplemental non-cash information:               
DRIP distribution payable  $35   $46   $- 
Cash distribution payable  $64   $74   $- 
DRIP distribution paid  $680   $49   $- 

 

The accompanying notes are an integral part of these financial statements.

 

F- 6
 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

SCHEDULE OF INVESTMENTS

(dollars in thousands)

 

December 31, 2013

 

Portfolio Company (a)  Industry  Investment Coupon Rate,
Maturity Date
  Principal   Amortized Cost   Fair Value   % of
Net Assets
 
                       
Senior Secured First Lien Debt - 8.4% (b)                          
Endeavour International Corp.  Energy: Oil & Gas  12.00%, 3/1/2018  $525   $551   $539    2.0%
EuraMax International Inc.  Metals & Mining  9.50%, 4/1/2016   775    779    777    2.8%
GSX Worldwide, Inc.  Services: Business  9.75%, 6/15/2015   940    965    971    3.6%
Sub Total Senior Secured First Lien Debt          2,240    2,295    2,287    8.4%
                           
Senior Secured Second Lien  Debt - 19.3% (b)                          
Apria Healthcare Group, Inc.  Healthcare & Pharmaceuticals  12.38%, 11/1/2014  $571   $581   $576    2.1%
Aspect Software, Inc.  Telecommunications  10.63%, 5/15/2017   692    696    697    2.6%
Bon-ton Department Stores, Inc.  Retail  10.63%, 7/15/2017   40    41    40    0.1%
Caesar's Entertainment Corp.  Hotel, Gaming & Leisure  10.00%, 12/15/2015   505    481    432    1.6%
Cenveo Corp.  Services: Business  8.88%, 2/1/2018   585    589    585    2.1%
Endeavour International Corp.  Energy: Oil & Gas  12.00%, 6/1/2018   700    688    655    2.4%
Logan's Roadhouse, Inc.  Beverage, Food & Tobacco  10.75%, 10/15/2017   750    715    557    2.0%
Radiation Therapy Services, Inc.  Healthcare & Pharmaceuticals  8.88%, 1/15/2017   935    922    944    3.5%
Saratoga Resources, Inc.  Energy: Oil & Gas  12.50%, 7/1/2016   860    888    804    2.9%
Sub Total Senior Secured Second Lien Debt          5,638    5,601    5,290    19.3%
                           
Senior Unsecured Debt - 30.6% (b)                          
Alion Science and Technology Corp.  Aerospace and Defense  12.00%, 11/1/2014  $1,030   $1,038   $1,051    3.9%
Avaya, Inc.  Telecommunications  9.75%, 11/1/2015   650    633    645    2.4%
Avaya, Inc.  Telecommunications  10.13%, 11/1/2015   460    442    457    1.7%
Caesar's Entertainment Corp.  Hotel, Gaming & Leisure  10.75%, 2/1/2016   445    416    358    1.3%
Cenveo Corp.  Services: Business  11.50%, 5/15/2017   510    492    502    1.8%
Ceridian Corporation  Services: Business  11.25%, 11/15/15   390    402    393    1.4%
Ceridian Corporation  Services: Business  12.25%, 11/15/15   560    576    564    2.1%
Colt Defense LLC  Aerospace and Defense  8.75%, 11/15/2017   853    718    737    2.7%
DynCorp International Inc.  Aerospace and Defense  10.38%, 7/1/2017   810    850    828    3.0%
Education Management LLC (d)  Services: Consumer  15.00%, 6/1/2014   270    232    293    1.1%
Harland Clarke Corp.  Banking, Finance, Insurance & Real Estate  9.50%, 5/15/5015   691    692    694    2.5%
Hutchinson Technology, Inc.  High Tech Industries  8.50%, 1/15/2026   443    406    388    1.4%
NII Cap Corp  Telecommunications  10.00%, 8/15/2016   925    907    490    1.8%
QuickSilver Resources, Inc.  Energy: Oil & Gas  7.13%, 4/1/2016   620    594    606    2.2%
Suntech Power Holdings Company, Ltd.  Environmental Industries  3.00%, 2/28/2014   100    98    8    0.0%
Travelport LLC  Services: Consumer  13.88%, 3/1/2016   340    308    361    1.3%
Sub Total Senior Unsecured Debt          9,097    8,804    8,375    30.6%
                           
Senior Subordinated Debt - 26.3% (b)                          
Accelent, Inc.  Healthcare & Pharmaceuticals  10.00%, 11/1/2017  $775   $732   $800    2.9%
Affinion Group, Inc.  Media: Advertising, Printing & Publishing  13.50%, 8/15/2018   816    689    812    2.9%
American Media, Inc.  Media: Advertising, Printing & Publishing  11.50%, 12/15/2017   670    704    729    2.7%
Claires Stores, Inc  Retail  10.50%, 6/1/2017   215    220    220    0.8%
DJO Finance, LLC.  Healthcare & Pharmaceuticals  9.75%, 10/15/2017   825    864    840    3.1%
First Data Corp.  Banking, Finance, Insurance & Real Estate  11.25%, 3/31/2016   374    375    375    1.4%
Radio One, Inc.  Media: Broadcasting & Subscription  12.50%, 5/24/16   875    889    875    3.2%
Ryerson Inc./Joseph T Ryerson & Son, Inc.  Metals & Mining  9.00%, 10/15/2017   420    438    445    1.6%
Serena Software, Inc.  High Tech Industries  10.38%, 3/15/2016   770    786    770    2.8%
Toys R Us Inc.  Retail  10.38%, 8/15/2017   825    790    707    2.6%
Travelport LLC  Services: Consumer  11.88%, 9/1/2016   620    582    629    2.3%
Sub Total Senior Subordinated Debt          7,185    7,069    7,202    26.3%
                           
Investments - Money Market - 6.0%                          
Investments - Money Market        $1,644    1,644    1,644    6.0%
Sub Total Investments - Money Market              1,644    1,644    6.0%
                           
TOTAL INVESTMENTS - 90.6% (b)             $25,413   $24,798    90.6%

  

(a)  All of our investments are issued by eligible U.S. portfolio companies, as defined in the Investment Company Act of 1940, except for Caesar's Entertainment Corp., Education Management LLC, NII Capital Corp., QuickSilver Resources, Inc., and Suntech Power Holdings Company, Ltd.
(b)  Percentages are based on net assets of $27,373 as of December 31, 2013.
(c)  Non-U.S. company. The principal place of business for Suntech Power Holdings Company, Ltd. Is China.
(d) The issuer has the option of paying interest in additional notes, in which event the interest rate is 15%.

 

The accompanying notes are an integral part of these financial statements. 

 

F- 7
 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

SCHEDULE OF INVESTMENTS

(dollars in thousands)

December 31, 2012

(Restated)

 

Portfolio Company (a)  Industry  Investment Coupon
Rate, Maturity
Date
  Principal   Amortized
Cost
   Fair Value   % of
Net Assets
 
                       
Senior Secured First Lien Debt - 10.0% (b)                          
Apria Healthcare Group, Inc.  Healthcare & Pharmaceuticals  11.25%, 11/01/2014  $150   $155   $155    2.0%
GXS Worldwide, Inc.  Services: Business  9.75%, 6/15/2015   350    364    365    4.4%
Rotech Healthcare, Inc.  Healthcare & Pharmaceuticals  10.75%, 10/15/2015   300    300    299    3.6%
Sub Total Senior Secured First Lien Debt         800    819    819    10.0%
                           
Senior Secured Second Lien Debt - 10.3% (b)                          
Apria Healthcare Group, Inc.  Healthcare & Pharmaceuticals  12.38%, 11/1/2014  $150   $149   $149    1.8%
Aspect Software, Inc.  Telecommunications  10.63%, 5/15/2017   400    409    362    4.3%
Logan's Roadhouse, Inc.  Beverage, Food & Tobacco  10.75%, 10/15/2017   375    353    348    4.2%
Sub Total Senior Secured Second Lien Debt         925    911    859    10.3%
                           
Senior Unsecured Debt - 37.3% (b)                          
Alliance HealthCare Services, Inc.  Healthcare & Pharmaceuticals  8.00%, 12/1/2016  $250   $217   $227    2.7%
Alliance One International, Inc.  Beverage, Food & Tobacco  10.00%, 7/15/2016   400    418    421    5.1%
Avaya, Inc.  Telecommunications  9.75%, 11/01/2015   225    198    200    2.4%
Avaya, Inc.  Telecommunications  10.13%, 11/01/2015   225    198    201    2.4%
Bon-ton Department Stores, Inc.  Retail  10.25%, 3/15/2014   350    351    347    4.2%
Claire's Stores, Inc.  Retail  9.63%, 6/01/2015   235    219    217    2.6%
Education Management LLC  Services: Consumer  8.75%, 6/1/2014   400    343    321    3.9%
First Data Corp.  Banking, Finance, Insurance & Real Estate  10.55%, 9/24/2015   175    181    179    2.1%
First Data Corp.  Banking, Finance, Insurance & Real Estate  9.88%, 9/24/2015   175    180    179    2.1%
Seitel, Inc.  High Tech Industries  9.75%, 2/15/2014   350    355    351    4.2%
Suntech Power Holdings Company, Ltd. (c)  Environmental Industries  3.00%, 3/15/2013   100    91    46    0.5%
Travelport LLC  Services: Consumer  9.88%, 9/01/2014   250    216    220    2.6%
YCC Holdings LLC (d)  Consumer goods: Non-durable  10.25%, 2/15/2016   200    207    206    2.5%
Sub Total Senior Unsecured Debt         3,335    3,174    3,115    37.3%
                           
Senior Subordinated Debt -12.3% (b)                          
Sealy Mattress Co.  Consumer goods: Durable  8.25%, 6/15/2014  $400   $404   $401    4.8%
Serena Software, Inc.  High Tech Industries  10.38%, 3/15/2016   410    424    420    5.0%
The Yankee Candle Company, Inc.  Consumer goods: Non-durable  9.75%, 2/15/2017   200    210    209    2.5%
Sub Total Senior Subordinated Debt         1,010    1,038    1,030    12.3%
                           
Investments - Money Market -15.6%                          
Investments - Money Market        $1,304    1,304    1,304    15.6%
Sub Total Investments - Money Market         1,304    1,304    1,304    15.6%
                           
TOTAL INVESTMENTS - 85.5% (b)             $7,246   $7,127    85.5%

 

(a) All of our investments are issued by eligible U.S. portfolio companies, as defined in the Investment Company Act of 1940, except for Alliance One International, Inc., Education Management LLC and Suntech Power Holdings Company, Ltd.

(b) Percentages are based on net assets of $8,336 as of December 31, 2012.

(c) Non-U.S. company. The principal place of business for Suntech Power Holdings Company, LTD is China.

(d) The issuer has the option of paying interest in additional notes, in which event the interest rate is 11%

 

The accompanying notes are an integral part of these financial statements.

 

F- 8
 

 

  VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

NOTES TO FINANCIAL STATEMENTS

December 31, 2013

 

Note 1.  Nature of Operations

 

VII Peaks Co-Optivist Income BDC II, Inc. (the “Fund”), a Maryland corporation formed on August 3, 2011, is an externally managed, non-diversified closed-end management investment company that has elected to be treated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). The Fund has elected to be treated for federal income tax purposes as a regulated investment company (“RIC”) under subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). The Fund intends to invest in discounted corporate debt and equity-linked debt securities of public and private companies whose securities trade on the secondary loan market for institutional investors.

 

On August 9, 2011, the Fund filed a registration statement on Form N-2 to sell up to 75,000,000 shares of common stock at an initial public offering price of $10.00 per share. The registration statement was declared effective by the Securities Exchange Commission (the “SEC”) on March 1, 2012. The Fund was to commence operations when it raised gross offering proceeds of over $1.0 million, all of which was from persons who were not affiliated with the Fund or VII Peaks-KBR BDC Advisor II, LLC by one year from the date the registration statement was declared effective by the SEC. Prior to the successful satisfaction of that condition, all subscription payments were placed in an account held by the escrow agent, UMB Bank, N.A., in trust for the benefit of the Fund’s subscribers, pending release to the Fund. The Fund achieved the minimum offering requirement on July 10, 2012 and commenced operations on such date. As of December 31, 2013, the Fund issued 3.2 million shares of common stock for gross proceeds of $31.6 million, including $0.7 million of distribution reinvestment plan (“DRIP”).

  

As of August 20, 2013, the independent Board Members of the Fund by unanimous vote agreed to terminate the investment advisory agreement between the Fund and VII Peaks-KBR BDC Advisor II, LLC (the “Prior Manager”) and enter into an investment advisory agreement with VII Peaks Capital, LLC (the “Manager” or “VII Peaks”) that provides for the same compensation as set forth in the Fund’s agreement with its prior investment advisor, VII Peaks-KBR BDC Advisor II, LLC.

 

Note 2.  Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying financial statements of the Fund have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP") and pursuant to the requirements for reporting on Form 10-K.

 

During the second quarter of fiscal 2013, the Fund restated its financial statements for organization and offering expenses in order to comply with the terms of the investment advisory agreement between the Fund and the Manager. Previously, the Fund expensed all organization costs as they were incurred by the Manager. Previously, the Fund capitalized all offering expenses incurred prior to the date of commencement of operations as deferred offering costs and amortized that amount over 12 months from the date of commencement of operations, and expensed all offering costs incurred by the Manager after the commencement of operations as they were incurred by the Manager. However, because the Fund is only obligated to reimburse the Manager to the extent of 1.5% of gross offering proceeds, the Fund restated its financial statements to reflect the expense and obligation to the Manager only as they are payable to the Manager at 1.5% of offering proceeds.

 

Use of Estimates in the Preparation of Financial Statements

 

The preparation of the accompanying financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and income, gains (losses) and expenses during the period reported. Actual results could differ materially from those estimates.

 

Investments – Money Market

 

The Fund has classified its money market investments as investments carried at fair value.

 

Organizational and Offering Costs

 

The Fund is a closed-end fund with a continuous offering period. Under the investment advisory agreement between the Fund and the Manager, our Manager fronts the cost of the organizational and offering expenses which are reimbursable by the Fund with up to a 1.5% of the gross offering proceeds. The Fund expenses organizational and offering costs as they become payable under the investment advisory agreement.

 

U.S. Federal Income Taxes

 

The Fund has elected to be treated for federal income tax purposes as a RIC under subchapter M of the Code and to operate in a manner so as to qualify for the tax treatment applicable to RICs. In order to qualify as a RIC, among other things, the Fund is required to annually distribute to its stockholders at least 90% of investment company taxable income, as defined by the Code. So long as the Fund maintains its status as a RIC, it generally will not pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that it distributes at least annually to its stockholders as distributions. Rather, any tax liability related to income earned by the Fund represents obligations of the Fund’s investors and will not be reflected in the financial statements of the Fund. The Fund will also be subject to nondeductible federal excise taxes if it does not distribute at least 98% of net ordinary income, 98.2% of capital gain net income, if any, and any recognized and undistributed income from prior years for which it paid no federal income taxes.

 

F- 9
 

 

The Fund has evaluated the implications of ASC Topic 740, for all open tax years and in all major tax jurisdictions, and determined that there is no material impact on the financial statements. The Fund continues to remain subject to examination by U.S. federal and state authorities for the years 2010 through 2013.

 

New Accounting Pronouncements

 

 In June 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-08, Financial Services – Investment Companies (Accounting Standards Codification (“ASC”) Topic 946), which affects the scope, measurement and disclosure requirements for investment companies under GAAP.  The amendments (i) change the approach to the investment company assessment in ASC Topic 946, clarify the characteristics of an investment company, and provide comprehensive guidance for assessing whether an entity is an investment company; (ii) require an investment company to measure non-controlling ownership interests in other investment companies at fair value rather than the equity method of accounting; and (iii) require the following additional disclosures (a) the fact that the entity is an investment company and is applying the guidance in ASC Topic 946, (b) information about changes, if any, in an entity’s status as an investment company, and (c) information about financial support provided or contractually required to be provided by an investment company to any of its investees.  This guidance is effective for interim an annual reporting periods beginning on or after December 15, 2013. The Fund is currently assessing the impacts ASU 2013-08 will have on its financial statements.

 

In January 2013, the FASB issued ASU No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, which clarifies which instruments and transactions are subject to the offsetting disclosure requirements originally established by ASU 2011-11. The new ASU addresses preparer concerns that the scope of the disclosure requirements under ASU 2011-11 was overly broad and imposed unintended costs that were not commensurate with estimated benefits to financial statement users. In choosing to narrow the scope of the offsetting disclosures, the Board determined that it could make them more operable and cost effective for preparers while still giving financial statement users sufficient information to analyze the most significant presentation differences between financial statements prepared in accordance with GAAP and those prepared under International Financial Reporting Standards (“IFRS”). Like ASU 2011-11, the amendments in this update will be effective for fiscal periods beginning on, or after January 1, 2013. The adoption of ASU 2013-01 did not have a material impact on our financial position or results of operations.

 

In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities, which requires entities to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The guidance is effective for fiscal years and interim periods beginning on or after January 1, 2013 with retrospective application for all comparative periods presented. The adoption of this guidance, which is related to disclosure only, did not have a material impact on the Fund’s financial position, results of operations or cash flows.

 

Revenue Recognition

 

We record interest income on an accrual basis to the extent that we expect to collect such amounts. For loans and debt securities with contractual payment-in-kind (“PIK”) interest, which represents contractual interest accrued and added to the principal balance, we generally will not accrue PIK interest for accounting purposes if the portfolio company valuation indicates that such PIK interest is not collectible. We do not accrue as a receivable interest on loans and debt securities for accounting purposes if we have reason to doubt our ability to collect such interest. Original issue discounts, market discounts or premiums are accreted or amortized using the effective interest method as interest income. We record prepayment premiums on loans and debt securities as interest income. Dividend income, if any, is recognized on an accrual basis to the extent that we expect to collect such amount.

 

Expense Reimbursement Agreement

 

On November 9, 2012, the Fund entered into an expense reimbursement agreement with the Prior Manager, under which the Prior Manager agreed to reimburse the Fund for all operating expenses recognized on the quarterly financial statements of the Fund for 2012, retroactive to the date of formation of the Fund on August 3, 2011. In 2013, the expense reimbursement agreement was modified to exclude management fees and incentive fees payable to the Manager effective as of January 1, 2013. The Fund recognizes a receivable on its books for the amount due from the Prior Manager under the expense reimbursement agreement, and the Prior Manager recognizes a liability on its books in the same amount. The expense reimbursement agreement allows the Prior Manager and the Fund to offset the receivable in favor of the Fund created under the expense reimbursement agreement against the contingent payable owed by the Fund to the Prior Manager under the investment advisory agreement, resulting in a net receivable or payable position. As of December 31, 2013, the Prior Manager was indebted to the Fund for $1.4 million of expense reimbursements under the expense reimbursement agreement.

 

Effective August 20, 2013, the Manager has terminated the expense reimbursement agreement.

 

Note 3. Valuation of Portfolio Investments

 

The Fund determines the net asset value of its investment portfolio each quarter. Securities that are publicly-traded are valued at the reported closing price on the valuation date. Securities that are not publicly-traded are valued at fair value as determined in good faith by the board of directors. In connection with that determination, the Manager will prepare portfolio company valuations using relevant inputs, including, but not limited to, indicative dealer quotes, values of like securities, the most recent portfolio company financial statements and forecasts, and valuations prepared by third-party valuation services.

 

F- 10
 

 

With respect to investments for which market quotations are not readily available, the Fund will undertake a multi-step valuation process each quarter, as described below:

 

  the quarterly valuation process begins with each portfolio company or investment being initially valued by members of the investment committee, with such valuation taking into account information received from an independent valuation firm, if applicable;

 

  preliminary valuation conclusions are then documented and discussed with the members of the board of directors; and

 

  the board of directors discusses valuations and determines the fair value of each investment in the portfolio in good faith based on various statistical and other factors, including the input and recommendation of members of the investment committee and any third-party valuation firm, if applicable.

 

Investments are valued utilizing a market approach, an income approach, or both approaches, as appropriate. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present value amount (discounted) calculated based on an appropriate discount rate. The measurement is based on the net present value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that we may take into account in fair value pricing our investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral, the portfolio company’s ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, mergers and acquisition comparables, the principal market and enterprise values, among other factors.

 

The Fund has adopted FASB ASC Topic 820, Fair Value Measurements and Disclosures (formerly Statement of Financial Accounting Standards No. 157, Fair Value Measurements ), which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements.

 

ASC Topic 820 clarifies that the exchange price is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of market participants. ASC Topic 820 provides a consistent definition of fair value which focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. In addition, ASC Topic 820 provides a framework for measuring fair value and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels of valuation hierarchy established by ASC Topic 820 are defined as follows:

 

Level 1:  Quoted prices in active markets for identical assets or liabilities, accessible by the Fund at the measurement date.

 

Level 2:  Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or other observable inputs other than quoted prices.

 

Level 3:  Unobservable inputs for the asset or liability.

 

In all cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level of input that is significant to the fair value measurement.

 

The following table presents fair value measurements of investments, by major class, as of December 31, 2013 according to the fair value hierarchy (dollars in thousands):

  

   Level 1   Level 2   Total 
Investments – Money Market  $1,644   $   $1,644 
Senior Secured First Lien Debt       2,287    2,287 
Senior Secured Second Lien Debt       5,290    5,290 
Senior Unsecured Debt       8,375    8,375 
Senior Subordinated Debt       7,202    7,202 
Total  $1,644   $23,154   $24,798 

 

F- 11
 

 

The following table presents fair value measurements of investments, by major class, as of December 31, 2012 according to the fair value hierarchy (dollars in thousands):

  

   Level 1   Level 2   Total 
Investments – Money Market  $1,304   $   $1,304 
Senior Secured First Lien Debt       819    819 
Senior Secured Second Lien Debt       859    859 
Senior Unsecured Debt       3,115    3,115 
Senior Subordinated Debt       1,030    1,030 
Total  $1,304   $5,823   $7,127 

 

No transfers between levels have occurred during the periods presented.

 

The composition of the Fund’s investments as of December 31, 2013, at amortized cost and fair value were as follows (dollars in thousands):

 

   Investments at
Amortized Cost
   Investments at Fair
Value
   Fair Value Percentage
of Total Portfolio
 
Investments – Money Market  $1,644   $1,644    6.6%
Senior Secured First Lien Debt   2,295    2,287    9.2 
Senior Secured Second Lien Debt   5,601    5,290    21.3 
Senior Unsecured Debt   8,804    8,375    33.8 
Senior Subordinated Debt   7,069    7,202    29.1 
Total  $25,413   $24,798    100.0%

  

The composition of the Fund’s investments as of December 31, 2012, at amortized cost and fair value were as follows (dollars in thousands):

 

   Investments at
Amortized Cost
   Investments at Fair
Value
   Fair Value Percentage
of Total Portfolio
 
Investments – Money Market  $1,304   $1,304    18.3%
Senior Secured First Lien Debt   819    819    11.5 
Senior Secured Second Lien Debt   911    859    12.1 
Senior Unsecured Debt   3,174    3,115    43.7 
Senior Subordinated Debt   1,038    1,030    14.4 
Total  $7,246   $7,127    100.0%

 

Note 4.  Related Party Transactions

 

As of August 20, 2013, the Fund is managed by the Manager. Prior to August 20, 2013 the Fund was managed by VII Peaks-KBR BDC Advisor II, LLC (the “Prior Manager”), which was wholly-owned by VII Peaks-KBR, LLC which was a joint venture between the Manager and KBR Capital Advisors, LLC (“KBR”).

 

Investment Advisory Agreement

 

The Fund has entered into an investment advisory agreement with the Manager to manage the Fund’s investment activities dated August 20, 2013. Prior to August 20, 2013, the Fund’s investment activities were managed by the Prior Manager pursuant to an investment advisory agreement that had substantially the same terms as the Funds’s present agreement with the Manager. Pursuant to the investment advisory agreement, the Manager implements the Fund’s business strategy on a day-to-day basis and performs certain services for us, subject to oversight by our board of directors. The Manager is responsible for, among other duties, determining investment criteria, sourcing, analyzing and executing investment transactions, asset sales, financings and performing asset management duties. Under the investment advisory agreement, the Manager is entitled to a base management and incentive fee as outlined in the investment advisory agreement with the Fund. The base management fee is 2% of net assets below $100 million; 1.75% of net assets between $100 million and $250 million; and 1.5% of net assets over $250 million. For the years ended December 31, 2013 and 2012, the Fund incurred $0.4 million and $0.06 million of base management fees, respectively.

 

The incentive fee has two parts. The first part, the subordinated incentive fee on income, is calculated and payable quarterly in arrears based upon the Fund’s “pre-incentive fee net investment income” for the immediately preceding quarter. The subordinated incentive fee on income is 20% of pre-incentive net investment income subject to a quarterly return to investors, expressed as a rate of return on adjusted capital at the beginning of the most recently completed calendar quarter, of 2.0% (8.0% annualized). The second part of the incentive fee, the incentive fee on capital gains, is an incentive fee on capital gains earned on liquidated investments from the portfolio and is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment advisory agreement). This fee equals 20% of the Fund’s incentive fee capital gains, which will equal the Fund’s realized capital gains on a cumulative basis from inception, calculated as of 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 gains incentive fees. For the years ended December 31, 2013 and 2012, the Fund did not incur any incentive fees related to net investment income or capital gains.

 

F- 12
 

 

Under GAAP, the Fund calculates capital gains incentive fees as if the Fund had realized all assets at their fair values and liabilities at their settlement amounts as of the reporting date. GAAP requires that the capital gains incentive fee accrual assume the cumulative aggregate unrealized capital appreciation is realized, even though such unrealized capital appreciation is not payable under the investment advisory agreement. Accordingly, the Fund accrues a provisional capital gains incentive fee taking into account any unrealized gains or losses. There can be no assurance that such unrealized capital appreciation will be realized in the future and that the provisional capital gains incentive fee will become payable.

 

Under the investment advisory agreement, the Manager bears all offering and organizational expenses. Pursuant to the terms of the investment advisory agreement, the Fund has agreed to reimburse the Manager for any such organizational and offering expenses incurred by the Manager not to exceed 1.5% of the gross subscriptions raised by the Fund over the course of the offering period, which is currently scheduled to terminate two years from the initial offering date, unless extended. From each sale of common stock, the Fund pays the Manager the lesser of 1.5% of the gross offering proceeds or the amount of unreimbursed offering and organizational expenses incurred by the Manager.

 

During the years ended December 31, 2013 and 2012 and for the period from August 3, 2011 (inception) through December 31, 2011, the Prior Manager incurred organizational and offering costs of $0.4 million, $1.0 million, and $0.4 million, respectively. Of the total $1.8 million organizational and offering costs incurred from inception through December 31, 2013, $0.3 million was reimbursed to the Prior Manager during the year ended December 31, 2013, and an aggregate of $0.5 million had been reimbursed since the Fund commenced operations on July 10, 2012. 

 

VII Peaks agreed to assume and pay the Fund all amounts due the Fund from the Prior Manager as reflected in the Fund’s books and records as of August 20, 2013, including any amounts due under the Expense Reimbursement Agreement between the Fund and the Prior Manager. The Fund agreed to pay VII Peaks any reimbursable organization and offering expenses incurred by Prior Manager which the Fund would otherwise be obligated to reimburse Prior Manager from future sales of the Company’s securities, beginning with any sales of securities occurring after August 20, 2013.

 

The Fund expects that the Manager will continue to incur organizational and offering costs as the Fund’s offering continues, and such additional organizational and offering costs will increase the amount to which the Manager will be entitled to reimbursement from gross offering proceeds. The unreimbursed amount will be eligible for reimbursement to the extent the Fund receives subscriptions until March 1, 2014. Organizational and offering expenses paid for by the Manager and reimbursed by the Fund are expensed on the Fund’s statement of operations as they are payable to the Manager.

 

From time to time, the Fund has paid directly certain expenses that were classified as organization or offering expenses that should have been borne by the Prior Manager and for which the Prior Manager is obligated to reimburse the Fund. As of December 31, 2013 and December 31, 2012, the unreimbursed amount of organization and offering expenses was $0.1 million and $0.1 million, respectively, which amount is included in “Due from related party” on the Fund’s balance sheet as of that date.

 

Expense Reimbursement Agreement

 

On November 9, 2012, the Fund entered into an expense reimbursement agreement with the Prior Manager, under which the Prior Manager agreed to reimburse the Fund for all operating expenses, excluding management fees recognized on the quarterly financial statements of the Fund for 2012, retroactive to the date of formation of the Fund on August 3, 2011. In 2013, the expense reimbursement agreement was modified to exclude management fees and incentive fees payable to the Manager effective as of January 1, 2013. The Fund recognizes a receivable on its books for the amount due from the Prior Manager under the expense reimbursement agreement, and the Prior Manager recognizes a liability on its books in the same amount. The expense reimbursement agreement allows the Prior Manager and the Fund to offset the receivable in favor of the Fund created under the expense reimbursement agreement against the contingent payable owed by the Fund to the Prior Manager under the investment advisory agreement, resulting in a net receivable or payable position. The Fund terminated the expense reimbursement agreement with the Prior Manager when it terminated the investment advisory agreement with the Prior Manager on August 20, 2013. While the Fund entered into a new investment advisory agreement with the Manager on August 20, 2013, it did not enter into a new expense reimbursement agreement with the Manager. However, the investment advisory agreement with the Manager includes the Manager’s undertaking the assume and pay all amounts due by the Prior Manager under the expense reimbursement agreement, and also that the Fund is obligated to pay the Manager all organization and offering costs previously borne by the Prior Manager (but only to the extent such costs are reimbursable from gross offering proceeds).

  

Administration Agreement

 

 The Fund has also entered into an administration agreement with the Manager under which the Manager provides the Fund with office facilities, equipment and clerical, bookkeeping and record keeping services at such facilities and provides or oversees the performance of, the Fund’s required administrative services, which include, among other things, being responsible for the financial records which the Fund is required to maintain and preparing reports to its stockholders. Under the administration agreement, we are obligated to reimburse our Manager for our allocable portion of overhead cost incurred by the Manager. During the years ended December 31, 2013 and 2012, the Fund reimbursed the Manager for $0.1 million and $0.02 million in administration expenses under the administration agreement, respectively. 

 

F- 13
 

  

Note 5.  Common Stock

 

The Manager purchased 111 and 22,222 shares of common stock on August 31, 2011 and December 31, 2011, respectively. These shares were purchased at a price of $9.00 per share, which represents the initial public offering (“IPO”) price of $10.00 per share, net of selling commissions and dealer manager fees.

 

On July 10, 2012, the Fund had raised sufficient proceeds to break escrow on its IPO and through December 31, 2013, the Fund has sold 3.2 million shares of common stock for gross proceeds of $31.6 million including the purchases made by the Manager.

 

During the year ended December 31, 2013, the Fund sold 2,200,643 shares of common stock in its offering for net proceeds of $20.1 million, including shares issued under the distribution reinvestment plan (“DRIP”).

 

Note 6.  Earnings Per Share

 

In accordance with the provisions of FASB ASC 260, “Earnings per Share” (“ASC 260”), basic earnings per share is computed by dividing earnings available to common shareholders 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 on a diluted basis.

 

The following information sets forth the computation of the weighted average basic and diluted net increase (decrease) in net assets per share from operations for the years ended December 31, 2013 and December 31, 2012 and for the period from August 3, 2011 (date of inception) to December 31, 2011 (dollars in thousands except share and per share amounts):

 

   For the Year
Ended
December 31
   For the Year
Ended
December 31
   For the Period
from August
3, 2011 (Date
of Inception)
to December
31
 
   2013   2012   2011 
       (Restated)   (Restated) 
Basic and diluted               
Net increase (decrease) in net assets resulting from operations  $646   $31   $(4)
Weighted average common shares outstanding   2,150,019    246,231    90 
Net increase (decrease) in net assets resulting from operations per share  $0.30   $0.13   $(44.44)

 

  The Fund had no potentially dilutive securities as of December 31, 2013 or December 31, 2012, resulting in the same number of shares for basic and diluted.

 

Note 7.  Distributions

 

The Fund has declared distributions to stockholders with record and payment dates on a semi-monthly basis since it commenced operations. From time to time, the Fund may also pay interim distributions at the discretion of its board of directors. The Fund may fund its distributions to stockholders from any sources of funds available to it, including offering proceeds, borrowings, net investment income from operations, capital gains proceeds from the sale of assets and non-capital gains proceeds from the sale of assets. The Fund’s distributions may exceed its earnings, especially during the period before the Fund has substantially invested the proceeds from its IPO. As a result, a portion of the distributions may represent a return of capital for tax purposes. As of December 31, 2013, the Fund has accrued $0.1 million in stockholder distributions that were unpaid. All amounts declared in December 2013 and paid in January 2014 have been accrued in the December 31, 2013 financial statements.

 

The following table reflects the distributions per share paid or payable in cash or with the distribution reinvestment plan (“DRIP”) on the Fund’s common stock to date (dollars in thousands except per share amounts):

 

SOURCE OF DISTRIBUTION 
  
Date Declared   Payment Dates  Net Investment Income   Realized Gain from Investments   Return of Capital   Total   Per Share   Paid in Cash   DRIP   TOTAL 
2012                                    
 July 31, 2012   August 17, 2012  $4   $-   $-   $4   $0.03   $3   $1   $4 
 July 31, 2012   August 31, 2012   4    -    -    4    0.03    3    1    4 
 August 29, 2012   September 14, 2012   9    -    -    9    0.03    6    3    9 
 August 29, 2012   September 28, 2012   9    -    -    9    0.03    6    3    9 
 September 26, 2012   October 15, 2012   6    -    6    12    0.03    8    4    12 
 September 26, 2012   October 31, 2012   -    -    12    12    0.03    8    4    12 
 October 29, 2012   November 16, 2012   17    -    -    17    0.03    11    6    17 
 October 29, 2012   November 30, 2012   17    -    -    17    0.03    11    6    17 
 November 29, 2012   December 17, 2012   22    -    -    22    0.03    12    10    22 
 November 29, 2012   December 31, 2012   23    -    -    23    0.03    14    11    25 
 December 27, 2012   January 17, 2013 (1)   35    -    57    92    0.11                
 December 27, 2012   January 31, 2013   4    -    25    29    0.03                
        $150   $-   $100   $250        $82   $49   $131